<PAGE>   1

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-Q


 X      Quarterly report pursuant to section 13 or 15(d) of the Securities
---     Exchange Act of 1934

For the quarterly period ended September 29, 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 number 33-14051
                       --------
                       
Family Restaurants, Inc.                                              
-------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)

Delaware                              33-0197361                         
-------------------------------------------------------------------------------
(State or other jurisdiction of       (I.R.S. Employer Identification No.)
incorporation or organization)      

18831 Von Karman Avenue, Irvine, California              92715  
-------------------------------------------------------------------------------
(Address of principal executive offices)               (Zip Code)

Registrant's telephone number, including area code:   (714) 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 November 13, 1996 is
988,285.


                                      - 1 -


<PAGE>   2
                         PART I.  FINANCIAL INFORMATION
                         ------------------------------

Item 1.  Financial Statements
-----------------------------

                            FAMILY RESTAURANTS, INC.
                            ------------------------

                     CONDENSED CONSOLIDATED BALANCE SHEETS
                     -------------------------------------
                       ($ in thousands, except per share)



<TABLE>
<CAPTION>
                                                                 September 29,           December 31,
                                                                     1996                    1995
                                                                 -------------           ------------
                                                                  (Unaudited)
<S>                                                              <C>                    <C>
ASSETS
------

Current assets:
  Cash and cash equivalents                                         $  31,844              $   8,370
  Restricted cash                                                      23,621                      0
  Receivables                                                           3,326                  8,172
  Inventories                                                           4,744                  5,645
  Other current assets                                                  4,992                  4,813
  Property held for sale                                                6,145                240,077
                                                                    ---------              ---------
    Total current assets                                               74,672                267,077

Property and equipment, net                                           198,258                207,223
Reorganization value in excess of amounts allocable
  to identifiable assets, net                                          38,280                 39,332
Other assets                                                           27,849                 37,638
                                                                    ---------              ---------
                                                                    $ 339,059              $ 551,270
                                                                    =========              =========

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
----------------------------------------------

Current liabilities:
  Loans payable to banks                                            $       0              $  79,815
  Current portion of long-term debt, including
    capitalized lease obligations                                       3,156                  3,046
  Accounts payable                                                     19,723                 22,400
  Self-insurance reserves                                              36,765                 35,488
  Other accrued liabilities                                            67,384                 78,319
  Income taxes payable                                                  2,968                  2,895
                                                                    ---------              ---------
    Total current liabilities                                         129,996                221,963

Other long-term liabilities                                             4,665                  5,680
Long-term debt, including capitalized lease
  obligations, less current portion                                   198,023                455,203

Stockholders' equity (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                158,251
  Notes receivable from stockholders                                        0                   (869)
  Accumulated deficit                                                (149,569)              (287,585)
  Less treasury stock, at cost (8,992 shares)                          (1,383)                (1,383)
                                                                    ---------              ---------
    Total stockholders' equity (deficit)                                6,375               (131,576)
                                                                    ---------              ---------
                                                                    $ 339,059              $ 551,270
                                                                    =========              =========
</TABLE>


     See accompanying notes to condensed consolidated financial statements



                                     - 2 -





<PAGE>   3
                            FAMILY RESTAURANTS, INC.
                            ------------------------
                            
                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                -----------------------------------------------
                       ($ in thousands, except per share)
                                  (Unaudited)


<TABLE>
<CAPTION>
                                                                      For the Quarters Ended
                                                                ----------------------------------
                                                                September 29,        September 24,
                                                                    1996                  1995
                                                                -------------        -------------
<S>                                                             <C>                   <C>
Sales                                                                $128,543             $281,337
                                                                     --------             --------
Product cost                                                           34,785               78,832
Payroll and related costs                                              49,992              103,518
Occupancy and other operating expenses                                 32,223               68,958
Depreciation and amortization                                           5,797               14,838
General and administrative expenses                                     8,005               13,012
Loss on disposition of properties, net                                  1,012                5,453
Provision for divestitures                                                  0               41,886
Restructuring costs                                                     1,030                1,366
                                                                     --------             --------

  Total costs and expenses                                            132,844              327,863
                                                                     --------             --------

Operating loss                                                         (4,301)             (46,526)

Interest expense, net                                                   4,127               15,838
Gain on sale of division                                                1,725                    0
                                                                     --------             --------

Loss before income tax provision (benefit)
  and extraordinary item                                               (6,703)             (62,364)

Income tax provision (benefit)                                           (112)                 277
                                                                     --------             --------

