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                UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549

                                   FORM 10-KSB

(Mark One)      [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
                       OF THE SECURITIES EXCHANGE ACT OF 1934
                    For the fiscal year ended December 31, 1996

                                       OR

              [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
                     OF THE SECURITIES EXCHANGE ACT OF 1934
                     For the transition period from ____ to

                           Commission File No. 1-13840
                                               -------

                             PUDGIE'S CHICKEN, INC.
             ------------------------------------------------------
             (Exact name of registrant as specified in its charter)

Delaware                                              31-1369735
---------------------------------                 -------------------
(State or jurisdiction of                          (I.R.S. Employer
incorporation or organization)                    Identification No.)

333 Earle Ovington Boulevard, Suite 604, Uniondale, NY             11553
------------------------------------------------------        -----------------
(Address of principal executive offices)                         (zip code)

Registrant's telephone number, including area code:             (516)222-8833
                                                              -----------------

Securities registered pursuant to Section 12(b) of the Exchange Act:  None

                                                     Name of Each Exchange
           Title of Class                            on which Registered
           --------------                            --------------------------
Common Stock, par value $.01 per share               The Boston Stock Exchange
--------------------------------------
          (Title of class)
    Common Stock Purchase Warrants                   The Boston Stock Exchange
--------------------------------------
          (Title of class)

Securities registered under Section 12(g) of the Exchange Act:  None

Check  whether the issuer (1) filed all reports  required to be filed by Section
13 or 15(d) of the  Exchange  Act during the past 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
                                                              -----

Check if there is no disclosure of delinquent filers in response to Items 405 of
Regulation S-B in this form, and no disclosure will be contained, to the best of
registrant's   knowledge,   in  definitive   proxy  or  information   statements
incorporated  by reference  in Part III of this Form 10-KSB or any  amendment to
this Form 10-KSB. [X]

The issuer's revenues for the year ended December 31, 1996 were $11,404,006

The aggregate market value of the voting stock held by  non-affiliates(1) of the
Registrant  as of April 8,  1997  Common  Stock,  par  value  $.01 per share was
$3,961,819.

Indicate  by check mark  whether  the  registrant  has filed all  documents  and
reports  required  to be filed by  Section  12,  13 or 15 (d) of the  Securities
Exchange Act of 1934 subsequent to the distribution  of  securities under a plan
of  reorganization  confirmed by a US Bankruptcy  Court. Yes X   No
                                                            ---

State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date

                 Class                            Outstanding at April 8, 1997
--------------------------------------            ----------------------------
Common Stock, par value $.01 per share                   4,488,385 shares

                   EXHIBIT Index Page 65. Page 1 of 66 pages.

Transitional Small Business Disclosure Format (check one): Yes    No  X
                                                                     ---

1   As used herein, "voting stock held by non-affiliates" means shares of Common
    Stock held by persons other than  executive  officers, directors and persons
    holdings in excess of 5% of the registrant's Common Stock. The determination
    of market value of the Common Stock is based on the last reported sale price
    as  reported  by the  Nasdaq  National  Market  on the date  indicated.  The
    determination of the "affiliate"  status for purposes of this report on Form
    10-K shall not be deemed a  determination  as to whether an individual is an
    "affiliate" of the registrant for any other purposes.






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PART I

ITEM 1.        DESCRIPTION OF BUSINESS

GENERAL

        Pudgie's  Chicken,  Inc. (the "Company")  owns,  operates and franchises
quick service Pudgie's"r" restaurants  featuring  Pudgie's  specially  prepared,
fresh, skinless fried chicken. The first Pudgie's restaurant was opened in 1981;
franchising  activities  began in 1988; the Company was incorporated in Delaware
in January 1993 and acquired the Pudgie's  restaurant  business from its founder
("Pudgie's  Acquisition")  in August  1993.  Currently,  there  are 47  Pudgie's
restaurants  in  operation,  consisting  of 17  Company-owned  and 29 franchised
restaurants in six states, chiefly in New York and New Jersey and one franchised
restaurant operating in Indonesia.

        Pudgie's  restaurants  offer consumers  tasty,  wholesome food at low to
modest prices,  based on their core menu of fresh,  skinless fried chicken.  The
Company attributes the good taste of Pudgie's fried chicken to the use of fresh,
bone-in chicken,  which is never frozen,  and the breading of the chicken in the
Company's  proprietary "dry batter" mix. The use of skinless chicken reduces fat
and cholesterol content and, the Company believes, enhances the cooking process.
Pudgie's restaurants offer a variety of other main dishes, such as fried shrimp,
fried clams,  baby back ribs and grilled  chicken  sandwiches,  and a variety of
complementary side dishes,  including french fries, mashed potatoes, corn on the
cob,  potato salad and buttermilk  biscuits.  The suggested  retail price of the
Pudgie's 12 Piece Chicken  Dinner,  which includes  mashed  potatoes,  salad and
dinner rolls,  and is intended to feed a family of four or more, is $14.99.  The
average check for a Pudgie's  order during 1996 was  approximately  $11.75.  The
restaurants are designed to have a clean,  efficient  appearance,  are typically
850 to  1,300  square  feet in size and are  usually  situated  inside  shopping
centers and similar locations in residential areas. Most of the restaurants have
limited or no eat-in  capacity and emphasize home delivery and take-out  orders.
The Company's anticipated cash investment for a new Company-owned  restaurant of
average size is approximately $150,000, inclusive of pre-opening costs.

        The Company derives its revenues from Company-owned restaurants and from
franchise royalty and advertising fees paid by Pudgie's franchisees and from the
sale of franchisees.

        On June 30, 1995, Gallus Investments, L.P. ("Gallus"), an area developer
of the Company's franchised restaurants, commenced an action against the Company
alleging common law fraud and alleging  violations of the Franchise Sales Act of
the State of New York regarding its area development agreement with the Company.

        On September 12, 1996, a panel of the American  Arbitration  Association
rendered  an award  against  the Company in favor of Gallus.  In  rendering  the
award,  the  arbitrators  determined that the Company had violated the Franchise
Sales Act of the State of New York. The award was in the amount of $1,375,888 in
damages and  $331,516 in attorney  fees.  A motion to confirm  this award in the
United States District Court for the Eastern  District of Virginia was stayed as
a result of the Company's bankruptcy filing (as described below).

        The Company was also  experiencing  significant  cash flow  problems and
accumulated certain arrearages on account of sales tax, rent and supplies.

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        On various dates from September 18, 1996 through  October  10,1996,  the
Company and its various  subsidiaries filed voluntary petitions for relief under
the  provisions of Chapter 11 of the  Bankruptcy  Code (the "Chapter 11 Cases").
The accompanying  consolidated financial statements do not purport to reflect or
provide for the potential  consequences  of the  bankruptcy  proceedings  of the
Company. In particular,  the consolidated financial statements do not purport to
show (a) as to assets,  their realizable  value on a liquidation  basis or their
availability  to satisfy  liabilities;  (b) as to prepetition  liabilities,  the
amounts  that may be  allowed  for  claims or  contingencies  or the  status and
priority thereof; (c) as to shareholder accounts, the effect of any changes that
may be made to the capitalization of the Company;  or (d) as to operations,  the
effect of any  changes  that may be made in its  business.  The outcome of these
matters is not presently determinable.  Accordingly,  the consolidated financial
statements  do not  include  adjustments  that might  result  from the  ultimate
outcome of these uncertainties.

        Following the  commencement of the Chapter 11 Cases, the Company and its
subsidiaries continued to operate its business as "debtors-in-possession"  under
the  protection  of the  Bankruptcy  Court.  The  Bankruptcy  Court has  certain
supervisory  powers over the  Debtors'  operations  during the Chapter 11 Cases,
which are generally  limited to reviewing and ruling on any objections raised to
the Debtors' operations or proposed outside of the ordinary course transactions.
The Debtors must notify parties in interest and obtain Bankruptcy Court approval
of any  transactions  that are outside the ordinary course of business,  such as
any sale of a major asset of the Debtors.  In addition,  the Debtors must obtain
Bankruptcy Court approval of certain other  transactions,  such as the borrowing
of money on a secured  basis or the  employment of  attorneys,  accountants  and
other professionals.

        An  immediate  effect  of the  filing  of the  Chapter  11 Cases was the
imposition of the automatic stay under the Bankruptcy  Code which,  with limited
exceptions,  enjoins  the  commencement  or  continuation  of  all  pre-petition
litigation  against,  and  efforts to collect  funds  from,  the  Debtors.  This
injunction  remains  in  effect  unless  modified  or  lifted  by  order  of the
Bankruptcy Court.

        Bankruptcy  proceedings  are  limited  solely to the  Debtors  and their
assets  and  properties.  The  Company's  franchises  are  not  included  in the
bankruptcy  proceedings  and, as such,  are not subject to the provisions of the
federal bankruptcy laws or the supervision of the Bankruptcy Court.

        The accompanying consolidated financial statements have been prepared on
a going concern  basis,  which  contemplates  the  realization of assets and the
satisfaction  of liabilities  in the normal course of business.  The Company has
been operating as a debtor-in-possession since filing for bankruptcy protection.
While the Company  believes it has adequate  financing to operate in  bankruptcy
for a limited  period of time,  its ability to continue  operations is dependent
upon,  among other things,  confirmation of a plan of  reorganization  that will
enable the Company to emerge from bankruptcy  proceedings,  obtaining additional
capital  or  other   financing   to  fund   distributions   under  the  plan  of
reorganization  and provide  working  capital.  There is no assurance  that such
financing  will occur.  These  factors,  among  others,  indicate  that there is
substantial doubt that the Company will be able to continue as a going concern.

COMPANY OBJECTIVES

        The Company's objectives include the following:

               Core, High Quality Menu. The Company offers a core menu featuring
        fresh, skinless,  fried chicken and a variety of side dishes designed to
        complement the Company's chicken.  The skinless bone-in chickens used at
        Pudgie's  restaurants  are  never  frozen  and  are  delivered  to

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        each  restaurant  twice a week in special  air-tight  packaging  to help
        ensure  freshness.  The  skinless  Chicken is  breaded in the  Company's
        proprietary "dry batter" mix and then fried in low cholesterol vegetable
        oil.

               Value.  The Company  believes that its menu provides  convenient,
        moderate to low-cost multiple meal combinations for couples, families or
        larger groups. For example,  the Pudgie's 12 Piece Chicken Dinner, which
        includes mashed potatoes, salad and dinner rolls, has a suggested retail
        price of $14.99,  and is intended to feed a family of four or more.  The
        average check for Pudgie's order during 1996 was approximately $11.75.

               Emphasis on Delivery and Take-out  Orders.  The Company  believes
        that its emphasis on delivery and take-out  orders has been  integral to
        the success of Pudgie's  restaurants in the past and will continue to be
        an  important  factor  in the  future.  Delivery  allows  customers  the
        convenience of having  Pudgie's food at home,  and the Company  believes
        that its ability to provide  delivery  gives it a competitive  advantage
        over other fast food restaurants that do not provide delivery.

               Franchise System. The Company is committed to developing a strong
        franchise  system by seeking  experienced  operators,  by expanding in a
        controlled  manner and by  monitoring  closely the  performance  of each
        franchisee  to help  ensure  adherence  to the  Company's  standards  of
        operation,  subject  to  local  and  regional  variances,  where  deemed
        appropriate.  The Company is committed to provide its  franchisees  with
        assistance  in  employee   training,   marketing,   site  selection  and
        restaurant  design.  With its emphasis on delivery and take-out,  rather
        than eat-in facilities, the Company seeks to locate Pudgie's restaurants
        at smaller secondary  locations,  thereby avoiding the larger spaces and
        higher costs typically  associated with eat-in facilities at higher rent
        locations.

               Site  Selection.  The  Company's  policy  is to open (or have its
        franchisees  open)  Pudgie's   restaurants  in  secondary  locations  at
        strip-shopping  centers and similar sites in residential  areas having a
        population  density  of  30,000 to 50,000  persons  within a  three-mile
        radius of the  restaurant.  Typically  850 to 1,300  square feet in size
        (including 500 square feet for kitchen operations), Pudgie's restaurants
        are  designed  to have a clean,  efficient  appearance,  generally  with
        limited or no eat-in capacity.

               Purchasing and Supplies.  The Company sets quality  standards for
        all  products  used in  Pudgie's  restaurants  and  designates  approved
        outside  suppliers of food and paper  products  that meet the  Company's
        quality  standards.  To ensure  product  quality  and  consistency,  all
        Pudgie's restaurants are required to purchase the Company's  proprietary
        "dry batter" mix.  Franchisees  may purchase  other goods  directly from
        approved  suppliers.  The Company  has  negotiated  national  purchasing
        agreements with most of its suppliers. These agreements typically enable
        the  Company's  franchisees  to purchase  supplies at prices below those
        that could normally be obtained by them independently.  Currently,  most
        Pudgie's  restaurants  obtain their fresh,  skinless  chicken from Rocco
        Chicken,  Inc. and their other chicken  products from Tyson Foods,  Inc.
        Distribution  to the  restaurants  of  chicken  and  other  standardized
        supplies is handled by Sysco  Corporation,  a  nationwide  food  service
        distributor.  The Company's  distribution system also takes advantage of
        volume   purchasing  of  food  and  supplies,   and  helps  to  maintain
        consistency among the restaurants. The Company believes that alternative
        suppliers of chicken are available at competitive prices.

                                       4




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RESTAURANT LOCATIONS

        The following table sets forth the locations and number of Company-owned
and franchised restaurants at December 31, 1996:

-------------------------------------------------------------------------------
                            NUMBER OF COMPANY-OWNED     NUMBER OF FRANCHISED
STATE                             RESTAURANTS               RESTAURANTS

-------------------------------------------------------------------------------
New York                               17                          23
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New Jersey                              1                           2
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Maryland                                0                           2
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Connecticut                             0                           1
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North Carolina                          0                           1
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Ohio                                    0                           1
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California                              0                           1
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TOTAL                                  18                          31
                                       ==                          ==
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        The Company acquired one and six franchised restaurants, during 1996 and
1995, respectively and opened four additional Company-owned  restaurants in each
year.  Seven  and five  franchised  restaurants  were  closed  in 1996 and 1995,
respectively, due to the failure of the franchisee to comply with the provisions
of the  franchise  agreement.  As a  result  of the  foregoing,  the  number  of
Company-owned  restaurants  in operation has  decreased  from 26 at December 31,
1995 to 18 at December 31, 1996. The number of franchised  restaurants decreased
from 36 at December 31, 1995 to 31 at December 31, 1996.

COMPANY-OWNED RESTAURANT OPERATIONS

        The Company  closed one additional  Company-owned  restaurant in January
1997. The Company currently owns and operates 17 restaurants. A typical Pudgie's
restaurant employs a restaurant  manager and 10 to 14 hourly employees,  five to
seven of which are delivery personnel.  Most of the employees work part-time and
are paid on an hourly basis.

THE FRANCHISE SYSTEM

        The Company believes that its franchise system is vital to the Company's
continued  operations.  There are  currently 29  franchised  restaurants  in six
states,  primarily  in New York and New  Jersey  and one  franchised  restaurant
operating in  Indonesia.  The Company is unable to access the impact the Chapter
11 filing will have on its franchising efforts going forward.

        Approval.  Franchisees  are  approved  on the  basis of the  applicant's
business  background,  restaurant  operating experience and financial resources.
The Company  seeks to attract both  qualified  franchisees  for single units and
experienced  multi-unit  franchisees willing to make a substantial investment in
development of targeted areas.

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        Company Assistance and Support. Business format franchises,  such as the
Company's,  offer the  franchise  owner a trademark,  logo and a system of doing
business.  The Company  furnishes each  franchisee  with assistance in selecting
sites and developing restaurants.  Franchisees are responsible for selecting the
location  for  their  restaurants  but  must  obtain  Company  approval  of each
restaurant design and each location based on accessibility and visibility of the
site and targeted demographic factors, including population density, income, age
and traffic.  The franchisee also receives  assistance with personnel  training,
advertising and marketing and product  supply.  The Company  provides  training,
research and development and support for the entire franchise system.

        Franchise  Operations.  The Company requires  franchisees to comply with
its  specifications  as to space,  menu items,  principal food  ingredients  and
day-to-day operations. Design and decor vary among locations, subject to Company
approval.   In  addition,   product   preparation   follows  uniform  ingredient
specifications and cooking processes.  Standardized  customer service procedures
are supported by a training  curriculum for both  franchisees  and the Company's
restaurant  management  personnel.  Employees receive standardized training from
the Company in food preparation, operating procedures and customer service. Each
franchisee  has full  discretion  to  determine  the prices to be charged to its
customers.

        Franchise  Agreements.  The initial term of a franchise  agreement is 10
years.  The  Company has  established  an initial  franchise  fee of $30,000 per
location.  The renewal fee is also currently $30,000.  Franchisees pay a royalty
fee of 5% of  gross  sales  and an  advertising  fee of 3% of gross  sales.  The
Company has both a right of first refusal and the right to approve or disapprove
the  proposed  transfer  of a  franchise.  The  Company  also  has the  right to
terminate  any  franchise  agreement  for a  variety  of  reasons,  including  a
franchisee's  failure  to make  payments  when due or  failure  to adhere to the
Company's policies and standards.

        Franchise  Financing.   The  Company  has  a  financing  agreement  with
Stephen's  Franchise  Financing  which  provides a $15,000,000  credit  facility
available  to the  Company's  franchisees  which  meet  both the  Company's  and
Stephen's  credit  approval  requirements.  The  Company  does not  receive  any
remuneration  if financing is granted to a franchisee but believes the financing
agreement  is  beneficial  in  attracting  franchisees.  The  specific  terms of
financing by Stephen's are negotiated separately with each franchisee.

        In the  event  that a  franchisee  is in  default  under  the  Stephen's
Agreement,  the Company is  required,  for a period of 90 days,  to use its best
efforts  to  either  sell  the  restaurant  or the  equipment  of the  defaulted
franchisee to a successor  franchisee  who agrees to assume the  obligations  to
Stephen's of the defaulted  franchisee.  If a successor  franchisee is not found
within 90 days,  the Company must pay  Stephen's  all accrued  interest then due
Stephens  by the  defaulted  franchisee  and must  continue  to seek a successor
franchisee  for an additional 180 days. If at the end of such period a successor
franchisee  has not been  located,  the Company  must  either  assume all of the
defaulted  franchisee's  obligations  under its agreement  with Stephen's or pay
Stephen's the  unamortized  principal  balance owed by the defaulted  franchisee
plus certain other costs; however, the Company's liability for such a pay-off is
limited to $1,500,000  or 30% of the total amount funded by Stephen's  under the
Stephen's   Agreement,   whichever   is  greater.   As  of  December  31,  1996,
approximately $14,600,000 of this facility remained available.  Pursuant to this
agreement,  the  Company  is  obligated  to the  financial  institution  for the
outstanding  balances  of two  closed  franchised  locations  for  $225,000.  At
December  31,  1996,  such amount has been  included in  liabilities  subject to
compromise.  In addition,  the Company is contingently  liable for the remaining
balances of two franchised locations of $187,000.

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        Area  Development  Agreements.  Initiated in late 1988 by the  Company's
predecessor,  the  franchise  program was  initially  sold  primarily  to single
restaurant  owner-operators  in the Long Island and greater New York areas.  The
Company has emphasized  area  development  agreements  since it began  operating
Pudgie's  restaurants in 1993.  Parties to area development  agreements agree to
develop an area by opening a  predetermined  number of units within a designated
span of time.

