UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended April 1, 2007

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from to

Commission File Number 000-22639

CHAMPPS ENTERTAINMENT, INC.

(Exact name of registrant as specified in its charter)

Delaware

04-3370491

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

10375 Park Meadows Drive, Suite 560

Littleton, Colorado

80124

(Address of principle executive offices)

(Zip Code)

(303) 804-1333

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer ¨ Accelerated Filer x Non-Accelerated Filer ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

Number of shares of Common Stock, $.01 par value, outstanding at May 4, 2007: 13,094,449.

CHAMPPS ENTERTAINMENT INC.

INDEX


	PART I – FINANCIAL INFORMATION

Item 1.	Financial Statements:

	Unaudited Consolidated Balance Sheets as of April 1, 2007 and July 2, 2006	1

	Unaudited Consolidated Statements of Operations – Three and Nine Months Ended April 1, 2007 and April 2, 2006	2

	Unaudited Consolidated Statement of Shareholders’ Equity – Nine Months Ended April 1, 2007	3

	Unaudited Consolidated Statements of Cash Flows – Nine Months Ended April 1, 2007 and April 2, 2006	4

	Notes to Unaudited Consolidated Financial Statements – Three and Nine Months Ended April 1, 2007 and April 2, 2006	5

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	33

Item 4.	Controls and Procedures	34

	PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	34

Item 1A.	Risk Factors	34

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	35

Item 3.	Defaults upon Senior Securities	35

Item 4.	Submission of Matters to a Vote of Security Holders	35

Item 5.	Other Information	35

Item 6.	Exhibits	35

	Signatures	36

PART I – FINANCIAL INFORMATION

ITEM 1. Financial Statements

CHAMPPS ENTERTAINMENT, INC.

CONSOLIDATED BALANCE SHEETS

As of April 1, 2007 and July 2, 2006

(In thousands except share data)

(Unaudited)


	April 1, 2007			July 2, 2006
ASSETS
Current assets:
Cash and cash equivalents	$	17,309		$	9,449
Accounts receivable, net		2,378			2,208
Inventories		4,338			4,461
Prepaid expenses and other current assets (Note 2)		2,965			2,871
Assets held for sale (Note 10)		—			2,670
Deferred tax assets		2,509			3,210

Total current assets		29,499			24,869

Property and equipment, net (Note 3)		69,311			75,076
Goodwill		5,069			5,069
Deferred tax assets		24,077			29,533
Other assets, net (Note 4)		1,773			2,155

Total assets	$	129,729		$	136,702

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	4,048		$	3,793
Accrued expenses (Note 5)		8,170			9,584
Current portion of long-term debt (Note 6)		14,858			—

Total current liabilities		27,076			13,377
Long-term debt, net of current portion (Note 6)		—			14,707
Other long-term liabilities (Note 5)		32,814			31,890

Total liabilities		59,890			59,974

Shareholders’ equity (Note 8):
Common stock ($.01 par value per share; authorized 30,000,000 shares; 13,281,520 and 13,258,151 shares issued at April 1, 2007 and July 2, 2006, respectively)		133			133
Additional paid-in capital		92,104			91,264
Accumulated deficit		(21,092	)		(13,966	)
Treasury stock, at cost (191,480 and 91,480 shares at April 1, 2007 and July 2, 2006, respectively)		(1,306	)		(703	)

Total shareholders’ equity		69,839			76,728

Total liabilities and shareholders’ equity	$	129,729		$	136,702

See accompanying notes to unaudited consolidated financial statements.

CHAMPPS ENTERTAINMENT, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

Three and Nine Months Ended April 1, 2007 and April 2, 2006

(In thousands except per share data)

(Unaudited)


	Three Months Ended						Nine Months Ended
	April 1, 2007			April 2, 2006			April 1, 2007			April 2, 2006
Revenue
Sales	$	49,055		$	51,485		$	150,482		$	157,177
Franchising and royalty, net		173			174			525			468

Total revenue		49,228			51,659			151,007			157,645

Costs and expenses
Cost of sales and operating expenses
Product costs		13,868			14,462			42,959			44,082
Labor costs		16,191			16,192			48,944			49,428
Other operating expense		7,990			7,987			24,130			23,905
Occupancy		5,092			5,208			15,343			15,572
Pre-opening expense		—			78			—			157
General and administrative expense		3,164			3,710			9,906			10,539
Depreciation and amortization		2,586			2,739			7,778			8,262
Severance		—			5			(136	)		110
Asset impairment charges and restaurant closings/disposals		—			2,136			530			2,136
Potential company sale expense (Note 12)		499			—			499			—
Other expense		157			131			269			286

Income from operations		(319	)		(989	)		785			3,168
Interest expense, net		153			237			632			913
Expense (income) related to predecessor companies		—			(2	)		12			(5	)

Income (loss) from continuing operations, before tax		(472	)		(1,224	)		141			2,260
Income tax expense (benefit) (Note 11)		(133	)		(700	)		6,941			26

Income (loss) from continuing operations		(339	)		(524	)		(6,800	)		2,234
Loss on discontinued operations, net of tax (Note 10)		232			1,405			326			1,798

Net income (loss)	$	(571	)	$	(1,929	)	$	(7,126	)	$	436

Basic income (loss) per share (Note 9):
Income (loss) from continuing operations	$	(0.03	)	$	(0.04	)	$	(0.52	)	$	0.17
Loss from discontinued operations, net of tax		(0.01	)		(0.11	)		(0.02	)		(0.14	)

Net income (loss)	$	(0.04	)	$	(0.15	)	$	(0.54	)	$	0.03

Diluted income (loss) per share (Note 9):
Income (loss) from continuing operations	$	(0.03	)	$	(0.04	)	$	(0.52	)	$	0.17
Loss from discontinued operations, net of tax		(0.01	)		(0.11	)		(0.02	)		(0.14	)

Net income (loss)	$	(0.04	)	$	(0.15	)	$	(0.54	)	$	0.03

Basic weighted average shares outstanding		13,086			13,194			13,104			13,135

Diluted weighted average shares outstanding		13,086			13,194			13,104			13,188

See accompanying notes to unaudited consolidated financial statements.

CHAMPPS ENTERTAINMENT, INC.

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

Nine Months Ended April 1, 2007

(In thousands except share data)

(Unaudited)


	Common Stock			Additional Paid-in Capital		Accum. Deficit			Treasury Stock				Total Shareholders’ Equity
	Shares	Amount		Additional Paid-in Capital		Accum. Deficit			Shares	Amount			Total Shareholders’ Equity
Balance as of July 2, 2006	13,258,151	$	133	$	91,264	$	(13,966	)	91,480	$	(703	)	$	76,728
Net loss	—		—		—		(7,126	)	—		—			(7,126	)
Common shares issued	23,369		—		122		—		—		—			122
Repurchase of common shares (Note 8)									100,000		(603	)		(603	)
Income tax benefit of stock options exercised	—		—		2		—		—		—			2
Stock-based compensation	—		—		716		—		—		—			716

Balance as of April 1, 2007	13,281,520	$	133	$	92,104	$	(21,092	)	191,480	$	(1,306	)	$	69,839

See accompanying notes to unaudited consolidated financial statements.

CHAMPPS ENTERTAINMENT, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Nine Months Ended April 1, 2007 and April 2, 2006

(In thousands)

(Unaudited)


	Nine Months Ended
	April 1, 2007			April 2, 2006
Cash flows from operating activities:
Net income (loss)	$	(7,126	)	$	436
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		8,044			8,699
Amortization of notes payable discount		151			151
Asset impairment charges		683			4,271
Loss on disposal of assets		400			236
Stock-based compensation		716			554
Deferred income tax expense (benefit)		6,157			(2,021	)
Changes in assets and liabilities:
Accounts receivable		(170	)		(270	)
Inventories		123			(105	)
Prepaid expenses and other current assets		(94	)		89
Accounts payable		255			(1,752	)
Accrued expenses		(1,414	)		(1,541	)
Other assets		317			179
Other long-term liabilities		924			172
Proceeds from tenant improvement allowances		—			1,969

Net cash provided by operating activities		8,966			11,067

Cash flows from investing activities:
Purchase of property and equipment		(3,250	)		(3,296	)
Proceeds from disposal of assets		—			7
Proceeds from assets held for sale		2,623			—

Net cash used in investing activities		(627	)		(3,289	)

Cash flows from financing activities:
Proceeds from issuance of common stock		122			997
Income tax benefit of stock options exercised		2			106
Repurchase of common stock		(603	)		(209	)
Repayment of long-term debt		—			(143	)

Net cash provided by (used in) financing activities		(479	)		751

Net change in cash and cash equivalents		7,860			8,529
Cash and cash equivalents, beginning of period		9,449			2,702

Cash and cash equivalents, end of period	$	17,309		$	11,231

Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest, net of amount capitalized	$	543		$	506
Income taxes, net of refunds		182			855

See accompanying notes to unaudited consolidated financial statements.

CHAMPPS ENTERTAINMENT, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Three and Nine Months Ended April 1, 2007 and April 2, 2006

(Unaudited)

1.	Summary of Significant Accounting Policies

Nature of Business

Champps Entertainment, Inc. (the “Company” or “Champps”), is a Delaware corporation formed on May 27, 1997 in connection with the spin-off of DAKA International, Inc. (“DAKA”). At April 1, 2007, the Company operated one business segment. The Company’s principal business activity is to own, operate and franchise/license casual dining restaurants that serve customers in upscale restaurant settings in 21 states throughout the United States with larger concentrations of restaurants in the upper midwest and mid-atlantic regions.

Basis of Presentation of Consolidated Financial Statements

The accompanying unaudited consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, which are, in the opinion of management, necessary for a fair statement of its financial position as of April 1, 2007 and the results of operations for the interim periods ended April 1, 2007 and April 2, 2006. These unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures, normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted pursuant to such SEC rules and regulations. However, in the opinion of management, all adjustments considered necessary for a fair presentation have been included and are of a normal recurring nature. Operating results for the three and nine month periods ended April 1, 2007 are not necessarily indicative of the results that may be expected for the fiscal year ending July 1, 2007.

These statements should be read in conjunction with the consolidated financial statements and related notes to consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended July 2, 2006. The accounting policies used in preparing these consolidated financial statements are the same as those described in our Form 10-K.

Fiscal Year

Champps utilizes a 52/53 week fiscal year ending on the Sunday closest to June 30^th. Fiscal 2007 and fiscal 2006 are both comprised of 52 weeks. The three month periods ended April 1, 2007 and April 2, 2006, each consisted of 13 weeks and the nine month periods ended April 1, 2007 and April 2, 2006, each consisted of 39 weeks.

Use of Estimates

In the process of preparing its consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, the Company estimates the carrying value of certain assets and liabilities that are subjective in nature. The primary estimates included in the Company’s consolidated financial statements include, but are not limited to, loss contingencies generally related to litigation and assessments, self-insured risks relating to workers’ compensation, general liability and medical claims, the useful lives and recoverability of our long-lived assets such as property and equipment, goodwill and other intangibles, lease accounting, fair value of stock based compensation including estimating forfeitures, valuation of deferred tax assets and the recording of income tax expense. Actual results could differ from those estimates.

Future Application of Accounting Standards

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 defines the threshold for recognizing the benefits of tax-return positions in the financial statements as “more-likely-than-not” to be sustained by the taxing authority, while earlier authoritative literature provided no specific guidance. FIN 48 is effective as of the beginning of the first fiscal year beginning after December 15, 2006. While we are still considering the implications of the pronouncement, the Company does not believe the adoption of FIN 48 will have a material impact on its financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” (“SFAS 157”). SFAS 157 clarifies the definition of fair value, describes methods used to appropriately measure fair value, and expands fair value disclosure requirements. This statement applies under other accounting pronouncements that currently require or permit fair value measurements and is effective as of the beginning of the first fiscal year beginning after November 15, 2007. While we are still considering the implications of the pronouncement, the Company does not believe the adoption of SFAS 157 will have a material impact on its financial statements.