Loss before extraordinary item                                         (6,591)             (62,641)
Extraordinary gain on extinguishment of debt                          123,080                    0
                                                                     --------             --------

Net income (loss)                                                    $116,489             $(62,641)
                                                                     ========             ========

Net income (loss) per common share:
  Loss before extraordinary item                                     $  (6.67)            $ (63.36)
  Extraordinary item                                                   124.54                 0.00
                                                                     --------             --------
  Net income (loss)                                                  $ 117.87             $ (63.36)
                                                                     ========             ========

Weighted average common shares outstanding                            988,285              988,602
                                                                     ========             ========
</TABLE>



     See accompanying notes to condensed consolidated financial statements





                                     - 3 -





<PAGE>   4
                            FAMILY RESTAURANTS, INC.
                            ------------------------
                            
                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                -----------------------------------------------
                       ($ in thousands, except per share)
                                  (Unaudited)


<TABLE>
<CAPTION>
                                                                     For the Nine Months Ended
                                                               -------------------------------------
                                                               September 29,           September 24,
                                                                   1996                    1995
                                                               -------------           -------------
<S>                                                            <C>                        <C>
Sales                                                               $606,618                $852,040
                                                                    --------                --------
Product cost                                                         168,398                 241,854
Payroll and related costs                                            230,753                 315,457
Occupancy and other operating expenses                               148,954                 208,741
Depreciation and amortization                                         28,751                  43,783
General and administrative expenses                                   33,293                  43,411
Loss on disposition of properties, net                                 5,207                   6,848
Provision for divestitures                                                 0                  41,886
Restructuring costs                                                    5,603                   1,366
                                                                    --------                --------

  Total costs and expenses                                           620,959                 903,346
                                                                    --------                --------

Operating loss                                                       (14,341)                (51,306)

Interest expense, net                                                 32,604                  45,988
Gain on sale of division                                              62,601                       0
                                                                    --------                --------

Income (loss) before income tax provision
  and extraordinary item                                              15,656                 (97,294)

Income tax provision                                                     720                   1,251
                                                                    --------                --------

Income (loss) before extraordinary item                               14,936                 (98,545)
Extraordinary gain on extinguishment of debt                         123,080                       0
                                                                    --------                --------

Net income (loss)                                                   $138,016                $(98,545)
                                                                    ========                ========

Net income (loss) per common share:
  Net income (loss) before extraordinary item                       $  15.11                $ (99.26)
  Extraordinary item                                                  124.54                    0.00
                                                                    --------                --------
  Net income (loss)                                                 $ 139.65                $ (99.26)
                                                                    ========                ========

Weighted average common shares outstanding                           988,285                 992,843
                                                                    ========                ========
</TABLE>



     See accompanying notes to condensed consolidated financial statements





                                     - 4 -





<PAGE>   5
                            FAMILY RESTAURANTS, INC.
                            ------------------------
                            
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                -----------------------------------------------
                                ($ in thousands)
                                  (Unaudited)


<TABLE>
<CAPTION>
                                                                          For the Nine Months Ended
                                                                   ----------------------------------------
                                                                    September 29,             September 24,
                                                                        1996                       1995
                                                                   --------------             -------------
<S>                                                                <C>                       <C>
Increase in Cash and Cash Equivalents

Cash flows from operating activities:
  Cash received from customers, franchisees and
    licensees                                                         $ 612,333                 $ 857,289
  Cash paid to suppliers and employees                                 (597,740)                 (815,147)
  Interest paid, net                                                    (33,134)                  (40,620)
  Income taxes paid                                                        (647)                     (887)
  Restructuring costs                                                    (5,603)                   (1,366)
                                                                      ---------                 ---------

    Net cash used in operating activities                               (24,791)                     (731)
                                                                      ---------                 ---------

Cash flows from investing activities:
  Proceeds from disposal of property and equipment                       21,326                     9,046
  Proceeds from sale of Family Restaurant Division, net                 121,342                         0
  Proceeds from sale of notes receivable, net                            32,116                         0
  Capital expenditures                                                   (5,676)                  (32,056)
  Capitalized opening costs                                                (235)                   (1,671)
  Other                                                                     796                      (730)
                                                                      ---------                 ---------

    Net cash provided by (used in) investing activities                 169,669                   (25,411)
                                                                      ---------                 ---------

