<PAGE>
 
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                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
 
                               ----------------
                                 
                              FORM 10-Q/A-1     
 
[X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
   ACT OF 1934
 
  FOR THE QUARTERLY PERIOD ENDED JUNE 28, 1998 OR
 
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
   EXCHANGE ACT OF 1934
 
  FOR THE TRANSITION PERIOD FROM      TO
 
                        COMMISSION FILE NUMBER 33-14051
 
                               ----------------
 
                           FAMILY RESTAURANTS, INC.
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
<TABLE>
<S>                                            <C>
                  DELAWARE                                       33-0197361
       (STATE OR OTHER JURISDICTION OF                        (I.R.S. EMPLOYER
       INCORPORATION OR ORGANIZATION)                       IDENTIFICATION NO.)
</TABLE>
 
               18831 VON KARMAN AVENUE, IRVINE, CALIFORNIA 92612
                         (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
                                                    (ZIP CODE)
 
      REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (949) 757-7900
 
                               ----------------
 
  Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
 
  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
confirmed by a court. Yes [X] No [_]
 
  Number of shares of outstanding common stock as of August 10, 1998 is
988,285.
 
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<PAGE>
 
                         PART I. FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
                            FAMILY RESTAURANTS, INC.
 
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                     ($ IN THOUSANDS, EXCEPT SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                        JUNE 28,   DECEMBER 28,
                                                          1998         1997
                                                       ----------- ------------
                                                       (UNAUDITED)
                        ASSETS
<S>                                                    <C>         <C>
Current assets:
  Cash and cash equivalents...........................  $  26,820   $  32,518
  Bridge note receivable--KKR merger..................      3,003           0
  Receivables.........................................      4,292       3,944
  Inventories.........................................      4,350       4,569
  Other current assets................................      4,241       4,086
                                                        ---------   ---------
    Total current assets..............................     42,706      45,117
Property and equipment, net...........................    182,828     183,601
Reorganization value in excess of amount allocable to
 identifiable assets, net.............................     35,829      36,529
Other assets..........................................     23,806      24,521
                                                        ---------   ---------
                                                        $ 285,169   $ 289,768
                                                        =========   =========
<CAPTION>
        LIABILITIES AND STOCKHOLDERS' DEFICIT
<S>                                                    <C>         <C>
Current liabilities:
  Current portion of long-term debt, including capi-
   talized lease obligations..........................  $   2,572   $   2,694
  Accounts payable....................................     13,625      13,959
  Self-insurance reserves.............................     28,603      32,515
  Other accrued liabilities...........................     56,729      58,573
  Income taxes payable................................      3,775       3,788
                                                        ---------   ---------
    Total current liabilities.........................    105,304     111,529
Other long-term liabilities...........................      4,518       4,478
Long-term debt, including capitalized lease
 obligations, less current portion....................    214,515     199,955
Stockholders' deficit:
  Common stock--authorized 1,500,000 shares, par value
   $.01 per share, 997,277 shares issued..............         10          10
  Additional paid-in capital..........................    157,317     157,317
  Accumulated deficit.................................   (195,112)   (182,138)
  Less treasury stock, at cost (8,992 shares).........     (1,383)     (1,383)
                                                        ---------   ---------
    Total stockholders' deficit.......................    (39,168)    (26,194)
                                                        ---------   ---------
                                                        $ 285,169   $ 289,768
                                                        =========   =========
</TABLE>
 
     See accompanying notes to condensed consolidated financial statements
 
                                      Q-2
<PAGE>
 
                            FAMILY RESTAURANTS, INC.
 
                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                ($ IN THOUSANDS)
                                  (UNAUDITED)
 
<TABLE>
<CAPTION>
                                                            FOR THE QUARTERS
                                                                  ENDED
                                                            ------------------
                                                            JUNE 28,  JUNE 29,
                                                              1998      1997
                                                            --------  --------
<S>                                                         <C>       <C>
Sales...................................................... $120,095  $123,103
                                                            --------  --------
Product costs..............................................   32,033    32,766
Payroll and related costs..................................   41,712    42,503
Occupancy and other operating expenses.....................   31,331    33,674
Depreciation and amortization..............................    5,283     5,611
General and administrative expenses........................    6,998     6,964
Opening costs..............................................      638         3
Loss on disposition of properties, net.....................      738       410
Impairment of long-lived assets............................        0     2,640
                                                            --------  --------
  Total costs and expenses.................................  118,733   124,571
                                                            --------  --------
Operating income (loss)....................................    1,362    (1,468)
Interest expense, net......................................    5,999     4,556
                                                            --------  --------
Loss before income tax provision...........................   (4,637)   (6,024)
Income tax provision.......................................      127       176
                                                            --------  --------
Net loss................................................... $ (4,764) $ (6,200)
                                                            ========  ========
</TABLE>
 
 
     See accompanying notes to condensed consolidated financial statements
 
                                      Q-3
<PAGE>
 
                            FAMILY RESTAURANTS, INC.
 
                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                ($ IN THOUSANDS)
                                  (UNAUDITED)
 
<TABLE>
<CAPTION>
                                                                 FOR THE
                                                            SIX MONTHS ENDED
                                                            ------------------
                                                            JUNE 28,  JUNE 29,
                                                              1998      1997
                                                            --------  --------
<S>                                                         <C>       <C>
Sales...................................................... $233,401  $238,081
                                                            --------  --------
Product costs..............................................   62,796    63,131
Payroll and related costs..................................   81,918    83,370
Occupancy and other operating expenses.....................   62,179    66,424
Depreciation and amortization..............................   10,622    11,181
General and administrative expenses........................   14,116    14,442
Opening costs..............................................    1,258         3
Loss on disposition of properties, net.....................    1,406     1,877
Impairment of long-lived assets............................        0     2,640
                                                            --------  --------
  Total costs and expenses.................................  234,295   243,068
                                                            --------  --------
Operating loss.............................................     (894)   (4,987)
Interest expense, net......................................   11,826     8,962
                                                            --------  --------
Loss before income tax provision...........................  (12,720)  (13,949)
Income tax provision.......................................      254       352
                                                            --------  --------
Net loss................................................... $(12,974) $(14,301)
                                                            ========  ========
</TABLE>
 
 
     See accompanying notes to condensed consolidated financial statements
 
                                      Q-4
<PAGE>
 
                            FAMILY RESTAURANTS, INC.
 
