UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

Commission file number 000-32369

(Exact name of registrant as specified in its charter)

(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.

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

     As of May 15, 2005 there were 29,395,992 shares of the registrant’s common stock, par value $.01 per share, outstanding.

AFC ENTERPRISES, INC.
INDEX

2

Part 1. Financial Information

Item 1. Financial Statements

AFC Enterprises, Inc.

See accompanying notes to condensed consolidated financial statements.

3

AFC Enterprises, Inc.

See accompanying notes to condensed consolidated financial statements.

4

AFC Enterprises, Inc.

See accompanying notes to condensed consolidated financial statements.

5

AFC Enterprises, Inc.

1. Description of Business

     Continuing Operations. AFC Enterprises, Inc. (“AFC” or “the Company”) develops, operates and franchises quick-service restaurants under the trade name Popeyes® Chicken & Biscuits (“Popeyes”). These operations constitute the Company’s chicken business segment, its sole business segment within continuing operations.

     Discontinued Operations. On December 28, 2004, the Company sold its Church’s Chicken™ (“Church’s”) division to an affiliate of Crescent Capital Investments, Inc. On November 4, 2004, the Company sold its Cinnabon® (“Cinnabon”) subsidiary to Focus Brands Inc. On July 14, 2003, the Company sold its Seattle Coffee subsidiary to Starbucks Corporation. See Note 12 for information concerning these divestitures and their associated operations.

     In the accompanying financial statements, financial results relating to these divestitures are presented as discontinued operations. Previously reported amounts have been restated to present the divested operations in a manner consistent with the 2005 presentation. Unless otherwise noted, discussions and amounts throughout these notes relate to AFC’s continuing operations.

2. Summary of Significant Accounting Policies

     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 (the “SEC”) for interim financial information. Accordingly, certain information required by generally accepted accounting principles in the United States for complete financial statements is not included. The consolidated balance sheet data as of December 26, 2004 that is presented herein was derived from the Company’s audited consolidated financial statements for the fiscal year then ended. The condensed consolidated financial statements have not been audited by the Company’s independent registered 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.

     Principles of Consolidation. The condensed consolidated financial statements include the accounts of AFC Enterprises, Inc. and certain variable interest entities that the Company is required to consolidate pursuant to Financial Accounting Standards Board Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51, as revised in December 2003 (“FIN 46R”). All significant intercompany balances and transactions are eliminated in consolidation.

     FIN 46R addresses the consolidation of those entities in which (i) the equity investment at risk does not provide its holders with the characteristics of a controlling financial interest or (ii) the equity investment 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 their primary beneficiary.

     As of December 29, 2003, the Company adopted FIN 46R and, at that time, began consolidating three of its franchisees. In each of these relationships, the Company determined that the franchisee was a VIE for which the Company was the primary beneficiary.

     Upon adoption of FIN 46R, the Company did not have a common equity interest in any of these three franchisees. When it consolidates these franchisees, the Company allocates their earnings and losses to their common equity holders as a component of minority interest. However, the Company does not allocate any losses to the common equity holders if doing such would reduce their common equity interests below zero.

6

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

     During the third quarter of 2004, one of the VIEs engaged in a series of transactions that substantially modified its equity interests and the Company’s relationship to the VIE. As a result, AFC’s management concluded that the Company was no longer the primary beneficiary for the enterprise and the Company stopped consolidating the enterprise’s balance sheet as well as its operations.

     During the first quarter of 2005, a second VIE relationship was substantially modified coincident with the sale of Church’s. As a result, AFC’s management concluded that the Company was no longer the primary beneficiary for the enterprise and the Company stopped consolidating the enterprise’s balance sheet as well as its operations. The VIE is a Church’s franchisee and its 2004 operations are a component of the Company’s discontinued operations.

     For the sixteen week periods ended April 17, 2005 and April 18, 2004, amounts included in sales by company-operated restaurants associated with VIE operations were $0.8 million and $4.8 million, respectively. For the sixteen week periods ended April 17, 2005 and April 18, 2004, royalties and rents of less than $0.1 million and $0.3 million, respectively, were eliminated in consolidation. During the first quarter of 2004, in conjunction with its adoption of FIN 46R, the Company recorded a cumulative effect adjustment that decreased net income in 2004 by $0.5 million, or $0.02 per diluted share (of which $0.2 million or $0.01 per dilutive share, related to continuing operations).