Cash flows from financing activities:
  Proceeds from (repayment of) working capital
    borrowings, net                                                     (79,815)                   32,564
  Repurchases of Notes                                                  (13,113)                        0
  Reductions of long-term debt, including capitalized
    lease obligations                                                    (4,855)                   (6,345)
  (Increase) decrease in restricted cash                                (23,621)                    1,850
  Purchase of treasury stock                                                  0                    (1,383)
  Payments of notes receivable from stockholders                              0                       766
                                                                      ---------                 ---------

    Net cash provided by (used in) financing activities                (121,404)                   27,452
                                                                      ---------                 ---------

Net increase in cash and cash equivalents                                23,474                     1,310
Cash and cash equivalents at beginning of period                          8,370                     8,239
                                                                      ---------                 ---------

Cash and cash equivalents at end of period                            $  31,844                 $   9,549
                                                                      =========                 =========
</TABLE>



     See accompanying notes to condensed consolidated financial statements





                                     - 5 -





<PAGE>   6
                            FAMILY RESTAURANTS, INC.
                            ------------------------
                            
          CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
          -----------------------------------------------------------
                                ($ in thousands)
                                  (Unaudited)


<TABLE>
<CAPTION>
                                                                        For the Nine Months Ended
                                                                    ---------------------------------
                                                                    September 29,       September 24,
                                                                        1996                1995
                                                                    -------------       -------------
<S>                                                                 <C>                 <C>
Reconciliation of net income (loss) to net cash
  used in operating activities:

Net income (loss)                                                     $ 138,016            $(98,545)
Adjustments to reconcile net income (loss) to net
  cash used in operating activities:
    Depreciation and amortization                                        28,751              43,783
    Amortization of debt issuance costs                                   1,918               2,464
    Loss on disposition of properties                                     5,207               6,848
    Provision for divestitures                                                0              41,886
    Gain on sale of division                                            (62,601)                  0
    Extraordinary gain on extinguishment of debt                       (123,080)                  0
    Accretion of interest on Discount Notes                               8,201               9,973
    Decrease in receivables, inventories and other
      current assets                                                      4,979               1,014
    Decrease in accounts payable, self-insurance
      reserves, other accrued liabilities and
      income taxes payable                                              (26,182)             (8,154)
                                                                      ---------            --------

Net cash used in operating activities                                 $ (24,791)           $   (731)
                                                                      =========            ========


Non-cash investing and financing activities:  See Note 4 to the condensed consolidated
  financial statements.

</TABLE>


     See accompanying notes to condensed consolidated financial statements




                                     - 6 -





<PAGE>   7
                            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 September 29, 1996 the Company operated 296 restaurants in 30
states, with approximately 67% of its restaurants located in California, Ohio,
Pennsylvania, Illinois, Indiana and Michigan.  The Company is the licensor of
four restaurants in Japan, the franchisor of one restaurant in the United
States and the franchisor of 21 restaurants outside the United States.

         On May 23, 1996, the Company completed the sale of its family
restaurant division, which operated full-service family restaurants (the
"Family Restaurant Division"), to an indirect wholly-owned subsidiary of
Flagstar Companies, Inc. ("Flagstar") in exchange for cash of $125 million,
$150 million principal amount of 12-1/2% Senior Notes due in 2004 (the "FRD
Notes"), and the assumption of $31.5 million of long-term debt, primarily
consisting of capitalized lease obligations.  Based on the subsequent
completion of a closing balance sheet, the purchase price was increased and
such increase was satisfied by the issuance of $6.9 million in additional FRD
Notes.  The Company recorded a gain of $62.6 million on the sale of the Family
Restaurant Division, which gain included the effect of the increase in purchase
price of $6.9 million discussed above.  Cash proceeds from the sale were used
to pay indebtedness outstanding under the Credit Facility (as defined below) of
$82 million.  As of September 29, 1996, the Company had sold or exchanged
$150.4 million aggregate principal amount of the FRD Notes.  The remaining
balance of $6.5 million is currently restricted in accordance with the sale
agreement with Flagstar to secure potential future indemnity claims.  The
remaining FRD Notes are carried at their fair value which approximates their
cost.

         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 31, 1995 included
in the Company's Annual Report on Form 10-K for the fiscal year ended December
31, 1995 (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 nine months ended September 29, 1996 are not
necessarily indicative of those for the full year.





                                     - 7 -
<PAGE>   8
         3.      IMPAIRMENT OF LONG-LIVED ASSETS.  Effective January 1, 1996,
the Company adopted SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of," which generally requires
the assessment of certain long-lived assets for possible impairment when events
or circumstances indicate the carrying value of these assets may not be
recoverable.