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                ($ IN THOUSANDS)
                                  (UNAUDITED)
 
<TABLE>   
<CAPTION>
                                                       FOR THE SIX MONTHS
                                                              ENDED
                                                       --------------------
                                                       JUNE 28,   JUNE 29,
                                                         1998       1997
                                                       ---------  ---------
<S>                                                    <C>        <C>        <C>
Increase in Cash and Cash Equivalents
Cash flows from operating activities:
  Cash received from customers, franchisees and
   licensees.........................................  $ 234,475  $ 238,691
  Cash paid to suppliers and employees...............   (227,995)  (238,045)
  Interest paid, net.................................     (7,365)    (6,652)
  Opening costs......................................       (914)         0
  Income taxes paid..................................       (267)      (269)
                                                       ---------  ---------
    Net cash used in operating activities............     (2,066)    (6,275)
                                                       ---------  ---------
Cash flows from investing activities:
  Proceeds from disposal of property and equipment...         74         42
  Bridge note receivable--KKR merger.................     (3,000)         0
  Capital expenditures...............................     (9,710)    (5,403)
  Mandatory lease buyback, net.......................          0     (2,828)
  Lease termination payments.........................       (722)    (2,651)
  Opening costs......................................          0        (65)
  Other..............................................       (172)    (1,817)
                                                       ---------  ---------
    Net cash used in investing activities............    (13,530)   (12,722)
                                                       ---------  ---------
Cash flows from financing activities:
  Reductions of long-term debt, including capitalized
   lease obligations.................................     (1,625)    (1,591)
  Net proceeds from issuance of notes................     11,620          0
  Payment of debt issuance costs.....................        (97)    (1,365)
                                                       ---------  ---------
    Net cash provided by (used in) financing
     activities......................................      9,898     (2,956)
                                                       ---------  ---------
Net decrease in cash and cash equivalents............     (5,698)   (21,953)
Cash and cash equivalents at beginning of period.....     32,518     33,820
                                                       ---------  ---------
Cash and cash equivalents at end of period...........  $  26,820  $  11,867
                                                       =========  =========
Reconciliation of net loss to net cash used in
 operating activities:
Net loss.............................................  $ (12,974) $ (14,301)
Adjustments to reconcile net loss to net cash used in
 operating activities:
  Depreciation and amortization......................     10,622     11,184
  Amortization of debt issuance costs................        597        506
  Expense of unamortized opening costs...............        344          0
  Loss on disposition of properties..................      1,406      1,877
  Impairment of long-lived assets....................          0      2,640
  Accretion of interest..............................      3,948        294
  (Increase) decrease in receivables, inventories and
   other current assets..............................       (628)       809
  Decrease in accounts payable, self-insurance re-
   serves, other accrued liabilities and income taxes
   payable...........................................     (5,381)    (9,284)
                                                       ---------  ---------
Net cash used in operating activities................  $  (2,066) $  (6,275)
                                                       =========  =========
</TABLE>    
 
     See accompanying notes to condensed consolidated financial statements
 
                                      Q-5
<PAGE>
 
                           FAMILY RESTAURANTS, INC.
 
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (UNAUDITED)
 
  1. Company. Family Restaurants, Inc. (together with its subsidiaries, the
"Company") was incorporated in Delaware in 1986 and is primarily engaged in
the operation of full-service restaurants through its subsidiaries. At June
28, 1998, the Company operated 273 restaurants in 30 states, with
approximately 65% of its restaurants located in California, Ohio,
Pennsylvania, Michigan, Illinois and Indiana. Additionally, as of June 28,
1998, the Company was the franchisor and licensor of 21 restaurants outside
the United States.
 
  2. Financial Statements. The Condensed Consolidated Financial Statements in
this Form 10-Q have been prepared in accordance with Securities and Exchange
Commission Regulation S-X. Reference is made to the Notes to the Consolidated
Financial Statements for the Year Ended December 28, 1997 included in the
Company's Annual Report on Form 10-K for the fiscal year ended December 28,
1997 (the "Form 10-K") for information with respect to the Company's
significant accounting and financial reporting policies, as well as other
pertinent information. The Company believes that all adjustments, consisting
only of normal recurring adjustments, necessary for a fair presentation of the
results of the interim periods presented have been made. The results of
operations for the quarter and six months ended June 28, 1998 are not
necessarily indicative of those for the full year.
 
  3. Long-Term Debt. On August 12, 1997, FRI-MRD Corporation (a wholly-owned
subsidiary of the Company) ("FRI-MRD") issued new senior discount notes (the
"Senior Discount Notes") in the face amount of $61 million at a price of
approximately 75% of par. The Senior Discount Notes are due on January 24,
2002 and accrete at a rate of 15% per annum until July 31, 1999, and
thereafter, interest will be payable in cash semi-annually at the rate of 15%
per annum. The $61 million of Senior Discount Notes were issued to an existing
holder of the Company's 9 3/4% Senior Notes due 2002 (the "Senior Notes") in
exchange for $15.6 million of Senior Notes plus approximately $34 million of
cash, and are part of an agreement pursuant to which FRI-MRD had the ability
to issue up to a maximum of $75 million of Senior Discount Notes. The gain of
$3,548,000 realized on the exchange of Senior Notes has been deferred and
classified as an element of long-term debt in accordance with the guidelines
of Emerging Issues Task Force Issue No. 96-19 because the present value of the
cash flows of the Senior Discount Notes was not at least 10% different from
the present value of the cash flows of the Senior Notes exchanged. The
deferred gain is being amortized as a reduction of interest expense over the
life of the Senior Discount Notes. On January 14 and 15, 1998, FRI-MRD issued
the remaining $14 million in face amount of the Senior Discount Notes
available under such agreement to the same purchaser at a price of 83% of par.
FRI-MRD received approximately $11.6 million in cash as a result of this
subsequent sale. Proceeds from the sales of the Senior Discount Notes have
been and will continue to be used to fund the Company's capital expenditure
programs and for general corporate purposes.
 