2.	Prepaid Expenses and Other Current Assets

The components of prepaid expenses and other current assets were as follows (in thousands):


	April 1, 2007		July 2, 2006
Prepaid rents, real estate taxes and related costs	$	1,571	$	1,594
Prepaid insurance		451		312
Prepaid licenses and permits		271		211
Prepaid contracts and other		672		754

	$	2,965	$	2,871

3.	Property and Equipment, Net

The components of property and equipment, net were as follows (in thousands):


	April 1, 2007			July 2, 2006
Land	$	2,923		$	2,923
Buildings and leasehold improvements		78,880			78,492
Software		1,336			1,327
Equipment		47,516			47,599
Construction in progress		197			377

		130,852			130,718
Accumulated depreciation and amortization		(61,541	)		(55,642	)

	$	69,311		$	75,076

Total depreciation and amortization expense per the consolidated statement of cash flows includes depreciation and amortization expense on corporate assets of $231,000 and $220,000 which is included in general and administrative expense on the consolidated statements of operations for the nine months ended April 1, 2007 and April 2, 2006, respectively.

During the nine months ended April 1, 2007, the Company recorded $530,000 for asset impairment charges and restaurant closings / disposals for one location whose future cash flows are not expected to cover its carrying value and to write-off the development costs for a new location project which will not be pursued.

During the three months ended April 2, 2006, the Company recorded asset impairment charges of $4,271,000, of which $2,135,000 is recorded as discontinued operations, for three restaurants that closed in May 2006.

4.	Other Assets, Net

The components of other assets, net were as follows (in thousands):


	April 1, 2007		July 2, 2006
Deferred financing costs	$	307	$	585
Liquor licenses		660		728
Long-term deposits		117		98
Leasehold rights		555		582
Equity investment in licensee		122		141
Other		12		21

	$	1,773	$	2,155

The equity investment in licensee reflects the Company’s cash investment and its share of losses through April 1, 2007 in a Champps’ licensed location at the Dallas/Fort Worth, Texas airport in which the Company has an eight percent equity interest.

5.	Accrued Expenses and Other Long-Term Liabilities

The components of accrued expenses were as follows (in thousands):


	April 1, 2007		July 2, 2006
Salaries, wages, and related benefits	$	1,879	$	3,066
Accrued taxes, predominantly sales and property		2,197		2,542
Accrued insurance		996		1,159
Accrued severance		—		136
Accrued utilities		423		428
Gift card/certificate liability		1,428		1,184
Lease termination		220		220
Other		1,027		849

	$	8,170	$	9,584

The decrease in salaries, wages and related benefits was due to timing of the payroll cycle. One week of payroll costs were accrued at April 1, 2007 compared to two weeks of payroll accrued as of July 2, 2006.

The components of other long-term liabilities were as follows (in thousands):


	April 1, 2007		July 2, 2006
Tenant improvement allowances	$	18,234	$	19,814
Deferred rents		11,435		10,688
Accrued insurance		949		884
Partnership buyout		1,673		417
Lease termination		523		87

	$	32,814	$	31,890

Tenant improvement allowances represent cash received from certain landlords for initial construction costs and are amortized as a reduction of rent expense on a straight-line basis over the lease term.

Deferred rents represent the cumulative difference between actual rent paid and rent expensed on a straight-line basis.

The increase in the partnership buyout was due primarily to cash flow bonus interest purchases by the new partners to the employee partner cash flow bonus program.

6.	Long Term Debt

The Company has a $25,000,000 senior secured credit facility with LaSalle Bank that expires in September 2010. The facility provides up to $7,000,000 for the issuance of letters of credit. The facility provides for a $10,000,000 one-time increase in the aggregate commitment amount if requested by the Company between September 30, 2007 and December 31, 2007 and approved by the lenders. The facility is secured by a blanket lien on all personal and real property of the Company. Borrowings under the facility bear interest at variable rates depending on a total funded debt to EBITDA (earnings before interest, taxes, depreciation and amortization prior to pre-opening expenses, as defined) ratio and range from the prime rate to prime plus 0.5 percent or, if elected, LIBOR plus 1.8 to 3.0 percent. The Company originally paid an up-front fee of $188,000 and is required to pay an annual unused commitment fee of between 0.375 percent to 0.5 percent. The facility also requires the Company to maintain a minimum fixed charge coverage ratio and not exceed certain thresholds for total funded debt to EBITDA and total senior debt to EBITDA ratios. As of April 1, 2007, we were in compliance with all debt covenants and financial ratios contained in the facility. Additionally, the facility limits the opening of new restaurants to a maximum of eight in any fiscal year and also sets limits on the amount of dividends and/or stock repurchases that can be made by the Company to $2,000,000 per fiscal year if the total senior debt to EBITDA ratio is equal to or more than 1.00 to 1.00. As of April 1, 2007, the Company had a senior debt to EBITDA ratio of 0.38 to 1.00. Also, the Company must maintain a margin of at least 0.25 to 1.00 with each of its financial covenants in order to declare dividends or acquire stock through share repurchases. As of April 1, 2007, the Company had no outstanding borrowings and had placed letters of credit of $3,481,000 under this facility. The available balance for borrowing under this facility as of April 1, 2007 was $21,519,000.

The Company has $15,000,000 of principal amount outstanding 5.5% convertible notes which are classified as “Current portion of long-term debt” on the Company’s consolidated balance sheet as of April 1, 2007 as the convertible notes mature in December 2007. The notes are convertible at the option of the holder at any time prior to maturity into shares of common stock at a conversion price of $10.66 per share, subject to adjustment upon certain events. The Company may redeem some or all of the notes at par plus accrued and unpaid interest. There are no assurances that the convertible debt holders will convert their debt into common shares prior to December 2007. If the debt is not converted, or repaid as part of a sale transaction (see Note 12), the Company expects to either pay the debt off with available cash, proceeds from credit facility borrowings, refinance term debt, or utilize a combination of these sources.

7.	Commitments and Contingencies

Letters of Credit

The Company had outstanding letters of credit of $3,481,000 as of April 1, 2007 primarily to guarantee its performance pursuant to certain insurance contracts. The letters of credit are irrevocable and have one-year renewable terms.

Indemnifications and Representations Related to Predecessor Companies

In fiscal 1997 in connection with the corporate restructuring of DAKA, DAKA spun-off its food service business. The remaining corporation continued to own Champps, Fuddruckers and several other restaurant companies and renamed itself Unique Casual Restaurants, Inc. Fuddruckers was sold in 1998 and the other restaurant businesses were either sold or closed during 1998 or 1999, leaving Champps as the only owned and operating restaurant group. Through a merger, the name of the Company was then changed to Champps Entertainment, Inc. As a result of these transactions, the Company remains responsible for liabilities of DAKA preceding its spin-off, as well as certain indemnification obligations assumed by the Company in connection with the sale of Fuddruckers. Certain matters arising in connection with these obligations are discussed in this section under the headings, “Accrued Insurance Costs,” and “Litigation.” Although the Company has incurred certain expenses in connection with these obligations and retained liabilities in the past, based upon the circumstances known to us, the Company believes additional claims under these obligations and retained liabilities are unlikely to have a material effect on the Company’s financial position or results of operations.

Fuddruckers Representations and Indemnity

The agreement whereby Fuddruckers was sold contains various representations and warranties by the Company, certain of which expired on December 31, 2000. The remaining representations and warranties will continue in effect as stated in the agreement.

The maximum aggregate liability of the Company on account of any breach of any representation or warranty is limited to the amount of the final purchase price. There is no limit on the liability of the Company to the purchaser on account of any breach by the Company of any of its covenants or agreements under the agreement or on account of indemnification obligations covering matters other than breaches of representations and warranties, provided that, if the purchaser is entitled to recover any losses in excess of the final purchase price ($43,000,000), the Company may require the purchaser to reconvey to the Company full ownership and control of the shares and all assets (to the extent then owned by the purchaser or Fuddruckers) that were transferred pursuant to the agreement in such a manner as to rescind the transactions contemplated by the agreement based upon a formula price. During 2006 and 2007, no claims for indemnification were presented by the purchaser and the Company believes the risk for significant claims for indemnification being presented in the future by the purchaser is remote.

Accrued Insurance Costs

The Company is self-insured for certain losses related to workers’ compensation, general liability and medical claims. The Company has purchased stop-loss coverage in order to limit its exposure to significant levels of such claims. Self-insured reserves are accrued based upon our estimates of the aggregate liability for uninsured claims incurred using certain assumptions that are based upon historical experience. Actual amounts required to settle such obligations may exceed those estimates.

Through June 29, 1997, the Company was self-insured for workers’ compensation, general liability, and various other risks up to specified limits. The Company’s share of prior workers’ compensation and general liability programs of DAKA through June 29, 1997 were allocated using labor costs and the aggregate costs of such programs were determined through actuarial studies which determined the estimated amount required to be provided for incurred incidents. In connection with the spin-off transaction from DAKA, the Company is liable for all claims made subsequent to the effective date of the spin-off, including claims related to associates of DAKA not continuing with the Company after the spin-off, provided the claims relate to events occurring prior to the effective date of the spin-off. The Company believes that any claims related to its obligations resulting from the spin-off, including those listed under “Litigation” in this Note, are adequately accrued and are unlikely to have a material effect on the Company’s financial position or results of operations.

Litigation

From time to time, lawsuits are filed against the Company in the ordinary course of business. Such lawsuits typically involve claims from customers, former or current employees, and others related to issues common to the restaurant industry. A number of such claims may exist at any given time. The Company is currently not a party to any litigation that management believes is likely to have a material adverse effect on the Company’s consolidated financial position or results of operations.

In connection with the spin-off of DAKA in late 1997, the Company assumed certain contingent liabilities of DAKA and its subsidiaries (see sections entitled “Indemnifications and Representations Related to Predecessor Companies” and “Accrued Insurance Costs” in this Note) including liabilities of DAKA’s insurance coverage provided by American International Group, Inc. (“AIG”) or its subsidiaries for the 1994 through 1997 policy periods. DAKA’s insurance coverage included “Large Deductible” workers compensation policies that contained a “Final Premium” section, which set forth AIG’s obligations to determine the “Final Premium” once the policy period ends. While the insurance policies were in place, surety bonds were purchased as collateral for the policies. Champps eventually replaced the surety bond with an irrevocable standby letter of credit for the payment of claims under the insurance policies, however AIG has not released the surety bond or the letter of credit. Champps maintains that it has satisfied its obligations under the insurance policies, and that AIG has accepted final payment from Champps as evidenced by a letter agreement between Champps and AIG. AIG asserts that the policies were with National Union Fire Insurance Company of Pittsburgh, PA (“National Union”), a subsidiary of AIG, and that the letter agreement is not valid. National Union contends that it is owed more than $2 million by Champps. Champps intends to vigorously defend its position in this matter.

In June 2004, Champps filed suit against AIG and National Union in the United States District Court for the District of Massachusetts based on the defendants’ failure to release Champps from further liability under the insurance policies and for wrongfully withholding a $526,000 irrevocable standby letter of credit and a surety bond posted in the amount of $526,254 (the “Federal Court Action”). In August 2004, National Union filed a Petition to Compel Arbitration in the United States District Court for the Southern District of New York. In December 2004, the Court granted National Union’s Petition to Compel Arbitration (the “National Union Arbitration”).

In February 2005, Champps filed an Amended Complaint in the Federal Court Action, in which it named only AIG as a defendant. In March 2005, Champps withdrew its Amended Complaint in the Federal Court Action, and filed suit against AIG in state court in Massachusetts (the “State Court Action”). In July 2005, the Court granted AIG’s motion to stay the State Court Action pending resolution of the National Union Arbitration in New York.