     Property and equipment, with a net book value of $0.9 million and $1.0 million at April 17, 2005 and December 26, 2004, respectively, relating to the third VIE, is included in the condensed consolidated balance sheets. This property and equipment is pledged as collateral under obligations of the franchisee.

     The Company has other VIE relationships for which it is not the primary beneficiary. These relationships arose in connection with certain loan guarantees that are described in Note 13 to the Company’s consolidated financial statements for the fiscal year ended December 26, 2004, which are contained in the Company’s 2004 Annual Report on Form 10-K/A.

     Significant Accounting Policies. The Company’s significant accounting policies are presented in Note 2 to the Company’s consolidated financial statements for the fiscal year ended December 26, 2004, which are contained in the Company’s 2004 Annual Report on Form 10-K/A.

     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 2005 and 2004 fiscal years both contain 52 weeks.

     Recent Accounting Pronouncements That The Company Has Not Yet Adopted. In December 2004, the FASB issued SFAS No. 123 (Revised 2004), “Share-Based Payment” (“SFAS 123R”) a revision of FASB No. 123, “Accounting for Stock-Based Compensation.” SFAS 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. It requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award. The statement provides alternative means of adoption. SFAS 123R was to be effective as of the beginning of the first interim or annual reporting period that begins after June 15, 2005 (the Company’s third quarter of fiscal 2005). In April 2005, the SEC announced that companies may implement Statement 123R at the start of their first fiscal year beginning after June 15, 2005 (for the Company, this would be fiscal 2006, which begins on December 26, 2005). The Company has not completed its assessment of SFAS 123R. Its expected impact is not presently known.

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

     In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4” (“SFAS 151”) which clarifies the types of costs that should be expensed rather than capitalized as inventory. This statement also clarifies the circumstances under which fixed overhead costs associated with operating facilities involved in inventory processing should be capitalized. The provisions of SFAS 151 are effective for fiscal years beginning after June 15, 2005. The Company will adopt SFAS 151 in fiscal 2006 and it believes such adoption will not have a material impact on its consolidated financial position or results of operations.

3. Short-Term Investments

     The Company invested a portion of the net proceeds from the sale of Church’s (see Note 12) in debt securities. These investments are accounted for as available-for-sale securities and, as a result, are stated at fair value. At April 17, 2005, all short-term investments consisted of variable rate demand notes issued by governmental entities. Cost of these variable rate securities approximates their market value.

4. Restricted Cash and Other Current Assets

     At April 17, 2005, $90.4 million of restricted cash relates to a portion of the net proceeds from the sale of Church’s that were deposited into an account to collateralize outstanding indebtedness under the Company’s 2002 Credit Facility and certain other contingencies (see Note 5); $7.7 million of restricted cash relates to the cooperative advertising fund the Company maintains for its Popeyes franchisees; and $0.2 million of restricted cash relates to VIE cash balances. With the refinancing of the 2002 Credit Facility in May of 2005 (see Note 5), the monies deposited in the collateral account are no longer restricted.

     At December 26, 2004, $7.0 million of restricted cash relates to the cooperative advertising fund the Company maintains for its Popeyes franchisees and $0.4 million of restricted cash relates to VIE cash balances.

     The assets held for sale at April 17, 2005 are land and buildings in San Antonio, Texas that had been the site of the Company’s centralized accounting operations. On May 6, 2005, the Company sold these assets for $3.2 million in cash.

     The deferred transaction costs at December 26, 2004 were associated with the sale of Church’s and were expensed in the first quarter of 2005 as a component of the gain on sale of Church’s.

8

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

5. Long-Term Debt and Other Borrowings

     2002 Credit Facility. On May 23, 2002, the Company entered into a bank credit facility (the “2002 Credit Facility”) which consisted 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 2002 Credit Facility was subsequently amended on March 31, 2003, May 30, 2003, July 14, 2003, August 22, 2003, October 30, 2003, March 26, 2004, October 19, 2004, October 29, 2004 and December 28, 2004.