  4. Opening Costs. Opening costs are incurred in connection with the opening
or remodeling of a restaurant and are principally related to stocking the
restaurant and training its staff. Through the year ended December 28, 1997,
the Company's policy had been to capitalize such opening costs and amortize
them over one year. In April 1998, the American Institute of Certified Public
Accountants issued Statement of Position 98-5 ("SOP 98-5"), "Reporting on the
Costs of Start-Up Activities," which specifies that all costs of start-up
activities, including restaurant opening costs, should be expensed as
incurred. Although SOP 98-5 is effective for fiscal years beginning after
December 15, 1998, early adoption is allowed, and the Company elected to adopt
the provisions of SOP 98-5 in the quarter ended March 29, 1998.
 
  Accordingly, $344,000 of unamortized opening costs at December 28, 1997
(classified as other current assets) was expensed in the condensed
consolidated statement of operations for the quarter ended March 29, 1998.
Opening costs incurred during the quarter and six months ended June 28,1998
were $638,000 and $914,000, respectively. Amortization of opening costs of
$3,000 in the comparable periods of 1997 has been reclassified.
 
                                      Q-6
<PAGE>
 
  5. KKR Merger. The Company, FRI-Sub, Inc., a newly organized Delaware
corporation and wholly owned subsidiary of FRI-MRD (the "Merger Sub"), and Koo
Koo Roo, Inc., a Delaware corporation ("KKR"), have entered into an Agreement
and Plan of Merger, dated as of June 9, 1998 (the "Merger Agreement"),
pursuant to which the Merger Sub will merge with and into KKR (the "Merger"),
with KKR as the surviving corporation of the Merger. As a result of the
Merger, KKR will become a wholly owned subsidiary of FRI-MRD. The closing of
the Merger is subject to certain conditions, including but not limited to, the
approval of the common stockholders of KKR and the obtaining of certain
regulatory approvals and third party consents.
   
  As a result of the Merger, each outstanding share of common stock, $.01 par
value, of KKR will be converted into the right to receive one share of common
stock, par value $0.01 per share, of the Company (the "Company Common Stock").
In connection with the signing of the Merger Agreement, FRI-MRD provided a
$3.0 million loan (the "Bridge Loan") to a subsidiary of KKR. Additionally, in
connection with the Merger, FRI-MRD will issue new senior secured discount
notes (the "New MRD Notes") for net proceeds of approximately $21.6 million
and the Company is expanding the Foothill Credit Facility (as defined below)
by an additional $20.0 million. The proceeds from the sale of the New MRD
Notes will be used to acquire all of the outstanding capital stock (the
"Hamlet Shares") of The Hamlet Group, Inc. ("Hamlet") immediately prior to the
consummation of the Merger (the "Hamlet Acquisition"). If the Effective Time
of the Merger does not occur within twenty-four hours of the closing of the
Hamlet Acquisition, FRI-MRD shall have the right to terminate and rescind the
Hamlet Acquisition. In such event, KKR shall pay to FRI-MRD the purchase price
received by KKR in the Hamlet Acquisition and the Hamlet Shares shall be sold
back to KKR. The Merger and the Hamlet Acquisition will be accounted for as a
purchase.     
 
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
 
  Certain information and statements included in this Management's Discussion
and Analysis of Financial Condition and Results of Operations, including,
without limitation, statements containing the words "believes," "anticipates,"
"expects" and words of similar import, constitute "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995 and
involve known and unknown risks and uncertainties that could result in actual
results of the Company or the restaurant industry differing materially from
expected results expressed or implied by such forward-looking statements.
Although it is not possible to itemize all of the factors and specific events
that could affect the outlook of a restaurant company operating in a
competitive environment, factors that could significantly impact expected
results include (i) the development of successful marketing strategies for the
Company's restaurants, (ii) the effect of national and regional economic
conditions, (iii) the availability of adequate working capital, (iv)
competitive products and pricing, (v) changes in legislation, (vi) demographic
changes, (vii) the ability to attract and retain qualified personnel, (viii)
changes in business strategy or development plans, (ix) business disruptions,
(x) changes in consumer preferences, tastes and eating habits and (xi)
increases in food and labor costs. The Company disclaims any obligation to
update any such factors or to publicly announce the result of any revisions to
any of the forward-looking statements contained herein to reflect future
events or developments.
 
  The following should be read in conjunction with "Management's Discussion
and Analysis of Financial Condition and Results of Operations" presented in
the Form 10-K.
 
  As used herein, "comparable restaurants" means restaurants operated by the
Company on January 1, 1997 and that continued in operation through the end of
the second quarter of 1998.
 
LIQUIDITY AND CAPITAL RESOURCES
 
  A. Liquidity
   
  The Company reported net cash used in operating activities for the six
months ended June 28, 1998 and June 29, 1997. Liquidity requirements were
funded by available cash balances, supplemented if necessary by working
capital advances available under the Foothill Credit Facility (as defined
below). In addition, FRI-MRD     
 
                                      Q-7
<PAGE>
 
raised approximately $45.6 million in cash from the issuance of the Senior
Discount Notes to supplement its liquidity needs. The Company's viability has
been and will continue to be dependent upon its ability to generate sufficient
cash flow to meet its obligations on a timely basis, and to comply with the
terms of its financing agreements.
   