The National Union Arbitration is in its preliminary phase, and the Company intends to vigorously defend any claims of further liability. The Company has not yet conducted discovery on AIG’s liability assertions.

The Company may also be required to assume other liabilities of DAKA in connection with the spin-off and may be required to indemnify Fuddruckers in connection with future breaches of our representations and warranties that survived the closing of DAKA’s sale of its Fuddruckers restaurant chain. These indemnifications are discussed further in this Note under the heading “Indemnifications and Representations Related to Predecessor Companies” and “Fuddruckers Representations and Indemnity”. Based upon the circumstances known to the Company at this time, and the length of time that has elapsed since the spin-off of DAKA and the sale of Fuddruckers, the Company believes any additional claims under these obligations and retained liabilities are unlikely to have a material effect on the Company’s financial position or results of operations.

Tax Contingencies

From time-to-time, the Company and its predecessors have been party to various assessments of taxes, penalties and interest from federal, state and local agencies. Tax reserves are accrued based upon our estimates of the ultimate settlement of the contingencies. Actual amounts required to settle those obligations may exceed the Company’s estimates.

8.	Shareholders’ Equity / Share Repurchase / Restricted Stock

In January 2006, the Company’s Board of Directors approved a plan to expend up to $5,000,000 to repurchase its common stock from time to time over the next two years. Through April 1, 2007, the Company purchased 191,480 shares of common stock for $1,306,000 under this plan. No purchases occurred in the quarter ended April 1, 2007. Purchases under the program may be made in the open market or in private transactions. Future purchases under the program will depend, among other factors, on the prevailing stock price, market conditions, limitations under debt agreements, alternative investment opportunities and are expected to be funded primarily with available cash balances and operating cash flow. There is no minimum or maximum number of shares to be repurchased under the program. The repurchased shares will be held in treasury and used for issuance under the Company’s equity incentive plans.

On August 16, 2006, the Company received the resignation, effective on that date, of Rich Scanlan, as the Company’s chief operating officer (“COO”) and vice president. Mr. Scanlan agreed to remain an employee of the Company in the capacity of director of operations overseeing the Illinois and Minnesota markets. As a part of Mr. Scanlan’s resignation, he agreed to release all right, title and interest to any unvested restricted stock grants previously granted to him by the Company in connection with his former position as the Company’s COO. The return of the unvested restricted stock totaling 102,000 shares by Mr. Scanlan was accounted for as a forfeiture and previously accrued compensation of $85,000 related to this unvested restricted stock was reversed during the quarter ended October 1, 2006. No future compensation expense will be recorded related to these restricted stock awards.

9.	Income (Loss) Per Share

The following table sets forth the computation of basic and diluted income (loss) per share:


	Three Months Ended						Nine Months Ended
	April 1, 2007			April 2, 2006			April 1, 2007			April 2, 2006
Basic income (loss) per share:
Income (loss) from continuing operations	$	(339,000	)	$	(524,000	)	$	(6,800,000	)	$	2,234,000
Loss from discontinued operations, net of tax		(232,000	)		(1,405,000	)		(326,000	)		(1,798,000	)

Net income (loss)	$	(571,000	)	$	(1,929,000	)	$	(7,126,000	)	$	436,000

Weighted average shares outstanding		13,085,900			13,193,912			13,104,114			13,134,949

Income (loss) from continuing operations per share - basic	$	(0.03	)	$	(0.04	)	$	(0.52	)	$	0.17
Loss from discontinued operations per share - basic		(0.01	)		(0.11	)		(0.02	)		(0.14	)

Net income (loss) per share - basic	$	(0.04	)	$	(0.15	)	$	(0.54	)	$	0.03

Diluted income (loss) per share:
Income (loss) from continuing operations	$	(339,000	)	$	(524,000	)	$	(6,800,000	)	$	2,234,000
Plus income impact of assumed conversion of 5.5% convertible subordinated notes		(a	)		(a	)		(a	)		(a	)

Income (loss) from continuing operations plus assumed conversions		(339,000	)		(524,000	)		(6,800,000	)		2,234,000

Loss from discontinued operations, net of tax		(232,000	)		(1,405,000	)		(326,000	)		(1,798,000	)

Net income (loss) plus assumed conversions	$	(571,000	)	$	(1,929,000	)	$	(7,126,000	)	$	436,000


Weighted average shares outstanding		13,085,900			13,193,912			13,104,114			13,134,949
Net effect of dilutive stock options based on the treasury stock method using average market price (b)		—			—			—			53,045
Net effect of dilutive warrants based on the treasury stock method using average market price		(c	)		(c	)		(c	)		(c	)
Assumed conversion of 5.5% convertible subordinated notes		(a	)		(c	)		(a	)		(a	)

Total shares outstanding for computation of per share earnings		13,085,900			13,193,912			13,104,114			13,187,994

Income (loss) from continuing operations per share - diluted	$	(0.03	)	$	(0.04	)	$	(0.52	)	$	0.17
Loss from discontinued operations per share - diluted		(0.01	)		(0.11	)		(0.02	)		(0.14	)

Net income (loss) per share - diluted	$	(0.04	)	$	(0.15	)	$	(0.54	)	$	0.03

(a)	Not included in calculation because the assumed conversion of convertible subordinated notes into 1,407,129 common shares was not dilutive.

(b)	For the three months ended April 1, 2007 and April 2, 2006, 656,223 and 230,181 of stock options, respectively, were not dilutive and, therefore, were not considered in the computation of diluted income per share.

For the nine months ended April 1, 2007 and April 2, 2006, 656,223 and 348,125 of stock options, respectively, were not dilutive and, therefore, were not considered in the computation of diluted income per share.

(c)	Not included in calculation because the assumed conversion of warrants into 386,961 common shares was not dilutive.

10.

Discontinued Operations, Net of Tax and Assets Held for Sale

The Company closed three restaurants in May 2006 and closed one restaurant in January 2007 whose financial results met the definition of a “component of an entity”. Operations and cash flows were clearly distinguished and measured at the restaurant level and, when aggregated, the financial results of the closed restaurants were determined to be material to our consolidated financial statements. Loss from discontinued operations, net of tax, consisted of the following (in thousands):


	Three Months Ended						Nine Months Ended
	April 1, 2007			April 2, 2006			April 1, 2007			April 2, 2006
Restaurant sales	$	41		$	2,519		$	1,177		$	7,565
Restaurant costs		(2	)		2,704			618			8,399
Asset impairment charges		—			2,135			—			2,135
Lease termination, closure costs and other		426			—			1,098			—

Loss from discontinued operations		383			2,320			539			2,969
Income tax benefit		(151	)		(915	)		(213	)		(1,171	)

Loss from discontinued operations, net of tax	$	232		$	1,405		$	326		$	1,798

As of April 1, 2007, the Company had exited two closed locations through lease termination agreements at a cost of $1,599,000. In addition, the Company had purchased a third closed location from the landlord for $3,161,000 and sold the location for $2,623,000, net. With the exception of $372,000 in expense, all closure costs associated with these transactions were recorded in fiscal year 2006.

The fourth closed location is expected to be disposed of through a sublease arrangement and a $307,000 lease termination liability was previously recorded based on original sublease estimates. The liability was increased to reflect the present value of the future minimum lease obligations offset by the sublease rental as is currently being contemplated under the proposed sublease. The following table displays the activity and balances relating to this lease termination liability (in thousands):


	Lease Termination Liability
Balance at July 2, 2006	$	307
Expense recognition		707
Payments		(271	)

Balance at April 1, 2007	$	743

11.	Income Tax Expense (Benefit)

The following schedule reflects the Company’s income tax expense (benefit) (in thousands) and effective tax rates:


	Three Months Ended										Nine Months Ended
	April 1, 2007			Effective Tax Rate		April 2, 2006			Effective Tax Rate		April 1, 2007			Effective Tax Rate		April 2, 2006			Effective Tax Rate
Income (loss) from continuing operations, before tax	$	(472	)			$	(1,224	)			$	141				$	2,260
Loss from discontinued operations		(383	)				(2,320	)				(539	)				(2,969	)

Income (loss) before tax	$	(855	)			$	(3,544	)			$	(398	)			$	(709	)

Income tax expense (benefit) from continuing operations	$	(133	)	28.2	%	$	(700	)	57.2	%	$	6,941		4922.7	%	$	26		1.2	%
Income tax (benefit) on loss from discontinued operations		(151	)	39.4	%		(915	)	39.4	%		(213	)	39.5	%		(1,171	)	39.4	%

Total income tax expense (benefit)	$	(284	)	33.2	%	$	(1,615	)	45.6	%	$	6,728		-1690.5	%	$	(1,145	)	161.5	%

Historically, the Company’s income tax provision is influenced significantly by benefits for FICA tip credits. In the three and nine months ended April 1, 2007, the Company recorded $404,000 and $7,785,000 of deferred income tax expense, respectively, to provide a valuation allowance against a portion of its FICA tip tax credit carryforwards. The valuation allowance was recorded because the Company believes the full realization of such credits is not more likely than not based on the current trends of earnings.

The valuation allowance reflects the belief that the FICA tax expense is more likely than not to be used as a tax deduction instead of a tax credit. Consistent with this belief, it is anticipated that tax provisions for the immediate future will continue to reflect FICA tax expense as a deduction as opposed to a credit.

Typically, an enterprise’s effective tax rate for interim periods is based on a reliable estimate of the effective tax rate for the full fiscal year. The rate used for the three and nine months ended April 2, 2006 was based on this approach. However, partly due to a negative estimated annual tax rate currently expected for fiscal 2007 and other variances in operating results in recent years, the Company believes that the use of a year-to-date provision is appropriate for the April 1, 2007 interim tax provision as permitted under FIN 18: “Accounting for Income Taxes in Interim Periods.” The use of such a method resulted in an income tax expense that differed from the statutory rate as follows (in thousands):


	Three Months Ended			Nine Months Ended
	April 1, 2007			April 1, 2007
Income tax expense (benefit) computed at statutory federal income tax rates	$	(165	)	$	49
FICA tip tax credit		(404	)		(1,144	)
Non-deductible costs		8			27
State income tax provision, net of federal benefit		20			234
Valuation allowance		404			7,785
Other, net		4			(10	)

Income tax expense (benefit)	$	(133	)	$	6,941

12.

Potential Company Sale Expense

On January 11, 2007, the Company announced that a Special Committee of its Board of Directors (“special committee”) had entered into a letter of intent with Kinderhook Industries, LLC to sell all of its assets (other than certain tax assets) to a new entity to be formed by Kinderhook. On March 1, 2007, the Company announced that the letter of intent expired pursuant to its terms and that the special committee was continuing to pursue a sale of the Company and that it had received indications of interest from a number of potential purchasers. There can be no assurance that any transaction will be agreed upon or consummated. As of April 1, 2007, the Company had incurred $499,000 of potential company sale expense related to the above mentioned matter, primarily consisting of legal and special committee expenses.

ITEM 2.