        Area development  agreements  provide for the development of a specified
number  of  restaurants  within a  delineated  territory  in  accordance  with a
schedule of dates. The entire development  schedule generally covers two to five
years and has restaurant  operation  benchmarks for the number of restaurants to
be  opened  and  in  operation  at  six-month  intervals.  An  area  developer's
restaurant development schedule may also encompass concurrent development by the
area  developer in multiple area  development  agreements or sub-areas  thereof.
Area developers currently pay a development fee, which is negotiated between the
Company and the  developer.  Such  payments  are made when the area  development
agreement  is  executed  and  are  nonrefundable.  Area  development  agreements
generally  provide  that  the area  developer  has the  exclusive  right to open
Pudgie's  restaurants  within  the  specified  territory  during the term of the
development  schedule,  except  that the area  development  agreement  generally
provides that the Company  reserves the right to engage in special  distribution
arrangements  and, if the area  developer  does not choose to develop  them,  to
develop  alternative  retail concept sites and conversion  sites within the area
developer's  specified territory or sub-areas.  Alternative retail concept sites
are sites that the Company  believes  should be  developed  for  competitive  or
market reasons regardless of the applicable development schedule or the location
of pre-existing sites.

        Failure to meet  development  schedules  or other  breaches  of the area
development  agreement  may  lead  to  termination  of the  limited  exclusivity
provided  by  the  agreements,   renegotiation   of  development  and  franchise
provisions,  or termination of the right to build future  restaurants,  although
such  termination does not generally  affect existing  franchise  agreements for
developed locations.

        Once an acceptable lease for an approved  restaurant site has been fully
executed,  the Company and the area developer  enter into a franchise  agreement
under  which  the  area  developer  becomes  the  franchisee  for  the  specific
restaurant to be developed at the site.

COMPETITION

        The food service industry is intensely  competitive with respect to food
quality, concept, restaurant location, service and price. In addition, there are
many  well-established  food  service  competitors  with  substantially  greater
financial and other  resources  than the Company and with  substantially  longer
operating  histories.  The Company believes that it competes with other take-out
food service  companies,  fast-food  restaurants,  casual  full-service  dine-in
restaurants,  delicatessens,  cafeteria-style buffets, and prepared food stores,
as well as with  supermarkets  and  convenience  stores.  Many of the  Company's
competitors have achieved  significant  national,  regional and local brand name
and product  recognition  and engage in extensive  advertising  and  promotional
programs, both generally and in response to efforts by additional competitors to
enter new markets or introduce  new  products.  In addition,  the  quick-service
delivery/takeout  industry is characterized by the frequent  introduction of new
products accompanied by substantial  promotional campaigns.  Also, the number of
chicken take-out or restaurant  establishments and the number of larger national
restaurant,  fast-food, and grocery chains offering chicken has increased in the
past few years providing more direct  competition for certain  customers.  Also,
one or more national food service chains or other  companies  could  introduce a
multi-unit  chain of food service  establishments  that  resemble the  Company's
concept.

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        The Company  believes that it competes  effectively with other fast food
restaurants  primarily on the basis of food quality,  taste, price and quick and
courteous service.

MARKETING

        Franchised  restaurants  are  currently  required  to  remit 3% of their
revenues to cooperative  advertising and promotion campaigns administered by the
Company.  These  campaigns  make use of print and other media and  emphasize the
trademarked  Pudgie's name and Pudgie's  chicken logo,  known as the "Pudgster".
The  Company  circulates  direct  mail  packages  from  time to  time  to  place
promotional  offers in the local consumer's hands. The Company uses the services
of a direct bulk mail  facility  and sends  promotional  offers to its  existing
customer  base to  increase  repeat  customer  sales.  During  1996 the  Company
expended approximately $745,000, on print advertising and other promotions.

TRADEMARKS AND SERVICE MARKS

        The Company  believes its rights in its trademarks and service marks are
significant  to its  business.  The  Company is the owner of the  United  States
registration of the trademark "Pudgie's" and of the Pudgie's chicken logo (known
as the  "Pudgster").  The Company has also registered  "Pudgie's Famous Chicken"
and design as a trademark in the United  States.  In  addition,  the Company has
registered in the United States "America's Favorite Skinless Chicken Since 1981"
and design as a  trademark  and  service  mark.  "The Bird is the Word" and "The
In-Place to Take-Out"  are  registered  as service  marks.  The Company has also
registered  "Pudgie's  Famous  Chicken"  and  design  in  a  number  of  foreign
countries.  It is the  Company's  policy  to  pursue  registration  of its marks
whenever possible and to vigorously oppose any infringement of its marks.

GOVERNMENT REGULATION

        The  Company  is  subject  to  federal,   state  and  local   government
regulations,  including  those relating to the  preparation and sale of food and
those  relating to building  and zoning  requirements.  The Company and its area
developers and  franchisees are also subject to federal and state laws governing
their   relationship  with  employees,   including  minimum  wage  requirements,
overtime,  working and safety  conditions,  and  citizenship  requirements.  The
Company  believes that it and its  franchisees  are in material  compliance with
these provisions.

        In  addition,  the  Company is subject to the Federal  Trade  Commission
("FTC")  regulation  and  various  state laws that  govern  the offer,  sale and
termination  of,  and  refusal  to renew,  franchises.  Several  state laws also
regulate substantive aspects of the franchisor-franchisee  relationship. The FTC
requires the Company to furnish  prospective  franchisees  a franchise  offering
circular  containing  prescribed  information.  A number  of states in which the
Company might  consider  franchising  also  regulate the sale of franchises  and
require  registration of the franchise offering circular with state authorities.
Substantive  state laws that  regulate  the  franchisor-franchisee  relationship
presently exist in a substantial  number of states.  The state laws often limit,
among other things, the duration and scope on non-competition provisions and the
ability of a franchisor to terminate or refuse to renew a franchise. The Company
believes that its operations comply  substantially  with the FTC regulations and
state franchise laws.

                                       8




<PAGE>
<PAGE>

EMPLOYEES

        As of December  31, 1996,  the Company  employed 304 persons (of whom 65
were  full-time  employees).  None of the  Company's  employees are covered by a
collective  bargaining  agreement.   The  Company  believes  that  its  employee
relations are satisfactory.

ITEM 2. DESCRIPTION OF PROPERTY

        The  Company  leases  its  principal   executive  offices,   located  in
Uniondale,  New York, at an annual rent of $145,000 subject to a 12% increase in
the  next  three  years  for a term  expiring  in  November  1999.  All  Company
restaurant  sites are leased by the Company from third  parties.  The restaurant
leases expire on dates  ranging from January 1, 1999 to November 30, 2014,  with
the  majority  providing  for  renewal  options.  All of the leases  require the
Company to maintain the property and pay the cost of insurance and taxes.

ITEM 3. LEGAL PROCEEDINGS

        On June 30, 1995, Gallus, an area developer of the Company's  franchised
restaurants,  commenced  an action  against  the Company  alleging,  among other
claims,  common law fraud and violations of the Franchise Sales Act of the State
of New York regarding its area development agreement with the Company.

        On September 11, 1996, a panel of the American  Arbitration  Association
rendered  an award  against  the Company in favor of Gallus.  In  rendering  the
award,  the  arbitrators  determined that the Company had violated the Franchise
Sales Act of the State of New York. The award was in the amount of $1,375,888 in
damages and  $331,516 in attorney  fees.  A motion to confirm  this award in the
United States District Court for the Eastern  District of Virginia had initially
been stayed as a result of the Company's  bankruptcy  filing.  The amount of the
award has been recorded as a liability subject to compromise by the Company.

        On September 18, 1996 the Company filed a voluntary  petition for relief
under  the  provisions  of  Chapter  11 of  the  Bankruptcy  Code.  For  further
discussion,  see Item 1 "Business  Description"  and Note 1 to the  Consolidated
Financial Statements included in this Form 10-KSB.

        On March 25,  1997,  the  Bankruptcy  Court  lifted the  automatic  stay
imposed  upon  filing the  Chapter 11 petition in order to permit the Company to
petition  the federal  court in Virginia to vacate the  arbitration  award while
simultaneously allowing Gallus to petition for confirmation of the award.

        The Company is involved in other court proceedings and claims incidental
to Company business. As a result of the filing of the Chapter 11 Cases, lawsuits
in which the Company is named as a defendant are stayed as to the Company.

        The Company is a defendant in eight separate causes of action brought by
a franchisee and its principals which allege that the Company misrepresented the
demographics  of the  franchisee's  franchise  territory.  The franchisee  seeks
$2,500,000  in damages and  $1,000,000  in punitive  damages under each cause of
action.

        The Company is a defendant in litigation  alleging  infringement  on the
plaintiff's  franchise  area.  The plaintiff  seeks damages of $1,250,000 and an
injunction  prohibiting  the Company from doing  business  within the  exclusive
franchise area allegedly granted to the franchisee. The Company intended

                                       9




<PAGE>
<PAGE>

to file a motion to dismiss the  complaint  based upon the fact that a franchise
agreement  does not exist  between  the  plaintiff  and the Company and that any
illicit  transfer of the franchise rights to a party not approved by the Company
constituted a termination of the franchisee's  franchise.  The motion to dismiss
was not filed due to the Company's  voluntary  petition  under Chapter 11 of the
United States Bankruptcy code.

        The  Company  has  brought  an  action  in New York  against  one of its
franchisees  seeking  approximately  $77,000 in unpaid  royalty and  advertising
fees. The franchisee counterclaimed and seeks $15,000,000 for the alleged breach
of the franchise agreement.

        The Company is the defendant in an action brought by a franchisee  which
seeks  damages of  approximately  $668,000  for the alleged  breach of franchise
agreement and  violations of the Texas Consumer  Protection  Act. The franchisee
was  initially  given  the  right to  develop  two  restaurants  in  Texas.  The
franchisee  opened only one  restaurant  which was closed  within one year after
opening.  The  complaint  alleges  that  the  Company  is  responsible  for  the
restaurant's failure.

        There are 243 claims scheduled and/or filed in the Company's  bankruptcy
case. The face amount of the claims are  $163,023,600.  Many of these claims are
contingent,  duplicate and/or disputed.  Based on the review of the claims,  the
Company  estimates  that the actual dollar amount of claims that will be allowed
is approximately $7.4 million.

        The maximum  liability on all claims is subject to resolution  under the
federal bankruptcy laws.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

        None

PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

        The Common Stock, and Common Stock Purchase  Warrants  ("Warrants") have
been traded  under the symbol  "PUDGQ" and  "PUDGWQ",  respectively,  during the
Chapter 11 bankruptcy  proceeding  and  previously  under the symbols "PUDG" and
"PUDGW,"  respectively  on the Nasdaq Small Cap Market  ("Nasdaq") and under the
symbols "PCK" and "PCKW,"  respectively,  the Boston Stock  Exchange  ("Boston")
since  August 15, 1995,  the  effective  date of the  Company's  initial  public
offering.  Prior to that  date,  there was no public  market  for the  Company's
securities.

        The  following  table  sets  forth  the high and low bid  prices  of the
Company's Common Stock as reported by the Nasdaq Small Cap Market, the principal
trading  market  for the  Company's  Common  Stock  for the  periods  indicated,
commencing in the period the Company completed its initial public offering.  The
quotations  set forth  represent  interdealer  prices and do not include  retail
mark-ups, mark-downs or commissions and do not represent actual transactions.

                                       10




<PAGE>
<PAGE>

        Year ended December 31, 1995              High         Low
                                                  ----         ---
        Third Quarter                             $6           $5
        (from August 15, 1995)

        Fourth Quarter                            $5 7/8       $5

        Year ended December 31, 1996              High         Low
                                                  ----         ---
        First Quarter                             $5 5/8       $5
        Second Quarter                            $5 1/2       $4 1/4
        Third Quarter                             $4 1/2       $1 3/8
        Fourth Quarter                            $2 1/4       $1

        The last sales price of the Common  Stock  reported on the NASDAQ  Small
Cap  Market on April 8, 1997 was $1 5/16 per  share.  As of April 8,  1997,  the
Company had 4,488,385 shares of Common Stock outstanding held by more than 1,000
beneficial holders.

DIVIDEND POLICY

        The Company has not paid a dividend with respect to its Common Stock and
does not anticipate that it will pay dividends in the foreseeable  future.  As a
result of the filing of the Chapter 11 Cases, the Company is legally  restricted
from paying any dividends. In any event, the payment of dividends by the Company
on the Common Stock would depend on its earnings and  financial  condition,  and
such other factors as the Board may consider relevant.  In addition, no dividend
may be paid or declared and set apart for payment on the Common Stock as long as
the Series A Preferred Stock is outstanding and unless the Redeemable  Preferred
Stock is fully redeemed together with dividends accrued thereon,  and cumulative
dividends on the Company's outstanding $4 Cumulative Preferred Stock are paid or
set aside for payment.

ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS

        The following discussion and analysis should be read in conjunction with
the  Company's   consolidated  financial  statements  and  the  notes  presented
following the financial statements. The discussion of results, causes and trends
should not be construed to imply any conclusion that such results or trends will
necessarily continue in the future.

        The first  Pudgie's  restaurant  was opened on Long Island,  New York in
1981 under the name "Pudgie's Famous Chicken." A second Pudgie's  restaurant was
opened on Long Island in 1984.  Franchising  operations  commenced in late 1988.
The  Company  acquired  the  Pudgie's   operations   pursuant  to  the  Pudgie's
Acquisition in August 1993.

        The Company,  organized as a Delaware Corporation in February 1993, is a
holding company for Pudgie's Famous Chicken,  Ltd. which operates and franchises
Pudgie's Famous Chicken restaurants.  Pudgie's Famous Chicken,  Ltd. was founded
in 1981, by George  Sanders.  George Sanders and Steven  Wasserman were the sole
owners  until 1993,  when  Pudgie's  Famous  Chicken,  Ltd.  was acquired by the
Company  (the   "Acquisition")  in  a  leveraged  buy-out.   The  Company  began
franchising  in 1989.  The Company  filed for Chapter 11 protection on September

                                       11




<PAGE>
<PAGE>

18,  1996 after the  Company  received  an adverse  decision  in an  arbitration
proceeding with a former franchisee. The Company was also experiencing liquidity
problems at the time, which played a significant role in the Company's  decision
to file.

        Since the Chapter 11 Bankruptcy  filing,  the Company has taken a number
of steps to restructure its operations, with a view towards making the Company a
much more  streamlined  entity like the entity which had  prospered in the early
1990's. Under the Company's new initiative, the Company has made progress toward
significantly reducing its general and administrative overhead and in downsizing
its operations  staff to conform with continuing  operations.  Under  performing
units  have  been  closed  and over 100 full and part time  employees  have been
relieved of their duties.  Consequently,  the Company  continues to "steam line"
its organization and refocus its efforts primarily on franchised operations. The
Company will continue to restructure its operations, not only to improve margins
at the store  level,  but also  corresponding  to "right size" its costs for the
future.

        During  the  Bankruptcy  the  Company  was  able  to  obtain  Debtor  in
Possession  ("DIP")  financing  in  the  sum of  $250,000  for  working  capital
purposes.

        Management  also has devoted  significant  time and effort to attracting
new  equity  and debt  financing  to enable  the  Company  to  confirm a plan of
reorganization that will provide significant  distributions to creditors, and to
provide adequate working capital for the future.

        The Company's revenue is derived from sales at Company-owned restaurants
and, to a lesser  extent,  from  up-front  franchise  fees,  royalties and other
franchise  related  fees.  The Company does not derive  revenue from the sale of
restaurant or other supplies to franchisees  (except for an immaterial amount of
revenue  obtained from the sale of breading).  All franchised  restaurants pay a
franchising  fee of 5% of gross sales and  advertising  royalties of 3% of gross
sales,  except for the two restaurants  operated by Pudgie's founder which pay a
flat licensing fee.  Payments from franchisees are required to be made weekly or
monthly (depending on when the franchises were acquired).  The Company has taken
legal action in the past to close franchises for failure to remit franchise fees
and royalties.

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 1996 COMPARED WITH YEAR ENDED DECEMBER 31, 1995

        Total  revenue  was  approximately  $11.4  million  for the  year  ended
December 31, 1996, an increase of approximately  $204,000 or 2%, over revenue of
approximately  $11.2 million for the year ended December 31, 1995. This increase
was  primarily  due to the increase in the number of  Company-owned  restaurants
from 26 open at December 31, 1995 to 30 open during 1996,  offset by the closing
of 12  Company-owned  restaurants  during the year ended December 31, 1996. This
resulted in a net decrease in the number of Company-owned restaurants from 26 at
December  31,  1995  to 18 at  December  31,  1996.  The  number  of  franchised
restaurants  decreased  from 36 at December 31, 1995 to 31 at December 31, 1996.
The  decrease  was the result of two new  franchised  restaurants  opening,  two
franchised  restaurants closing and being reopened as Company-owned  restaurants
and five franchised restaurants closing during the year ended December 31, 1996.

                                       12




<PAGE>
<PAGE>

        System-wide sales at all  Company-owned and franchised  restaurants were
approximately  $21.8 million for 1996 and approximately  $24.9 million for 1995.
The effect of the lower average  number of Pudgie's  restaurants in operation in
1996  resulted in the decrease in system  sales.  The Company also believes that
revenues for the first quarter of 1996 were adversely affected by severe weather
conditions.

        Revenue from sales at Company-owned  restaurants was approximately $10.1
million for the year ended  December  31,  1996,  an  increase of  approximately
$703,000 or 8%, over sales at Company-owned  restaurants of  approximately  $9.4
million for the year ended  December  31,  1995.  This  increase  was due to the
increased number of Company-owned  restaurants  operating during 1996. Franchise
royalty and advertising fees paid by franchisees were approximately $967,000 for
the year ended December 31, 1996, a decrease of  approximately  $322,000 or 25%,
from  approximately  $1.3 million for the year ended  December  31,  1995.  This
decrease  resulted from the lower number of franchised  restaurants in operation
during the year ended  December 31, 1996 compared to the year ended December 31,
1995.  The reduction in the number of franchised  restaurants in operation was a
result of the Company repurchasing one franchised restaurant to be operated as a
Company-owned  restaurant,  the  Company  reopening  two  previously  franchised
restaurants as Company-owned, and the closing of five franchised restaurants due
to the  failure of the  franchisee  to remit  royalties  or to comply with other
provisions  of  the  franchise  agreement.  Franchise  fees  were  approximately
$270,000  for the year ended  December  31, 1996, a decrease of $140,000 or 34%,
from $410,000 for the year ended  December 31, 1995.  The decrease was primarily
attributable  to the  recognition  of higher  revenue for fees  relating to area
developers who forfeited their development rights in 1995.

        The Company has reserved for the full amount of receivables due from two
of its  franchisees  (approximately  $300,000  at December  31,  1996) which are
withholding  payment pending the resolution of litigation with the Company.  For
further  discussion,  see  Item  3  "Legal  Proceedings"  and  Note  13  to  the
Consolidated Financial Statements.  Such receivables represent approximately 34%
of the allowance for uncollectible receivables at December 31, 1996. The balance
of the  reserve  is made up of  identified  potential  bad  debts of  individual
receivable balances of franchisees and a general reserve.

        With respect to  Company-owned  restaurants,  costs of products sold and
restaurant operating expenses were approximately $9.6 million for the year ended
December  31,  1996,  an increase of  approximately  $1.0  million or 12%,  from
approximately  $8.6 million for the year ended December 31, 1995.  This increase
was due primarily to the increased number of Company-owned restaurants operating
during 1996 and an adjustment for lease  escalations of approximately  $190,000.
General and administrative expenses were approximately $4.8 million for the year
ended December 31, 1996, an increase of approximately  $1.1 million or 29%, from
approximately  $3.7 million for the year ended  December 31, 1995.  The increase
was  primarily  due to  approximately  a $425,000  increase in bad debt  expense
during  1996,   approximately  $110,000  in  legal  expenses  incurred  for  the
arbitration of a dispute with Gallus,  and an increase in professional  fees and
insurance  costs for the year ended  December 31, 1996,  as result of the IPO in
August 1995.