         The Company evaluates property and equipment for impairment by
comparison of the carrying value of the assets to estimated undiscounted cash
flows (before interest charges) expected to be generated by the asset over its
estimated useful life.  In addition, the Company's evaluation considers data
such as continuity of personnel, changes in the operating environment, name
identification, competitive information and market trends.  Finally, the
evaluation considers changes in management's strategic direction or market
emphasis.  When the foregoing considerations suggest that a deterioration of
the financial condition of the Company or any of its assets has occurred, the
Company measures the amount of an impairment, if any, based on the estimated
fair value of each of its assets over the remaining amortization period.

         The Company believes that there has been no impairment of its
long-lived assets based on re-engineering and re-positioning plans currently
under development, other than impairment already recognized in connection with
various properties held for sale.

         4.      LONG-TERM DEBT.  On July 3, 1996, the Company repurchased
$151.0 million aggregate principal amount of its 9-3/4% Senior Notes due 2002
(the "Senior Notes") and $108.6 million aggregate principal amount of its
10-7/8% Senior Subordinated Discount Notes due 2004 (the "Discount Notes" and
together with the Senior Notes, the "Notes") in exchange for (or from the
proceeds from the sale of) $133.5 million aggregate principal amount of the FRD
Notes.  In separate transactions, the Company repurchased an additional $8.5
million aggregate principal amount of its Discount Notes in the third quarter
of 1996.  The Company recognized an extraordinary gain of $123.1 million in the
third quarter of 1996 as a result of these repurchases.

         5.      INCOME (LOSS) PER COMMON SHARE.  Income (loss) per common
share is computed based on the weighted average number of shares actually
outstanding.  The impact of a warrant to acquire an additional 111,111 shares
of common stock of the Company and outstanding options have not been included
because the impact would be antidilutive for 1995 and would not provide
meaningful information in 1996 because the Company believes that neither the
warrant nor the outstanding options would be exercised at their current
exercise prices.





                                     - 8 -
<PAGE>   9
Item 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS

         Certain information and statements included in 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 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
implementation of a successful cost restructuring program and the development
of a successful marketing strategy for Chi-Chi's, (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 and (ix)
business disruptions.  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, 1995, which continued in operation through the end of
the third quarter of 1996.

LIQUIDITY AND CAPITAL RESOURCES.
--------------------------------

         A.      LIQUIDITY

         The Company currently relies primarily on internally generated funds,
supplemented by proceeds received from the sale of the Family Restaurant
Division, for its liquidity.  The Company's viability is therefore dependent
upon its ability to generate sufficient cash flow to meet its obligations on a
timely basis.

         Operating Cash Flow.  During the first nine months of 1996, the
Company reported EBITDA (defined as earnings (loss) before gain (loss) on
disposition of properties, restructuring costs, interest, taxes, depreciation
and amortization) of $25.2 million.  The Company has included information
concerning EBITDA herein because it understands that such information is used
by certain investors as one measure of a company'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





                                     - 9 -
<PAGE>   10
operating performance or to cash flows from operating activities as a measure
of liquidity.

         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 $61.5 million on September 29, 1996 (excluding the impact of $6.1
million in property held for sale).

         Credit Facility.  On January 27, 1994, the Company, FRI-M Corporation
("FRI-M") and certain subsidiaries of FRI-M entered into a credit facility (the
"Credit Facility").  In connection with the sale of the Family Restaurant
Division, (i) the Company used a portion of the cash proceeds from the sale to
repay $82 million outstanding under the Credit Facility and (ii) the Credit
Facility was amended to change the borrower from FRI-M (which, following
consummation of the sale, is no longer owned by the Company) to FRI-MRD
Corporation, a wholly owned subsidiary of the Company, to remove all
restrictive covenants, and to reduce the commitment thereunder to up to $32
million of letters of credit with no provision for revolving loans.  Letters of
credit are issued under the Credit Facility primarily to provide security for
future amounts payable under the Company's workers' compensation insurance
program ($21.8 million of such letters of credit were outstanding as of
November 13, 1996) and must be fully cash collateralized.  On October 23, 1996,
the Company signed a letter of intent with another lending institution for a
five-year, $35 million credit facility (the "New Facility") to provide for the
ongoing working capital needs of the Company.  The New Facility would provide
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).  Although
the New Facility would not require that letters of credit be cash
collateralized (other than upon the occurrence of certain events), the New
Facility would be secured by all of the real and personal property of the
Company and would contain customary restrictive covenants, including the
maintenance of certain financial ratios.  Completion of the New Facility is
subject to completion of due diligence, final documentation and other customary
terms and conditions.  There can be no assurances that the New Facility will be
entered into.