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

Forward-Looking Statements

This Quarterly Report on Form 10-Q and the documents incorporated by reference into the Quarterly Report on Form 10-Q include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. We use words such as “may,” “believe,” “estimate,” “expect,” “plan,” “intend,” “project,” “anticipate” and similar expressions to identify forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events, activities or developments. Our actual results could differ materially from those discussed in or implied by these forward-looking statements. Forward-looking statements include, without limitation, statements relating to, among other things:

•

the ability to successfully develop and implement strategies to increase revenues and profitability;

•

the ability to achieve our key strategic initiatives, including menu changes, bar reinvigoration and real estate site selection strategy;

•

the highly competitive nature of the casual dining restaurant industry;

•

our ability to open and operate additional restaurants profitably;

•

our ability to secure additional debt or equity financing in the future;

•

our ability to control restaurant operating costs, including commodity prices, energy and insurance costs;

•

potential fluctuation in our quarterly operating results due to seasonality and other factors including the levels of pre-opening expenses for new restaurants;

•

the continued service of key management personnel;

•

consumer perceptions of food safety;

•

changes in consumer tastes and trends and general business and economic conditions;

•

our ability to attract, motivate and retain qualified employees;

•

labor shortages or increased labor charges;

•

our ability to protect our name, trademarks, logo and other proprietary information;

•

the impact of litigation and assessments;

•

the impact of federal, state or local government regulations relating to our associates, such as increases in minimum wage, or the sale of food and alcoholic beverages;

•

the ability to fully utilize income tax operating loss and credit carryforwards;

•

the inability to cancel or renegotiate unfavorable leases;

•

the ability to repay or refinance our indebtedness;

•

the ability to maintain effective internal controls;

•

the ability of our restaurants to cover their asset values and avoid asset impairment charges; and

•

the ability to locate a purchaser of the Company and if a definitive agreement is reached, the occurrence of any event, change or other circumstance that could result in the inability to consummate a sale or merger agreement including the inability to obtain shareholder approval or the failure to satisfy other conditions required to complete a sale.

These forward-looking statements are subject to numerous risks, uncertainties and assumptions about us, including the factors described under “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended July 2, 2006 and under “Item 1A. Risk Factors” in this Quarterly Report on Form 10-Q. The forward-looking events we discuss in this Quarterly Report on Form 10-Q might not occur in light of these risks, uncertainties and assumptions. We undertake no obligation and disclaim any obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Readers are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and, therefore, readers should not place undue reliance on these forward-looking statements.

Overview

We are a restaurant company competing in the upscale casual dining market. As of April 1, 2007, we owned and operated 49 restaurants and franchised/licensed 12 restaurants primarily under one of the following names: Champps Americana, Champps Restaurant or Champps Restaurant and Bar. The first Champps opened in 1984. We operate and franchise / license restaurants in 21 states with larger concentrations of restaurants in the upper midwest and mid-atlantic regions. Champps’ menu consists of high quality ingredients, freshly prepared and served with exceptional service in an exciting environment through the use of videos, music, sports and promotions. Our restaurants generally are open seven days a week from 11:00 a.m. to 1:00 a.m. We serve our guests in the dining room and bar area during lunch, after work, during dinner and after dinner during our late night period.

We opened one Company-owned restaurant in fiscal 2006. Also, a licensee/joint venture restaurant, in which we own an eight percent equity interest, opened in the Dallas/Fort Worth airport in October 2005. We do not expect to open any new stores in fiscal 2007. Our growth in fiscal 2006 and thus far in fiscal 2007 has been purposely modest as we concentrated on certain initiatives outlined below aimed at improving our existing operations and redefining our growth plans and site selection criteria. We expect to resume modest growth in fiscal 2008.

We closed three underperforming restaurants in May 2006 and we closed one underperforming restaurant in January 2007. Financial results related to these four restaurants have been classified as discontinued operations in our Consolidated Financial Statements. Also, a franchised location in Omaha, Nebraska closed in January 2007. No decisions have been made relative to the closure of any further locations. The ultimate decision on whether or not to close restaurants will depend on various factors including, without limitation, reaching mutually acceptable termination or lease concession arrangements with the landlords; assessing the alternatives of operating or subleasing to third parties; analyzing the improvement or further deterioration in revenues or profitability; and reviewing various other financial, operational and market considerations.

Our current restaurants range in size from approximately 7,000 square feet to 12,100 square feet, with an average of about 9,200 square feet. We have built smaller restaurants starting in fiscal 2003, averaging approximately 8,400 square feet. Pre-opening expenses have historically averaged approximately $340,000 per restaurant but may increase in the future because of the new accounting requirement directing companies to expense rents during the construction period.

Historically, our primary sources of liquidity for funding our operations and expansion have been cash provided from operations, and standard restaurant financing methods, such as build-to-suit transactions, sale-leaseback transactions, mortgage facilities, notes payable, tenant improvement allowances and equipment financing. Also, in 2003 we issued $15.0 million of 5.5% convertible subordinated notes and warrants and in 2004 we secured a $25.0 million revolving bank credit facility which was amended and extended in October 2006. As of April 1, 2007, we did not have any outstanding borrowings under the bank credit facility.

Key factors that can be used in evaluating and understanding our restaurants and assessing our business include the following:

•

Comparable sales or same store sales—this indicator compares the revenue performance of our restaurants open for more than 18 full months to the same restaurants in the prior year thereby eliminating the impact of new openings in comparing the operations of existing stores. Small changes in comparable sales can have a proportionally higher impact on operating margins because of the high degree of fixed costs associated with operating restaurants.

•

Average unit volumes—a per store average sales amount. This indicator helps us assess the changes in customer traffic, pricing and impact of adding different sized restaurants.

•

Store operating margin—restaurant sales less restaurant-level operating costs (product costs, labor costs, other operating expenses and occupancy). We review store operating margins both in absolute dollar terms and as a percentage of restaurant sales.

Our results, and the results of the restaurant industry as a whole, may be adversely affected by changes in consumer tastes, discretionary spending priorities, national, regional and local economic conditions, demographic trends, consumer confidence in the economy, customer confidence in food safety, traffic patterns, weather conditions, employee availability, state and federal minimum wage requirements and the type, number and location of competing restaurants. Our operating margins are also susceptible to fluctuations in prices of food commodities, costs associated with delivering the products to our stores and other operating necessities such as natural gas and other utility supplies. The timing of revenues and expenses associated with opening new restaurants is also expected to result in fluctuations in our quarterly and annual results. Changes in any of these factors could adversely affect us and our financial results.

Our comparable sales trends have been negative for eleven consecutive quarters after being modestly positive for fiscal year 2004. We believe that certain site selection factors may have contributed to the lower sales, as well as other external factors, (such as the NHL hockey strike for the entire 2004/2005 NHL season) and macro-economic factors affecting consumer spending through fiscal year 2007.

Our average weekly sales per restaurant have also been decreasing over the last several years as our new stores have lower average weekly sales than our existing stores due in part to their reduced size. However, the average sales per square foot for our newer stores have been substantially lower than those of our more established locations. We believe this is due largely to certain underperforming sites selected over the past years. We have implemented a new site selection process which incorporates an improved analytical evaluation, which we believe will lead to better site selection and ultimately to more positive restaurant results.

From a store operating margin perspective, we believe we have generally been successful in controlling our product costs and labor costs over the past several years, however, other operating expenses and occupancy have increased as a percent of restaurant sales primarily due to the fixed nature of these costs over lower average sales volumes for our restaurants. Rising costs coupled with negative comparable sales have also contributed to the decrease in operating margin. In particular, over the last 18 months, we have experienced significantly higher utility costs.

Minimum wage increases have occurred in both the current and the last fiscal year in a number of states where we operate. In addition, effective January 1, 2007, the tipped minimum wage increased in the following states where the Company operates: California, Colorado, Florida, New York, North Carolina, and Ohio. The Company has 16 restaurants in those states. Most of our kitchen staff are paid in excess of minimum wage levels and are typically not affected by the increases, however, our servers and bar staff are generally paid the tipped minimum wage and we generally must pay a higher hourly wage to those individuals as a result of any state mandated tipped minimum wage increase.

Over the last 24 months, we have been working on certain key strategic initiatives outlined herein. We believe we have made significant progress in many of these areas, but our goal of reversing our negative comparable sales trends and ultimately improving our long-term profitability has not yet materialized. We believe that beginning in the second half of fiscal 2006 our efforts were hampered by macroeconomic factors that, were generally believed to negatively impact sales of many companies in the full-service casual restaurant industry. These macroeconomic factors include higher gas prices, higher health care costs, higher interest rates and lower consumer confidence. We plan to continue to pursue our key strategic initiatives and enhancements thereto, described below, as we believe our goals will ultimately be achieved through these initiatives.

•

Menu Changes: Our main goal has been to renew the focus in the menu on popular, memorable and craveable items favored by our customers. We have been and plan to continue revising and improving our menu. The menu changes are intended to allow for better execution, increased quality of our menu items and ultimately greater guest satisfaction. Improving our consistency in food execution will be a key focus to improve guest satisfaction during fiscal 2007.

Also, we revamped our menu specials program in fiscal 2006 and are using the same program in fiscal 2007. Our specials have been developed with the assistance of outside culinary experts and are now featured more prominently within our menu utilizing a full color layout. The specials are also being rotated less frequently than in past years to build consumer trial and improve operational execution. We have seen an increase in our menu mix associated with specials as a result of these efforts.

Because of our confidence in our product offerings, we increased our menu prices by approximately 1.6% in September 2006, and will consider additional increases throughout fiscal 2007.

•

Validation and Training Programs: This continuous improvement effort is aimed at improving our systems and developing our people and culture while creating a heightened awareness of Champps’ mission of offering exceptional food and hospitality to our customers.

Last year, we recertified and validated all of our restaurant managers and we also targeted certain training toward our hourly employees. Heightened and enhanced training will be a key focus for us in fiscal 2007. We are revamping a number of our training programs including use of new training tools and techniques and also providing leadership development programs for select management level employees. We completed a “visioneering” process near the end of fiscal 2006 to define and communicate our foundational ideas, principles and stakeholder commitments with the help of a consultant who pioneered the process. The visioneering program is being rolled-out system-wide in fiscal 2007 as a key focus in our 2007 training program.

•

Bar Reinvigoration: For several years prior to fiscal 2006, our alcohol sales had declined as a percentage of overall revenues. In fiscal 2006 we reversed this trend and for the fiscal 2006 period approximately 28.9% of our restaurant food and beverage sales were attributable to the sale of alcoholic beverages, which is one of the highest alcohol sales percentages in the upscale casual dining market and we have maintained the improvement in fiscal 2007. Our goal has been to attract new customers to our bars by improving service levels, ingredient quality and drink presentation. Over the last year and a half, we have implemented a training program aimed at improving customer service levels, updated or replaced draft beer systems, and added beer mug chillers in all of our restaurants. We also reworked many of our recipes and drink mixes and developed new specialty drinks for promotions. Prices were adjusted based on competitive considerations and we modified happy hour programs in a number of stores to enhance the guest experience.

•

Revised General Manager Bonus Plan: In fiscal 2006, we implemented a more aggressive and performance-based bonus plan for our managers based on monthly unit level cash flow improvements over the prior year. We believe this plan provides our restaurant managers with greater performance-based compensation and an increased sense of accountability and ownership in their restaurant’s success. This bonus plan has been further enhanced by creating cash-flow arrangements under which selected general managers and directors of operations may purchase a cash flow interest in the restaurants they operate and oversee. As of the end of March 2007, 20 of our general managers and five of our directors of operations had executed such agreements. We expect to continue to offer this opportunity to a number of other general managers over the balance of fiscal 2007.

•

Real Estate Strategy: While we do not expect to open any new restaurants in fiscal 2007, our site selection process has been upgraded to include more rigorous evaluation of the success factors for new site development to allow us to achieve our expected investment returns on renewed future growth. To aid in this process, we are using a multi-factor, risk-analysis regression software model, developed by an outside consultant, aimed at accurately predicting sales levels and decreasing the risks associated with opening new restaurants. We expect to resume opening new restaurants in fiscal 2008. Also, as part of our real estate strategy, we closed three underperforming restaurants in May 2006 and closed one underperforming location in January 2007. We also plan to actively monitor and evaluate our restaurant portfolio on an ongoing basis to determine if further closures are warranted.

•

Franchise Development: We value franchising as a potentially profitable function but we purposely did not actively pursue this initiative in fiscal 2006 as we viewed the other initiatives (such as menu design and prototype development) as important precursors to our franchising efforts. We have started to increase our franchising sales efforts in fiscal 2007.