        The  arbitration  award of  approximately  $1.7 million  during the year
ended  December  31, 1996 was the result of an award  rendered  by the  American
Arbitration Association relating to a decision on an action against the Company.
Restaurant  closing  expenses  of  approximately  $347,000  for the  year  ended
December  31,  1996 were the result of costs  expenses in  conjunction  with the
closing of three Company-owned  unprofitable restaurants prior to the Chapter 11
petition.

                                       13




<PAGE>
<PAGE>

        Advertising  expenses  were  approximately  $745,000  for the year ended
December  31,  1996,  a  decrease  of   approximately   $458,000  or  38%,  from
approximately  $1.2 million for the year ended  December 31, 1995.  The decrease
was  principally  due to a change in the type of  advertising  undertaken by the
Company in 1996.

        For the year ended  December 31, 1996,  the Company has taken a non-cash
charge of $8,097,897 as a result of the write down of  long-lived  assets.  As a
result of the reduced  carrying  value for the affected  long-lived  assets that
will  continue to be used in the  business,  the Company  expects  future annual
depreciation to be reduced by approximately  $270,000. As the initial charge was
based upon  estimated  cash flow  forecasts  requiring  judgment by  management,
actual results could differ significantly from the estimates used.

        Depreciation and amortization  was  approximately  $906,000 for the year
ended  December  31,  1996,  an  increase of  approximately  $20,000 or 2%, from
approximately $887,000 for the year ended December 31, 1995. The slight increase
was  attributable to the initial increase in  Company-owned  restaurants  during
1996, the purchase and  depreciation of equipment for those  restaurants and the
closing of  Company-owned  restaurants  in  September  and October  1996 and the
writing off of the net value of the related assets.

        Interest expense was approximately  $321,000 for the year ended December
31,  1996,  a decrease  of  approximately  $451,000 or 58%,  from  approximately
$770,000 for the year ended December 31, 1995.  This decrease  resulted from the
payments by the Company in August 1995 to reduce  outstanding  promissory  notes
from an aggregate of $3.9 million to $3.6 million,  on which  interest  accruals
were stopped as of the filing of the Chapter 11 Cases,  the repayment in full in
August  1995 of a  separate  promissory  note  held  by  Pudgie's  founder,  the
outstanding  balance of which was then $4.7 million and the  repayment in August
1995 of bridge notes issued by the Company in May 1995 in the  aggregate of $1.0
million.

        Interest income and other revenue was approximately $97,000 for the year
ended  December  31,  1996,  a decrease of  approximately  $37,000 or 27%,  from
approximately  $134,000 for the year ended December 31, 1995.  This decrease was
primarily due to a decreased  interest  income  resulting from lower  investment
balances maintained.

        As a  result  of the  Company  filing  of the  Chapter  11  Cases,  nine
Company-owned  unprofitable  restaurants  were closed resulting in approximately
$1.4 million of expenses . These  restaurants were closed to reduce cash outflow
and operating  expenses.  The reorganization  professional fees of approximately
$443,000 for the year ended  December 31, 1996 were incurred in connection  with
the Company's bankruptcy filing and related U.S. Trustee fees.

        The Company incurred a net loss of  approximately  $17.0 million for the
year ended  December 31, 1996,  an increase of  approximately  $12.8  million or
305%,  from the net  loss of  approximately  $4.2  million  for the  year  ended
December 31, 1995. The increase in the loss was attributable  principally to the
non-cash charge of  approximately  $8.1 million as a result of the write down of
long-lived  assets,  an accrual for an arbitration  award of approximately  $1.7
million,  approximately $1.4 million expensed in conjunction with the closing of
nine  Company-owned  restaurants in 1996 as a result of the Company's  filing of
the Chapter 11 Cases, approximately $347,000 of expenses incurred in conjunction
with the closing of three Company-owned unprofitable restaurants,  approximately
$443,000  in   bankruptcy   related   professional   fees  and  an  increase  of
approximately 10% in operating expenses.

        No  provision  for income  taxes was  required  in either the year ended
December 31, 1996 or 1995 because of the net losses  incurred by the Company for
federal and state income tax purposes.

                                       14




<PAGE>
<PAGE>

FOURTH QUARTER ADJUSTMENTS

        During the fourth  quarter of 1996,  the Company  recorded an impairment
adjustment to goodwill of approximately  $8,098,000 due to the diminution of the
carrying  value of this asset.  The Company  also  recorded  additional  accrued
expenses of approximately $766,000 in the fourth quarter of 1996.

LIQUIDITY AND CAPITAL RESOURCES

        The Company's primary capital requirements are for restaurant operations
and franchise  development.  As of December 31, 1996,  the Company had a working
capital  deficit  of  $806,504  as  compared  to  working  capital of $49,455 at
December 31, 1995. This change in working  capital is primarily  attributable to
timing of the payment of current liabilities.

        Cash used in operating  activities  was  $1,751,706  for  the year ended
December 31, 1996 and  $1,898,749  for the year ended  December  31,  1995.  The
cash  used in operating activities is primarily the result of the funding of the
Company's loss for 1996.

        Cash  used  in  investing  activities  of  $375,141 was utilized for the
purchase  of property  and  equipment  primarily  relating to the opening of new
Company-owned restaurants during 1996.

        Cash  provided  by  financing  activities  of  $1,575,587  for  1996 was
primarily  due to net proceeds received from a private placement of stock in the
amount of $1,637,952 offset by restricted cash balances in escrow of $62,365 for
the year ended December 31, 1996.

        Immediately  upon the  commencement of the Chapter 11 Cases, the Company
obtained a post-petition credit facility in the form of food and supply advances
(the "Sysco Credit Facility") from Sysco up to the amount of $250,000. The Sysco
Credit  Facility  further  provides that the obligations of the Company to Sysco
under the Sysco Credit Facility constitutes  administrative  expense obligations
with priority over any and all administrative expenses of the kinds specified in
Sections  503(b) and 507(b) of the  Bankruptcy  Code (with limited  exceptions),
secured by a superpriority  lien on substantially  all of the Company's  assets.
During the  Chapter 11 Cases the  Bankruptcy  Court  approved  the Sysco  Credit
Facility on interim and final bases,  respectively.  The Company  currently owes
Sysco under the Sysco Credit  Facility the approximate  amount of $85,000,  with
costs, interest and fees thereon.

        The Company has also obtained  Bankruptcy  Court  approval for a certain
"debtor-in-possession"  credit facility (the "DIP Credit Facility") with Jeffrey
Zisselman  ("Zisselman") up to the amount of $250,000,  subject to the terms and
limitations of a stipulation  entered into between the Company and Herbert Turk,
which limits senior  indebtedness  to Mr. Turk's secured claims in the aggregate
amount of $375,000. In consideration for the DIP Credit Facility,  Zisselman has
been granted (a) a second lien on all of the Company's  assets and (b) a warrant
to be issued within sixty days after  confirmation of a  reorganization  plan to
purchase  Reorganized  Pudgie's Common Stock on terms such that, under the Black
Scholes formula the warrant will have an estimated  fair value of  approximately
$100,000.  The loan  provides for  interest at a rate of 16% per annum,  payable
monthly on all amounts drawn down on and is due the earlier of February 1, 1998,
dismissal of the Chapter 11 Cases or at  conversion of the Chapter 11 Cases to a
proceeding  under Chapter 7 of the Bankruptcy  Code.  The Company  currently has
approximately $190,000 outstanding under the DIP Credit Facility.

        In May 1996, the Company received  $2,000,000,  exclusive of expenses of
approximately $360,000,  from a private placement,  which consists of 200 shares
of Redeemable Convertible Preferred

                                       15




<PAGE>
<PAGE>

Stock, Series A and 100,000 common stock purchase warrants.  The preferred stock
is  convertible  into common stock at the option of the holder at a price of the
lower  of  $4.47  or  82% of the  average  closing  price  on  the  trading  day
immediately  preceding the conversion date and automatically convert into shares
of common  stock on April 30, 1998.  The  preferred  stock has a redemption  and
liquidation  value of $12,200 per share plus unpaid  dividends,  as defined,  or
cash at the option of the  Company.  The  preferred  stockholders  also  receive
penalty shares since a  Registration  Statement for the sale of common stock was
not registered by July 29, 1996.

        This class of preferred  stock also  contains a  redemption  option that
requires the Company to purchase the  Preferred  Shares if at any time after May
3, 1996, the  conversion  price on any 20 trading days during any 30 consecutive
trading day period is less than $2.00.  Each holder of any  Preferred  Shares is
then,  upon  notice  from the  Company,  entitled  to elect to have the  Company
purchase  all, but not less than all of the  Preferred  Shares then held by such
holder for a cash purchase  price of $10,800 per Preferred  Share  together with
all accrued and unpaid dividends  thereon.  The redemption  option was triggered
subsequent  to September  18, 1996 and as a result of the  Company's  bankruptcy
filing,  this provision has been stayed until a plan of reorganization  has been
approved by the Bankruptcy Court.

        The  Company's  promissory  note  to  Herbert  Turk  in  the  amount  of
$3,606,837 has been litigated in the Bankruptcy  Court. For further  discussion,
see  Item 12 "A.  Turk"  and  Note 8 to the  Consolidated  Financial  Statements
included in this Form 10-KSB.

        The  terms  of  the  Company's  Redeemable  Preferred  Stock  have  been
modified.  For further  discussion,  see Item 12 "C. Sanders" and Note 11 to the
Consolidated Financial Statements in this Form 10-KSB.

        Due to the  Company's  filing of the  Chapter 11 Cases and  pending  the
filing of the Company's plan of reorganization,  the Company is currently unable
to predict its needs for liquidity and capital resources.

SEASONALITY

        The   Company's   business  is   affected   by  seasonal   fluctuations.
Historically,  sales and  earnings  have been lower in the  months of  November,
December,  January and February as a result of the holiday  season and inclement
weather.  The  Company's  revenues  and expenses may be affected by a variety of
other  factors,   including,  but  not  limited  to,  general  economic  trends,
competition, marketing programs and special events.

IMPACT OF INFLATION

        The Company believes that inflation has not had a material impact on its
operations to date.  Substantial  increases in labor,  food and other  operating
expenses could adversely affect the operations of the Company and the restaurant
industry.

ITEM 7. FINANCIAL STATEMENTS

        The following financial statements are included in this Report:


Index To Consolidated Financial Statements
--------------------------------------------------------------------------------
                                                                         Page

STATEMENTS OF PUDGIE'S CHICKEN, INC. AND SUBSIDIARIES

Independent Auditor's Report.............................................F-2

Consolidated Balance Sheet - December 1996...............................F-4

Consolidated Statement of Operations -
For the year ended December 31, 1996.....................................F-5

Consolidated Statement of Stockholders' Deficit -
For the year ended December 31, 1996.....................................F-6

Consolidated Statement of Cash Flows -
For the year ended December 31, 1996.....................................F-7

Notes to Consolidated Statements.........................................F-8

Report of Independent Accountants........................................F-27

Consolidated Statement of Operations -
For the year ended December 31, 1995.....................................F-28

Consolidated Statement of Changes in Stockholders' Equity -
For the year ended December 31, 1995.....................................F-29

Consolidated Statement of Cash Flows -
For the year ended December 31, 1995.....................................F-30

Notes to Consolidated Statements.........................................F-32






                                       16




<PAGE>

<PAGE>

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        DISCLOSURE.

        On November 11, 1996, the Company  dismissed Price Waterhouse LLP as its
independent  auditors.  The reports by Price  Waterhouse LLP on the consolidated
financial statements of the Company for the fiscal years ended December 31, 1994
and December 31, 1995,  (i) did not contain an adverse  opinion or disclaimer of
opinion and (ii) were not qualified or modified as to  uncertainty,  audit scope
or accounting principles.  In connection with the audits for the two most recent
fiscal years and through  November 11,  1996,  the Company had no  disagreements
with Price  Waterhouse LLP on any matter of accounting  principles or practices,
financial  statement   disclosure,   or  auditing  scope  or  procedure,   which
disagreements  if not resolved to the satisfaction of Price Waterhouse LLP would
have  caused them to make  reference  thereto in their  report on the  financial
statements for such years.

        The  Company  engaged the  services of KPMG Peat  Marwick LLP as its new
independent auditors as of November 15, 1996. The decision to change accountants
was recommended and approved by the Company's board of directors.

PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
        WITH SECTION 16(a) OF THE EXCHANGE ACT.

Information Concerning Directors and Executive Officers

Name                 Age   Position
----                 ---   --------
Steven Wasserman     36    President/Chief Executive Officer,
                           Director (Class I)
Helen Papa           29    Vice President, Chief Financial Officer and Secretary
Udi Toledano         46    Director (Class I)
Joseph Vittoria      61    Director (Class II)

STEVEN  WASSERMAN  has been the  President  and Chief  Executive  Officer of the
Company  since April 1995 and a director of the Company  since August 1993.  Mr.
Wasserman has been the President of Pudgie's Famous Chicken, Ltd. a wholly owned
subsidiary of the Company  ("PFC") since 1991.  From August 1987 to December 31,
1990, Mr. Wasserman was a practicing attorney with the law firm Phillips, Nizer,
Benjamin, Krim & Ballon in New York City.

HELEN PAPA was elected Vice  President  and Secretary of the Company in May 1995
and has been the  Company's  Chief  Financial  Officer  since June 1, 1994.  She
previously was an accountant with Price Waterhouse from August 1989 to May 1994.
Ms. Papa is a Certified Public Accountant.

UDI TOLEDANO has been a Director of the Company since January 1993. Mr. Toledano
has been the  President of  Andromeda  Enterprises,  Inc., a private  investment
company, since December 1993. Prior to that, he was the President of CR Capital,
Inc., a private  investment  company,  for more than five years.  He has been an
advisor to various public and private corporations,  none of which competes with
the  Company.  Since  May  1996,  Mr.  Toledano  has

                                       17




<PAGE>
<PAGE>

been a director of Alyn Corporation,  a public advanced materials  company,  and
since January 1997 its Chairman of the Board.  Since May 1996, Mr.  Toledano has
been a director of HumaScan  Inc., a public medical  device  company,  and since
April  1995,  he has been a director  of Global  Pharmaceutical  Corporation,  a
public  generic  pharmaceutical  manufacturing  company.  Since July  1994,  Mr.
Toledano has been a director of Universal  Stainless & Alloy  Products,  Inc., a
public specialty steel producing company.

JOSEPH VITTORIA has been a director of the Company since July 1994. Mr. Vittoria
was the  Chairman  of the  Board of Avis,  Inc.,  a  multi-national  car  rental
company, from 1982 to January 31, 1997. Mr. Vittoria is a director of UAL Corp.,
the parent of United Airlines and a Vice-Chairman  of the Business  Committee of
the Metropolitan Museum of Art. In addition,  Mr. Vittoria serves as a member of
the Development Board of Yale University, president of the board of directors of
the Alumni Association of Columbia University Graduate School of Business and is
the  founding  chairman  and  current  member  of the board of  visitors  of the
Georgetown University School of Organization and Management.

        The Board of  Directors  consists of three  directors  divided  into two
classes of directors:  Class I Directors  and Class II Directors.  The Company's
current  Class I Directors  and Class II  Directors  will serve until the annual
meeting of the Company's stockholders to be held in 1998 and 1997, respectively,
and until their  respective  successors  are duly elected and qualified or until
their earlier  resignation  or removal.  Directors of each Class will be elected
for a full term of three years (or any lesser period representing the balance of
the previous term of such Class) and until their respective  successors are duly
elected and qualified or until their earlier  resignation  or removal.  Officers
are appointed by and serve at the discretion of the Board.

COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

        Section  16(a)  of the  Securities  Exchange  Act of 1934,  as  amended,
requires the Company's officers, directors and persons who beneficially own more
than ten percent of the Company's  Common Stock to file reports of ownership and
changes in ownership with the Securities and Exchange  Commission,  the National
Association of Securities  Dealers,  Inc. and the Boston Stock  Exchange.  These
reporting  persons  also are  required to furnish the Company with copies of all
Section 16(a) forms they file. To the Company's  knowledge,  based solely on its
review of the copies of such forms furnished to it and  representations  that no
other  reports  were  required,  the Company  believes  that all  Section  16(a)
reporting  requirements  were complied  with during the year ended  December 31,
1996.

ITEM 10.       EXECUTIVE COMPENSATION

        The following table sets forth information  concerning  compensation for
1996 and 1995,  earned by or paid to the Company's chief  executive  officer and
each other executive officer whose compensation exceeded $100,000 in 1996:

                                       18



<PAGE>
<PAGE>


                           SUMMARY COMPENSATION TABLE

                                                            Annual Compensation
        Name And Principal Position          Year                 Salary
--------------------------------------------------------------------------------
              Steven Wasserman,              1996                237,000
President and Chief Executive Officer        1995                237,000
                                             1994                222,000
--------------------------------------------------------------------------------

(1)     The named executive  routinely receives other benefits from the Company,
        the aggregate amounts of which during the years indicated did not exceed
        the lesser of either $50,000 or 10% of the total annual salary and bonus
        set forth above.

COMPENSATION ARRANGEMENTS

        Effective  June 1, 1995,  Mr.  Wasserman  was employed as President  and
Chief Executive  Officer of the Company under an employment  agreement  expiring
May 31, 2000, at an annual base salary of $237,000 subject to his entitlement to
an annual  incentive  bonus of up to a maximum of 60% of his base  salary  based
upon a formula tied to the Company's performance in any given year.

DIRECTOR COMPENSATION

        Directors of the Company do not receive compensation for their services.

ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

        The following  table sets forth certain  information  as of December 31,
1996 (on which date 4,488,385 shares of Common Stock were  outstanding),  except
as  indicated  below,  with  respect to (i) those  person or groups known to the
Company to  beneficially  own more than 5% of the Company's  Common Stock,  (ii)
each director, (iii) each executive officer whose compensation exceeded $100,000
in 1996,  and (iv) all directors  and officers as a group.  The  information  is
determined  in  accordance  with Rule  13d-3  promulgated  under the  Securities
Exchange Act of 1934 based upon  information  furnished by the persons listed or
contained  in  filings  made by them with the  Securities  Exchange  Commission.
Except as  indicated  below,  the  stockholders  listed  possess sole voting and
investment power with respect to their shares.

                                       19



<PAGE>
<PAGE>


--------------------------------------------------------------------------------
 Name And Address Of            Amount And Nature Of        Percent Of Class Of
   Beneficial Owner             Beneficial Ownership           Common Stock
--------------------------------------------------------------------------------
George Sanders                        615,500                     13.8%
16 Plainview Road
Bethpage, NY  11714
--------------------------------------------------------------------------------
Herbert & Edith Turk           (1)    491,364                     10.9%
2132 Cedarwood Lane
San Jose, CA  95125
--------------------------------------------------------------------------------
Steven Wasserman                      191,929                      4.3%
c/o Pudgie's Chicken, Inc.
333 Earle Ovington Blvd.
Uniondale, NY  11553
--------------------------------------------------------------------------------
Udi Toledano                   (2)    112,041                      2.5%
c/o Pudgie's Chicken, Inc.
333 Earle Ovington Blvd.
Uniondale, NY  11553
--------------------------------------------------------------------------------
Joseph Vittoria                (3)     40,993                          *
c/o Pudgie's Chicken, Inc.
333 Earle Ovington Blvd.
Uniondale, NY  11553
--------------------------------------------------------------------------------
All Executive Officers and     (4)    363,013                         8%
Directors as a Group
(4 persons)
--------------------------------------------------------------------------------

-----------
*less than one percent

(1)   Includes  145,524  shares  of Common  Stock  held by Mr.  and Mrs.  Turk's
      daughters  over which Mr.  Turk has power of attorney to direct the voting
      and as to which Mr. Turk disclaims beneficial  ownership.  Includes 67,307
      shares of Common Stock  issuable  upon the  exercise of Investor  Warrants
      which were exercisable beginning in September 1996. Includes 55,122 shares
      of common stock issuable upon the exercise of warrants granted to Mr. Turk
      which warrants are exercisable between August 9, 1996 and August 9, 2000.