         Other.  In the third quarter, the Company repurchased $151.0 million
aggregate principal amount of its Senior Notes and $108.6 million aggregate
principal amount of its Discount Notes in exchange for (or from the proceeds
from the sale of) $133.5 million aggregate principal amount of the FRD Notes.
In separate transactions, the Company repurchased an additional $8.5 million
aggregate principal amount of its Discount Notes in the third quarter of 1996.
As of September 29, 1996, the Company had sold or exchanged $150.4 million
aggregate principal amount of the FRD Notes.  The remaining balance of $6.5
million is currently





                                     - 10 -
<PAGE>   11
restricted in accordance with the sale agreement to secure potential future
indemnity claims.

         Notwithstanding the completion of the sale of the Family Restaurant
Division and the repurchases of the Notes, the Company continues to be highly
leveraged and have significant debt service requirements.  Although management
believes that its current sources of cash should be sufficient to meet its
operating and debt service requirements for the foreseeable future, there can
be no assurance that the Company will be able to satisfy current debt service
requirements of the Notes or to repay or refinance the Notes at their
respective maturities.  Notwithstanding the execution of the letter of intent
with respect to the New Facility, the Company is continuing to explore
alternatives to further reduce its debt (including additional open market
purchases or other transactions to further reduce remaining indebtedness
outstanding under the Notes).  However, there can be no assurances that the
Company will be able to further reduce such debt on satisfactory terms.

         B.      CAPITAL EXPENDITURES

         Net cash provided by investing activities was $169.7 million for the
first nine months of 1996 versus net cash used in investing activities of $25.4
million for the first nine months of 1995, primarily due to the completion of
the sale of the Family Restaurant Division and certain FRD Notes during the
first nine months of 1996 and a reduction in capital expenditures during such
period.  The reduction in capital expenditures resulted primarily from the
indefinite suspension of the Company's remodel and new restaurant construction
programs for all restaurants, which was necessary due to the reduced levels of
operating cash flow.

RESULTS OF OPERATIONS.
----------------------

THIRD QUARTER OF 1996 AS COMPARED TO THE THIRD QUARTER OF 1995.

         The Company's total sales decreased by $152,794,000 or 54.3%
for the third quarter of 1996 as compared to the same period in 1995.  This
decrease was due to (i) the loss of sales from the Family Restaurant Division,
which was sold by the Company at the end of May 1996, (ii) decreased sales of
comparable restaurants and (iii) restaurants divested or closed.

<TABLE>
<CAPTION>
                                                               Third Quarter Sales
                                                                     Decrease     
                                                               -------------------
                                                                ($ in thousands)
<S>                                                             <C>
Decrease in Sales of Family Restaurant
  Division                                                            $(126,429)
Decrease in Sales of Comparable Restaurants                             (11,579)
Decrease in Sales of Restaurants Divested
  or Closed                                                             (14,786)
                                                                      ---------
    Total                                                             $(152,794)
                                                                      =========  
</TABLE>





                                     - 11 -
<PAGE>   12
         Sales for comparable restaurants decreased by $11,579,000 or 8.7% for
the third quarter of 1996 as compared to the same period in 1995.  This
comparable sales decrease reflects decreases in both the El Torito and
Chi-Chi's restaurants primarily due to an increasingly competitive operating
environment for restaurants.  Also contributing to the comparable sales
decrease during the third quarter was the timing of the July 4th holiday during
1996 and the 1996 summer Olympics, which affected three weekends and two full
weeks during July and August.  The Company continues to work to develop
appropriate long-term marketing plans for Chi-Chi's and El Torito.

         Product cost decreased by $44,047,000 or 55.9% in the third quarter of
1996 as compared to the same period in 1995, reflecting the impact of 29
restaurants sold or closed since the end of the third quarter of 1995 and the
decrease in Family Restaurant Division's product cost, based on the sale of the
Family Restaurant Division at the end of May 1996.  As a percentage of sales,
product cost declined to 27.1% in the third quarter of 1996 as compared to
28.0% in the same period in 1995.

         Payroll and related costs decreased by $53,526,000 or 51.7% in the
third quarter of 1996 as compared to the same period in 1995.  This decrease
reflects the impact of the restaurants sold or closed since the end of the
third quarter of 1995 and the sale of the Family Restaurant Division.  As a
percentage of sales, payroll and related costs increased from 36.8% in the
third quarter of 1995 to 38.9% in the same period in 1996, primarily as a
result of labor inefficiencies due to the impact of declining sales on fixed
costs and higher management costs at the restaurant level due to salary
increases.