  Statement of Cash Flows. For the first six months of 1998, the Company
reported net cash used in operating activities of $2.1 million compared to net
cash used in operating activities of $6.3 million for the same period in 1997.
The difference in cash received from customers, franchisees and licensees as
compared to cash paid to suppliers and employees improved by $5.8 million from
1997 to 1998 which more than offset cash paid for opening costs of $0.9
million and an increase in interest paid, net of $0.7 million. For the first
six months of 1998, the Company reported net cash used in investing activities
of $13.5 million compared to net cash used in investing activities of $12.7
million for the same period in 1997. The increase in net cash used in
investing activities of $0.8 million was due to the $3.0 million bridge loan
related to the KKR Merger and an increase in capital expenditures of $4.3
million which more than offset decreases in mandatory lease buyback of
$2.8 million, lease termination payments of $1.9 million and other amounts of
$1.6 million. For the first six months of 1998, the Company reported net cash
provided by financing activities of $9.9 million compared to net cash used in
financing activities of $3.0 million for the same period in 1997. During 1998,
$11.6 million in net proceeds from the issuance of notes was received, while
payment of debt issuance costs decreased $1.3 million from 1997.     
 
  EBITDA. For the first six months of 1998, the Company reported EBITDA
(defined as earnings (loss) before opening costs, gain (loss) on disposition
of properties, provision for divestitures and write-down of long-lived assets,
restructuring costs, interest, taxes, depreciation and amortization) of $12.4
million, compared to $10.7 million for the same period in 1997. The $1.7
million improvement was primarily due to the continuing impact of El Torito
and Chi-Chi's cost reduction and reengineering strategies, which have improved
operating margins. This improved EBITDA is the continuation of the trend that
began in 1996 when new management was installed at both El Torito and Chi-
Chi's. Since 1995, the divisional EBITDA of the Company's ongoing operations
is set forth in the following table.
 
<TABLE>
<CAPTION>
                                                                  DIVISIONAL
                                                                    EBITDA
                                                               ----------------
                                                                 EL      CHI-
     FISCAL YEAR ENDED                                         TORITO   CHI'S
     -----------------                                         ------- --------
                                                               ($ IN THOUSANDS)
     <S>                                                       <C>     <C>
     December 31, 1995 (a).................................... $13,508 $(10,455)
     December 29, 1996........................................  11,956   (4,278)
     December 28, 1997........................................  17,627       36
</TABLE>
--------
(a) Includes 53 weeks of operations and, in accordance with Company policy at
    that time, excludes certain unallocated corporate overhead.
 
  The Company has included information concerning EBITDA herein because it
understands that such information is used by certain investors as one measure
of an issuer's historical ability to service debt. EBITDA should not be
considered as an alternative to, or more meaningful than, operating income
(loss) as an indicator of operating performance or to cash flows from
operating activities as a measure of liquidity. Furthermore, other companies
may compute EBITDA differently, and therefore, EBITDA amounts among companies
may not be comparable.
 
  Working Capital Deficiency. The Company operates with a substantial working
capital deficiency because (i) restaurant operations are conducted primarily
on a cash (and cash equivalent) basis with a low level of accounts receivable,
(ii) rapid turnover allows a limited investment in inventories and (iii) cash
from sales is usually received before related accounts payable for food,
beverages and supplies become due. The Company had a working capital
deficiency of $62.6 million on June 28, 1998.
 
  Credit Facility. The Company has a $35 million credit facility with Foothill
Capital Corporation (the "Foothill Credit Facility") to provide for the
ongoing working capital needs of the Company. The Foothill Credit
 
                                      Q-8
<PAGE>
 
Facility provides for up to $15 million in revolving cash borrowings and up to
$35 million in letters of credit (less the outstanding amount of revolving
cash borrowings). The Foothill Credit Facility is secured by substantially all
of the real and personal property of the Company, contains customary
restrictive covenants, including the maintenance of certain financial ratios,
and expires on January 10, 2002. The Company is in compliance with all
financial ratios for the quarter ended June 28, 1998. Letters of credit are
issued under the Foothill Credit Facility primarily to provide security for
future amounts payable under the Company's workers' compensation insurance
program ($16.0 million of such letters of credit were outstanding as of August
10, 1998). No revolving cash borrowings were outstanding as of August 10,
1998.
 
  On June 9, 1998, the Company entered into an amendment to the Foothill
Credit Facility. The amendment permits, among other things, (i) an increase in
the amount of borrowings available under the Foothill Credit Facility from
$35.0 million to $55.0 million, (ii) the consummation of the transactions
under the Bridge Loan, (iii) the issuance of the New MRD Notes and (iv) the
consummation of the Hamlet Acquisition and the Merger. Although the amendments
set forth in clauses (i) and (ii) above become effective upon execution of the
amendment, the additional borrowings under the Foothill Credit Facility only
will become available after the consummation of the Hamlet Acquisition and the
Merger and then only on a pro rata basis as each mortgage on the real property
securing the Foothill Credit Facility is amended to reflect the increase in
the maximum amount. The amendments set forth in clauses (iii) and (iv) above
are subject to customary closing conditions, including consummation of the
Merger and the payment of a consent fee in the amount of $100,000. In
connection with the execution of the amendment, Foothill earned a line
increase fee of $500,000 of which $150,000 was paid upon execution of the
amendment and $350,000 is due upon consummation of the Hamlet Acquisition and
the Merger.
 
  Senior Discount Notes. On August 12, 1997, FRI-MRD issued the Senior
Discount Notes in the face amount of $61 million to an existing holder of the
Company's Senior Notes in exchange for $15.6 million of Senior Notes plus
approximately $34 million of cash. On January 14 and 15, 1998, FRI-MRD issued
an additional $14 million in face amount of the Senior Discount Notes to the
same purchaser for approximately $11.6 million in cash. Proceeds from the
sales of the Senior Discount Notes have been and will continue to be used to
fund the Company's capital expenditure programs and for general corporate
purposes. The Company continues to consider additional sources of cash, such
as the sale of non-core assets.
 
  On June 9, 1998, FRI-MRD and the holders of the existing Senior Discount
Notes entered into an amendment to the Note Agreement governing the Senior
Discount Notes. Pursuant to the amendment, upon the closing of the Merger, the
Senior Discount Notes will be amended to, among other things, permit (i) the
issuance of the New MRD Notes, (ii) the consummation of the Hamlet Acquisition
and the Merger and (iii) an increase in the amount of borrowings available
under the Foothill Credit Facility by up to $20.0 million.
 