(2)   Includes 61,489 shares held by Mr.  Toledano's wife and 24,596 shares held
      by a trust for the benefit of Mr.  Toledano's  minor children of which Mr.
      Toledano's wife serves as trustee.

(3)   Shares are held in the name of Fincon Enterprises, Inc. for the benefit of
      Mr. Vittoria.

(4)   Includes  18,029  shares  issued to one  executive  officer of the Company
      pursuant to the Restricted Stock Plan. See also footnotes 2 and 3 above.

                                       20




<PAGE>
<PAGE>

ITEM 12.       CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

A.      TURK

        In 1994, the Company  obtained a total of five bridge loans from Herbert
Turk  (a  principal   stockholder)   in  the  aggregate   principal   amount  of
approximately $3.9 million with interest at 3.5% plus the prime rate. Such loans
were evidenced by promissory notes issued between February 19, 1994 and December
1, 1994 with maturity dates that ranged from two to four months from the date of
issuance.  The Company issued 16,397 shares of Common Stock to Mr. Turk as a fee
for the loans.  In August 1995,  the Company paid $600,000 to repay a portion of
the  promissory  notes  and  issued  to  replace  those  promissory  notes a new
promissory  note in principal  equal to the remaining  principal of the original
notes  ($3,606,837).  The Company  also issued to that  stockholder  warrants to
purchase  50,000  shares  of  Common  Stock  at a price of  $6.00  per  share in
consideration  of the replacement note  transaction  exercisable  August 9, 1996
through August 6, 2000. The  replacement  note is secured by a first lien on the
Company's  principal  assets  and will  mature  in  February  1997,  subject  to
mandatory  prepayment  by the Company to the extent of any net proceeds from the
sale of Common Stock by the Company. Interest on the replacement note accrues at
a variable  rate of 3.5% above prime.  Pursuant to the terms of the  replacement
note, the Company is not permitted to incur additional indebtedness in excess of
$500,000  without  the  consent  of the  holder  except  for  certain  unsecured
obligations incurred in the ordinary course of business.

        In January  1995,  the  Company  sold 81,986  shares of Common  Stock to
certain investors  (including 45,092 shares to Mr. Turk and family members) in a
private  placement  at a  purchase  price of $6.10  per share  and  granted  the
investors certain demand and "piggyback"  registration  rights (including rights
to register those shares in the Company's initial public offering).  In exchange
for the  cancellation  by such  investors of such  registration  rights,  at the
closing of the  Company's  initial  public  offering  the  Company  issued  such
investors  111,522  investor  warrants  "Investor  Warrants"  (including  61,337
Investor  Warrants to Mr. Turk and family members) and granted to such investors
new  "piggyback"  registration  rights.  The terms of the Investor  Warrants are
identical to the terms of the  Warrants,  except that the Investor  Warrants are
not  redeemable  and are not  registered  under  the  Securities  Act of 1933 as
amended.  The new  registration  rights are  exercisable as to not more than two
registration  statements filed by the Company after the Company's initial public
offering in August 1995,  and will require the Company to register the shares of
Common Stock  purchased by such investors in the January 1995 private  placement
and the shares of Common Stock issuable upon exercise of the Investor Warrants.

        In November 1996, Turk commenced an adversary  proceeding in the Chapter
11 case  seeking,  inter alia,  a  determination  as to the  nature,  extent and
validity of his  security  interests  in and to the assets of the  Company.  The
Adversary  Proceeding also sought injunctive  relief requiring,  inter alia, for
the  Company to  continue to escrow its  franchise  royalties/fees  as per prior
interim cash collateral orders.

        Turk had objected to the Company's continued use of cash collateral and,
prior to a December 4, 1996  hearing to consider  the  Company's  request to use
cash collateral,  Turk filed, under the Adversary  Proceeding,  an Order to Show
Cause for an order, inter alia, continuing the escrow of the Company's franchise
fees and proceeds  from the auction  sale of certain  restaurant  equipment  and
granting Turk a preliminary injunction (the "Turk Motion").

                                       21



<PAGE>
<PAGE>

        At the December 4th hearing,  the Court denied the Turk motion,  and Mr.
Turk immediately  filed an appeal of the denial of the Turk Motion in the United
States District Court for the Southern District of New York (the "Turk Appeal").

        After  vigorous  negotiation,   Mr.  Turk,  the  Company,  the  official
Creditors'  Committee  and the official  Equity  Committee  agreed to settle and
compromise  all issues  concerning  Mr. Turk's claims and security  interests as
well as all issues  concerning  the Company's use of cash  collateral on a final
basis.

        In order to resolve all outstanding issues between the Company, Mr. Turk
and the  respective  committees  with respect to the Adversary  Proceeding,  the
claim of Mr. Turk and the Company's use of cash  collateral,  respectively,  the
parties,  after substantial  negotiation entered into a certain Stipulation (the
"Turk  Stipulation"  which was approved by the Bankruptcy  Court on February 12,
1997).  The  Stipulation:  (1)  resolved  all  issues  raised  in the  Adversary
Proceeding;  (2) authorized the Company's  continued use of cash collateral on a
final  basis;  (3)  authorized  the  release to the  Company of all sums held in
escrow by the Company's  counsel,  which sums were badly needed in order to help
sustain the Company's operations;  (4) avoided further costly and time consuming
litigation;  and (5) helped "pave the way" towards  confirmation of a consensual
plan of reorganization.

        The Stipulation  validated Mr. Turk's  security  interests and liens and
further provided that in the event a plan of  reorganization  is confirmed on or
before  October 1, 1997,  and  provides  for a payment on account of Mr.  Turk's
secured claim in the amount of $1,000,000, then Mr. Turk would agree to vote his
remaining  claims,  on  account of which he will  receive  no  further  monetary
consideration  (only  common  stock),  in favor of such plan of  reorganization.
Moreover,  the Stipulation permitted Mr. Turk's secured claim to be subordinated
to senior secured  financing and professional  carveouts in the aggregate amount
of $375,000.  Finally,  the  Stipulation  resulted in the  dismissal of the Turk
Advisory Proceeding and the Turk Appeal, with prejudice.

B.      WASSERMAN

        In May 1995,  Steven  Wasserman,  currently the Company's  President and
Chief Executive  Officer,  received from escrow,  54,652 shares of Common Stock.
These  shares  had  been  purchased  by  Mr.   Wasserman  in  1993  for  nominal
consideration  and held in  escrow  pending  performance  under  his  employment
agreement.

C.      SANDERS

        In August 1995, the Company repaid in full a promissory note to Pudgie's
founder,  the  outstanding  balance of which was then  $4,669,000,  through  (i)
payment of $1.5 million in cash from the net proceeds of the IPO,  (ii) issuance
of 525,000  shares of Common  Stock and (iii)  issuance of 10,000  shares of the
Company's  Redeemable  Preferred Stock having an aggregate  redemption price and
liquidation value initially equal to $1,069,000.

                                       22




<PAGE>
<PAGE>

        Pursuant  to  an  agreement  dated  February  12,  1997,  the  preferred
stockholder  amended  the  terms of the  preferred  stock  so that the  stock is
redeemable for the Company's $.01 par value common stock,  but is not, under any
circumstances, redeemable for cash. Additionally, pursuant to an agreement dated
February 20, 1997,  the preferred  stockholder  irrevocably  waived his right to
sell or otherwise  transfer  the  preferred  stock to another  party unless such
party  executes and delivers to the Company a confirmation  and agreement  which
binds the party to the terms of the aforementioned agreements.

PART IV

ITEM 13.       EXHIBITS AND REPORTS ON FORM 8-K.

        a.     Exhibits Filed

               27. Financial Data Schedule

        b.     Reports on Form 8-K

               Two reports on Form 8-K were filed during the year ended
               December 31, 1996:

               (i) On September  18, 1996,  a Form 8-K was filed  reporting  the
filing of a voluntary  petition under Chapter 11 of the  Bankruptcy  Code and an
award against the Company by a panel of the American Arbitration Association.

               (ii) On September  30, 1996, a Form 8-K was filed  reporting  the
Company's  altering of its business and  financial  plans in light of its recent
filing of a voluntary petition under the Bankruptcy Code.

                                       23



<PAGE>
<PAGE>

                                   SIGNATURES

        Pursuant to the  requirements  of Section 13 or 15(d) 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.

PUDGIE'S CHICKEN, INC.

By: /s/ Steven Wasserman
    -----------------------------------------
        Steven Wasserman
        President and Chief Executive Officer
        Dated:  April 14, 1997

        In accordance with the Securities  Exchange Act of 1934, this Report has
been signed below by the  following  persons on behalf of the  Registrant in the
capacities and on the dates indicated.

                                                                 Date
                                                                 ----

/s/ Steven Wasserman                                        April 14, 1997
------------------------------------------------       -----------------------
Steven Wasserman
President/Chief Executive Officer (and Principal
Executive Officer), Director

/s/ Helen Papa                                              April 14, 1997
------------------------------------------------       -----------------------
Helen Papa
Vice President/Chief Financial Officer/Secretary
(and Principal Financial and Accounting Officer)

/s/ Joseph Vittoria                                         April 14, 1997
------------------------------------------------       -----------------------
Joseph Vittoria, Director

/s/ Udi Toledano                                            April 14, 1997
------------------------------------------------       -----------------------
Udi Toledano, Director

                                       24


<PAGE>

<PAGE>

Pudgie's Chicken, Inc.
And Subsidiaries

Index To Consolidated Financial Statements
--------------------------------------------------------------------------------
                                                                         Page

STATEMENTS OF PUDGIE'S CHICKEN, INC. AND SUBSIDIARIES

Independent Auditor's Report.............................................F-2

Consolidated Balance Sheet - December 1996...............................F-4

Consolidated Statement of Operations -
For the year ended December 31, 1996.....................................F-5

Consolidated Statement of Stockholders' Deficit -
For the year ended December 31, 1996.....................................F-6

Consolidated Statement of Cash Flows -
For the year ended December 31, 1996.....................................F-7

Notes to Consolidated Statements.........................................F-8

Report of Independent Accountants........................................F-27

Consolidated Statement of Operations -
For the year ended December 31, 1995.....................................F-28

Consolidated Statement of Changes in Stockholders' Equity -
For the year ended December 31, 1995.....................................F-29

Consolidated Statement of Cash Flows -
For the year ended December 31, 1995.....................................F-30

Notes to Consolidated Statements.........................................F-32


                                      F-1




<PAGE>
<PAGE>










                          INDEPENDENT AUDITORS' REPORT

    The Board of Directors
        and Stockholders
    Pudgie's Chicken, Inc.
       and subsidiaries
       Debtors-in-Possession:

    We have  audited the  accompanying  consolidated  balance  sheet of Pudgie's
    Chicken,  Inc. and  subsidiaries  as of December  31, 1996,  and the related
    consolidated statements of operations,  stockholders' deficit and cash flows
    for the year then ended.  These  consolidated  financial  statements are the
    responsibility of the Company's management. Our responsibility is to express
    an opinion on these consolidated financial statements based on our audit.

    We  conducted  our audit in  accordance  with  generally  accepted  auditing
    standards.  Those  standards  require  that we plan and perform the audit to
    obtain reasonable  assurance about whether the financial statements are free
    of material  misstatement.  An audit  includes  examining,  on a test basis,
    evidence supporting the amounts and disclosures in the financial statements.
    An  audit  also  includes  assessing  the  accounting  principles  used  and
    significant estimates made by management,  as well as evaluating the overall
    financial  statement  presentation.  We  believe  that our audit  provides a
    reasonable basis for our opinion.

    In our opinion,  the  consolidated  financial  statements  referred to above
    present fairly, in all material respects, the financial position of Pudgie's
    Chicken,  Inc. and  subsidiaries as of December 31, 1996, and the results of
    its operations and its cash flows for the year then ended in conformity with
    generally accepted accounting principles.

    As discussed in Note 1 to the consolidated  financial  statements,  Pudgie's
    Chicken,  Inc. and all of its  subsidiaries  filed  voluntary  petitions for
    relief under Chapter 11 of the United States  Bankruptcy  Code in the United
    States  Bankruptcy  Court for the  Southern  District of New York on various
    dates from September 18, 1996 through October 10, 1996. The effects, if any,
    arising from these filings by Pudgie's Chicken, Inc. and its subsidiaries on
    its operations or consolidated  financial  statements as of and for the year
    ended December 31, 1996 cannot be determined.

    As  discussed  in notes  2(o) and 3 of the notes to  consolidated  financial
    statements,  the Company  adopted the  provisions  of Statement of Financial
    Accounting  Standards  No.121,  "Accounting for the Impairment of Long-Lived
    Assets and for Long-Lived Assets to be Disposed Of" in 1996.

    The  accompanying  consolidated  financial  statements  have  been  prepared
    assuming that the Company will continue as a going concern.  As discussed in
    the  second  preceding  paragraph,  Pudgie's  Chicken,  Inc.  and all of its
    subsidiaries  filed  voluntary  petitions for relief under Chapter 11 of the
    United States  Bankruptcy Code in the United States Bankruptcy Court for the
    Southern  District  of New York on various  dates from  September  18,  1996
    through  October 10,  1996.  This event and  circumstances  relating to this
    event, including the Company's recurring losses from operations resulting in
    cumulative  stockholder's deficit, raise substantial doubt about its ability
    to continue as a going concern.  Although the Company is currently operating
    their  business  as a  debtor-in-possession  under the  jurisdiction  of the
    Bankruptcy

                                      F-2

<PAGE>
<PAGE>


    Court,  the  continuation  of the business as a going  concern is contingent
    upon,  among other  things,  (1) the  successful  consummation  of a plan of
    reorganization  and (2) the  achievement  of  satisfactory  levels of future
    operating profit.  The consolidated  financial  statements as of and for the
    year ended December 31, 1996 neither include any adjustments relating to the
    recoverability  and  classification of reported asset amounts or the amounts
    and classification of liabilities that might be necessary should the Company
    not be able  to  continue  as a going  concern,  nor do  those  consolidated
    financial  statements  include any  adjustments  relating to  establishment,
    settlement  and  classification  of  liabilities  that  may be  required  in
    connection with the  restructuring  the Company and its subsidiaries as they
    reorganize under Chapter 11 of the United States Bankruptcy Code.

                                        KPMG PEAT MARWICK LLP

    Jericho, New York
    April 8, 1997

                                      F-3





<PAGE>
<PAGE>

                             PUDGIE'S CHICKEN, INC.
                                AND SUBSIDIARIES
                              DEBTORS-IN-POSSESSION

                           Consolidated Balance Sheet

                                December 31, 1996

<TABLE>
<CAPTION>
                                     ASSETS
<S>                                                                                            <C>
Current assets:

    Cash                                                                                       $    272,180
    Restricted cash                                                                                  62,365
    Franchise and advertising royalties, net of allowance for doubtful
       accounts of approximately $888,000                                                           129,908
    Inventory                                                                                        97,060
                                                                                               ------------
           Total current assets                                                                     561,513

Property and equipment, net                                                                       1,663,706
Other assets                                                                                        164,175
                                                                                               ------------
           Total assets                                                                        $  2,389,394
                                                                                               ============

                      LIABILITIES AND STOCKHOLDERS' DEFICIT

Liabilities not subject to compromise:
    Accounts payable and accrued expenses                                                           536,106
    Deferred franchise fees                                                                         297,500
    Accrued Chapter 11 fees                                                                         249,971
    Accrued professional fees                                                                        95,000
    Deferred rent                                                                                   189,440
                                                                                               ------------
           Total current liabilities                                                              1,368,017

Liabilities subject to compromise                                                                 8,056,704
                                                                                               ------------
           Total liabilities                                                                      9,424,721

Redeemable Preferred Stock, $.01 par value; 10,000 shares authorized,
    issued and outstanding (redemption and liquidation value of $1,069,000)                       1,069,000

Redeemable Convertible Preferred Stock, Series A $.01 par value; 550 shares
    authorized, 200 shares issued and outstanding (redemption value of $2,520,000)                1,978,770

Stockholders' equity:
    Preferred stock - 250,000 shares authorized (including 10,000 shares of
       Redeemable Convertible Preferred Stock): $4 Cumulative Preferred Stock $.01
       par value, 50,000 shares issued and outstanding (liquidation value $500,000)                     500
    Common stock - $.01 par value, 10,000,000 shares authorized, 4,488,385 shares
       issued and outstanding                                                                        44,884
    Additional paid-in capital                                                                   15,781,541
    Accumulated deficit                                                                         (25,856,492)
    Deferred compensation                                                                           (53,530)
                                                                                               ------------
           Total stockholders' deficit                                                          (10,083,097)
                                                                                               ------------
           Total liabilities and stockholders' deficit                                         $  2,389,394
                                                                                               ============
</TABLE>


See accompanying notes to consolidated financial statements.

                                      F-4


<PAGE>
<PAGE>





                             PUDGIE'S CHICKEN, INC.
                                AND SUBSIDIARIES
                              DEBTORS-IN-POSSESSION

                      Consolidated Statement of Operations

                          Year ended December 31, 1996

<TABLE>
<S>                                                                     <C>
Revenues:
    Restaurant sales                                                    $ 10,069,748
    Franchise and advertising royalties                                      966,908
    Franchise fees                                                           270,000
    Interest income and other revenue                                         97,350
                                                                        ------------
                                                                          11,404,006

Expenses:
    Restaurant cost of sales                                               3,929,726
    Restaurant operating expenses                                          5,696,573
    Franchising costs                                                        116,562
    General and administrative                                             4,765,352
    Arbitration award                                                      1,707,404
    Restaurant closing expenses                                              347,010
    Advertising expenses                                                     744,536
    Depreciation and amortization                                            906,333
    Interest expense                                                         320,543
                                                                        ------------
                                                                          18,534,039
                                                                        ------------
         Loss before reorganization items                                 (7,130,033)
                                                                        ------------
Reorganization items:
    Impairment of long-lived assets                                        8,097,897
    Loss on closing of restaurants                                         1,366,002
    Professional fees                                                        443,325
                                                                        ------------
         Net loss                                                       $(17,037,257)
                                                                        ============
Loss per share                                                          ($      3.80)
                                                                        ============
Weighted average number of common shares outstanding                       4,486,404
                                                                        ============
</TABLE>


See accompanying notes to consolidated financial statements. 

                                      F-5


<PAGE>
<PAGE>


                             PUDGIE'S CHICKEN, INC.
                                AND SUBSIDIARIES
                              DEBTORS-IN-POSSESSION

                 Consolidated Statement of Stockholders' Deficit

                          Year ended December 31, 1996

<TABLE>
<CAPTION>
                                     PREFERRED            COMMON                                                           TOTAL
                                       STOCK              STOCK                ADDITIONAL    DEFERRED                      STOCK-
                                       NUMBER             NUMBER                PAID-IN       COMPEN-    ACCUMULATED      HOLDERS'
                                     OF SHARES  AMOUNT  OF SHARES   AMOUNT      CAPITAL       SATION       DEFICIT        DEFICIT
<S>                                  <C>        <C>     <C>         <C>         <C>        <C>         <C>            <C>

Balance at December 31, 1995           50,000    $500   4,506,972   $45,070   $16,159,920  $(225,362)  $ (8,699,235)  $  7,280,893

Issuance of common stock purchase
    warrants                             --       --         --        --         100,000       --             --          100,000
Private placement issuance costs         --       --         --        --        (360,818)      --             --         (360,818)
Accrual of Convertible Preferred
    Stock Dividend Shares                --       --         --        --            --         --          (60,000)       (60,000)
Accrual of Convertible Preferred
    Stock Penalty Shares                 --       --         --        --            --         --          (20,000)       (20,000)
Issuance of Convertible Preferred
    Stock Penalty Shares                 --       --       12,964       130        39,870       --          (40,000)          --
Forfeit of restricted stock              --       --      (31,551)     (316)     (157,431)   157,747           --             --
Amortization of deferred compensation
    relating to restricted stock         --       --         --        --            --       14,085           --           14,085
Net loss                                 --       --         --        --            --         --      (17,037,257)   (17,037,257)
                                       ------    ----   ---------   -------   -----------   --------   ------------   ------------
Balance at December 31, 1996           50,000    $500   4,488,385   $44,884   $15,781,541   $(53,530)  $(25,856,492)  $(10,083,097)
                                       ======    ====   =========   =======   ===========   ========   ============   ============
</TABLE>


See accompanying notes to consolidated financial statements.