On January 11, 2007, we announced that a Special Committee of our Board of Directors (“special committee”) had entered into a letter of intent with Kinderhook Industries, LLC to sell all of our assets (other than certain tax assets) to a new entity to be formed by Kinderhook. On March 1, 2007, we announced that letter of intent expired pursuant to its terms and that the special committee was continuing to pursue a sale of the Company and that it had received indications of interest from a number of potential purchasers. There can be no assurance that any transaction agreement will be reached or consummated (see “Part II, Item 1A. Risk Factors”).

Our financial results for third quarter of fiscal 2007 ended April 1, 2007 included:

•

Consolidated revenues decreased by 4.8% to $49.2 million reflective of the decreased comparable store sales of 4.3%.

•

A loss from continuing operations before income taxes of $0.5 million was recorded in third quarter of fiscal 2007 compared to a loss from continuing operations before income taxes of $1.2 million in the same quarter of the prior fiscal year. Included in continuing operations results for 2007 was a $0.5 million potential company sale expense and included in continuing operations results for 2006 was a $2.1 million asset impairment charge.

•

A loss from discontinued operations, net of tax, of $0.2 million was recorded during the quarter compared to a loss of $1.4 million during the third quarter of fiscal 2006.

•

Net loss of $0.6 million, or $0.04 diluted loss per share, was reported in the third quarter of fiscal 2007 compared to a net loss of $1.9 million, or $0.15 diluted loss per share, in the third quarter of fiscal 2006.

Financial Definitions

Revenue—Our revenue is comprised of restaurant sales and net franchise royalties and fees. Restaurant sales are comprised almost entirely of food and beverage sales with approximately 0.1% of the restaurant sales represented by sales of Champps’ merchandise and other revenue. In calculating our Company-owned comparable restaurant sales, we include restaurants open at least 18 months. As of April 1, 2007, 48 of our 49 restaurants in operation were included in our comparable sales calculation. In January 2007, one of the Company-owned locations in Pennsylvania was converted from a Champps Americana restaurant to a local tavern concept. The Company is treating this conversion as a new opening from a comparative sales perspective, and therefore, the new tavern will not be included in the comparative sales base until eighteen months following the conversion.

Cost of Sales and Operating Expenses—Product costs are composed primarily of food and beverage expenses. Labor costs include direct hourly and management wages, our restaurant employees’ wages during training, bonuses, workers’ compensation and payroll taxes and benefits for restaurant employees. Other operating expenses includes restaurant supplies, marketing costs specifically related to the restaurants’ activities, utilities, repairs and maintenance, banking and credit card fees and other directly related restaurant costs. Occupancy costs include land and building operating lease rents, percentage rent, common area maintenance charges, general liability and property insurance and real estate and personal property taxes. Pre-opening expenses, which are expensed as incurred, consist of direct costs related to hiring and training the initial restaurant workforce and other expenses incurred prior to the opening of a new restaurant that are directly associated with opening the new restaurants. Pre-opening expense, starting January 2, 2006, also includes rental costs under operating leases incurred during a construction period.

Depreciation and Amortization—Depreciation and amortization principally includes depreciation on capital expenditures for restaurants. Depreciation and amortization excludes corporate level depreciation and amortization, which are included in general and administrative expense.

General and Administrative Expenses—General and administrative expenses include all corporate and administrative functions that support existing operations and provide infrastructure to facilitate our future growth. Components include executive and management salaries, regional supervisory and staff salaries, stock award costs, restaurant manager-in-training wages and costs, bonuses and related employee payroll taxes and benefits, travel, information systems, communication expenses, corporate rent and related occupancy and operating costs, corporate depreciation and amortization and professional and consulting fees.

Other Financial Definitions—Severance expense consists of the cost associated with the separation agreements with certain former employees. Asset impairment charges and restaurant closings / disposals relate to the write-down of assets of certain under-performing restaurants to their estimated fair value and costs for exits and closures which are not classified as discontinued operations. Other (income) expense, net generally consists of gains or losses on asset disposals primarily from asset replacements. Interest expense and income, net consists of interest expense on notes payable and capitalized lease obligations and amortization of loan fee costs partially offset by interest income earned on excess cash balances and interest capitalized as part of the construction process. Expenses related to predecessor companies consist of expenses for indemnity obligations related to the spin-off of DAKA in 1997. Discontinued operations consist of operating results, asset impairment charges and exit and closure costs for the three restaurants closed in May 2006 and the one restaurant closed in January 2007. Discontinued operations are reported on a basis net of income taxes.

Fiscal Calendar—We utilize a 52/53 week fiscal year ending on the Sunday closest to June 30th. The third quarters of fiscal 2007 and fiscal 2006 both consisted of 13 weeks.

Results of operations

The following table sets forth certain financial information for the Company (dollars in thousands).


	Three Months Ended										Nine Months Ended
	April 1, 2007					April 2, 2006					April 1, 2007					April 2, 2006
Revenue:
Sales	$	49,055		99.6	%	$	51,485		99.7	%	$	150,482		99.7	%	$	157,177		99.7	%
Franchising and royalty, net		173		0.4			174		0.3			525		0.3			468		0.3

Total revenue		49,228		100.0	%		51,659		100.0	%		151,007		100.0	%		157,645		100.0	%

Cost of sales and operating expenses (as a percentage of sales)
Product costs		13,868		28.2	%		14,462		28.1	%		42,959		28.6	%		44,082		28.1	%
Labor costs		16,191		33.0			16,192		31.4			48,944		32.5			49,428		31.4
Other operating expenses		7,990		16.3			7,987		15.5			24,130		16.0			23,905		15.2
Occupancy		5,092		10.4			5,208		10.1			15,343		10.2			15,572		9.9
Pre-opening expenses		—		—			78		0.2			—		—			157		0.1

Total cost of sales and operating expenses		43,141		87.9			43,927		85.3			131,376		87.3			133,144		84.7
(as a percentage of total revenue)
General and administrative expenses		3,164		6.4			3,710		7.2			9,906		6.6			10,539		6.7
Depreciation and amortization		2,586		5.3			2,739		5.3			7,778		5.2			8,262		5.2
Severance		—		—			5		—			(136	)	(0.1	)		110		0.1
Asset impairment charges and restaurant closings/disposals		—		—			2,136		4.1			530		0.4			2,136		1.4
Potential company sale expense		499		1.0			—		—			499		0.3			—		—
Other expense, net		157		0.3			131		0.3			269		0.2			286		0.2

Income from operations		(319	)	(0.6	)		(989	)	(1.9	)		785		0.5			3,168		2.0

Other expense:
Interest expense, net		153		0.4			237		0.5			632		0.4			913		0.6
Expense (income) related to predecessor companies		—		—			(2	)	—			12		—			(5	)	—

Income (loss) from continuing operations, before tax		(472	)	(1.0	)		(1,224	)	(2.4	)		141		0.1			2,260		1.4
Income tax expense (benefit)		(133	)	(0.3	)		(700	)	(1.4	)		6,941		4.6			26		—

Income (loss) from continuing operations		(339	)	(0.7	)		(524	)	(1.0	)		(6,800	)	(4.5	)		2,234		1.4
Loss on discontinued operations, net of tax		232		0.5			1,405		2.7			326		0.2			1,798		1.1

Net income (loss)	$	(571	)	(1.2	)%	$	(1,929	)	(3.7	)%	$	(7,126	)	(4.7	)%	$	436		0.3	%

Restaurant operating weeks (a)		637					637					1,911					1,911
Restaurant sales per operating week	$	77.0				$	80.8				$	78.7				$	82.2
Number of restaurants (end of period)
Company-owned (a)												49					49
Franchised												12					13

Total restaurants												61					62

(a)	Excludes three restaurants closed in May 2006 and one restaurant closed in January 2007, whose results have been classified as discontinued operations.

Our sales fluctuate seasonally and therefore our quarterly results are not necessarily indicative of results that may be achieved for a full fiscal year. For fiscal years 2006 and 2005, our relative sales were highest in our second quarter (October through December), followed by our third quarter (January through March), then by our first quarter (July through September). Our fourth quarter (April through June) recorded the lowest relative sales for those years. Factors influencing sales variability in addition to those noted above include the frequency and popularity of sporting events, holidays (including which day of the week the holiday occurs) and weather.

Third Quarter (13 Weeks) of Fiscal 2007 Ended April 1, 2007 Compared to the Third Quarter (13 Weeks) of Fiscal 2006 Ended April 2, 2006

Total revenue. Total revenue decreased by $2.5 million, or 4.8%, to $49.2 million in the third quarter of fiscal 2007 from $51.7 million for the comparable prior year period. The decrease was due to a comparable same store sales decrease of 4.3% for the third quarter of fiscal 2007 compared to our third quarter of last year. During the third quarter of fiscal 2007, comparable same store food sales decreased 3.4% while comparable same store alcohol sales decreased 6.5%. Restaurant sales per operating week for all restaurants decreased $3,815, or 4.7%, to $77,009 in the third quarter of fiscal 2007 from $80,824 for the comparable quarter in the prior year.

The average guest check in our dining room, excluding alcoholic beverages, was approximately $14.07 for the third quarter of fiscal 2007 compared to $13.73 for the third quarter of fiscal 2006, a 2.5% increase. During the third quarter of fiscal 2007, food sales and alcoholic beverage sales represented 71.5% and 28.5% of our total sales, respectively. During the third quarter of fiscal 2006, food and alcoholic beverage sales represented 70.9% and 29.1% of our total food and beverage sales, respectively.

Our sales in the third quarter of fiscal 2007 were affected by adverse weather conditions in many of the markets where the Company operates. As a whole, companies in the casual dining industry, especially those with a substantial presence in the Midwestern and Eastern markets of the United States, experienced a decline in same store sales during the months of January and February due in part to the inclement weather conditions.

Cost of Sales and Operating Expenses

Product costs. Product costs decreased by $0.5 million, or 3.5%, to $13.9 million in the third quarter of fiscal 2007 from $14.4 million in the comparable prior year period. Product costs as a percentage of restaurant sales were 28.2% for fiscal 2007 and 28.1% for fiscal 2006. The increased product cost as a percentage of restaurant sales resulted primarily from higher costs spread across many of the food cost categories.

Labor costs. Labor costs were $16.2 million in both the third quarter of fiscal 2007 and in the comparable prior year period. Labor costs as a percentage of restaurant sales increased to 33.0% in the third quarter of fiscal 2007 from 31.4% in the comparable prior year period. The increase was due primarily to higher server and bartender costs from tipped minimum wage increases principally in our eleven stores in Ohio and Colorado, higher kitchen and management labor costs as a percentage of restaurant sales resulting primarily from the lower average sales per restaurant and higher bonus costs as a result of the rollout of the partnership bonus program, which started in March 2006.

Other operating expense. Other operating expense was $8.0 million in both the third quarter of fiscal 2007 and in the comparable prior year period. Other operating expense as a percentage of restaurant sales increased to 16.3% in the third quarter of fiscal 2007 from 15.5% in the same prior year quarter. The increase as a percent of sales resulted primarily from higher marketing costs and the impact of lower average sales per restaurant on utility costs.

Occupancy. Occupancy expense decreased $0.1 million, or 1.9%, to $5.1 million in the third quarter of fiscal 2007 from $5.2 million in the comparable prior year period. Occupancy expense decreased due primarily to reduced property tax and general insurance costs. Occupancy expense as a percentage of restaurant sales was 10.4% in the third quarter of fiscal 2007 and 10.1% in the comparable prior year period.

Total Cost of Sales and Operating Expenses. Total cost of sales and operating expenses decreased $0.8 million, or 1.8%, to $43.1 million in the third quarter of fiscal 2007 from $43.9 million in the comparable prior year quarter primarily for the reasons described above.

General and administrative expenses. General and administrative expenses decreased by $0.5 million, or 13.5%, to $3.2 million in the third quarter of fiscal 2007 from $3.7 million in the comparable prior year period. General and administrative expenses decreased as a result of lower legal costs and reduced support staff levels partially offset by higher bonus expense as a result of the rollout of the partnership bonus program to directors of operations, which started in May 2006. General and administrative expenses as a percentage of total revenue decreased to 6.4% for the third quarter of fiscal 2007 from 7.2% in the third quarter of fiscal 2006.