  Senior Secured Discount Notes. On June 9, 1998, FRI-MRD entered into a Note
Agreement pursuant to which FRI-MRD agreed to issue $24.0 million of New MRD
Notes for cash in an amount that provides a yield to July 31, 1999 of 14% per
annum. The New MRD Notes are due on January 24, 2002, and accrete at a rate of
14% per annum until July 31, 1999. After July 31, 1999, interest will be
payable in cash semi-annually at the rate of 14% per annum with the first cash
interest payment due on January 31, 2000. The New MRD Notes are redeemable by
FRI-MRD, in whole or in part, on or before January 23, 2001, at a price of
105% of the accreted value thereof, or after January 23, 2001, at a price of
102.5% of the accreted value thereof. The New MRD Notes contain restrictive
covenants, including limitations on (i) the incurrence of certain indebtedness
and liens, (ii) the ability to make certain restricted payments, (iii) certain
mergers, consolidations and asset sales, (iv) certain transactions with
affiliates and (v) the issuance of any equity securities of Hamlet. Proceeds
from the sale of the New MRD Notes will be used exclusively to purchase, and
thereafter will be secured by, all of the outstanding shares of Hamlet. The
closing of the sale of the New MRD Notes is subject to customary closing
conditions, including the consummation of the Hamlet Acquisition.
 
  The Company continues to be highly leveraged and has significant debt
service requirements. Although management believes that its current sources of
cash should be sufficient to meet its operating and debt service
 
                                      Q-9
<PAGE>
 
requirements for the foreseeable future, there can be no assurance that the
Company will be able to repay or refinance its Senior Notes and its 10 7/8%
Senior Subordinated Discount Notes due 2004, or that FRI-MRD will be able to
repay or refinance the Senior Discount Notes or the New MRD Notes, at their
respective maturities.
 
  B. Capital Expenditures
 
  Net cash used in investing activities was $14.4 million for the first six
months of 1998, including $9.7 million for capital expenditures, as compared
to net cash used in investing activities of $12.7 million for the same period
in 1997.
 
  Capital expenditures of approximately $30 million are planned for fiscal
1998, including approximately $6 million devoted to normal improvements of the
Company's restaurants. The Company is continuing its remodeling of both El
Torito and Chi-Chi's restaurants and anticipates spending approximately $13
million to $14 million for this purpose in fiscal 1998. In fiscal 1998, the
Company also anticipates opening up to seven new El Torito restaurants,
including its newly developed quick-service casual-style restaurant, "El
Torito Express Grill," the first of which opened on July 6, 1998 in Pasadena,
California. The Company also plans to upgrade El Torito's in-store POS
technology during fiscal 1998.
 
  By August 10, 1998, the Company had completed the remodeling of 13
additional El Torito restaurants, primarily in the Los Angeles/Orange County
market, and 21 additional Chi-Chi's restaurants in various markets in 1998.
The Company has announced plans for an aggressive remodel program for the Chi-
Chi's chain over the next three years. This program could cost up to $50
million.
 
  Included in 1998 capital spending are continuing expenditures to replace the
Company's mainframe computer software applications with new software to be run
in a client/server environment. In addition to improving processes and
allowing wider access to data, the new software is designed to make the
Company's computer systems Year 2000 compliant. The Company expects to spend
approximately $1.6 million on the new software and related hardware and
installation costs in 1998, approximately $0.7 million of which has been spent
through June 28, 1998. The project is expected to be completed by year-end
1998. The Company is requesting Year 2000 compliance reports from its
significant vendors and service providers. If the computer systems of a
significant vendor or service provider are not Year 2000 compliant, it could
have a material adverse effect on the Company.
 
RESULTS OF OPERATIONS.
 
  The Company's total sales of $120,095,000 for the second quarter of 1998
decreased by $3,008,000 or 2.4% as compared to the same period in 1997. For
the first six months of 1998, total Company sales of $233,401,000 decreased by
$4,680,000 or 2.0% as compared to the same period in 1997. As shown below,
these decreases were primarily due to restaurants divested or closed in 1997
and 1998.
 
<TABLE>
<CAPTION>
                                               SECOND QUARTER FIRST SIX MONTHS
                                               SALES DECREASE  SALES DECREASE
                                               -------------- ----------------
                                                      ($ IN THOUSANDS)
   <S>                                         <C>            <C>
   Decrease in Sales of Restaurants Divested
    or Closed.................................    $(2,150)        $(3,907)
   Decrease in Sales of Comparable
    Restaurants...............................       (858)           (773)
                                                  -------         -------
     Total....................................    $(3,008)        $(4,680)
                                                  =======         =======
</TABLE>
 
                                     Q-10
<PAGE>
 
  Sales for comparable restaurants of $119,101,000 for the second quarter of
1998 decreased by $858,000 or 0.6% as compared to the same period in 1997. For
the first six months of 1998, sales of comparable restaurants of $230,732,000
decreased by $773,000 or 0.3% as compared to the same period in 1997. As shown
below, these decreases were due to decreased sales for comparable Chi-Chi's
restaurants in both the quarter and six month periods and comparable El Torito
restaurants in the six month period which continue to reflect a competitive
operating environment for restaurants.
 
<TABLE>
<CAPTION>
                                                                     FIRST SIX
                                                  SECOND QUARTER    MONTHS SALES
                                                  SALES DECREASE      DECREASE
                                                  ---------------  ---------------
                                                  AMOUNT  PERCENT  AMOUNT  PERCENT
                                                  ------  -------  ------  -------
                                                        ($ IN THOUSANDS)
   <S>                                            <C>     <C>      <C>     <C>
   Comparable Chi-Chi's.......................... $(968)   (1.4)%  $(267)   (0.2)%
   Comparable El Torito..........................   110     0.3     (506)   (0.5)
                                                  -----    ----    -----    ----
     Total....................................... $(858)   (0.6)%  $(773)   (0.3)%
                                                  =====    ====    =====    ====
</TABLE>
 
  El Torito comparable sales in the second quarter were up 0.3% as compared to
the same period in 1997. This was an improvement over the first quarter when
El Torito reported comparable sales down 1.2%. The "Getaway to Mexico at El
Torito" advertising campaign continued into the second quarter, with a focus
on the Sonora region via promotional television and radio advertising. In
addition, the El Torito concept reintroduced Rolled Grilled Tacos with a free
Mexican Caesar Salad as the second quarter promotional product.
 