         Effective October 1, 1996 the federal minimum wage has been increased
from $4.25 to $4.75 and effective September 1, 1997 it will be further
increased to $5.15.  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) increase the Company's payroll cost.  A provision of the new
measure effectively freezes the minimum wage for tipped employees, in those
states which allow for a tip credit, at current levels by increasing the
allowable tip credit.  In response to the minimum wage increase on October 1st,
the Company raised menu prices at its El Torito restaurants in an effort to
recover the higher payroll costs.  Menu prices were not increased at Chi-Chi's,
however, due to marketing strategies and the fact that Chi-Chi's will
experience a lesser impact from the minimum wage increase due to the increased
allowable tip credit.  On November 5, 1996, California voters approved a
proposition that would increase the state's minimum wage to $5.00 on March 1,
1997 and $5.25 on March 1, 1998.  There is no tip credit in California.

         Occupancy and other expenses decreased by $36,735,000 or 53.3% in the
third quarter of 1996 as compared to the same period in 1995.  This decrease
reflects the impact of the restaurants sold or closed since the end of the
third quarter of 1995 and the sale of





                                     - 12 -
<PAGE>   13
the Family Restaurant Division.  As a percentage of sales, occupancy and other
operating expenses increased from 24.5% in the third quarter of 1995 to 25.1%
in the same period in 1996 primarily due to lower costs as a percentage of
sales in the Family Restaurant Division in 1995.

         Depreciation and amortization decreased by $9,041,000 or 60.9% in the
third quarter of 1996 as compared to the same period in 1995.  The decrease
reflects the reduced depreciable asset base resulting from (i) the third
quarter 1995 adjustment for Chi-Chi's restaurants either held for sale or
having impaired values and (ii) the sale of the Family Restaurant Division.
The decrease is offset, in part, by additional depreciation related to capital
expenditures made from the fourth quarter of 1995 through the third quarter of
1996.

         General and administrative expenses decreased by $5,007,000 or 38.5%
in the third quarter of 1996 as compared to the same period in 1995.  The
decrease primarily resulted from overall cost reductions plus the impact of the
sale of the Family Restaurant Division.  As a percentage of sales, general and
administrative expenses increased from 4.6% in the third quarter of 1995 to
6.2% in the same period of 1996 primarily resulting from corporate general and
administrative expenses in the third quarter of 1996 spread over fewer
restaurants due to the sale of the Family  Restaurant Division as compared to
the same period in 1995.  Management continues to closely evaluate the
Company's general and administrative cost structure in light of the sale of the
Family Restaurant Division.

         Chi-Chi's management continues to work to significantly restructure
Chi-Chi's costs during 1996 in an attempt to bring operating margins in line
with the current sales levels.  This restructuring is intended to reduce
restaurant operating costs and includes strong inventory and meal preparation
controls as well as closely monitored restaurant labor scheduling and
management staffing levels.  El Torito management has also introduced several
programs early in the fourth quarter in an effort to improve margins.

         The Company reported a loss on disposition of properties of $1.0
million in the third quarter of 1996 as compared to a loss of $5.5 million for
the same period in 1995.  The loss in 1995 was primarily due to the write-off
of costs associated with cancelled capital projects (both remodels and new
restaurant expansion) and the loss associated with the closure of six
restaurants.

         The Company reported restructuring costs of $1.0 million in the third
quarter of 1996 as compared to restructuring costs of $1.4 million for the same
period in 1995.  These costs are primarily related to amounts paid to
consultants, professional fees, severance and related costs and other
restructuring related expenses.





                                     - 13 -
<PAGE>   14
         Interest expense, net decreased by $11,711,000 or 73.9% in the third
quarter of 1996 as compared to the same period in 1995.  This decrease
primarily resulted from (i) interest income related to the FRD Notes, (ii) no
working capital borrowings under the Credit Facility during the third quarter
of 1996, (iii) the impact of the elimination of Family Restaurant Division's
interest costs, primarily for capitalized lease obligations, and (iv) lower
accretion of interest related to the Discount Notes and interest expense
related to the Senior Notes due to the repurchases of the Notes, as previously
discussed.

         The Company recorded an additional gain of $1.7 million in the third
quarter of 1996 as a result of the sale of the Family Restaurant Division.
This additional gain primarily represents the adjustment resulting from the
completion of the final balance sheet and the subsequent upward adjustment of
the purchase price.