                                      F-6


<PAGE>
<PAGE>




                             PUDGIE'S CHICKEN, INC.
                                AND SUBSIDIARIES
                              DEBTORS-IN-POSSESSION

                      Consolidated Statement of Cash Flows

                          Year ended December 31, 1996

<TABLE>
<S>                                                                              <C>
Cash flows from operating activities:
   Net loss                                                                      $(17,037,257)
   Adjustments to reconcile net income to net cash
      provided by operating activities:

         Depreciation and amortization                                                906,333
         Provision for bad debts                                                      690,647
         Write down of intangible assets                                            8,097,897
         Loss on closure of restaurants                                             1,713,012
         Loss on arbitration                                                        1,707,404
         Deferred compensation expense                                                 14,085
         Change in assets and liabilities:

           Increase in franchise and advertising royalties receivable                (592,433)
           Decrease in inventory                                                       26,610
           Decrease in other assets                                                   254,400
           Increase in accounts payable and accrued expenses                          161,710
           Increase in deferred franchise fees                                         67,500
           Decrease in other liabilities                                             (135,823)
           Increase in liabilities subject to compromise                            2,374,209
                                                                                 ------------
              Net cash used in operating activities                                (1,751,706)
                                                                                 ------------

Cash flows from investing activities:
   Proceeds from sale of equipment                                                     62,815
   Capital expenditures                                                              (437,956)
                                                                                 ------------
              Net cash used in investing activities                                  (375,141)
                                                                                 ------------
Cash flows from financing activities:
   Increase in restricted cash                                                        (62,365)
   Net proceeds from private placement                                              1,637,952
                                                                                 ------------
              Net cash provided by financing activities                             1,575,587
                                                                                 ------------
Net decrease in cash and cash equivalents                                            (551,260)

Cash and cash equivalents, beginning of year                                          823,440
                                                                                 ------------
Cash and cash equivalents, end of year                                           $    272,180
                                                                                 ============
</TABLE>


        See accompanying notes to consolidated financial statements.

                                      F-7



<PAGE>
<PAGE>


                             PUDGIE'S CHICKEN, INC.
                                AND SUBSIDIARIES
                              DEBTORS-IN-POSSESSION

                   Notes to Consolidated Financial Statements

                                December 31, 1996

(1)   PROCEEDINGS UNDER CHAPTER 11 AND BASIS OF PRESENTATION OF FINANCIAL
      STATEMENTS

      Pudgie's Chicken,  Inc. and all of its subsidiaries  ("the Company") filed
      voluntary  petitions  for relief  under  Chapter  11 of the United  States
      Bankruptcy  Code in the United  States  Bankruptcy  Court for the Southern
      District  of New York  ("the  Bankruptcy  Court")  on  various  dates from
      September  18, 1996  through  October 10, 1996.  On October 15, 1996,  the
      individual petitions of the Company were administratively  consolidated by
      the Bankruptcy Court. The  Company is currently  operating its business as
      debtors-in-possession, subject to the approval of the Bankruptcy Court for
      certain  proposed  actions.  Additionally,  certain  creditor  and  equity
      committees  have been formed  which have the right to review and object to
      non-ordinary course business  transactions and are expected to participate
      in the  formulation  and approval of any plan or plans of  reorganization.
      The  Company's  exclusivity  period  for  filing a plan of  reorganization
      expires on April 27,  1997,  which is shared as of March 27, 1997 with the
      Equity and Creditors Committees.

      As of the petition date, actions to collect pre-petition  indebtedness are
      stayed and other  contractual  obligations may not be enforced against the
      Company.  These claims are reflected in the December 31, 1996 consolidated
      balance sheet as  "liabilities  subject to compromise".  In addition,  the
      Company has rejected executory contracts and lease obligations and parties
      affected  by these  rejections  may file claims  ("liabilities  subject to
      compromise")   with  the   Bankruptcy   Court  in   accordance   with  the
      reorganization  process  through the claim  expiration date of January 31,
      1997 (note 9). Additional claims may also arise from  determination by the
      Bankruptcy  Court (or agreed to by parties in interest) of allowed  claims
      for   contingencies   and  other  disputed   amounts.   Substantially  all
      liabilities as of the petition date are subject to settlement under a plan
      of reorganization  to be filed by the Company and subsequently  voted upon
      by all  impaired  classes of  creditors  and equity  security  holders and
      approved by the Bankruptcy Court.

      The Company has discontinued  accruing  interest on its pre-petition  debt
      obligation,  as well as dividends and related  penalties on its redeemable
      convertible  preferred stock  effective  September 18, 1996. For financial
      reporting  purposes,  all pre-petition debt obligations have been included
      in   "liabilities   subject  to  compromise"  on  the  December  31,  1996
      consolidated  balance sheet. The ultimate adequacy of the security for any
      secured pre-petition debt obligations cannot be determined until a plan or
      reorganization is confirmed.

      On October 15, 1996,  the  Bankruptcy  Court  granted an order  allowing a
      secured claim on amounts not to exceed $250,000 to a supplier,  to provide
      the Company with a credit  facility to purchase  food and other  operating
      supplies.

      On November 22, 1996,  effective  November 14, 1996, the Bankruptcy  Court
      approved an order  allowing the  rejection of the leases for twelve stores
      closed by the Company (note 4).

      On February 12, 1997, the Bankruptcy Court granted an order which provided
      the holder of a $3.6 million secured note replacement liens on principally
      all of the Company's assets,

                                                                     (Continued)

                                      F-8


<PAGE>
<PAGE>

                             PUDGIE'S CHICKEN, INC.
                                AND SUBSIDIARIES
                              DEBTORS-IN-POSSESSION

                   Notes to Consolidated Financial Statements

(1), CONTINUED

      subordinate only to liabilities for debtor-in-possession  financing,  U.S.
      Trustees  fees,  a  supplier  lien and  professional  fees  not to  exceed
      $375,000  in the  aggregate  (note 8). The order  allows the  pre-petition
      claim  of  the  noteholder  amounting  to  approximately  $3,600,000  plus
      interest  and  releases  cash  held  in  escrow  by  Company   counsel  of
      approximately  $60,000.  The  order  also  provides  that  if  a  plan  of
      reorganization  is confirmed  before October 1, 1997,  which plan provides
      for the payment of $1,000,000 to the  noteholder,  the noteholder  will be
      deemed to have an allowed secured claim in the amount of $1,000,000 and an
      allowed  unsecured  claim for the balance.  The noteholder  would agree to
      vote in favor of the Company sponsored plan of reorganization and upon the
      receipt  of  $1,000,000,  would  release  the  security  interest.  If the
      $1,000,000 is not paid or if the plan of reorganization is not approved by
      the stipulated  dates,  the noteholder would not be bound by the foregoing
      terms.

      On March 13, 1997, the Bankruptcy  Court granted an order  authorizing the
      Company  to  obtain  debtor-in-possession  financing  up to a  maximum  of
      $250,000  pursuant to a loan and security  agreement  dated as of February
      28,  1997 and  granted  the lender a secured  claim for loans made up to a
      maximum  of  $250,000  (note 8).  The  order  amended  the first  priority
      supplier's lien to $150,000 and the remaining  balance would be pari-passu
      with  the  other  secured   claims.   The  order  also  provides  for  the
      reimbursement  to the  supplier of certain  attorney  fees and granted the
      supplier  an  administrative   priority  claim  of  approximately  $98,000
      relating to the supplier's reclamation claim.

      For financial reporting  purposes,  the Company has applied the provisions
      of the American  Institute of Certified  Public  Accountants  Statement of
      Position 90-7,  "Financial  Reporting by Entities in Reorganization  Under
      the Bankruptcy Code" (SOP 90-7) in the accompanying consolidated financial
      statements.

      The accompanying consolidated financial statements have been prepared on a
      going  concern  basis,  which   contemplates   continuity  of  operations,
      realization  of assets and  liquidation  of  liabilities  in the  ordinary
      course of  business.  However,  as a result of the  Chapter 11 filings and
      circumstances  relating to this event,  including the Company's  recurring
      losses from  operations  as  reflected  in the  consolidated  statement of
      operations,  such  realization of assets and liquidation of liabilities is
      subject to significant uncertainty.  While under the protection of Chapter
      11, the Company may sell or otherwise dispose of assets,  and liquidate or
      settle  liabilities,  for  amounts  other  than  those  reflected  in  the
      consolidated financial statements. Further, a plan of reorganization could
      materially  change the  amounts  reported  in the  consolidated  financial
      statements.  The  accompanying  consolidated  financial  statements do not
      include  any  adjustments  to the  carrying  value of assets or amounts of
      liabilities  that  might be  necessary  should  the  Company  be unable to
      continue  as  a  going  concern  or  as  a   consequence   of  a  plan  of
      reorganization.  The  appropriateness  of using the going concern basis is
      dependent   upon,   among  other  things,   confirmation   of  a  plan  of
      reorganization,  future profitable operations,  the ability to comply with
      debtor-in-possession  and other  financing  agreements  and the ability to
      generate  sufficient  cash from  operations and financing  sources to meet
      obligations.

                                                                     (Continued)

                                      F-9


<PAGE>
<PAGE>


                             PUDGIE'S CHICKEN, INC.
                                AND SUBSIDIARIES
                              DEBTORS-IN-POSSESSION

                   Notes to Consolidated Financial Statements

(1), CONTINUED

      While the Company believes it has adequate financing to operate during the
      bankruptcy  proceeding  for a  limited  period  of time,  its  ability  to
      continue operations is dependent upon, among other things, confirmation of
      a plan of  reorganization  that will  enable the  Company  to emerge  from
      bankruptcy  proceedings,  obtain additional  capital or other financing to
      fund distributions under the plan of reorganization and to provide working
      capital.  There is no assurance that such reorganization or financing will
      occur.  These  factors,  among others,  indicate that there is substantial
      doubt that the Company can continue as a going concern.

(2)   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

      (A)  NATURE OF BUSINESS

           Pudgie's  Chicken,  Inc. was  incorporated in Delaware on January 28,
           1993. The Company  operates and franchises food service  restaurants.
           In exchange for franchise  fees and royalties,  the Company  provides
           franchisees with site approval,  interior layout plans,  training and
           operations   advice.   The  Company  also   provides   marketing  and
           advertising support.

      (B)  OPERATION OF RESTAURANTS

           During 1996,  the Company  acquired the net assets of one  franchised
           restaurant, in exchange for forgiveness of amounts due the Company in
           the amount of $56,607.  The excess of the  aggregate  purchase  price
           over the fair value of net assets  acquired of $96,634,  was recorded
           as goodwill and is being amortized over 30 years (note 3).

           During 1996,  the Company opened three  Company-owned  restaurants in
           locations  previously operating as franchised  restaurants.  Revenues
           and expenses  related to the operation of these  restaurants from the
           dates of  acquisition  are  included  in food  sales  and  restaurant
           opening  costs,  respectively.  In 1996,  the Company  closed  twelve
           stores,  including  three  prior to its  Chapter  11 filing  and nine
           subsequent  to the filing.  In January  1997,  the Company  closed an
           additional store (note 4).

      (C)  PRINCIPLES OF CONSOLIDATION

           The  consolidated  financial  statements  include the accounts of the
           Company  and  its   subsidiaries.   All  intercompany   accounts  and
           transactions have been eliminated in consolidation.

      (D)  RESTRICTED CASH

           Restricted  cash  represents  funds received from asset sales and the
           collection  of  franchisee  receivables  which  are held in escrow by
           Company  counsel.  Pursuant  to an Order of the  Bankruptcy  Court on
           February 12, 1997 (note 1), such funds were realized from escrow.

                                                                     (Continued)

                                      F-10


<PAGE>
<PAGE>


                             PUDGIE'S CHICKEN, INC.
                                AND SUBSIDIARIES
                              DEBTORS-IN-POSSESSION

                   Notes to Consolidated Financial Statements

(2), CONTINUED

      (E)  INVENTORIES

           Inventories are stated at the lower of cost (first-in,  first-out) or
           market value and consist of food and paper products.

      (F)  PROPERTY AND EQUIPMENT

           Property and equipment are stated at cost and are  depreciated on the
           straight-line  method  over  estimated  useful  lives of the  assets.
           Leasehold  improvements  are amortized over the lesser of the life of
           the lease or five years. The estimated useful lives are as follows:

                  Furniture and fixtures                      5 years
                  Restaurant equipment                        8 years
                  Computer equipment and software           4-5 years
                  Vehicles                                    7 years

      (G)  INTANGIBLE ASSETS

           Goodwill  represents the excess of cost over fair value of net assets
           acquired and is amortized on a straight-line  basis over the expected
           period to be benefited, thirty years.

           The Company assesses the  recoverability  of this intangible asset by
           determining whether the amortization of the goodwill balance over its
           remaining life can be recovered through undiscounted future operating
           cash flows (note 3).

           The costs  incurred to develop and register the Company's  trademarks
           have been  capitalized and are being  amortized on the  straight-line
           method over 40 years.  Legal costs associated with incorporation were
           capitalized and are being amortized over a 10 year period.

           Amortization  expense,  excluding  the  impact  of the  write-off  of
           goodwill  associated  with the closing of restaurants  (note 4) and a
           charge  associated  with the  impairment  of  goodwill  (note 3), was
           approximately $336,000.

      (H)  REVENUE RECOGNITION

           Revenue from franchised  restaurants is derived from the initial sale
           of franchises for a fee of $30,000 for an individual restaurant, from
           area development agreements for a predesignated number of restaurants
           to be opened within a designated span of time at negotiated  contract
           prices and from royalty fees for franchising  support and advertising
           at 5% and 3%, respectively, of retail product sales. Revenue from the
           sale  of   individual   franchises  is  recognized  at  the  time  of
           substantial  performance  of  the  obligations  of  the  Company,  as
           described  in note 7.  Revenue from area  development  agreements  is
           recognized as each restaurant is opened and royalties are recorded on
           the accrual basis.

                                                                     (Continued)

                                      F-11


<PAGE>
<PAGE>


                             PUDGIE'S CHICKEN, INC.
                                AND SUBSIDIARIES
                              DEBTORS-IN-POSSESSION

                   Notes to Consolidated Financial Statements

(2), CONTINUED

      (H), CONTINUED

           Revenue from  Company-owned  restaurants  is recognized in the period
           the related products are sold.

      (I)  PREOPENING COSTS

           The Company expenses preopening costs as incurred.

      (J)  CONCENTRATION OF CREDIT RISK

           Financial instruments which potentially subject the Company to credit
           risk consist  principally  of franchisee  receivables,  which are not
           collateralized.   Approximately  83%  of  the  Company's   franchised
           restaurants  are  in the  same  geographical  area.  Credit  risk  is
           affected  by  conditions  or  occurrences  within the economy and the
           geographic area. The Company maintains  reserves for potential credit
           losses  for trade  accounts  receivable  and  discontinues  recording
           revenue  when  amounts are deemed  uncollectible  based upon  factors
           surrounding the credit risk of specific customers,  historical trends
           and other information.

      (K)  INCOME TAXES

           Income taxes are accounted for under the asset and liability  method.
           Deferred tax assets and liabilities are recognized for the future tax
           consequences   attributable  to  differences  between  the  financial
           statement  carrying  amounts of existing  assets and  liabilities and
           their  respective  tax  bases  and  operating  loss  and  tax  credit
           carryforwards. Deferred tax assets and liabilities are measured using
           enacted tax rates expected to apply to taxable income in the years in
           which those temporary  differences and  carryforwards are expected to
           be  recovered  or  settled.  The  effect on  deferred  tax assets and
           liabilities  of a change in tax rates is  recognized in income in the
           period that includes the enactment date.

      (L)  NET LOSS PER COMMON SHARE

           Net loss per  common  share is  determined  on the basis of  weighted
           average  number of shares of common  stock  outstanding.  For 1996, a
           weighted  average  number of shares was not  calculated  for options,
           warrants and  convertible  preferred  stock  outstanding due to their
           anti-dilutive effect on the Company's net loss per share calculation.

      (M)  FINANCIAL INSTRUMENTS

           Statement of Financial Accounting Standards No.107, "Disclosure about
           Fair Value of Financial  Instruments"  ("SFAS No.107"),  requires the
           Company  to  disclose   estimated   fair  values  for  its  financial
           instruments.  The Company has  determined  that cash,  notes  payable
           which are included in liabilities  subject to compromise (note 9) and
           its preferred

                                                                     (Continued)

                                      F-12


<PAGE>
<PAGE>


                             PUDGIE'S CHICKEN, INC.
                                AND SUBSIDIARIES
                              DEBTORS-IN-POSSESSION

                   Notes to Consolidated Financial Statements

(2), CONTINUED

      (M), CONTINUED

           stock meet the  definition  of  financial  instruments.  The carrying
           amount of cash  approximates its fair value because of the short-term
           maturities of the investments.  The fair value of the other financial
           instruments depends upon the terms and conditions of a confirmed plan
           of  reorganization  which will resolve certain  uncertainties.  These
           uncertainties preclude the Company from determining the fair value of
           these financial instruments during the pendency of its reorganization
           proceedings.

      (N)  USE OF ESTIMATES

           Management  of  the  Company  has  made a  number  of  estimates  and
           assumptions  relating to the reporting of assets and  liabilities and
           the disclosures of contingent assets and liabilities to prepare these
           financial statements in conformity with generally accepted accounting
           principles. Actual results could differ from these estimates.

      (O)  IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED
           OF

           The Company adopted the provisions of SFAS No.121, Accounting for the
           Impairment  of  Long-Lived  Assets  and for  Long-Lived  Assets to Be
           Disposed  Of, on  January  1,  1996.  This  Statement  requires  that
           long-lived  assets and certain  identifiable  intangibles be reviewed
           for impairment  whenever events or changes in circumstances  indicate
           that  the  carrying  amount  of an  asset  may  not  be  recoverable.
           Recoverability  of  assets  to be  held  and  used is  measured  by a
           comparison  of the  carrying  amount of an asset to  future  net cash
           flows  expected  to be  generated  by the asset.  If such  assets are
           considered  to  be  impaired,  the  impairment  to be  recognized  is
           measured  by the  amount by which the  carrying  amount of the assets
           exceed the fair value of the  assets.  Assets to be  disposed  of are
           reported at the lower of the carrying amount or fair value less costs
           to sell.

           As a result of the  Company's  Chapter 11 filing,  management  of the
           Company  determined that the carrying value of intangible  assets was
           impaired and recorded a charge of $8,097,897 (note 3).

      (P)  STOCK-BASED COMPENSATION

           The Company  records  compensation  expense for stock options only if
           the current market price of the underlying stock exceeds the exercise
           price on the date the options are  granted.  On January 1, 1996,  the
           Company adopted Statement of Financial  Accounting  Standards No.123,
           Accounting  for  Stock-Based   Compensation  ("Statement  123").  The
           Company has elected not to implement the fair value based  accounting
           method for stock  options,  but has elected to disclose  the proforma
           net earnings and proforma  earnings per share for stock option grants
           made as if such  method  had been  used to  account  for  stock-based
           compensation  costs as described in Statement 123. As of December 31,
           1996, the Company has not granted any stock options to employees.