  Comparable sales for Chi-Chi's were down 1.4% for the second quarter as
compared with the same period in 1997. After a disappointing sales month in
April, comparable sales results improved throughout the second quarter, with
June comparable sales up 2.1% as compared with the same period in 1997. For
the first six months of 1998, Chi-Chi's comparable sales were down 0.2% as
compared with the same period in 1997, a continuation of the positive trend in
the rate of sales improvement begun in the second quarter of 1997. From a
marketing perspective, Chi-Chi's began its third advertising campaign of the
year on May 11, featuring the Twice Grilled Burrito and supported by
television, radio and print advertising. Additionally, sales for the
traditional Cinco de Mayo celebration increased 25% over the 1997 holiday.
Cinco de Mayo was bolstered by print advertising in all markets and featured
food and drink specials as well as festive activities.
 
  Product costs of $32,033,000 for the second quarter of 1998 decreased by
$733,000 or 2.2% as compared to the same period in 1997. For the first six
months of 1998, product costs of $62,796,000 decreased by $335,000 or 0.5% as
compared to the same period in 1997. The decreases are primarily due to the
impact of the eight restaurants sold or closed since the beginning of 1997 and
the effects of the El Torito and Chi-Chi's cost reduction strategies. As a
percentage of sales, product costs increased to 26.7% in the second quarter of
1998 as compared to 26.6% in the same period of 1997 and increased to 26.9%
for the first six months of 1998 as compared to 26.5% in the same period of
1997.
 
  Payroll and related costs of $41,712,000 for the second quarter of 1998
decreased by $791,000 or 1.9% as compared to the same period in 1997. For the
first six months of 1998, payroll and related costs of $81,918,000 decreased
by $1,452,000 or 1.7% as compared to the same period of 1997. The decreases
are primarily due to the impact of the eight restaurants sold or closed since
the beginning of 1997. As a percentage of sales, payroll and related costs
increased to 34.7% in the second quarter of 1998 as compared to 34.5% in the
same period of 1997 and increased to 35.1% for the first six months of 1998 as
compared to 35.0% in the same period of 1997. Savings realized from the El
Torito and Chi-Chi's cost reduction strategies which have focused on improving
labor scheduling and efficiencies have been offset by the impact of the
minimum wage increases nationally on September 1, 1997, and on March 1, 1997
and March 1, 1998 in California.
 
  The Company is subject to Federal and state laws governing matters such as
minimum wages, overtime and other working conditions. Approximately half of
the Company's employees are paid at rates related to the minimum wage.
Therefore, increases in the minimum wage or decreases in the allowable tip
credit (tip credits reduce the minimum wage that must be paid to tipped
employees in certain states) increase the Company's labor
 
                                     Q-11
<PAGE>
 
costs. This is especially true in California, where there is no tip credit.
Effective October 1, 1996, the Federal minimum wage was increased from $4.25
to $4.75, and effective September 1, 1997, it was further increased to $5.15.
However, a provision of the new measure effectively froze the minimum wage for
tipped employees at current levels by increasing the allowable tip credit in
those states which allow for a tip credit. Furthermore, in California, voters
approved a proposition on November 5, 1996 that increased the state's minimum
wage to $5.00 on March 1, 1997 and further increased the state's minimum wage
to $5.75 on March 1, 1998. In response to the minimum wage increases on
October 1, 1996, March 1, 1997 and March 1, 1998, the Company raised menu
prices at its El Torito restaurants in an effort to recover the higher payroll
costs. Chi-Chi's also raised menu prices in October and December 1997 as a
result of the cumulative impact of these minimum wage increases. At the
request of President Clinton, Congress is considering further increases in the
Federal minimum wage over the next two years. In addition, the California
legislature is considering a further minimum wage increase which would be
effective in 1999.
 
  Occupancy and other operating expenses of $31,331,000 for the second quarter
of 1998 decreased by $2,343,000 or 7.0% as compared to the same period in
1997. For the first six months of 1998, occupancy and other operating expenses
of $62,179,000 decreased by $4,245,000 or 6.4% as compared to the same period
in 1997. The decreases are due, in part, to the impact of the eight
restaurants sold or closed since the beginning of 1997. As a percentage of
sales, occupancy and other operating expenses decreased to 26.1% in the second
quarter of 1998 as compared to 27.4% in the same period in 1997 and decreased
to 26.6% for the first six months of 1998 as compared to 27.9% in the same
period of 1997. These decreases primarily reflect (i) the impact of El Torito
and Chi-Chi's cost reduction strategies and (ii) a decrease in media expense
in El Torito in the first six months of 1998 as compared to the same period of
1997.
 
  Depreciation and amortization of $5,283,000 for the second quarter of 1998
decreased by $328,000 or 5.9% as compared to the same period in 1997. For the
first six months of 1998, depreciation and amortization of $10,622,000
decreased by $559,000 or 5.0% as compared to the same period in 1997. These
decreases reflect the impact of (i) the eight restaurants sold or closed since
the beginning of 1997 and (ii) the write-down of certain long-lived assets in
the second quarter of 1997.
 
  General and administrative expenses of $6,998,000 for the second quarter of
1998 increased by $34,000 or 0.5% as compared to the same period of 1997. For
the first six months of 1998, general and administrative expenses of
$14,116,000 decreased by $326,000 or 2.3% as compared to the same period in
1997. As a percentage of sales, general and administrative expenses increased
to 5.8% in the second quarter of 1998 as compared to 5.7% in the same period
of 1997 and remained flat at 6.1% for the first six months of 1998 and the
same period of 1997. Management continues to closely evaluate the Company's
general and administrative cost structure for savings opportunities.
 