Depreciation and amortization. Depreciation and amortization expense decreased $0.1 million, or 3.7%, to $2.6 million for the third quarter of fiscal 2007 from $2.7 million in the comparable prior year period. The decrease was primarily due to reduced depreciation on assets whose values were written down in conjunction with an asset impairment charge of $2.1 million recorded in the third quarter of fiscal 2006. We estimate that an additional $0.2 million of depreciation and amortization expense would have been recorded in the third quarter of fiscal 2007 absent the asset impairment charge. Depreciation and amortization expense as a percentage of revenue was 5.3% in both the third quarter of fiscal 2007 and in the third quarter of fiscal 2006.

Asset impairment charges and restaurant closings / disposals. An asset impairment / disposal charge of $2.1 million was recorded in the third quarter of fiscal 2006 for two locations whose future cash flows are not expected to cover their carrying values.

Potential company sale expense. Potential company sale expense of $0.5 million was recorded in the third quarter of fiscal 2007 versus none in the comparable prior year period. The expense related to legal and board of directors’ special committee costs associated with the potential sale of the Company.

Income (loss) from continuing operations, before income taxes. Income (loss) before income taxes improved $0.7 million to a loss of $0.5 million in the third quarter of fiscal 2007 compared to a loss of $1.2 million in the comparable prior year quarter primarily for the reasons described above.

Income tax expense (benefit). For the third quarter of fiscal 2007, we recorded an income tax benefit of $0.1 million compared to an income tax benefit of $0.7 million in the comparable prior year quarter, largely reflective of the different levels of pre-tax loss recorded in each respective year and a $0.4 million charge in the third quarter of fiscal 2007 for a valuation allowance placed against our FICA tip tax credit carryforwards because full realization of such credits is not more likely than not because of the trend in earnings.

Loss on discontinued operations, net of tax. Loss on discontinued operations, net of tax was $0.2 million in the third quarter of fiscal 2007 and $1.4 million in the third quarter of fiscal 2006. The net loss in fiscal 2007 was due largely to costs associated with the closure of one restaurant in January 2007, net of tax benefit. The net loss in fiscal 2006 largely relates to asset impairment costs associated with one restaurant which ultimately closed in May 2006, net of tax benefit.

Nine Months (Thirty-Nine Weeks) of Fiscal 2007 Ended April 1, 2007 Compared to the Nine Months (Thirty-Nine Weeks) of Fiscal 2006 Ended April 2, 2006

Total revenue. Total revenue decreased $6.6 million, or 4.2%, to $151.0 million in the first nine months of fiscal 2007 from $157.6 million for the comparable period in the prior fiscal year. The decrease was due to a comparable same store sales decrease of 4.0% for the first nine months of fiscal 2007 compared to our first nine months of last year. During the first nine months of fiscal 2007, comparable same store food sales decreased 3.9% while comparable same store alcohol sales decreased 4.3%. Restaurant sales per operating week for all restaurants decreased $3,504, or 4.3%, to $78,745 in the first nine months of fiscal 2007 from $82,249 for the comparable period in the prior year.

The average guest check in our dining room, excluding alcoholic beverages, was approximately $14.04 for the first nine months of fiscal 2007 compared to $13.71 for the first nine months of fiscal 2006, a 2.4% increase. During the first nine months of fiscal 2007, food sales and alcoholic beverage sales represented 71.0% and 29.0% of our total sales, respectively. During the first nine months of fiscal 2006, food and alcoholic beverage sales represented 70.9% and 29.1% of our total food and beverage sales, respectively.

In addition to the inclement weather in the third quarter of fiscal 2007, we also believe that our sales were negatively impacted in the first nine months of fiscal 2007 by lower consumer discretionary spending due to higher fuel and utility costs, higher interest rates, and rising health care costs.

Cost of Sales and Operating Expenses

Product costs. Product costs decreased by $1.1 million, or 2.5%, to $43.0 million in the first nine months of fiscal 2007 from $44.1 million in the comparable prior year period. Product costs as a percentage of restaurant sales increased to 28.6% for fiscal 2007 from 28.1% for fiscal 2006. The increased product cost as a percentage of restaurant sales resulted from higher produce, grocery and seafood costs partially offset by lower poultry and beef costs.

Labor costs. Labor costs decreased by $0.5 million, or 1.0%, to $48.9 million in the first nine months of fiscal 2007 from $49.4 million in the comparable prior year period. Labor costs as a percentage of restaurant sales increased to 32.5% in the first nine months of fiscal 2007 from 31.4 % in the comparable prior year period due primarily to higher kitchen and management labor costs as a percentage of restaurant sales resulting primarily from the lower average sales per restaurant, increases in the tipped minimum wage in certain states, higher bonus costs as a result of the rollout of the partnership bonus program, which started in March 2006 and higher workers compensation costs.

Other operating expense. Other operating expense increased by $0.2 million, or 0.8%, to $24.1 million in the first nine months of fiscal 2007 from $23.9 million in the comparable prior year period. Other operating expense as a percentage of restaurant sales increased to 16.0% in the first nine months of fiscal 2007 from 15.2% in the same prior year quarter. The increase as a percent of sales resulted primarily from higher marketing costs. In the first quarter of fiscal 2007, $0.3 million was spent on testing radio advertising in two markets.

Occupancy. Occupancy expense decreased by $0.3 million, or 1.9%, to $15.3 million in the first nine months of fiscal 2007 from $15.6 million in the comparable prior year period. Occupancy expense decreased primarily due to reduced general and property insurance costs. Occupancy expense as a percentage of restaurant sales increased to 10.2% in the first nine months of fiscal 2007 from 9.9% in the comparable prior year period due to the lower average restaurant sales.

Total Cost of Sales and Operating Expenses. Total cost of sales and operating expenses decreased by $1.7 million, or 1.3%, to $131.4 million in the first nine months of fiscal 2007 from $133.1 million in the comparable prior year period primarily for the reasons described above.

General and administrative expenses. General and administrative expenses decreased by $0.6 million, or 5.7%, to $9.9 million in the first nine months of fiscal 2007 from $10.5 million in the comparable prior year period. General and administrative expenses decreased as a result of reduced support staff levels, reduced compensation expense for stock-based compensation, reduced legal costs and reduced relocation expense partially offset by higher professional fees, bonus and tax costs. The higher bonus expense resulted from the rollout of the partnership bonus program to directors of operations, which started in May 2006. General and administrative expenses as a percentage of total revenue decreased to 6.6% for the first nine months of fiscal 2007 from 6.7% in the first nine months of fiscal 2006.

Depreciation and amortization. Depreciation and amortization expense decreased by $0.5 million, or 6.0%, to $7.8 million for the first nine months of fiscal 2007 from $8.3 million in the comparable prior year period. The decrease was primarily due to reduced depreciation on assets whose value was written down in conjunction with an asset impairment charge of $2.1 million recorded in the third quarter of fiscal 2006. We estimate that an additional $0.5 million of depreciation and amortization expense would have been recorded in the first nine months of fiscal 2007 absent the asset impairment charge. Depreciation and amortization expense as a percentage of revenues was 5.2% in the first nine months of both fiscal 2007 and fiscal 2006.

Severance. A severance expense of negative $0.1 million was recorded in the first nine months of fiscal 2007 compared to $0.1 million in the first nine months of fiscal 2006. The $0.1 million credit related to the reversal of a previously accrued severance expense that will not be paid. The fiscal 2006 severance expense related to payments to six employees whose services with the Company were terminated.

Asset impairment charges and restaurant closings / disposals. An asset impairment charge of $0.5 million was recorded in the first nine months of fiscal 2007 for one location whose future cash flows are not expected to cover its carrying value and to write-off the development costs for a new location project which will not be pursued. An asset impairment charge of $2.1 million was recorded in the first nine months of fiscal 2006 for two locations whose future cash flows were not expected to cover their carrying value.

Interest expense, net. Interest expense, net decreased by $0.3 million, or 33.3%, to $0.6 million for the first nine months of fiscal 2007 from $0.9 million in the comparable prior year period. The decrease was due to higher interest income from larger invested excess cash balances.

Income from continuing operations, before income taxes. Income before income taxes decreased by $2.2 million to income of $0.1 million in the first nine months of fiscal 2007 compared to income of $2.3 million in the comparable prior year period primarily for the reasons described above.

Income tax expense/(benefit). For the first nine months of fiscal 2007, we recorded an income tax expense of $6.9 million compared to an income tax expense of approximately zero in the comparable prior year period. The tax expense for the first nine months of fiscal 2007 included a $7.8 million charge for a valuation allowance placed against our FICA tip tax credit carryforwards because full realization of such credits is not more likely than not because of the trend in earnings.

Loss on discontinued operations, net of tax. Loss on discontinued operations, net of tax was $0.3 million in the first nine months of fiscal 2007 and $1.8 million in the comparable period of fiscal 2006. The net loss in fiscal 2007 was due largely to costs associated with the closure of one restaurant in January 2007 and the change in estimate of sublease costs for one restaurant closed in fiscal 2006, net of tax benefit. The net loss in fiscal 2006 largely relates to asset impairment costs associated with one restaurant which ultimately closed in May 2006, net of tax benefit.

Liquidity and Capital Resources

As of April 1, 2007, our cash balance was $17.3 million, which reflects a $7.9 million increase during the fiscal year. Our cash balance and working capital needs are generally low, as sales are made for cash or through credit cards that are quickly converted to cash, purchases of food and supplies and other operating expenses are generally paid within 30 to 60 days after receipt of invoices and labor costs are paid bi-weekly. The timing of our sales collections and vendor and labor payments are consistent with other companies in the restaurant industry.

In the first three quarters of fiscal year 2007, we generated cash flow from operating activities of $9.0 million and in the first three quarters of fiscal year 2006, we generated cash flow from operating activities of $11.1 million. The decrease in cash flow from operations from the first three quarters of 2007 compared to same period in 2006 was primarily due to reduced profitability and $2.0 million of proceeds from tenant improvement allowances received in the first three quarters of fiscal 2006, partially offset by increased cash from working capital changes. Tenant improvement allowances are reimbursements received from certain of our

landlords for a portion of our initial construction expenditures. Our operating cash flow is enhanced by our ability to utilize net operating loss carryforwards and other tax credits to offset our federal income tax liability. At April 1, 2007, we had $36.5 million of such gross net operating loss carryforwards and $12.0 million of tax credits available through 2027 to offset federal taxes.

Historically, a significant portion of our cash flow generated from operating activities has been invested in capital expenditures, the majority of which was for the construction of new restaurants. However, we significantly reduced our new restaurant growth in fiscal 2006 and fiscal 2007. We opened only one new restaurant in fiscal 2006, the capital expenditures of which were mostly incurred in the prior year and we do not expect to open any new restaurants in fiscal 2007. We expect to resume modest growth in fiscal 2008. The following table, in thousands, details our capital expenditures.


	Nine Months Ended
	April 1, 2007		April 2, 2006
New store construction	$	110	$	424
Existing store remodel and refurbishment		3,026		2,679
Corporate related capital expenditures		114		193

Purchase of property and equipment	$	3,250	$	3,296

We expect to spend from $4.5 million to $5.0 million for capital expenditures for fiscal 2007. These expenditures will primarily be used for upgrades to existing restaurants but are expected to include expenditures for a new restaurant expected to open in fiscal 2008. We review our capital expenditures budget frequently and accordingly, stated amounts are subject to change.