                                                                     (Continued)

                                      F-13


<PAGE>
<PAGE>


                             PUDGIE'S CHICKEN, INC.
                                AND SUBSIDIARIES
                              DEBTORS-IN-POSSESSION

                   Notes to Consolidated Financial Statements

      (Q)  SUPPLEMENTAL CASH FLOW INFORMATION

           Cash paid during the year for:

                             Interest                $    140,870
                                                        =========

                             Income taxes            $     11,845
                                                        =========

           In 1996,  the Company  charged  $120,000 to  accumulated  deficit for
           dividends and penalties  associated  with its $.01 par value series A
           redeemable  convertible preferred stock. Of this amount,  $40,000 was
           paid in common stock and $80,000 was recorded in preferred stock.

           The  Company  acquired  one  franchised  store  (note  2(b))  and the
           equipment  of  three  additional  franchised  operations  in  1996 in
           exchange for the  forgiveness of  approximately  $149,000 of accounts
           receivable  and the  issuance  of a note  payable  for  approximately
           $125,000.  The Company received  approximately $177,000 of  equipment
           and  recorded  approximately  $97,000 of goodwill as a result of this
           transaction.

           Operating cash payments resulting from reorganization items:

                U.S. Trustee fees paid                          $  2,750
                Chapter 11 filing fees paid                       17,700
                Professional fees paid for services rendered
                    in connection with the Chapter 11
                    proceedings                                   43,000
                                                                 -------
                         Total reorganization payments          $ 63,450
                                                                 =======

(3)   IMPAIRMENT OF LONG-LIVED ASSETS

      As discussed in note 2 (o), the Company  adopted SFAS No.121 as of January
      1, 1996 for purposes for determining  and measuring  impairment of certain
      long-lived assets to be held and used in the business.  Assets are grouped
      and  evaluated  for  impairment  at the lowest  level for which  there are
      identifiable  cash flows that are  independent  of the cash flows of other
      groups of assets.  The Company has identified the appropriate  grouping of
      assets  to be  individual  Company-owned  restaurants  and  the  Corporate
      franchising  part of the  business.  The  asset  groups  are  deemed to be
      impaired  if a forecast  of  undiscounted  future  operating  cash  flows,
      including  disposal value, if any, is less than its carrying  amount.  The
      loss is measured as the amount by which the carrying  amount of the assets
      exceed its fair value.

      The Company recorded an impairment charge of $8,097,897 to fully write-off
      its intangible assets.

                                                                     (Continued)

                                      F-14


<PAGE>
<PAGE>


                             PUDGIE'S CHICKEN, INC.
                                AND SUBSIDIARIES
                              DEBTORS-IN-POSSESSION

                   Notes to Consolidated Financial Statements

(4)   STORE CLOSINGS

      In fiscal 1996, the Company closed twelve stores, including three prior to
      its Chapter 11 filing and nine subsequent to the filing.  In January 1997,
      the Company  closed an additional  store.  On October 22, 1996,  effective
      November 14, 1996, the Bankruptcy Court approved an order  authorizing the
      rejection  of the  leases  for the twelve  stores  closed by the  Company.
      Included in  liabilities  subject to compromise at December 31, 1996, is a
      provision for $324,436,  representing  management's  estimate of the lease
      termination liability pursuant to Section 502 of the Bankruptcy Code (note
      9).

      Included in the accompanying 1996 consolidated statement of operations are
      losses of $347,010 and  $1,366,002  relating to the pre and  post-petition
      store  closures,  respectively,  including  the  write-off of goodwill for
      acquired stores and the above-mentioned lease termination liability.

(5)   PROPERTY AND EQUIPMENT

      Property and equipment consists of the following at December 31, 1996:

            Restaurant equipment                       $ 1,157,590
            Furniture and fixtures                         158,529
            Computer equipment                             129,282
            Truck                                            7,690
            Leasehold improvements                       1,252,484
                                                       -----------
                                                         2,705,575
            Less accumulated depreciation and
                amortization                             1,041,869
                                                       -----------
                   Property and equipment, net         $ 1,663,706
                                                       ===========

      Depreciation and amortization  expense on property and equipment  amounted
      to approximately $571,000 in 1996.

(6)   INTANGIBLE ASSETS

      Intangible assets consist of the following at December 31, 1996:

            Goodwill                                   $ 8,596,164
            Restrictive covenants                           30,000
            Trademarks                                      61,000
            Other                                           61,121
                                                       -----------
                                                         8,748,285
            Less accumulated amortization                8,748,285
                                                       -----------
                     Intangible assets, net            $     --  
                                                       ===========

                                                                     (Continued)

                                      F-15


<PAGE>
<PAGE>


                             PUDGIE'S CHICKEN, INC.
                                AND SUBSIDIARIES
                              DEBTORS-IN-POSSESSION

                   Notes to Consolidated Financial Statements

(7)   DEFERRED FRANCHISE FEES

      At  December  31,  1996,  four area  development  agreements  were  signed
      however,  the  restaurants  had not opened  for  business.  Franchise  fee
      revenue  related to franchise  agreements is recognized  when  substantial
      performance of all  obligations  and services as outlined in the franchise
      agreements  has  occurred and ratably as  restaurants  are opened for area
      development agreements. The obligations and duties of the Company pursuant
      to the  franchise  agreement  include  approval of a restaurant  location;
      providing  interior  layout plans;  providing  training for the franchisee
      prior to the restaurant opening; and having representatives  available for
      consultation.  During  1996,  two  franchise  restaurants  were opened for
      business and seven  restaurants  were closed due to failure to comply with
      the provisions of the franchise  agreement or failure to remit  royalties.
      During 1996, two area developers  forfeited their  development  rights and
      $200,000 of franchise fees  previously paid to the Company were recognized
      as revenue.

(8)   FINANCING ARRANGEMENTS

      (A)  NOTES PAYABLE TO STOCKHOLDERS

           In  August  1995,  the  Company  renegotiated  a  note  payable  to a
           stockholder.  The $3.6  million  note  required  monthly  payments of
           interest  at 3.5% above the prime  rate as  defined,  was  secured by
           principally  all of the Company's  assets and matured in its entirety
           in February 1997.

           As indicated  in footnote 1, the Company  filed a Chapter 11 petition
           on September 18, 1996 and discontinued  accruing  interest expense at
           that  time.  On  November  11,  1996,  the  noteholder  commenced  an
           adversary proceeding against the Company.

           On February 12, 1997,  the  Bankruptcy  Court  granted an Order which
           provided  the  $3.6  million  noteholder  with  replacement  liens on
           principally  all  of  the  Company's  assets,   subordinate  only  to
           liabilities for debtor-in-possession financing, U.S. Trustees fees, a
           supplier  lien and  professional  fees not to exceed  $375,000 in the
           aggregate.  The order allows the pre-petition claim of the noteholder
           amounting to approximately $3,600,000 plus interest and releases cash
           held in escrow by Company counsel of approximately $60,000. The Order
           also provides that if a plan of  reorganization  is confirmed  before
           October 1, 1997, which plan provides for the payment of $1,000,000 to
           the noteholder,  subject to certain other conditions,  the noteholder
           will be  deemed to have an  allowed  secured  claim in the  amount of
           $1,000,000  and an  allowed  unsecured  claim  for the  balance.  The
           noteholder would agree to vote in favor of the Company sponsored plan
           of reorganization  and upon the receipt of $1,000,000,  would release
           the security  interest.  If the $1,000,000 is not paid or if the plan
           of  reorganization  is not  approved  by the  stipulated  dates,  the
           noteholder would not be bound by the foregoing terms.

           At December 31, 1996,  included in liabilities  subject to compromise
           is the aforementioned  note payable and interest  accrued through the
           Chapter 11 filing date aggregating $177,649.

                                                                     (Continued)

                                      F-16


<PAGE>
<PAGE>


                             PUDGIE'S CHICKEN, INC.
                                AND SUBSIDIARIES
                              DEBTORS-IN-POSSESSION

                   Notes to Consolidated Financial Statements

(8), CONTINUED

      (B)  POST-PETITION FINANCING

           On October 30, 1996, the Bankruptcy Court granted an Order allowing a
           secured  claim not to exceed  $250,000  to a supplier  pursuant to an
           agreement dated as of October 1, 1996, under which the supplier would
           provide the Company with a credit facility to purchase food and other
           operating supplies.

           On March 13, 1997, the Bankruptcy Court granted an Order  authorizing
           the Company to obtain debtor-in-possession  financing up to a maximum
           of $250,000 pursuant to a loan and security  agreement dated February
           28, 1997 and granted the lender a secured  claim for loans made up to
           a maximum of  $250,000.  The facility  bears  interest at 16% payable
           monthly  and  is due  the  earlier  of (i)  February  1,  1998,  (ii)
           dismissal  of the  Chapter  11 case or  (iii)  at  conversion  of the
           Chapter 11 case to a  proceeding  under  Chapter 7 of the  Bankruptcy
           Code.  Subsequently,  the Company has  borrowed  $190,000  under this
           facility.

           The order amended the first priority  supplier's lien to $150,000 and
           the  remaining  balance  would be  pari-passu  with the other secured
           claims. The order also provides for the reimbursement to the supplier
           of certain  attorney fees and granted the supplier an  administrative
           priority claim of  approximately  $98,000  relating to the supplier's
           reclamation claim.

           In the event of confirmation of a Plan of reorganization,  the lender
           shall receive additional compensation (the "Additional Compensation")
           in the form of such number of warrants  to purchase  common  stock of
           the Company  ("Warrants")  with an estimated  fair value of $100,000.
           The   Warrants   (1)   shall  be  issued   pursuant   to  a  plan  of
           reorganization, (2) shall be delivered to Lender within 60 days after
           confirmation  of a plan of  reorganization,  (3) shall be exercisable
           during a period of seven  years, commencing six months after the date
           of  confirmation  of a plan of  reorganization  and (4) shall have an
           exercise price equal to 115% of fair market value, as defined.

(9)   LIABILITIES SUBJECT TO COMPROMISE IN BANKRUPTCY REORGANIZATION

      Liabilities subject to compromise consist of the following at December 31,
      1996:

            Note payable to stockholder            $ 3,606,837
            Arbitration award                        1,707,404
            Accounts payable and accrued
                expenses                             2,050,492
            Sales tax payable                          514,322
            Interest payable                           177,649
                                                   -----------

                                                   $ 8,056,704
                                                   ===========

                                                                     (Continued)

                                      F-17


<PAGE>
<PAGE>


                             PUDGIE'S CHICKEN, INC.
                                AND SUBSIDIARIES
                              DEBTORS-IN-POSSESSION

                   Notes to Consolidated Financial Statements

(9), CONTINUED

      The expiration  date for filing  creditor  claims against the Company with
      the Bankruptcy Court was January 31, 1997.  Approximately  $163,000,000 of
      creditor claims have been filed with the Bankruptcy  Court. The Company is
      in the process of reviewing  each proof of claim to reconcile  the claimed
      amount with the Company's books and records.  Company manage-ment believes
      that the claimed amounts are grossly  overstated.  The final determination
      of the  allowed  claims  is  expected  to invoke  litigation  of which the
      outcome is  uncertain  (note 13). The  Company's  estimates of the allowed
      claims as presented in the accompanying consoli-dated financial statements
      are  therefore  subject to change based upon the outcome of the Chapter 11
      proceedings.  The additional liability or reduction of liabilities arising
      from this  reconciliation  process,  if any, is not subject to  reasonable
      estimation. As a result, no provision has been recorded for these possible
      claims. The Company will recognize the additional  liability or reduction,
      if any, as the amounts become subject to reasonable estimation.

      Included in liabilities subject to compromise is approximately $324,000 of
      claims  related  to  rejected   leases  (notes  1  and  4),   representing
      management's  estimate of the Company's  liability pursuant to Section 502
      of the Bankruptcy Code. Also included in liabilities subject to compromise
      at  December  31,  1996 is  approximately  $225,000  relating  to  Company
      guarantees  of  franchisees'  financing  obligations.   Additionally,   as
      indicated  in note 13,  management  has not  established  a provision  for
      settlement of outstanding  litigation in liabilities subject to compromise
      at December 31, 1996.

      A plan of reorganization  ultimately confirmed by the Bankruptcy Court may
      materially change the amounts and terms of these prepetition liabilities.

(10)  REORGANIZATION COSTS

      The net  expense  incurred  as a result  of the  Chapter  11  filings  and
      subsequent  reorganization  efforts  has  been  segregated  from  ordinary
      operations in the consolidated  statement of operations for the year ended
      December 31, 1996. Reorganization costs are comprised of the following:

              Impairment of goodwill                      $ 8,097,897
              Loss on closing of restaurants                1,366,002
              Professional fees and other expenses
                  related to bankruptcy                       443,325
                                                          -----------
                                                          $ 9,907,224
                                                          ===========
      Reorganization   costs  include  expenses  from  closing  of  restaurants,
      consolidation  of  operations,  certain  expenses  incurred in the general
      restructuring  of  business  operations  and  the  write-off  of  impaired
      intangible assets (note 3).

                                                                     (Continued)

                                      F-18


<PAGE>
<PAGE>


                             PUDGIE'S CHICKEN, INC.
                                AND SUBSIDIARIES
                              DEBTORS-IN-POSSESSION

                   Notes to Consolidated Financial Statements

(11)  CAPITAL STRUCTURE

      (A)  AUTHORIZATION OF COMMON AND PREFERRED STOCK

           In May  1995,  the Board of  Directors  and  Stockholders  authorized
           amendments to the Certificate of Incorporation  which provided for an
           increase  in the  number of  authorized  shares of Common  Stock from
           125,000 to  10,000,000  and  Preferred  Stock from  50,000 to 250,000
           including  10,000 shares of Redeemable  Preferred Stock. On April 23,
           1996, the Board of Directors and Stockholders authorized the issuance
           of 550 shares of Redeemable  Convertible  Preferred Stock,  Series A.
           The Board of  Directors  also  authorized  Warrants to purchase up to
           1,350,000 shares of Common Stock.

      (B)  REDEEMABLE CONVERTIBLE PREFERRED STOCK, SERIES A

           In May 1996, the Company received  $2,000,000,  exclusive of expenses
           of approxi-mately $360,000, from a private placement,  which consists
           of 200 shares of Redeemable Convertible Preferred Stock, Series A and
           100,000  common  stock  purchase  warrants.  The  preferred  stock is
           convertible  into common stock at the option of the holder at a price
           of the  lower  of $4.47 or 82% of the  average  closing  price on the
           trading  day  immediately   preceding  conversion  and  automatically
           converts into shares of common stock on April 30, 1998. The preferred
           stock has a  redemption  and  liquidation  value of $12,200 per share
           plus  unpaid  dividends,  as  defined,  or cash at the  option of the
           Company. The preferred stockholders also receive penalty shares since
           a  Registration  Statement  for the  sale  of  common  stock  was not
           registered  by July 29,  1996.  Through the  Chapter 11 filing  date,
           approximately  $60,000 of  dividends  and $20,000 of  penalties  were
           accrued.   Dividends  and  penalties  have  not  been  accrued  since
           September 18, 1996.

           This class of preferred stock also contains a redemption  option that
           requires the Company to purchase the Preferred  Shares if at any time
           after May 3, 1996, the conversion price on any 20 trading days during
           any 30 consecutive trading day period is less than $2.00. Each holder
           of any  Preferred  Shares  is then,  upon  notice  from the  Company,
           entitled to elect to have the Company purchase all, but not less that
           all of the  Preferred  Shares  then  held by such  holder  for a cash
           purchase  price of $10,800  per  Preferred  Share  together  with all
           accrued  and unpaid  dividends  thereon.  The  redemption  option was
           triggered  subsequent  to  September  18, 1996 and as a result of the
           Company's  bankruptcy filing,  this provision has been stayed until a
           plan of reorganization has been approved by the Bankruptcy Court.

      (C)  REDEEMABLE PREFERRED STOCK

           In August 1995, in connection with the initial public offering of its
           common  stock,   the  Company  issued  10,000  shares  of  Redeemable
           Preferred Stock in partial satisfaction of its promissory note to the
           founder.  The  Redeemable  Preferred  Stock ranks senior to all other
           preferred  stock of the Company in priority  of  dividends,  right of
           redemption and payment upon  liquidation.  The principal terms of the
           Redeemable Preferred Stock are as follows:

                                                                     (Continued)

                                      F-19


<PAGE>
<PAGE>


                             PUDGIE'S CHICKEN, INC.
                                AND SUBSIDIARIES
                              DEBTORS-IN-POSSESSION

                   Notes to Consolidated Financial Statements

(11), CONTINUED

      (C), CONTINUED

               LIQUIDATION PREFERENCE

               In the event of a liquidation  of the Company,  the holder of the
               Redeemable  Preferred  Stock is entitled  to receive  $106.90 per
               share, plus any dividends accrued and unpaid to date.

               REDEMPTION

               The  Redeemable  Preferred  Stock is subject to redemption at any
               time at the option of the Board at a redemption  price of $106.90
               per share, plus any declared, accrued and unpaid dividends.

               The Redeemable Preferred Stock is subject to mandatory redemption
               by the Company,  at the redemption  value plus cumulative  unpaid
               declared dividends, to the extent of the net proceeds of any sale
               of Common Stock by the Company (after any required application of
               such proceeds to the payment of outstanding  indebtedness  of the
               Company for borrowed money).

               DIVIDENDS

               Dividends  are  payable  when  declared  by the  Company and then
               accrue on the Redeemable  Preferred Stock at an annual rate equal
               to 150 basis  points  in  excess  of the rate on three  year U.S.
               Treasury obligations on the date of issuance.  As of December 31,
               1996, no dividends have been declared.

               Pursuant to an agreement  dated  February 12, 1997, the preferred
               stockholder  amended the terms of the preferred stock so that the
               stock is  redeemable  for the  Company's  $.01 par  value  common
               stock, but is not, under any circumstances,  redeemable for cash.
               Additionally,  pursuant to an agreement  dated February 20, 1997,
               the preferred stockholder irrevocably waived his right to sell or
               otherwise  transfer the  preferred  stock to another party unless
               such party  executes and  delivers to the Company a  confirmation
               and  agreement  which  binds  the  party  to  the  terms  of  the
               agreements dated February 12, 1997 and February 20, 1997.

      (D)  $4 CUMULATIVE PREFERRED STOCK

           The  principal  terms of the $4  Cumulative  Preferred  Stock  are as
           follows:

               LIQUIDATION PREFERENCE

               In the event of a liquidation of the Company,  the holders of the
               Preferred  Stock  are  entitled  to  receive  a  $100  per  share
               liquidation preference, plus accrued dividends.

                                                                     (Continued)

                                      F-20


<PAGE>
<PAGE>


                             PUDGIE'S CHICKEN, INC.
                                AND SUBSIDIARIES
                              DEBTORS-IN-POSSESSION

                   Notes to Consolidated Financial Statements

(11), CONTINUED

      (D), CONTINUED

               REDEMPTION

               The  Preferred  Stock  has no  mandatory  redemption  but  can be
               redeemed by the Company at any time at a redemption price of $100
               plus accrued dividends.

               DIVIDENDS

               The  holders  of the  Preferred  Stock are  entitled  to  receive
               dividends at the rate of $4 per annum only after the  outstanding
               Stockholders Notes are first satisfied in full and the Redeemable
               Preferred Stock is fully redeemed with dividend  accrued thereon.
               As of December 31, 1996, no dividends have been declared.