  The Company reported a loss on disposition of properties of $0.7 million in
the second quarter of 1998 and $1.4 million for the first six months of 1998
as compared to a loss of $0.4 million for the second quarter in 1997 and $1.9
million for the first six months of 1997. These amounts reflect losses
associated with restaurant divestments and closures in such periods.
 
  The Company recorded a write-down of long-lived assets in the second quarter
of 1997 of $2.6 million.
 
  Interest expense, net for the second quarter of 1998 of $5,999,000 increased
by $1,443,000 or 31.7% as compared to the same period in 1997. Interest
expense, net for the first six months of 1998 of $11,826,000 increased by
$2,864,000 or 32.0% as compared to the same period in 1997. These increases
were primarily the result of the issuance of the Senior Discount Notes in
August 1997 and January 1998 and the accretion of interest thereon, partially
offset by the elimination of cash interest expense associated with the $15.6
million of Senior Notes received as part of the exchange on August 12, 1997.
 
                                     Q-12
<PAGE>
 
SELECTED DIVISION OPERATING DATA.
 
  The Company primarily operates full-service Mexican restaurants in two
divisions under the El Torito, Chi-Chi's, Casa Gallardo and other names. At
June 28, 1998 the Company's El Torito restaurant division operated 94 full-
service restaurants and the Company's Chi-Chi's restaurant division operated
179 full-service restaurants.
 
  The following table sets forth certain information regarding the Company,
its El Torito and Chi-Chi's restaurant divisions, and the various operations
divested in 1996.
 
<TABLE>
<CAPTION>
                           FOR THE QUARTER ENDED           FOR THE SIX MONTHS ENDED
                         ------------------------------   ------------------------------
                         JUNE 28,   JUNE 29,   JUNE 30,   JUNE 28,   JUNE 29,   JUNE 30,
                           1998       1997       1996       1998       1997       1996
                         --------   --------   --------   --------   --------   --------
                             ($ IN THOUSANDS, EXCEPT AVERAGE CHECK AMOUNT)
<S>                      <C>        <C>        <C>        <C>        <C>        <C>
EL TORITO RESTAURANT
 DIVISION
Restaurants Open at End
 of Period:
  Owned/operated........       94         97         99         94         97         99
  Franchised and
   Licensed.............        8          7          5          8          7          5
Sales................... $ 57,583   $ 58,780   $ 58,593   $109,392   $112,380   $113,027
Restaurant Level
 Cashflow(a)............    9,943      9,345      7,884     17,030     16,579     13,732
Divisional EBITDA(b)....    6,985      6,187      4,475     11,298     10,436      7,349
Percentage increase
 (decrease) in
 comparable restaurant
 sales..................      0.3%       0.4%      (2.8)%     (0.5)%     (0.5)%     (3.3)%
Average check........... $  10.10   $   9.80   $   9.33   $   9.95   $   9.66   $   9.37
CHI-CHI'S RESTAURANT
 DIVISION
Restaurants Open at End
 of Period:
  Owned/operated........      179        180        191        179        180        191
  Franchised and
   Licensed.............       13         18         18         13         18         18
Sales................... $ 62,512   $ 64,323   $ 74,628   $124,009   $125,701   $149,381
Restaurant Level
 Cashflow(a)............    4,809      4,539      2,268      8,937      8,017      1,661
Divisional EBITDA(b)....    1,102      1,048     (1,122)     1,204        358     (5,634)
Percentage decrease in
 comparable restaurant
 sales..................     (1.4)%     (9.2)%     (8.8)%     (0.2)%    (10.9)%    (10.5)%
Average check........... $   7.80   $   7.48   $   7.28   $   7.80   $   7.50   $   7.37
ONGOING OPERATIONS
Restaurants Open at End
 of Period:
  Owned/operated........      273        277        290        273        277        290
  Franchised and
   Licensed.............       21         25         23         21         25         23
Sales................... $120,095   $123,103   $133,221   $233,401   $238,081   $262,408
Divisional EBITDA(b)....    8,087      7,235      3,353     12,502     10,794      1,715
DIVESTED OPERATIONS(C)
Restaurants Open at End
 of Period:
  Owned/operated........        0          0         17          0          0         17
  Franchised and
   Licensed.............        0          0          0          0          0          0
Sales................... $      0   $      0   $ 85,802   $      0   $      0   $215,667
Divisional EBITDA(b)....        0          0      7,740          0          0     19,688
TOTAL COMPANY
Restaurants Open at End
 of Period:
  Owned/operated........      273        277        307        273        277        307
  Franchised and
   Licensed.............       21         25         23         21         25         23
Sales................... $120,095   $123,103   $219,023   $233,401   $238,081   $478,075
EBITDA(d)...............    8,021      7,196     11,251     12,392     10,714     21,682
</TABLE>
 
                                     Q-13
<PAGE>
 
--------
(a) Restaurant Level Cashflow with respect to any operating division
    represents Divisional EBITDA (as defined below) before general and
    administrative expenses and any net franchise profit or miscellaneous
    income (expense) reported by the respective division.
 
(b) Divisional EBITDA with respect to any operating division is defined as
    earnings (loss) before opening costs, gain (loss) on disposition of
    properties, interest, taxes, depreciation and amortization.
 
(c) Divested Operations in 1996 includes the results of the Family Restaurant
    Division until it was divested on May 23, 1996 and the traditional
    dinnerhouse restaurants that were divested by year-end 1996.
 
(d) EBITDA is defined as earnings (loss) before opening costs, gain (loss) on
    disposition of properties, provision for divestitures and write-down of
    long-lived assets, restructuring costs, interest, taxes, depreciation and
    amortization. The Company has included information concerning EBITDA
    herein because it understands that such information is used by certain
    investors as one measure of an issuer's historical ability to service
    debt. EBITDA should not be considered as an alternative to, or more
    meaningful than, operating income (loss) as an indicator of operating
    performance or to cash flows from operating activities as a measure of
    liquidity. Furthermore, other companies may compute EBITDA differently,
    and therefore, EBITDA amounts among companies may not be comparable.
 