         The Company recognized an extraordinary gain of $123.1 million in the
third quarter of 1996 as a result of several repurchases of the Notes.

FIRST NINE MONTHS OF 1996 AS COMPARED TO FIRST NINE MONTHS OF 1995.

         The Company's total sales decreased by $245,422,000 or 28.8%
for the first nine months of 1996 as compared to the same period in 1995.  This
decrease was due to (i) the loss of sales from the Family Restaurant Division
which was sold by the Company at the end of May 1996, (ii) decreased sales of
comparable restaurants and (iii) restaurants divested or closed.

<TABLE>
<CAPTION>
                                                                   First Nine Months
                                                                      1996 Sales
                                                                       Decrease     
                                                                   -----------------
                                                                   ($ in thousands)
<S>                                                                <C>
Decrease in Sales of Family Restaurant
  Division                                                              $(175,595)
Decrease in Sales of Comparable Restaurants                               (36,441)
Decrease in Sales of Restaurants Divested
  or Closed                                                               (33,386)
                                                                        ---------
    Total                                                               $(245,422)
                                                                        =========  
</TABLE>


         Sales for comparable restaurants decreased by $36,441,000 or 8.3% for
the first nine months of 1996 as compared to the same period in 1995.  This
comparable sales decrease reflects decreases in both the El Torito and
Chi-Chi's restaurants.

         Product cost decreased by $73,456,000 or 30.4% in the first nine
months of 1996 as compared to the same period in 1995, reflecting the impact of
29 restaurants sold or closed since the end of the second quarter of 1995 and
the sale of the Family Restaurant Division.  As a percentage of sales, product
cost declined to 27.8% in the first nine months of 1996 as compared to 28.4% in
the same period in 1995.





                                     - 14 -
<PAGE>   15
         Payroll and related costs decreased by $84,704,000 or 26.9% in the
first nine months of 1996 as compared to the same period in 1995.  This
decrease reflects the impact of the restaurants sold or closed since the end of
the second quarter of 1995 and the sale of the Family Restaurant Division.  As
a percentage of sales, payroll and related costs increased from 37.0% in the
first nine months of 1995 as compared to 38.0% in the same period in 1996,
primarily as a result of labor inefficiencies due to the impact of declining
sales on fixed costs, higher management costs at the restaurant level due to
salary increases and higher bonuses earned in 1996 in the Family Restaurant
Division.

         Occupancy and other expenses decreased by $59,787,000 or 28.6% in the
first nine months of 1996 as compared to the same period in 1995.  This
decrease reflects the impact of the restaurants sold or closed since the end of
the second quarter of 1995 and the sale of the Family Restaurant Division.  As
a percentage of sales, occupancy and other operating expenses increased
slightly from 24.5% in the first nine months of 1995 to 24.6% in the same
period in 1996.

         Depreciation and amortization decreased by $15,032,000 or 34.3% in the
first nine months of 1996 as compared to the same period in 1995.  The decrease
reflects the reduced depreciable asset base resulting from (i) the third
quarter 1995 adjustment for Chi-Chi's restaurants either held for sale or
having impaired values, (ii) the sale of certain owned properties and (iii) the
sale of the Family Restaurant Division.  The decrease is offset, in part, by
additional depreciation related to capital expenditures made from the third
quarter of 1995 through the third quarter of 1996.  Depreciation and
amortization of $11.2 million related to the Family Restaurant Division was
recorded in the first 21 weeks of 1996, as the Company treated the related
restaurants as operating assets until their sale.

         General and administrative expenses decreased by $10,118,000 or 23.3%
in the first nine months of 1996 as compared to the same period in 1995.  The
decrease resulted from overall cost reductions plus the impact of the sale of
the Family Restaurant Division.  As a percentage of sales, general and
administrative expenses increased from 5.1% for the first nine months of 1995
to 5.5% for the same period in 1996.

         The Company reported a loss on disposition of properties of $5.2
million in the first nine months of 1996 as compared to a loss of $6.8 million
for the same period in 1995.  The loss in 1996 is primarily due to losses
related to the sale of certain owned properties.  The loss in 1995 was
primarily due to the write-off of costs associated with cancelled capital
projects (both remodels and new restaurant expansion) and the loss associated
with the closure of six restaurants.

         The Company reported restructuring costs of $5.6 million for the first
nine months of 1996 as compared to restructuring costs of $1.4 million for
the same period in 1995.  These costs are





                                     - 15 -
<PAGE>   16
primarily related to amounts paid to consultants, professional fees, severance
and related costs and other restructuring related expenses.