     The Company’s weighted average interest rate for all outstanding indebtedness under the 2002 Credit Facility was 7.69% at April 17, 2005 and 5.82% at December 26, 2004.

     As of April 17, 2005, there were no outstanding borrowings under the revolving credit facility and $5.2 million of outstanding letters of credit. As of April 17, 2005, the Company was in compliance with the financial and other covenants of the 2002 Credit Facility, as amended.

     All outstanding balances due under the 2002 Credit Facility were repaid in conjunction with a refinancing that occurred subsequent to the end of the Company’s first quarter of 2005, which is discussed below under the heading “2005 Credit Facility.” Because of the refinancing, the balance of the 2002 Credit Facility at April 17, 2005 which would otherwise have been due within the next twelve months is presented as a long-term liability. Amounts presented as a current liability at April 17, 2005 include the scheduled principle payments due over the next four fiscal quarters associated with the new credit facility.

     2005 Credit Facility. On May 11, 2005, the Company entered into a new bank credit facility (the “2005 Credit Facility”) which consists of a $60.0 million, five-year revolving credit facility and a six-year $190.0 million term loan.

     The revolving credit facility and term loan bear interest based upon alternative indices (LIBOR, Federal Funds Effective Rate, Prime Rate and a Base CD rate) plus an applicable margin as specified in the facility. The margins on the revolving credit facility may fluctuate because of changes in certain financial leverage ratios and the Company’s compliance with applicable covenants in the 2005 Credit Facility. 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.

     At the closing of the 2005 Credit Facility, the Company drew the entire $190.0 million term loan and applied approximately $57.4 million of the proceeds to payoff its 2002 Credit Facility, to pay fees associated with that facility and closing costs associated with the new facility. The remaining proceeds from the term loan

9

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

will be used to fund a portion of the Company’s special cash dividend (Note 6) and for general corporate purposes.

     The 2005 Credit Facility is secured by a first priority security interest in substantially all of the Company’s assets. The 2005 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. The 2005 Credit Facility includes customary events of default, including, but not limited to, the failure to pay any interest, principal or fees when due, the failure to perform certain covenants agreements, inaccurate or false representations or warranties, insolvency or bankruptcy, change of control, the occurrence of certain ERISA events and judgment defaults.

     Under the terms of the revolving credit facility, the Company may obtain short-term borrowings of up to $10.0 million and letters of credit up to $25.0 million, both amounts being further limited by the amount of unused borrowings under the 2005 Credit Facility.

     In addition to the scheduled payments of principle associated with the term loan, at the end of each fiscal 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. Whenever any prepayment is made, subsequent scheduled payments of principle are ratably reduced.

     As it pertains to the amounts drawn on our 2005 Credit Facility at closing, future minimum payments for principle, by fiscal year, are $0.5 million for 2005, $2.4 million for 2006, $1.4 million for 2007, $1.9 million for 2008, $1.9 million for 2009, and $181.9 million thereafter.

     2005 Interest Rate Swap Agreements. Effective May 12, 2005, the Company entered into two interest rate swap agreements with a combined notional amount of $130.0 million. Pursuant to these agreements, the Company pays a fixed rate of interest and receives a floating rate of interest. The effect of the agreements is to limit the interest rate exposure on a portion of the 2005 Credit Facility to a fixed rate of 6.4%. The agreements terminate on June 30, 2008, or sooner under certain limited circumstances.

6. Special Cash Dividend to Shareholders

     On May 11, 2005, the Company’s Board of Directors declared a special cash dividend of $12.00 per common share. The dividend is to be paid on June 3, 2005 to the common shareholders of record at the close of business on May 23, 2005. The Company will use a portion of the net proceeds from the sale of Church’s (see Note 12) and a portion of the net proceeds from the 2005 Credit Facility (see Note 5) to pay the dividend. Based on the number of the Company’s outstanding common shares at May 15, 2005, the Company estimates that the aggregate dividend payment will be approximately $352.8 million.