                                     Q-14
<PAGE>
 
                          PART II. OTHER INFORMATION
 
ITEM 1. LEGAL PROCEEDINGS
 
  The Company is involved in various litigation matters incidental to its
business. The Company does not believe that any of the existing claims or
actions will have a material adverse effect upon the consolidated financial
position or results of operations of the Company.
 
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
 
  None.
 
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
 
  None.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
  None.
 
ITEM 5. OTHER INFORMATION
 
  None.
 
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
 
  (a) Exhibits
 
<TABLE>
 <C>            <S>
          2(a)  Stock Purchase Agreement dated as of March 1, 1996 by and
                 among Family Restaurants, Inc., Flagstar Companies, Inc.,
                 Flagstar Corporation and FRD Acquisition Co. (Filed as
                 Exhibit 2.1 to the Company's Form 10-Q filed with the SEC on
                 May 15, 1996.)
          2(b)  Agreement and Plan of Merger, dated as of June 9, 1998, by and
                 among the Company, FRI-Sub, Inc. and Koo Koo Roo, Inc.
                 ("KRR"). (Filed as Exhibit 2.1 to the Company's Form S-4
                 filed with the SEC on July 1, 1998.)
          3(a)  Fourth Restated Certificate of Incorporation of the Company.
                 (Filed as Exhibit 4.1 to the Company's Form S-8 filed with
                 the SEC on March 23, 1994.)
          3(b)  Bylaws of the Company. (Filed as Exhibit 4.2 to the Company's
                 Form S-8 filed with the SEC on March 23, 1994.)
          4(a)  Indenture dated as of January 27, 1994 Re: $300,000,000 9 3/4%
                 Senior Notes due 2002. (Filed as Exhibit 4(a) to the
                 Company's Form 10-K filed with the SEC on March 28, 1994.)
          4(b)  Indenture dated as of January 27, 1994 Re: $150,000,000 10
                 7/8% Senior Subordinated Discount Notes due 2004. (Filed as
                 Exhibit 4(b) to the Company's Form 10-K filed with the SEC on
                 March 28, 1994.)
          4(c)  First Supplemental Indenture, dated as of July 3, 1996,
                 between the Registrant and IBJ Schroder Bank & Trust Company,
                 a New York Banking corporation, as Trustee. (Filed as Exhibit
                 10.1 to the Company's Form 8-K filed with the SEC on July 9,
                 1996.)
          4(d)  First Supplemental Indenture, dated as of July 3, 1996,
                 between the Registrant and Fleet National Bank, as successor
                 by merger to Fleet National Bank of Massachusetts, formerly
                 known as Shawmut Bank, N.A., as Trustee. (Filed as Exhibit
                 10.2 to the Company's Form 8-K filed with the SEC on July 9,
                 1996.)
          4(e)  Note Agreement dated as of August 12, 1997 Re: Up to
                 $75,000,000 FRI-MRD Corporation Senior Discount Notes due
                 January 24, 2002. (Filed as Exhibit 4(e) to the Company's
                 Form 10-Q filed with the SEC on November 12, 1997.)
</TABLE>
 
                                     Q-15
<PAGE>
 
<TABLE>   
 <C>            <S>
          4(f)  Joinder Agreement dated as of January 14, 1998 Re: FRI-MRD
                 Corporation Senior Discount Notes due January 24, 2002.
                 (Filed as Exhibit 4(f) to the Company's Form 10-K filed with
                 the SEC on March 30, 1998.)
          4(g)  First Amendment dated as of June 9, 1998 to the Note Agreement
                 dated August 12, 1997. (Filed as Exhibit 4.7 to the Company's
                 Form S-4 filed with the SEC on July 1, 1998.)
          4(h)  Note Agreement dated as of June 9, 1998 Re: $24,000,000 FRI-
                 MRD Corporation Senior Secured Discount Notes due January 24,
                 2002. (Filed as Exhibit 4.8 to the Company's Form S-4 filed
                 with the SEC on July 1, 1998.)
         10(ee) Stock Purchase Agreement dated as of June 9, 1998 by and
                 between FRI-MRD Corporation and KKR. (Filed as Exhibit 10.1
                 to the Company's Form S-4 filed with the SEC on July 1,
                 1998.)
         10(ff) Bridge Loan Agreement dated as of June 9, 1998 among The
                 Hamlet Group, Inc. as borrower, KKR, H.H.K. of Virginia, Inc.
                 and H.H. of Maryland, Inc., as Guarantors and FRI-MRD
                 Corporation as Lender. (Filed as Exhibit 10.2 to the
                 Company's Form S-4 filed with the SEC on July 1, 1998.)
         10(gg) Amendment Number Three to Loan and Security Agreement, dated
                 as of April 9, 1998 by and among the parties thereto. (Filed
                 as Exhibit 10.29 to the Company's Form S-4 filed with the SEC
                 on July 1, 1998.)
         10(hh) Amendment Number Four to Loan and Security Agreement dated as
                 of June 9, 1998 by and among the parties thereto. (Filed as
                 Exhibit 10.30 to the Company's Form S-4 filed with the SEC on
                 July 1, 1998.)
         27     Financial Data Schedule. (Filed as Exhibit 27 to the Company's
                 Form 10-Q filed with the SEC on August 12, 1998.)
</TABLE>    
 
  (b) Reports on Form 8-K.
 
  On June 16, 1998 the Company filed a report on Form 8-K announcing the
planned merger between the Company and Koo Koo Roo, Inc. (see Note 5 of the
Notes to Condensed Consolidated Financial Statements included herein).
 
 
                                     Q-16
<PAGE>
 
                                   SIGNATURE
 
  Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
 
                                          Family Restaurants, Inc.
                                           (Registrant)
 
                                             /s/ Robert T. Trebing, Jr.
                                          By: _________________________________
                                                 Robert T. Trebing, Jr.
                                              Executive Vice President and
                                                 Chief Financial Officer
                                              (Principal Financial Officer)
   
Date: September 9, 1998     
 
 
                                      Q-17