      (E)  COMMON STOCK PURCHASE WARRANTS

           In August 1995,  the Company  sold  1,150,000  common stock  purchase
           warrants  ("the  Warrants").   Each  of  the  Warrants  entitles  the
           registered holder to purchase one share of common stock at a price of
           $5.50 per  share at any time  during  the  period  September  6, 1996
           through August 9, 2000. The Warrants are subject to redemption by the
           Company at a redemption price of $.10 per Warrant  commencing October
           9, 1996 upon 30 days prior  written  notice to the  Warrant  holders,
           provided  the average  closing bid  quotation  of the common stock as
           reported  on the  NASDAQ  Stock  Market has been at least 150% of the
           then  current  exercise  price of the Warrants  (initially  $8.25 per
           share) for a period of 20 consecutive trading day ending on the third
           day  prior  to  the  date  on  which  the  Company  gives  notice  of
           redemption.

           Pursuant to a January 1995 private  placement  of common  stock,  the
           Company issued 111,522 common stock purchase  warrants at an exercise
           price of $5.50.

           In August 1995,  the Company  issued  50,000  Common  Stock  Purchase
           Warrants to a stockholder as consideration for the renegotiation of a
           loan. They are exercisable at $6.00.

           Additionally,  in August 1995,  the Company  granted  200,000  common
           stock  purchase  warrants  exercisable at $8.25 per share and 100,000
           common stock  purchase  warrants  exercisable at a $5.66 per share to
           its underwriter in connection with its initial public  offering,  and
           20,000 common stock purchase warrants  exercisable at $8.25 per share
           relating to a financing.

      (F)  RESTRICTED STOCK

           In May 1995,  the  Board of  Directors  approved  the  adoption  of a
           Restricted Stock Plan pursuant to which a maximum of 72,115 shares of
           common stock may by awarded to officers of the Company.  In May 1995,
           these shares were awarded to four executive  officers of the Company.
           The shares awarded to three of the officers have been forfeited.

                                                                     (Continued)

                                      F-21


<PAGE>
<PAGE>


                             PUDGIE'S CHICKEN, INC.
                                AND SUBSIDIARIES
                              DEBTORS-IN-POSSESSION

                   Notes to Consolidated Financial Statements

(11), CONTINUED

      (G)  STOCK OPTION PLAN

           The  Company has  adopted  the 1995 Stock  Option  Plan ("the  Option
           Plan"),  pursuant to which options to acquire an aggregate of 250,000
           shares of Common  Stock may be  granted  to  employees,  officers  or
           directors  of, or  consultants  to,  the  Company.  The  Option  Plan
           authorizes the Board to issue  incentive stock options  ("ISOs"),  as
           defined in Section 422A(b) of the Internal Revenue Code (the "Code"),
           and stock  options  that do not conform to the  requirements  of that
           Code section ("Non-ISOs").  The Board has discretionary  authority to
           determine the types of stock options to be granted, the persons among
           those  eligible to whom options may be granted,  the number of shares
           to be  subject  to such  options  and the terms of the  stock  option
           agreements.  Officers,  directors  and  consultants  who are not also
           employees of the Company may only be granted  Non-ISOs.  The exercise
           price  of an ISO  will be  equal  to the  fair  market  value  of the
           underlying  shares of stock as of the date of the grant. The exercise
           price of a Non-ISO  will be  determined  by the Board at the time the
           option is granted.  The exercise price may be paid in cash, certified
           or bank check or by promissory note on terms prescribed by the Board.
           Notwithstanding  the foregoing,  no option may be issued  pursuant to
           the  Option  Plan with an  exercise  price  less than  either (i) the
           initial  public  offering  price per  share of  Common  Stock in this
           Offering or (ii) 85% of the fair  market  value per share on the date
           of grant.

           As of December 31, 1996, no options have been granted under the terms
           of the Plan.

(12)  INCOME TAXES

      The tax effects of  temporary  differences  that give rise to  significant
      portions  of the  deferred  tax assets at December  31, 1996 is  presented
      below:

          Deferred tax assets:
             Accounts receivable, principally due to
                allowance for doubtful accounts                $   337,102
             Property and equipment, principally due to
                differences in depreciation                         12,141
             Deferred Rent                                          71,911
             Liabilities subject to compromise                   1,689,170
             Net operating loss carryforwards                    4,549,852
                                                               -----------
                        Total deferred tax assets                6,630,176

          Less valuation allowance                              (3,640,183)
                                                                ----------
                        Net deferred tax assets                  2,989,993

          Deferred tax liability:
             Intangible assets, principally due to impairment
                charge                                           2,989,993
                                                               -----------
                        Net deferred tax assets                $        --
                                                               ===========

                                                                     (Continued)

                                      F-22


<PAGE>
<PAGE>


                             PUDGIE'S CHICKEN, INC.
                                AND SUBSIDIARIES
                              DEBTORS-IN-POSSESSION

                   Notes to Consolidated Financial Statements

(12), CONTINUED

      The valuation  allowance for deferred tax assets as of January 1, 1996 was
      $3,245,510. The change in the total valuation allowance for the year ended
      December 31, 1996 was $394,673. In assessing the realizability of deferred
      tax assets,  management  considers whether it is more likely than not that
      some portion or all of the  deferred tax assets will not be realized.  The
      ultimate  realization  of  deferred  tax  assets  is  dependent  upon  the
      generation  of future  taxable  income  during the  periods in which those
      temporary   differences  become  deductible.   Management   considers  the
      scheduled  reversal of deferred tax liabilities,  projected future taxable
      income, and tax planning strategies in making this assessment. In order to
      fully  realize the deferred  tax asset,  the Company will need to generate
      future taxable income of approximately $17,448,000.  At December 31, 1996,
      the Company has net operating  loss  carryforwards  for Federal income tax
      purposes  of  approximately  $11,986,000  (the NOL  carryforwards),  which
      expire in varying amounts through 2011. Losses for income tax purposes for
      the year ended December  31,  1996  was approximately  ($3,982,000). Based
      upon  the  Company's  Chapter  11  filing  and  losses  incurred  to date,
      management believes that the value of the deferred  tax asset is  impaired
      and has fully reserved the deferred tax asset.

      In  accordance  with Section 382 of the Internal  Revenue Code of 1986, as
      amended, as it applies to the NOL carryforwards, a change in more than 50%
      in the beneficial  ownership of the Company within a three-year period (an
      "Ownership  Change")  will  place an annual  limitation  on the  Company's
      ability to utilize its existing NOL  carryforwards to offset United States
      Federal taxable income in future years.  Generally,  such limitation would
      be  equal  to the  value of the  Company  as of the date of the  Ownership
      Change  multiplied by the Federal  long-term tax exempt  interest rate, as
      published by the Internal  Revenue  Service.  The Company had  significant
      changes  in  ownership  in 1993 and  1995  that  would  cause  the  annual
      limitations as described  above to apply.  Further  limitations on the NOL
      carryforward may occur if further  ownership  changes as contemplated in a
      plan of reorganization  are confirmed by the Bankruptcy Court. The Company
      has not  determined  what the maximum  annual amount of taxable  income is
      that can be reduced by the NOL carryforwards.

(13)  COMMITMENTS AND CONTINGENCIES

      (A)  COMMITMENTS

           The Company leases certain  office and  restaurant  facilities  under
           noncancelable  operating  lease  agreements.  Certain  leases contain
           contingent  rental provisions based upon a percent of gross sales and
           or provide for scheduled rent escalations during the initial terms of
           such  leases.   Included  in  "deferred  rent"  in  the  accompanying
           consolidated  balance sheet at December 31, 1996 are accruals related
           to such rent  deferrals  of  approximately  $189,000.  For  financial
           reporting purposes,  such leases are accounted for on a straight-line
           basis.  Future minimum annual lease  commitments  under these leases,
           excluding  leases rejected by the Company pursuant to an order of the
           Bankruptcy  Court  effective  November  14,  1996  (note  4),  are as
           follows:

                                                                     (Continued)

                                      F-23


<PAGE>
<PAGE>


                             PUDGIE'S CHICKEN, INC.
                                AND SUBSIDIARIES
                              DEBTORS-IN-POSSESSION

                   Notes to Consolidated Financial Statements

(13), CONTINUED

      (A), CONTINUED

                         1997                     $   670,297
                         1998                         706,188
                         1999                         626,139
                         2000                         298,600
                         2001                         207,835
                         2002 and thereafter          789,012
                                                   ----------
                                                  $ 3,298,071
                                                  ===========

           Contingent  rental  payments  on  building  leases are based upon the
           percentage of gross sales on the individual  restaurants  that exceed
           predetermined  levels.  The  percentage of gross sales to be paid and
           related  gross  sales  level  vary by  unit.  No  contingent  rentals
           expenses were incurred in 1996.

           Rent expense was $1,509,186 for 1996.

           The Company has a financing  agreement  with a financial  institution
           which  provides  a  $15,000,000  credit  facility  available  to  the
           Company's franchisees which meet both the Company's and the financial
           institution's credit requirements.  In the event that a franchisee is
           in default under the Agreement, the Company is required, for a period
           of 90 days, to use its best efforts to either sell the  restaurant or
           the equipment of the defaulted  franchisee to a successor  franchisee
           who agrees to assume the obligations of the defaulted franchisee.  If
           a successor  franchisee is not found within 90 days, the Company must
           pay all accrued  interest  then due by the defaulted  franchisee  and
           must continue to seek a successor  franchisee  for an additional  180
           days.  If at the end of such  period a successor  franchisee  has not
           been  located,  the Company must either  assume all of the  defaulted
           franchisee's  obligations  under the Agreement or pay the unamortized
           principal balance owed by the defaulted franchisee plus certain other
           costs; however, the Company's liability for such a pay-off is limited
           to $1,500,000 or 30% of the total amount funded under the  Agreement,
           whichever  is  greater.  Pursuant to this  agreement,  the Company is
           obligated to the financial  institution for the outstanding  balances
           of  two  closed  franchised  locations,   aggregating   approximately
           $225,000.  At December  31,  1996,  such amount has been  included in
           liabilities  subject  to  compromise.  In  addition,  the  Company is
           contingently  liable  for the  remaining  balances  of two  franchise
           locations  of  approximately  $187,000.  As  of  December  31,  1996,
           approximately $14.6 million of this facility remained available.

           The Company entered into employment agreements effective June 1, 1995
           with  the  President  and  Chief  Executive  Officer  and  the  Chief
           Financial  Officer  which  expire on May 31,  2000 and May 31,  1998,
           respectively.  The employment agreements provide for aggregate annual
           base salaries of approximately $327,000,  certain benefits and annual
           incentive   bonuses   based  on  a  formula  tied  to  the  Company's
           performance.

                                                                     (Continued)

                                      F-24


<PAGE>
<PAGE>


                             PUDGIE'S CHICKEN, INC.
                                AND SUBSIDIARIES
                              DEBTORS-IN-POSSESSION

                   Notes to Consolidated Financial Statements

(13), CONTINUED

      (B)  CONTINGENCIES

           On  June 30, 1995,  an area  developer  of the  Company's  franchised
           restaurants,  commenced an action against the Company alleging common
           law fraud and  violations of the Franchise  Sales Act of the State of
           New York regarding its area  development  agreement with the Company.
           The  action  sought  damages of an  unspecified  amount not less than
           $50,000 and punitive damages of an unspecified  amount.  On September
           12, 1996, a panel of the American  Arbitration  Association  ruled in
           favor of the area  developer,  finding  that the Company has violated
           the  Franchise  Sales  Act of the State of New York and  awarded  the
           developer  $1,375,888  in damages and  $331,516 in attorney  fees.  A
           motion  to  confirm  this  award  has been  stayed as a result of the
           Company's  bankruptcy  filing.  The  amount  of the  award  has  been
           recorded  as a  liability  subject  to  compromise  (note  9) by  the
           Company.   The  area   developer  and  its  principal  have  asserted
           additional  claims  aggregating   approximately  $10,500,000  in  the
           Company's Chapter 11 case.

           The Company is a defendant in eight separate causes of action brought
           by a  franchisee  and its  principals  which  allege that the Company
           misrepresented   the  demographics  of  the  franchisee's   franchise
           territory.  The franchisee seeks $2,500,000 in damages and $1,000,000
           in punitive damages under each cause of action.

           The Company is a defendant in litigation alleging infringement on the
           plaintiff's franchise area. The plaintiff seeks damages of $1,250,000
           and an injunction  prohibiting the Company from doing business within
           the exclusive franchise area allegedly granted to the franchisee. The
           Company  intended on filing a motion to dismiss the  complaint  based
           upon the fact that a franchise  agreement  does not exist between the
           plaintiff  and the  Company  and that  any  illicit  transfer  of the
           franchise rights to a party not approved by the Company constituted a
           termination of the franchisee's franchise.  The motion to dismiss was
           not filed due to the Company's voluntary petition under Chapter 11 of
           the United States Bankruptcy Code.

           The  Company  has  brought in action in New York  against  one of its
           Franchisees  seeking  approximately  $77,000  in unpaid  royalty  and
           advertising fees. The franchisee counterclaimed and seeks $15,000,000
           for the alleged breach of the franchise agreement.

           The Company is the  defendant  in an action  brought by a  franchisee
           which seeks damages of approximately  $668,000 for the alleged breach
           of  franchise   agreement  and   violations  of  the  Texas  Consumer
           Protection  Act.  The  franchisee  was  initially  given the right to
           develop two  restaurants  in Texas.  The  franchisee  opened only one
           restaurant which was closed within one year of opening. The compliant
           alleges that the Company is responsible for the restaurant's failure.

           On November 19, 1996, a secured  creditor of the Company who was owed
           an approximate  principal amount of $3,600,000 commenced an adversary
           proceeding in

                                                                     (Continued)

                                      F-25


<PAGE>
<PAGE>


                             PUDGIE'S CHICKEN, INC.
                                AND SUBSIDIARIES
                              DEBTORS-IN-POSSESSION

                   Notes to Consolidated Financial Statements

(13), CONTINUED

      (B), CONTINUED

           the Bankruptcy Court which sought to determine the nature, extent and
           validity  of the  creditor's  claims  against  the Company and sought
           injunctive relief requiring the Company to continue to escrow certain
           of its royalty fees.  Subsequent to December 31, 1996 the  proceeding
           was settled (notes 1 and 8).

           The  Company is also a party to  various  other  lawsuits  and claims
           arising in the ordinary course of business.

           Management  believes  that the  Company  has  valid  and  meritorious
           defenses against the claims described above. By virtue of the Chapter
           11 petition (note 1), all of the above mentioned  actions are pending
           confirmation of a reorganization  plan to be filed by the Company. At
           present,  the claims are being treated as unliquidated claims in that
           they have not yet been  reduced to judgment  by a court of  competent
           jurisdiction and no agreement between the Company, as debtor, and the
           plaintiffs as creditors has been reached.  It is anticipated that the
           plan of reorganization  will take into account all of the forestalled
           claims and that each one of the claims will be resolved  based upon a
           formula   contained   within  the  plan  of   reorganization.   As  a
           consequence,  the amounts  sought by the plaintiffs in their lawsuits
           are being treated as  unliquidated  amounts  subject to  readjustment
           pursuant to the plan of reorganization. Therefore, an estimate of the
           ultimate  settlement  of these claims cannot be made and no provision
           has been recorded for such amounts in the  accompanying  consolidated
           financial statements.

(14)  FOURTH QUARTER ADJUSTMENT

      During the fourth  quarter of 1996,  the Company  recorded  an  impairment
      adjustment to intangible  assets of  approximately  $8,098,000  due to the
      diminution of the carrying value of this asset.  The Company also recorded
      additional accrued expenses of $765,700 in the fourth quarter of 1996.

                                      F-26



<PAGE>
<PAGE>

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors
and Stockholders of
Pudgie's Chicken, Inc.

In our opinion,  the  accompanying  consolidated  statements of  operations,  of
changes  in  stockholders'  equity  and of cash  flows  present  fairly,  in all
material respects,  the results of operations,  changes in stockholders'  equity
and cash flows of Pudgie's  Chicken,  Inc. and subsidiaries  (the "Company") for
the year  ended  December  31,  1995,  in  conformity  with  generally  accepted
accounting principles.  These statements are the responsibility of the Company's
management;  our  responsibility  is to express  an opinion on these  statements
based on our audit.  We conducted  our audit of these  statements  in accordance
with  generally  accepted  auditing  standards  which  require  that we plan and
perform the audit to obtain  reasonable  assurance  about whether the statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the statements, assessing the
accounting  principles  used and  significant  estimates  made by management and
evaluating  the  overall  statement  presentation.  We  believe  that our  audit
provides a reasonable basis for the opinion expressed above.


PRICE WATERHOUSE LLP
Jericho, New York
March 11, 1996

                                      F-27




<PAGE>
<PAGE>

Pudgie's Chicken Inc.
and Subsidiaries

Consolidated Statement of Operations
--------------------------------------------------------------------------------

                                                              For The
                                                             Year Ended
                                                          December 31, 1995

REVENUE
  Restaurant sales                                           $ 9,366,689
  Franchise and
   advertising royalties                                       1,289,025
  Franchise fees                                                 410,000
  Interest income and
   other revenue                                                 134,054
                                                             -----------
                                                              11,199,768
                                                             -----------

COSTS AND EXPENSES
  Restaurant cost of sales                                     3,730,273
  Restaurant operating expenses                                4,914,788
  Franchising costs                                              158,155
  General and administrative                                   3,680,481
  Research and development                                        20,000
  Advertising expenses                                         1,202,714
  Depreciation and amortization                                  886,536
  Interest expense                                               771,438
                                                             -----------

                                                              15,364,385
                                                             -----------

NET LOSS                                                    $ (4,164,617)
                                                             -----------

NET LOSS PER COMMON SHARE                                   $     (1.44)
                                                             -----------

SHARES USED IN COMPUTATION                                     2,892,182
                                                             -----------

The accompanying notes are an integral part of these consolidated statements.

                                      F-28




<PAGE>
<PAGE>

Pudgie's Chicken, Inc.
and Subsidiaries

Consolidated Statement of Changes in Stockholders' Equity
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                        For The Year Ended December 31, 1995

                                          Preferred Stock     Common Stock      Additional                                 Total
                                        Number Of          Number Of             Paid-in-     Deferred    Accumulated   Stockholders
                                         Shares    Amount   Shares     Amount    Capital    Compensation    Deficit        Equity

<S>                                      <C>       <C>     <C>        <C>      <C>            <C>         <C>            <C>       
Balance at December 31, 1994             50,000    $  500  1,730,803  $17,308  $ 4,913,803    $     -     $(4,534,618)   $  396,993

Private Placement of Common Stock             -         -     98,383      984      494,832          -               -       495,816

Sale of Common Stock, net of issuance
costs of approximately $2.2 million           -         -  2,000,000   20,000    7,779,133          -               -     7,799,133

Issuance of Common Stock as fee for loan      -         -      8,199       82       40,913          -               -        40,995

Issuance of Common Stock in partial
satisfaction of promissory note and
for additional contingent
consideration for sale of Company             -         -    615,500    6,155    2,546,345          -               -     2,552,500

Sale of Common Stock Purchase Warrants        -         -          -        -      115,000          -               -       115,000

Deferred Compensation arising from
award of Restricted Common Stock
to employees                                  -         -     54,087      541      269,894    (270,435)             -             -

Amortization of deferred
compensation relating to 
restricted stock                              -         -          -        -            -      45,073              -        45,073

Net loss                                      -         -          -        -            -           -     (4,164,617)   (4,164,617)
                                         ------     -----  ---------  -------  -----------   ----------   ------------  ------------
Balance at December 31, 1995             50,000     $ 500  4,506,972  $45,070  $16,159,920   $(225,362)   $(8,699,235)  $ 7,280,893
                                         ======     =====  =========  =======  ===========   ==========   ============  ============
</TABLE>

The accompanying notes are an integral part of these consolidated statements.