We have a $25.0 million senior secured credit facility, which expires in September 2010. We initially used a portion of the facility to refinance certain of our existing debt, and the facility may also be used to support opening new restaurants and general working capital needs and provide up to $7.0 million for the issuance of letters of credit. The facility provides for a $10.0 million one-time increase in the aggregate commitment amount if requested by us between September 30, 2007 and December 31, 2007 and approved by the lenders. The facility is secured by a blanket lien on all of our personal assets and real property. Borrowings under the facility will bear interest depending on a total funded debt to EBITDA ratio and can range from the prime rate to prime plus 0.5 percent or, if elected by us, LIBOR plus 1.8 to 3.0 percent. Total funded debt is defined as all indebtedness of our consolidated entities, including senior and subordinated debt, capital lease obligations and contingent liabilities. We originally paid an up-front fee of $188,000 and are required to pay an annual unused commitment fee of 0.375 to 0.5 percent.

The facility limits our opening of new company-owned restaurants to a maximum of eight in any fiscal year and also sets limits on the amount of dividends and/or stock repurchases that can be made by us to $2.0 million per fiscal year if the total senior debt to EBITDA ratio is equal to or more than 1.00 to 1.00. Also, we must maintain a margin of at least .25 to 1.00 with each of our financial covenants in order to declare dividends or re-acquire stock through share repurchases. As of April 1, 2007, we had no outstanding borrowings under this facility and had placed letters of credit of $3.5 million under the facility with $21.5 million available for additional borrowing.

The facility requires us to maintain a minimum fixed charge coverage ratio and tangible net worth level and not exceed certain thresholds for total funded debt to EBITDA and total senior debt to EBITDA ratios. EBITDA is defined in the facility as “(the) Consolidated Entities’ net income for such period, plus (a) without duplication the sum of (i) interest expense, (ii) federal and state income taxes, (iii) depreciation and amortization expenses, (iv) start-up costs associated with the opening of new restaurants, (v) one-time prepayment fees associated with payment in full of all Indebtedness of Borrower that is pre-paid at the Closing Date with proceeds from the 3-Year Loan, (vi) non-cash impairment expenses associated with write down of assets, and (vii) non-cash stock-based compensation expenses; minus (b) without duplication, extraordinary gains, in each case as charged against (or added to, as the case may be) revenues to arrive at net income for such period, all as determined in accordance with GAAP.” As of April 1, 2007, we were in compliance with all debt covenants and financial ratios contained in the facility.

In addition, we have $15.0 million of principal amount outstanding 5.5% convertible notes due December 2007. The notes are convertible at the option of the holder at any time prior to maturity into shares of common stock at a conversion price of $10.66 per share, subject to adjustment upon certain events. At any time on or after December 15, 2005, we may redeem some or all of the notes at par plus accrued and unpaid interest. There are no assurances that the convertible debt holders will convert their debt into common shares prior to December 2007, nor are there any assurances that the stock price will rise, allowing us to automatically convert the debt. If the debt is not converted, or repaid as part of a sale transaction discussed below, we expect to either pay the debt off with available cash, proceeds from borrowings under our facility, refinanced term debt, or by a combination of these sources. If we seek additional financing there are no assurances that we will be able to obtain new financing at that time, and the terms of any new debt may not be as favorable as our existing financing arrangements.

In January 2006, our Board of Directors approved and announced a plan to use up to $5 million to repurchase our common stock from time to time over the next two years. Through April 1, 2007, we purchased 191,480 shares of common stock for $1.3 million under this plan. No purchases occurred in the quarter ended April 1, 2007. Purchases under the program may be made in the open market or in private transactions. Purchases under the program depend, among other factors, on the prevailing stock price, market conditions, limitations under debt agreements, alternative investment opportunities and are expected to be funded primarily with available cash balances and operating cash flow. There is no minimum or maximum number of shares to be repurchased under the program. The repurchased shares will be held in treasury and used for issuance under our equity incentive plans. We have never declared or paid dividends on our common stock and currently have no plans to do so.

We closed three restaurants in May 2006 and closed another restaurant in January 2007. We resolved our lease obligations with respect to one location in June 2006 and one in January 2007 through lease terminations at a cost of $1.6 million, which was recognized during the fourth quarter of fiscal year 2006. We purchased one of the closed locations from the owner for $3.2 million and we subsequently sold the property for $2.6 million in November 2006. We are still paying rent for the other closed location, which we expect to sublease. Ultimately, we believe that the net cash cost will be approximately $3 to $4 million to exit all four locations. No decisions have been made regarding the closure of any further locations. The ultimate decision on whether or not to close additional restaurants will depend on various factors including, without limitation, reaching mutually acceptable closure or lease concession arrangements with the landlords; assessing the alternatives of operating or subleasing to third parties; analyzing the improvement or further deterioration in revenues or profitability; and reviewing various other financial, market, and operational considerations.

During the first three quarters of fiscal 2007 and all of fiscal 2006, we did not incur any significant costs related to predecessor company matters. During fiscal 2005 and fiscal 2004, we expended approximately $2.2 million for settlements and on-going legal costs related to the predecessor company matters. We believe that such costs in the future will not be significant. For additional information regarding our commitments and contingencies, including our payments associated with our predecessor company activities, please refer to the information provided under Note 9 “Commitments and Contingencies”, to the accompanying unaudited consolidated financial statements.

We believe our cash flow from operations, together with funds available under our $25.0 million credit facility (under which we have $21.5 million available as of April 1, 2007) will be sufficient to fund our operations, debt repayment, share repurchases, expansion and any additional potential restaurant closure costs at least through the the next twelve months. However, changes in our operating plans, acceleration of our expansion plans, lower than anticipated sales, increased expenses or other events, including those described previously under “Forward Looking Statements” and in “Part II, Item 1A. Risk Factors” may cause us to seek additional debt or equity financing on an accelerated basis. Additional financing may not be available on acceptable terms, or at all, and our failure to raise capital when needed could negatively impact our growth plans and our financial condition and results of operations. Any additional equity financing may be dilutive to the holders of our common stock and debt financing, if available, may involve significant cash payment obligations and covenants and/or financial ratios that could restrict our ability to operate or grow our business.

On January 11, 2007, we announced that a Special Committee of our Board of Directors (“special committee”) had entered into a letter of intent with Kinderhook Industries, LLC to sell all of our assets (other than certain tax assets) to a new entity to be formed by Kinderhook. On March 1, 2007, we announced that the letter of intent expired pursuant to its terms and that the special committee was continuing to pursue a sale of the Company and that it had received indications of interest from a number of potential purchasers. There can be no assurance that any transaction agreement will be reached or consummated.

Contractual obligations and commitments

Payments, including interest, due by period as of April 1, 2007 (in thousands).


Contractual obligations	Total		One year and less		Two to three years		Four to five years		After five years
Operating leases	$	179,820	$	15,758	$	31,948	$	29,770	$	102,344
Long-term debt		15,859		15,859		—		—		—
Letters of credit		3,481		3,481		—		—		—
Royalties		20,709		370		783		847		18,709

	$	219,869	$	35,468	$	32,731	$	30,617	$	121,053

We are obligated under non-cancelable operating leases for our headquarters and all but one of our restaurants. The fixed terms of the restaurant leases range up to 20 years and generally contain multiple renewal options for various periods ranging from five to 20 years. The table, as presented above, includes only the non-cancelable portion of our leases as we are only obligated for that period. Our restaurant leases also contain provisions that require additional percentage rent payments based on achieving threshold sales performance and the payment of common area maintenance charges and real estate taxes. Amounts in this table do not reflect any of these additional amounts.

Our debt is comprised of a $15.0 million issuance of 5.5% convertible notes due December 2007. The notes are convertible at the option of the holder at any time prior to maturity into shares of common stock, at a conversion price of $10.66 per share, subject to adjustment upon certain events. At any time on or after December 15, 2005, we may redeem some or all of the notes at par plus accrued and unpaid interest. There are no assurances that the convertible debt holders will convert their debt into common shares prior to December 2007, nor are there any assurances that the stock price will rise, allowing us to automatically convert the debt. If the debt is not converted, or repaid as part of a sale transaction, it may be necessary for us to seek additional financing when this debt matures. If we seek additional financing there are no assurances that we will be able to do so at that time, and the terms of the debt may not be as favorable as our existing debt.

We have letters of credit outstanding to guarantee performance under insurance contracts and to secure other arrangements. The letters of credit are irrevocable and have one-year renewable terms.

We are obligated to pay a licensing fee for the use of the “Champ’s” and “Champps” service marks, trademarks and trade names. Although this agreement runs in perpetuity as long as we are using the names, under “royalties” in the schedule above we have presented only 30 years of our obligation.

Critical Accounting Policies

The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements. The estimates and assumptions are evaluated on an on-going basis and are based on historical experience and on various other factors that are believed by us to be reasonable under the circumstances.

Items significantly impacted by estimates and judgments include, but are not limited to, loss contingencies generally related to litigation and assessments, self-insured risks relating to workers’ compensation, general liability and medical claims, the useful lives and recoverability of our long-lived assets such as property and equipment, goodwill and other intangibles, lease accounting, fair value of stock based compensation including estimating forfeitures, valuation of deferred tax assets and the recording of income tax expense.

Loss contingencies and self-insurance reserves

We maintain accrued liabilities and reserves relating to the resolution of certain contingent obligations and reserves for self-insurance. Significant contingencies may include those related to litigation and state tax assessments. We account for contingent obligations in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 5, “Accounting for Contingencies,” as interpreted by FASB Interpretation No. 14: Reasonable Estimation of the Amount of a Loss which requires that we assess each contingency to determine estimates of the degree of probability and range of possible settlement. Contingencies which are deemed to be probable and where the amount of such settlement is reasonably estimable are accrued for in our financial statements. If only a range of loss can be determined, we accrue to the best estimate within that range; if none of the estimates within that range is better than another, we accrue to the low end of the range.

We are self-insured for a significant portion of our employee health benefits, workers’ compensation and general liability programs. However, we maintain stop-loss coverage with third party insurers to limit our individual claim and total exposure under those programs. We estimate our accrued liability for the ultimate costs to close known claims, including claims incurred but not yet reported to us as of the balance sheet date. Our recorded estimated liability for self-insurance is based on the insurance companies incurred loss estimates and management’s judgment, including assumptions and factors related to the frequency and severity of claims, our claims development history and our claims settlement practices.

The assessment of loss contingencies and self-insurance reserves is a highly subjective process that requires judgments about future events. Contingencies are reviewed at least quarterly to determine the adequacy of the accruals and related financial statement disclosure. The ultimate settlement of loss contingencies and self-insurance reserves may differ significantly from amounts we have accrued in our consolidated financial statements.

Useful lives of property and equipment

Land, buildings, leasehold improvements and equipment are recorded at cost less accumulated depreciation. These assets are depreciated using the straight-line method over the shorter of the estimated useful lives of the assets or reasonably assured lease term for leasehold improvements. These estimates may produce materially different amounts of reported depreciation and amortization expense if different assumptions were used. As discussed further below, these judgments may also impact our need to recognize an impairment charge on the carrying amount of these assets as the cash flows associated with the assets are realized. The annualized effect of a one year increase in the estimated useful lives of our property and equipment would decrease our depreciation expense by approximately $0.9 million. The effect of a one year decrease in the estimated useful lives would increase our depreciation expense by approximately $1.1 million.

Valuation of long-lived assets

We evaluate the carrying value of long-lived assets including property, equipment and related identifiable intangible assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” Under SFAS No. 144, an assessment is made to determine if the sum of the expected future undiscounted cash flows from the use of the assets and eventual disposition is less than the carrying value. If the sum of the expected undiscounted cash flows is less than the carrying value, an impairment loss is recognized based on fair value.

We separately evaluate each individual restaurant for impairment. Generally, a restaurant is not evaluated for impairment until it has been open a full six quarters, as the initial two quarters of operations are generally characterized by operating inefficiencies associated with start-up operations. However, we may review a restaurant sooner for impairment if it is operating significantly below our expectations or other factors indicate that impairment could be likely. We consider a total of four trailing quarters of negative cash flow or losses to be an indication that an individual restaurant may be impaired. In evaluating whether an impairment charge is appropriate, we estimate the future cash flows for such potentially impaired restaurants utilizing such factors as restaurant sales trends, local conditions, demographics and competition, management plans and initiatives and other factors deemed appropriate in the circumstances.