     In connection with the declaration of the special cash dividend, the Company’s Board of Directors also approved adjustments to outstanding options under the Company’s employee stock option plans. The modifications adjusted the exercise price and the number of shares associated with each employee’s outstanding stock options to preserve the value of the options after the special cash dividend. The Company will recognize no charge as a result of the modifications because the intrinsic value of the awards and the ratio of the exercise price to the market value per share for each award will not change.

10

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

7. 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. On December 29, 2004, the Court entered an Order granting in part and denying in part the Defendants’ Motions to Dismiss the Complaint. The Court dismissed all insider trading claims; dismissed Section 10(b) and Rule 10b-5 claims against certain current and former officers and directors. Because Plaintiffs declined to re-plead their allegations, the foregoing claims have been dismissed with prejudice. Subsequent to the Court’s December 29, 2004 Order, Defendants AFC and the former CFO filed a Motion to Dismiss the Section 10(b) and Rule 10b-5 claims of the named Plaintiffs for lack of standing (jurisdiction), as both remaining Plaintiffs continue to hold the AFC stock made the subject of their claims and, therefore, given the recovery and continuing rise of the AFC stock price, Plaintiffs can prove no damages under Section 10(b) or Rule 10b-5. Also, pending are certain motions filed by the outside directors for reconsideration of portions of the December 29, 2004 Order. Discovery commenced on February 23, 2005.

     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 secondary 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 secondary 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. On November 5, 2004, after briefing and argument, the United States Court of Appeals for the Eleventh Circuit ruled that it lacked jurisdiction to hear the appeal. Defendants filed a Motion to Reconsider the Court’s ruling on November 24, 2004. On February 22, 2005, the Eleventh Circuit panel ruled that the full Court, as opposed to the panel only, could consider defendants’ request to reconsider the Court’s November 5, 2004 Order. On

11

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

May 16, 2005 the parties submitted a joint motion to suspend the court’s consideration of Defenants’ Motion to Reconsider until such time as the Effective Date of the joint settlement of these securities actions.

     On April 22, 2005, AFC announced that it had reached a joint settlement agreement with plaintiffs in the Section 10(b) securities litigation initially filed on March 25, 2003, the Section 11 securities claim relating to the Company’s initial public offering (“IPO”) raised on January 26, 2004, and the Section 11 securities litigation relating to the Company’s secondary public offering (“SPO”) initially filed on May 15, 2003. The agreement provides for the general terms of a settlement under which AFC would pay (1) to the putative plaintiff class in the Section 10(b) and Section 11 (relating to the Company’s IPO) securities litigation $13 million in cash, plus up to an additional $3.5 million based on a formula applied to any recovery of funds from its former insurers for directors’ and officers’ liability, and up to an additional $3.5 million based on a formula applied to any recovery of funds from its ongoing lawsuit against Arthur Andersen LLP (described below); and (2) to the putative plaintiff class in the Section 11 securities litigation (relating to the Company’s SPO) $2.0 million in cash, plus up to an additional $2.5 million based on a formula applied to any recovery of funds from its former insurers for directors’ and officers’ liability, and up to an additional $2.0 million based on a formula applied to any recovery of funds from its ongoing lawsuit against Arthur Andersen LLP (described below). The settlement does not reflect any admission of liability by the Company, its current or former directors or officers, underwriters of the Company’s public offerings or investor defendants. The Company will be obligated to make payments in addition to the $15 million cash payment only to the extent that it recovers amounts from Arthur Andersen LLP or its former insurers for directors’ and officers’ liability. The parties intend to enter into a further agreement to set forth more specific terms of the settlement. Any such agreement is subject to court approval.

     During the first quarter of 2005, the Company recognized $21.1 million of charges related to shareholder litigation, including an accrual of $15.0 million associated with the agreement to settle the two matters described above.