         Interest expense, net decreased by $13,384,000 or 29.1% in the first
nine months of 1996 as compared to the same period in 1995.  This decrease
primarily resulted from (i) interest income related to the FRD Notes, (ii) no
working capital borrowings under the Credit Facility for the five weeks of June
1996 and the third quarter of 1996, (iii) the impact of Family Restaurant
Division's June 1995 and third quarter 1995 interest costs, primarily for
capitalized lease obligations, and (iv) lower accretion of interest related to
the Discount Notes and interest expense related to the Senior Notes due to the
repurchases of the Notes, as previously discussed.  The decrease is offset, in
part, by (i) interest on working capital borrowings which were outstanding
throughout the first 21 weeks of 1996 as compared to lower working capital
borrowings during the first 21 weeks of 1995, (ii) fees paid to the banks in
connection with an amendment to the Credit Facility, (iii) higher accretion of
interest related to the Discount Notes during the first 26 weeks of 1996 as
compared to 1995, and (iv) accelerated amortization of the Credit Facility debt
issuance costs as compared to the same period of 1995.

         The Company recorded a gain of $62.6 million in 1996 as a result of
the sale of the Family Restaurant Division.





                                     - 16 -
<PAGE>   17
                          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 and results of operations of the Company.

Item 2.  CHANGES IN SECURITIES

         None.

Item 3.  DEFAULTS UPON SENIOR SECURITIES

         None.

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

         In connection with the Company's previously announced repurchase of
certain Notes, on July 2, 1996, the  Company obtained the requisite consents to
the adoption of certain amendments to the respective indentures relating to the
Notes (the "Indentures").  In accordance with the terms of the respective
Indentures, the holders of at least a majority in aggregate principal amount of
the notes outstanding thereunder are required to effectuate any amendment to
the Indentures.  On July 2, 1996, there were outstanding $300,000,000 aggregate
principal amount of Senior Notes and $150,000,000 aggregate principal amount of
Discount Notes.  The Company obtained the consent of the holders of
$150,966,000 aggregate principal amount of its Senior Notes and $108,600,000
aggregate principal amount of its Discount Notes.

         The amendments to the Indentures (i) amended the definition of
"Restricted Payment" and made such other changes necessary to permit the
Company to repurchase Junior Debt (as defined) without restriction, (ii)
clarified that the maximum amount that can be borrowed under the Bank Credit
Agreement (as defined) is to be reduced by the amount of Excess Proceeds (as
defined), if any, applied to permanently repay Indebtedness (as defined)
outstanding thereunder, (iii) eliminated the requirement that any permitted
refunding or replacements of the Bank Credit Agreement take place within six
months of payment in full of such agreement, (iv) allowed any Subsidiary (as
defined) of the Company to incur certain debt, and (v) allowed the Company to
use Excess Proceeds from Asset Sales (as defined) to repay or repurchase any
Indebtedness of the Company, including the Senior Notes, the Discount Notes and
Junior Debt.

         The foregoing is only a summary of, and is qualified in its entirety
by, the terms of the First Supplemental Indentures, dated as of July 3, 1996,
relating to the Indentures, copies of which were filed as Exhibits 10.1 and
10.2 to the Company's Current Report on Form 8-K filed on July 9, 1996.





                                     - 17 -
<PAGE>   18
Item 5.  OTHER INFORMATION

         None.

Item 6.  EXHIBITS AND REPORTS ON FORM 8-K

         (a)     Exhibits

                 10.1      Family Restaurants, Inc. and FRI-MRD Corporation
                           Value Creation Units Plan and sample Value Creation
                           Units Agreement.

                 27        Financial Data Schedule.

         (b)     Reports on Form 8-K.

                 On July 9, 1996 the Company filed a report on Form 8-K
                 announcing the repurchase of $151.0 million aggregate
                 principal amount of its Senior Notes and $108.6 million
                 aggregate principal amount of its Discount Notes from
                 unrelated third parties in exchange for (or from the proceeds
                 from the sale of) $133.5 million aggregate principal amount of
                 the FRD Notes.





                                     - 18 -
<PAGE>   19
                                   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)


                                         By: /S/ Robert T. Trebing, Jr.
                                             ----------------------------------
                                                  Robert T. Trebing, Jr.
                                                Senior Vice President and
                                                 Chief Financial Officer
                                              (Principal Financial Officer)

Date:  November 13, 1996



                                     - 19 -