During the second quarter of fiscal 2007, we recorded an asset impairment charge of $0.3 million covering one restaurant. During the third quarters of fiscal 2006 and 2005, we recorded asset impairment charges of $4.3 million covering six restaurants and $6.6 million covering four restaurants, respectively, part of which was classified as discontinued operations. Additionally, six restaurants open for at least six quarters had cash flows which would not cover any of the restaurants’ long-term asset values if such cash flows continue for the remainder of the restaurants’ lives. As of April 1, 2007, the long-lived asset value of these six restaurants was $7.0 million. We have not recorded an impairment charge at this time for these restaurants because our management believes certain plans can be implemented to improve the future prospects of those restaurants.

We evaluate impairment of goodwill and other unidentifiable intangible assets in accordance with SFAS No. 142 “Goodwill and Other Intangible Assets.” Under the provisions of SFAS No. 142, we are required to assess impairment at least annually by means of a fair value-based test. At July 2, 2006, we evaluated our goodwill and determined that the goodwill was not impaired. The determination of fair value requires us to make certain assumptions and estimates related to our business and is highly subjective, and accordingly, actual amounts realized may differ significantly from our estimate.

Leases

We lease most of our properties including our corporate office. We account for our leases under the provisions of SFAS No. 13 and SFAS No. 98, both entitled “Accounting for Leases”, as well as other subsequent amendments and authoritative literature. To classify the lease as either an operating or a capital lease we use the non-cancelable term of the lease if there is no penalty to cancel the lease at the conclusion of the non-cancelable period. If a penalty exists, we use the non-cancelable period plus option(s) in determining the term to use when classifying the lease. A penalty is deemed to occur if we would forego an economic benefit, or suffer an economic detriment by not renewing the lease. This penalty can either be pursuant to the lease provisions or can arise from the retirement of an asset with value. This same lease term is used to calculate straight-line rent and in calculating depreciation expense for our leasehold improvements. We record the total rent payable during the lease term on a straight-line basis over the term of the lease and record the difference between the rent paid and the straight-line rent as a deferred rent liability. Lease incentive payments (“tenant improvement allowances”) received from landlords are recorded as deferred rent liabilities and are amortized on a straight-line basis over the lease term as a reduction in rent. The FASB has announced its intention to review lease accounting standards and future authoritative changes to the methods of accounting for leases could have a material impact on the Company’s reported results of operations and financial position.

Stock-based compensation

We have granted stock options and restricted stock awards to certain employees and non-employee directors. Effective at the beginning of fiscal 2006, we account for stock-based compensation in accordance with the fair value recognition provisions of SFAS No. 123 (Revised), “Accounting for Stock-Based Compensation.” Under the fair value provisions of SFAS No. 123(R), stock-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the requisite service period (usually the vesting period). Determining the fair value of stock-based awards at the date requires judgment, including estimating the expected term of stock options, the expected volatility of our stock and expected dividends. In addition, judgment is also required in estimating the amount of stock-based awards that are expected to be forfeited. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially impacted.

Valuation of deferred tax assets

We recognize deferred tax assets and liabilities for the future tax consequences attributable to temporary differences between the carrying value for financial reporting purposes and the tax basis of assets and liabilities in accordance with SFAS No. 109, “Accounting for Income Taxes.” Deferred tax assets and liabilities are recorded using the enacted tax rates expected to apply to taxable income in the years in which such differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities, resulting from a change in tax rates, is recognized as a component of income tax expense (benefit) in the period of enactment. Net operating loss and other credit carryforwards, including FICA tip tax credits, are recorded as deferred tax assets. A valuation allowance is recorded for the tax benefit of the deferred tax assets that are not considered more likely than not to be utilized based on projected future taxable income, feasible tax planning strategies and the reversal of temporary taxable differences. As of April 1, 2007, we had net deferred tax assets of $26.6 million. In the first three quarters of fiscal 2007 ended April 1, 2007, we recorded a $7.8 million income tax expense to provide a valuation allowance against our FICA tip tax credit carryforwards we now believe are less than likely to be fully realized over the carryforward period based on current trends of income. We currently believe that it is still more likely than not that we will be able to realize our deferred tax assets related to our net operating loss carryforwards. However, negative evidence such as cumulative net losses over a period of time or continued reductions in the level of operating results may cause us to conclude that it is not likely that we are going to be able to realize all or a portion of our net deferred tax assets and we would record additional valuation allowance accordingly. As of April 1, 2007, we had federal net operating loss carryforwards of approximately $36.5 million, expiring at various dates through 2023 and gross FICA tip credit carryforwards of approximately $12.0 million, expiring at various dates through 2027.

Income tax provision

Certain components of our provision for income taxes are estimated. These estimates include, among other items, effective rates for local and state taxes, allowable tax credits for items such as FICA taxes paid on reported tip income, estimates related to depreciation and amortization allowable for tax purposes, and the tax deductibility of certain other items.

Our estimates are based on the best available information at the time that we prepare the provision. We generally file our annual income tax returns many months after our fiscal year-end. Income tax returns are subject to audit by federal, state and local governments, generally years after the returns are filed. These returns could be subject to material adjustments or differing interpretations of the tax laws.

New and Future Accounting Pronouncements

In June 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections,” which requires entities that voluntarily make a change in accounting principle to apply that change retrospectively to prior period’s financial statements, unless this would be impracticable. SFAS No. 154 supersedes Accounting Principles Board Opinion No. 20, “Accounting Changes” (“APB 20”), which previously required that most voluntary changes in accounting principle be recognized by including in the current period’s net income the cumulative effect of changing to the new accounting principle. SFAS No. 154 also makes a distinction between “retrospective application” of an accounting principle and the “restatement” of financial statements to reflect the correction of an error. SFAS No. 154 applies to accounting changes and error corrections that are made in fiscal years beginning after December 15, 2005. The Company adopted SFAS No. 154 in fiscal 2007 and the adoption did not have a material impact on its financial statements.

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements (“SAB 108”), which provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. SAB 108 is effective for fiscal years ending after November 15, 2006. The adoption of SAB 108 did not have a material impact on our Condensed Consolidated Financial Statements.

ITEM 3.

Quantitative and Qualitative Disclosures about Market Risk

We are exposed to market risk primarily from changes in interest rates and changes in commodity prices.

We are subject to interest rate market risk for short-term invested cash and cash equivalents. The principal of such invested funds is not subject to fluctuating value because of their highly liquid short-term nature. As of April 1, 2007, we had $18.7 million of such funds invested in short-term maturing investments.

Many of the ingredients purchased for use in the food and beverages sold to our guests are subject to unpredictable price volatility outside of our control. We try to manage this risk by entering into selective short-term pricing agreements for the products we use extensively. Also, we believe that our commodity cost risk is diversified as many of our food products are available from several sources and we have the ability to modify product recipes or vary our menu items offered. Historically, we have also been able to increase certain menu prices in response to food commodity price increases and believe the opportunity may exist in the future. To compensate for a hypothetical price increase of 10% for food and beverages, we would need to increase prices charged to our guests by an average of approximately 2.9%. We have not used financial instruments to hedge our commodity product prices.

ITEM 4.

Controls and Procedures

Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit to the Securities and Exchange Commission (the “Commission”) under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified by the Commission’s rules and forms, and that information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. The effectiveness of our disclosure controls and procedures is subject to certain limitations, including the exercise of judgment in designing, implementing and evaluating the controls and procedures, the assumptions used in identifying the likelihood of future events, and the inability to eliminate errors or misconduct completely. As a result, there can be no assurance that our disclosure controls and procedures will detect all errors or fraud. By their nature, any system of internal control, including our system, can provide only reasonable assurance regarding management’s control objectives.

Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of April 1, 2007, the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of April 1, 2007.

Changes in Internal Control Over Financial Reporting

During the fiscal quarter ended April 1, 2007, there was no change in our internal control and procedures over financial reporting (as defined in Rule 13a-15(f) under the Securities and Exchange Act, as amended) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II—OTHER INFORMATION

ITEM 1.

Legal Proceedings

See “Note 7. Commitments and Contingencies–Litigation” in “Notes to Unaudited Consolidated Financial Statements.”

ITEM 1A.

Risk Factors

Information regarding risk factors appears in “Item 2. MD&A – Forward-Looking Statements,” and various risks faced by us are also discussed elsewhere in “Item 2. MD&A” of this Report on Form 10-Q. In addition, risk factors are included in Part I-Item 1 of our Report on Form 10-K for the fiscal year ended July 2, 2006. In addition to these risk factors, the failure to complete a proposed sale with the investment entity (or other party) could likely have an adverse effect on us.

On January 11, 2007, we announced that a Special Committee of our Board of Directors (“special committee”) had entered into a letter of intent with Kinderhook Industries, LLC to sell all of our assets (other than certain tax assets) to a new entity to be formed by Kinderhook. On March 1, 2007, we announced that the letter of intent expired pursuant to its terms and that the special committee was continuing to pursue a sale of the Company and that it had received indications of interest from a number of potential purchasers. There can be no assurance that any transaction agreement will be reached or consummated. We would be subject to several risks as a result of a merger or sale agreement, including the following:

•

If a definitive agreement is not signed and a sale is not completed, the share price of our common stock may change to the extent that the current market price of our common stock reflects an assumption that the sale would be completed;

•

Certain costs related to the sale, including legal, accounting and financial advisory fees, must be paid even if the sale is not completed;

•

Shareholder lawsuits may be filed against us in the event the Company enters into an agreement for a sale transaction; and

•

Our management and employees’ attention may be diverted from day-to-day operations;

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Shares

In January 2006, our Board of Directors approved a plan to use up to $5.0 million to repurchase our common stock from time to time over the next two years. Purchases under the program may be made in the open market or in private transactions. Purchases under the program will depend, among other factors, on the prevailing stock price, market conditions, alternative investment opportunities and are expected to be funded primarily with available cash balances and operating cash flow. There is no minimum or maximum number of shares to be repurchased under the program. The repurchased shares will be held in treasury and used for issuance under our equity incentive plans. No shares were repurchased during the third quarter ended April 1, 2007. As of April 1, 2007, under this authorization we have repurchased a total of 191,480 shares of our common stock for approximately $1.3 million.

ITEM 3.

Defaults upon Senior Securities

Not applicable.

ITEM 4.

Submission of Matters to a Vote of Security Holders

Not applicable.

ITEM 5.

Other Information

Not applicable.

ITEM 6.

Exhibits


Exhibit Number		Description
2.1		Kinderhook Industries, LLC letter of intent to purchase assets of Champps Entertainment, Inc., incorporated herein by reference to the Company’s Current Report on Form 8-K filed January 17, 2007.

31.1		Certification of Michael P. O’Donnell pursuant to Section 302 of the Sarbanes Oxley Act of 2002.

31.2		Certification of David D. Womack pursuant to Section 302 of the Sarbanes Oxley Act of 2002.

32.1		Certification of Michael P. O’Donnell pursuant to Section 906 of the Sarbanes Oxley Act of 2002.

32.2		Certification of David D. Womack pursuant to Section 906 of the Sarbanes Oxley Act of 2002.

SIGNATURES

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


	CHAMPPS ENTERTAINMENT, INC.
	(Registrant)

May 9, 2007	By:	/s/ Michael P. O’Donnell
		Michael P. O’Donnell
		Chairman of the Board, President and Chief Executive Officer
		(Principal Executive Officer)

May 9, 2007	By:	/s/ David D. Womack
		David D. Womack
		Chief Financial Officer and Treasurer
		(Principal Financial and Accounting Officer)

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CHAMPPS ENTERTAINMENT INC 10-Q