                                      F-29




<PAGE>
<PAGE>

Pudgie's Chicken, Inc.
and Subsidiaries

Consolidated Statement of Cash Flows
--------------------------------------------------------------------------------
                                                         For The Year Ended
                                                          December 31, 1995

Cash flows provided by (used in) operating activities
Net loss                                                     $(4,164,617)
  Adjustments to reconcile net income
  to net cash provided by operations
     Interest paid in stock                                      197,385
     Loan fee paid in stock                                       40,995
     Deferred compensation expense                                45,073
     Depreciation and amortization                               886,536
     Bad debt expense                                            268,811
     Changes in operating assets and liabilities
      (Increase) decrease in operating assets
        Franchise and advertising
         royalties receivable                                   (221,769)
        Inventories                                              (54,721)
        Other assets                                            (171,442)
     Increase (decrease) in operating liabilities
        Accounts payable and
         accrued expenses                                       (713,923)
        Deferred franchise fees                                 (530,000)
        Sales tax payable                                         31,088
        Other liabilities                                         93,145
                                                             -----------

     Net Cash Used In
      Operating Activities                                    (4,293,439)
                                                             -----------

Cash flows used in investing activities
  Purchase of property and equipment                            (516,532)
  Acquisition of stores                                       (1,102,068)
                                                             -----------

     Net Cash Used In
      Investing Activities                                    (1,618,600)
                                                             -----------

Cash flows provided by
  financing activities
   Additions to notes payable                                  1,436,312
   Repayment of borrowings                                    (3,276,642)
   Proceeds from issuance of
     Common and Preferred Stock, net of issuance costs         8,409,949
                                                             -----------
     Net Cash Provided By
      Financing Activities                                     6,569,619
                                                             -----------

     Net Increase (Decrease) In Cash                             657,580

     Cash At Beginning Of Year                                   165,860
                                                             -----------

     Cash At End Of Year                                     $   823,440
                                                             ===========

The accompanying notes are an integral part of these consolidated statements.

                                      F-30




<PAGE>
<PAGE>

Pudgie's Chicken, Inc.
and Subsidiaries

Consolidated Statement of Cash Flows (continued)
--------------------------------------------------------------------------------

                                                                For The
                                                              Year Ended
                                                           December 31, 1995
Supplemental disclosures of
cash flow information:

Cash paid during the year for:
   Interest                                                  $   494,402
   Taxes                                                     $    22,452

Supplemental schedule of noncash activities:

In connection  with the acquisition of six franchised  restaurants  during 1995,
the Company forgave amounts due from  franchisees  totaling  $46,632 in exchange
for restaurant equipment, leasehold improvements and intangibles.

In August 1995, in connection  with the completion of an initial public offering
of its common stock,  the Company  repaid in full a promissory  note to Pudgie's
founder,  the  outstanding  balance of which was then  $4,669,000,  through  (i)
payment of $1.5  million,  (ii)  issuance of 615,500  shares of Common Stock and
(iii) issuance of 10,000 shares of Redeemable Preferred Stock.

In April 1995,  the Company  issued  8,199 shares of Common Stock as a fee for a
loan.

                                      F-31




<PAGE>
<PAGE>

Pudgie's Chicken, Inc.
and Subsidiaries

Notes to Consolidated Statements
--------------------------------------------------------------------------------

  1.   SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES

       NATURE OF BUSINESS
       Pudgie's  Chicken,  Inc. was incorporated in Delaware on January 28, 1993
       (Pudgie's  Chicken  Inc.  and  Subsidiaries  are  herein  defined  as the
       "Company"). The Company operates and franchises food service restaurants.
       In exchange  for  franchise  fees and  royalties,  the  Company  provides
       franchisees  assistance  with  site  approval,   interior  layout  plans,
       training and operations  advice.  The Company also provides marketing and
       advertising support.

       OPERATION OF RESTAURANTS
       During  1995,  the  Company  acquired  the net  assets of six  franchised
       restaurants  in exchange for cash of $878,000 and  forgiveness of $46,632
       due the Company. The excess of the aggregate purchase price over the fair
       value of net assets  acquired of $648,546 was recorded as goodwill and is
       being  amortized  over 30 years.  At  December  31,  1995,  there were 62
       Pudgie's restaurants in operation,  consisting of 26 Company-owned and 36
       franchised restaurants in nine states.

       During  1995,  the Company  opened  three  Company-owned  restaurants  in
       locations previously operating as franchised restaurants.

       Revenues and expenses related to the operation of these  restaurants from
       the dates of  acquisition  are  included  in food  sales  and  restaurant
       operating costs, respectively.

       USE OF ESTIMATES IN FINANCIAL STATEMENT PREPARATION
       The  preparation  of financial  statements in accordance  with  generally
       accepted accounting  principles requires management to make estimates and
       assumptions  that  affect the  reported  amounts and  disclosures  in the
       financial statements. Actual results could differ from those estimates.

       BASIS OF PRESENTATION
       The consolidated  statements  include the accounts of the Company and its
       subsidiaries.   All  significant  intercompany   transactions  have  been
       eliminated in consolidation.

       INVENTORIES
       Inventories  included in restaurant cost of sales are stated at the lower
       of cost  (first-in,  first-out)  or market and  consist of food and paper
       products.

                                       F-32




<PAGE>
<PAGE>

Pudgie's Chicken, Inc.
and Subsidiaries

Notes to Consolidated Statements
--------------------------------------------------------------------------------

       REVENUE RECOGNITION
       Revenue from  franchised  restaurants is derived from the initial sale of
       franchises for a fee of $30,000 for an individual  restaurant,  from area
       development  agreements for a  predesignated  number of restaurants to be
       opened within a designated span of time at negotiated contract prices and
       from royalty fees for  franchising  support and advertising at 5% and 3%,
       respectively,   of  retail  product  sales.  Revenue  from  the  sale  of
       individual  franchises is recognized at the time substantial  performance
       of the obligations of the Company,  as described in Note 2, has occurred.
       Revenue from area  development  agreements is recognized  ratably as each
       restaurant is opened. Franchise and advertising royalties are recorded as
       earned and include approximately $146,000 in finance charges for 1995.

       Revenue from  Company-owned  restaurants  is recognized in the period the
       related products are sold.

       DEPRECIATION AND AMORTIZATION
       Depreciation  is provided  on the  straight  line  method over  estimated
       useful lives of the assets as follows:  furniture and fixtures,  5 years;
       restaurant  equipment,  8 years;  computer  equipment and  software,  4-5
       years; and trucks, 7 years. Leasehold improvements are amortized over the
       lesser of the term of the lease or 5 years.

       INTANGIBLE ASSETS
       The costs incurred to develop and register the Company's  trademarks have
       been capitalized and are being amortized on the straight line method over
       40 years.  Legal costs  associated  with  incorporation  of Pudgie's were
       capitalized and are being amortized over 10 years.

       Goodwill  represents  the  excess of cost over fair  value of net  assets
       acquired and is being  amortized  over 30 years using the  straight  line
       method. Periodically,  the Company reviews the recoverability of goodwill
       based  on  estimated   undiscounted  future  cash  flows  from  operating
       activities  compared  with the  carrying  value of  goodwill.  Should the
       aggregate future cash flows be less than the carrying value, a write down
       would be required,  measured by the difference  between the  undiscounted
       cash flows and the carrying  value of goodwill.  At December 31, 1995, no
       impairment of such assets was indicated.

       PREOPENING COSTS
       The Company expenses preopening costs as incurred.

       CONCENTRATION OF CREDIT RISK
       Financial  instruments  which  potentially  subject the Company to credit
       risk consist  principally of trade receivables.  Approximately 75% of the
       Company's  franchised  restaurants  are in the  same  geographical  area.
       Receivables  from  franchisees  are not  collateralized.  Credit  risk is
       affected  by  conditions  or  occurrences  within  the  economy  and  the
       geographic  area.  The Company  provides  reserves for  potential  credit
       losses for trade accounts  receivable and discontinues  recording revenue
       when amounts are deemed  uncollectible based upon factors surrounding the
       credit risk of specific customers, historical

                                       F-33




<PAGE>
<PAGE>

Pudgie's Chicken, Inc.
and Subsidiaries

Notes to Consolidated Statements
--------------------------------------------------------------------------------

       trends and other information. Such losses have historically  been  within
       management's expectations.

       NET LOSS PER COMMON SHARE
       Net loss per common share is determined on the basis of weighted  average
       number of  shares  of  Common  Stock  outstanding  during  the year.  The
       weighted  average number of shares  outstanding  during the year has been
       retroactively  adjusted  using  the  modified  treasury  stock  method to
       reflect  common  stock that was issued  within a one year period prior to
       the initial public offering at a price below the proposed  initial public
       offering price.

       STOCK SPLIT
       The Company  completed  an initial  public  offering  of common  stock in
       August 1995. The Company was  recapitalized to provide for a distribution
       of shares to effect the  equivalent  of a 16.39717 for one stock split of
       all common stock at a par value of $.01, which became effective on August
       15, 1995.  All share and per share data have been restated to reflect the
       stock split.

       ACCOUNTING PRONOUNCEMENTS
       In March 1995, the Financial  Accounting  Standard Board Issued Statement
       of Financial Accounting Standards No. 121, "Accounting for the Impairment
       of Long-Lived  Assets and for Long-Lived Assets To Be Disposed Of" ("SFAS
       121").  The Company  will adopt SFAS 121 in 1996 and  believes  that such
       adoption  will not have a material  effect on the  financial  position or
       results of operations of the Company.

       In October 1995, the Financial Accounting Standard Board issued Statement
       of Financial  Accounting  Standards No. 123,  "Accounting for Stock-Based
       Compensation"  ("SFAS 123"). The Company will adopt the disclosure method
       permitted by SFAS 123 in 1996.

  2.   DEFERRED FRANCHISE FEES

       At December  31,  1995,  four area  development  agreements  were signed;
       however,  the  restaurants  had not opened for  business.  Franchise  fee
       revenue related to franchise  agreements is recognized  when  substantial
       performance of all  obligations and services as outlined in the franchise
       agreements  has occurred and ratably as  restaurants  are opened for area
       development  agreements.  The  obligations  and  duties  of  the  Company
       pursuant to the  franchise  agreement  include:  approval of a restaurant
       location;  providing  interior layout plans;  providing  training for the
       franchisee  prior to the restaurant  opening;  approval of the opening of
       the restaurant for business;  assisting in restaurant opening; and having
       representatives  available for  consultation.  During 1995, two franchise
       restaurants  were opened for business and seven  restaurants  were closed
       due to failure to comply with the  provisions of the franchise  agreement
       or failure to remit royalties. During 1995, two area developers forfeited
       their  development  rights and $350,000 of franchise fees previously paid
       to the Company were recognized as revenue.

                                       F-34




<PAGE>
<PAGE>

Pudgie's Chicken, Inc.
and Subsidiaries

Notes to Consolidated Statements
--------------------------------------------------------------------------------

  3.   NOTES PAYABLE

       In August 1995, the Company renegotiated a Stockholder Note in the amount
       of  $3,606,837  which  bears  interest  at  the  prime  rate  plus  3.5%,
       calculated  on the first day of each  month.  The note is due in February
       1997.  Interest expense related to this loan was  approximately  $467,000
       for 1995.

4.     REDEEMABLE PREFERRED STOCK

       In August 1995, in  connection  with the initial  public  offering of its
       common stock,  the Company  issued 10,000 shares of Redeemable  Preferred
       Stock in partial  satisfaction of its promissory note to the founder. The
       Redeemable  Preferred  Stock ranks senior to all other preferred stock of
       the Company in priority of  dividends,  right of  redemption  and payment
       upon liquidation.  The principal terms of the Redeemable  Preferred Stock
       are as follows:

            LIQUIDATION PREFERENCE
            In the event of a  liquidation  of the  Company,  the  holder of the
            Redeemable Preferred Stock is entitled to receive $106.90 per share,
            plus any dividends accrued and unpaid to date.

            REDEMPTION
            The Redeemable  Preferred Stock is subject to redemption at any time
            at the option of the Board at a redemption price of $106.90 plus any
            declared, accrued and unpaid dividends.

            The Redeemable Preferred Stock is subject to mandatory redemption by
            the Company, at the redemption value plus cumulative unpaid declared
            dividends,  to the extent of the net  proceeds of any sale of Common
            Stock  by the  Company  (after  any  required  application  of  such
            proceeds to the payment of outstanding  indebtedness  of the Company
            for borrowed money).

            DIVIDENDS
            Dividends  are payable when  declared by the Company and then accrue
            on the  Redeemable  Preferred  Stock at an annual  rate equal to 150
            basis  points  in excess  of the rate on three  year  U.S.  Treasury
            obligations on the date of issuance.

  5.   STOCKHOLDERS' EQUITY

       AUTHORIZATIONS OF COMMON AND PREFERRED STOCK
       In  May  1995,  the  Board  of  Directors  and  Stockholders   authorized
       amendments to the  Certificate  of  Incorporation  which  provided for an
       increase in the number of authorized  shares of Common Stock from 125,000
       to 10,000,000 and Preferred Stock from 50,000 to 250,000 including 10,000
       shares  of  Redeemable  Preferred  Stock.  The  Board of  Directors  also
       authorized Warrants to purchase up to 1,350,000 shares of Common Stock.

                                      F-35




<PAGE>
<PAGE>

Pudgie's Chicken, Inc.
and Subsidiaries

Notes to Consolidated Statements
--------------------------------------------------------------------------------

       INITIAL PUBLIC OFFERING
       In August 1995, the Company  completed an initial public offering ("IPO")
       of 2,000,000  shares of Common Stock and 1,150,000  Common Stock Purchase
       Warrants for a total purchase price of $10,115,000.  Costs related to the
       IPO were  approximately  $2,200,000,  which have been  accounted for as a
       reduction of the related proceeds.

       SALE OF COMMON AND PREFERRED STOCK
       In January 1995,  the Company  raised  approximately  $500,000 of capital
       through a private sale of 98,383 shares of Common  Stock.  The holders of
       the stock  received  111,522  warrants to purchase the  Company's  Common
       Stock at an exercise price of $5.50.

       ISSUANCE OF COMMON STOCK
       In April 1995,  the Company  issued 8,199 shares of Common Stock as a fee
       for a loan. The fair value of the stock of $40,995 was accounted for as a
       general and administrative expense during 1995.

       In August 1995, in connection  with the IPO, the Company  issued  525,000
       and  90,500  shares  of Common  Stock to the  Company's  former  owner as
       partial  satisfaction of a promissory  note and as additional  contingent
       consideration, respectively.

       PREFERRED STOCK
       The principal terms of the Preferred Stock are as follows:

            LIQUIDATION PREFERENCE
            In the event of a  liquidation  of the  Company,  the holders of the
            Preferred Stock are entitled to receive a $100 per share liquidation
            preference.

            REDEMPTION
            The Preferred Stock has no mandatory  redemption but can be redeemed
            by the  Company  at any  time at a  redemption  price  of $100  plus
            accrued dividends.

            DIVIDENDS
            The holders of the Preferred Stock are entitled to receive dividends
            only after the outstanding Stockholders Notes are first satisfied in
            full and the  Redeemable  Preferred  Stock is  fully  redeemed  with
            dividends accrued thereon.

       COMMON STOCK PURCHASE WARRANTS
       In  August  1995,  the  Company  sold  1,150,000  Common  Stock  Purchase
       Warrants. Each of the Warrants entitles the registered holder to purchase
       one  share of  Common  Stock at a price  of $5.50  per  share at any time
       during the period  September 6, 1996 through August 9, 2000. The Warrants
       are subject to  redemption  by the Company at a redemption  price of $.10
       per Warrant  commencing October 9, 1996 upon 30 days prior written notice
       to the Warrant holders, provided the average closing bid quotation of the
       Common Stock as

                                      F-36




<PAGE>
<PAGE>

Pudgie's Chicken, Inc.
and Subsidiaries

Notes to Consolidated Statements
--------------------------------------------------------------------------------

       reported  on the Nasdaq  Stock  Market has been at least 150% of the then
       current exercise price of the Warrants  (initially $8.25 per share) for a
       period of 20  consecutive  trading  days ending on the third day prior to
       the date on which the Company gives notice of redemption.

       In August 1995, the Company issued 50,000 Common Stock Purchase  Warrants
       to a Stockholder as consideration  for the  renegotiation of a loan. They
       are exercisable at $6.00.

       RESTRICTED STOCK
       In May 1995, the Board of Directors approved the adoption of a Restricted
       Stock Plan  pursuant to which a maximum of 72,115  shares of common stock
       may be awarded to officers  the Company.  In May 1995,  these shares were
       awarded to four executive officers of the Company.  The shares awarded to
       one such  officer have been  forfeited  and, as a result,  18,028  shares
       remain available for award under the Restricted Stock Plan. In connection
       with  these  awards,  the  Company  recorded  approximately  $270,000  of
       deferred  compensation  expense  which  approximated  fair value of these
       shares  and  which is being  amortized  over the  vesting  period of four
       years.

       In May  1995,  the  Board of  Directors  and  Stockholders  approved  the
       adoption  of a stock  option  plan which  permits  the  issuance of up to
       250,000  shares of Common Stock to  employees,  officers,  directors  and
       consultants of the Company. No options have been granted.

  6.   INCOME TAXES

       At December 31, 1995,  the Company had net operating  loss carry forwards
       for tax  purposes of  approximately  $8,000,000  which expire in 2008 and
       2009.

       The  Company had  significant  changes in its  ownership  during 1995 and
       1993, which resulted in a statutory  annual  limitation on utilization of
       net  operating  loss  carryforwards  pursuant to the change in  ownership
       rules enacted under the Tax Reform Act of 1986. Any additional changes in
       ownership may result in further limitations of the loss carryforwards.

7.     COMMITMENTS AND CONTINGENCIES

       The Company is obligated under operating leases for office and restaurant
       space.  At December  31,  1995,  the Company  had  minimum  annual  lease
       obligations under these leases as follows:

            1996                             $1,208,437
            1997                              1,214,105
            1998                              1,240,640
            1999                              1,200,563
            2000 and thereafter               3,369,048
                                             ----------
                                             $8,232,793
                                             ==========

                                      F-37




<PAGE>
<PAGE>

Pudgie's Chicken, Inc.
and Subsidiaries

Notes to Consolidated Statements
--------------------------------------------------------------------------------

       Rent expense was $1,057,620 for 1995.

       On  June  30,  1995,  an  area  developer  of  the  Company's  franchised
       restaurants  commenced an action against the Company  alleging common law
       fraud and alleging  violations of the Franchise Sales Act of the State of
       New York regarding its area development  agreement with the Company.  The
       Company has interposed  federal  counterclaims  against the developer for
       its fraudulent misrepresentations which induced the Company to enter into
       development  agreements.  The Company also instituted a separate  federal
       action in August 1995 for wrongful  conduct of the  developer's  company.
       The Company believes that is has meritorious defenses to the action which
       has been stayed pending  arbitration  and expects to succeed on its claim
       for fraudulent inducement to contract.  Although a range of possible loss
       cannot be reasonably  estimated at this time,  the Company  believes that
       the ultimate  resolution of this matter will not have a material  adverse
       effect on its financial position, results of operations or liquidity.

       The  Company is subject to various  other  legal  proceedings  and claims
       which arose in the  ordinary  course of its  business.  In the opinion of
       management,  the amount of ultimate liability, if any, which may arise as
       the result of these  proceedings will not materially affect the Company's
       financial position or results of operations.

       The Company  entered into  employment  agreements  effective June 1, 1995
       with the President and Chief  Executive  Officer and the Chief  Financial
       Officer which expire on May 31, 2000 and May 31, 1998, respectively.  The
       employment agreements provide for a base salary,  certain benefits and an
       annual bonus under specific conditions.


                               STATEMENT OF DIFFERENCES
          The registered trademark symbol shall be expressed by...."r"


                                      F-38





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<PAGE>

                                  EXHIBIT INDEX

Exhibit Number        Description                                     Page
--------------        -----------                                     ----
27                    Financial Data Schedule                          66
                                                                      ----








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