     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 or by selling Company stock while in possession of undisclosed material information. The lawsuit seeks, purportedly 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 August 12, 2004, the Court dismissed in part three of AFC’s current or former officers and the two AFC shareholders from the suit without prejudice to the plaintiffs’ right to replead the claims against these defendants. The Court denied the motion to dismiss as it related to the other defendants. Plaintiffs did not replead before the deadline set by the Court. Certain defendants moved for reconsideration but the Court declined to reconsider. The discovery process in this action is being coordinated with the consolidated securities action and commenced on February 23, 2005. On April 14, 2005, plaintiffs filed a motion for a preliminary injunction imposing a constructive trust freezing the assets of certain individual defendants. Defendants filed a written response in opposition to plaintiffs motion for preliminary injunctions. On May 20, 2005, plaintiffs requested and defendants joined in a consent voluntary dismissal with prejudice of one of the lead plantiffs as he has sold his shares of the Company’s stock.

     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

12

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

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. The parties have currently agreed to coordinate the discovery of this case and the federal derivative action.

     On April 30, 2003, the Company received an informal, nonpublic inquiry from the staff of the SEC requesting voluntary production of documents and other information. The requests, for documents and information, which are ongoing, 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 staff has informed the Company’s counsel that the SEC has issued an order authorizing a formal investigation with respect to these matters. 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 restatement of its financial statements. On August 27, 2004, Executive Risk Indemnity, Inc. (“Executive Risk”), one of the Company’s D&O insurers, delivered to the Company a notice of rescission of its D&O insurance policy and returned the insurance premiums paid by the Company for that policy. On August 27, 2004, Executive Risk also filed suit in the United States District Court for the Northern District of Georgia against AFC and each of the individuals who are named as defendants in the litigation relating to the Company’s decision to restate. The complaint alleges that the D&O insurance policy was procured through material misstatements or omissions. The alleged material misstatements or omissions relate to statements AFC allegedly made to Executive Risk by the Company prior to the Company’s announcements indicating that it would restate its financial statements for 2000, 2001 and the first three quarters of 2002. The complaint seeks a judgment that the Executive Risk policy is rescinded, a declaration that Executive Risk owes no obligation under its D&O insurance policy, costs and expenses incurred in litigation, and other relief. AFC and the individual director and officer defendants filed their Answers and Counterclaims to the complaint on January 24, 2005. AFC will continue to pursue recovery from all of its former D&O insurers for these matters, including continuing to defend vigorously the lawsuit filed by Executive Risk Indemnity, Inc. However, there is risk that Executive Risk will be successful in its litigation seeking rescission of its D&O Policy; that AFC’s other D&O insurers will rescind their policies; that AFC’s D&O insurance policies will not cover some or all of the claims described above; or, even if covered, that the Company’s ultimate liability will exceed the available insurance.

     As announced on August 31, 2004, AFC has filed a lawsuit against Arthur Andersen, LLP, two of its former partners, and a former audit manager asserting that the defendants violated generally accepted auditing standards and accounting principles, committed auditing malpractice and breached contracts between the parties, resulting in AFC having to restate its financial statements for fiscal years 2000, 2001 and the first three quarters of 2002 and incur substantial costs, fees, and lost profits. The suit, which was filed in the Superior Court of Fulton County, Georgia, further alleges that as a result of Arthur Andersen LLP’s negligent acts or omissions and breaches of contract, AFC is entitled to monetary damages and equitable relief from Arthur Andersen LLP.

     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 (other than with respect to the claims subject to the settlement described above). However, the parties to the settlement agreement described above intend to enter into a further agreement to set forth more specific terms of the settlement and such agreement will be subject to court approval. 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 and the ultimate resolution of these matters may exceed the $20.5 charge described above and may not be offset by recovery from either its insurers or Arthur Andersen LLP.

13

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

     The ultimate resolution of these matters could have a material adverse impact on the Company’s financial results, financial condition and liquidity.

     The Company is a defendant in various legal proceedings arising in the ordinary course of business, including claims resulting from “slip and fall” accidents, employment-related claims, claims from guests or employees alleging illness, injury or other food quality, health or operational concerns and claims related to franchise matters. We have established adequate reserves to provide for the defense and settlement of such matters and we believe their ultimate resolution will not have a material adverse effect on our financial condition or our results of operations.

8. Shareholder Litigation and Other Expenses, Net