** **

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

----

** **

**FORM 10-Q**

 

(Mark One)

 
| **ý** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE**

**SECURITIES EXCHANGE ACT OF 1934** |
|------------|--------------------------------------------------------------------------------------------------------|

 

**For the quarterly period ended April 3, 2005**

** **
| **OR** |
|--------|
| o      | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE**

**SECURITIES EXCHANGE ACT OF 1934** |

 

For the transition period from              to             

 

**Commission File No. 001-13579**

 

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**FRIENDLY ICE CREAM CORPORATION**

(Exact Name of Registrant as Specified in Its Charter)

 

| **Massachusetts**                                                                   | ** ** | **04-2053130**                     |
|-------------------------------------------------------------------------------------|------------|------------------------------------|
| (State or Other  Jurisdiction of  Incorporation or Organization)                    |       | (IRS Employer  Identification No.) |
|                                                                                |       |                               |
| **1855  Boston Road****Wilbraham, Massachusetts**                                   | ** ** | **01095**                          |
| (Address of  Principal Executive Offices)                                           |       | (Zip Code)                         |
|                                                                                |
| **(413)  543-2400**                                                                 |
| (Registrant’s  Telephone Number, Including Area Code)                          |
|                                                                                |
| **Not Applicable**                                                                  |
| (Former name,  former address and former fiscal year, if changed since last report) |

 

                Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes ý No o

 

                Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Exchange Act Rule12b-2). Yes ý  No o

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock as of thelatest practicable date.

 

| **Class**                     | ** ** | **Outstanding  at April 15, 2005** |
|-------------------------------|------------|------------------------------------|
| Common Stock, $.01 par  value |       | 7,742,989 shares                   |

** **

** **

----

 

**PART I —FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

**FRIENDLYICE CREAM CORPORATION AND SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

(Unaudited)

(In thousands)
| ** **                                                                | ** ** | **April 3,** | ** ** | **January 2,** | ** ** |
|---------------------------------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                                                | ** ** | **2005**     | ** ** | **2005**       | ** ** |
| ** **                                                                | ** ** | ** **   | ** ** | ** **     | ** ** |
| ASSETS                                                                    |       |         |       |           |       |
| CURRENT ASSETS:                                                           |       |         |       |           |       |
| Cash and cash  equivalents                                                |       | $            | 11,150     |           | $          | 13,405 |   |
| Restricted cash                                                           |       | 1,470        |       | 1,711          |       |
| Accounts  receivable, net                                                 |       | 12,406       |       | 10,448         |       |
| Inventories                                                               |       | 15,866       |       | 17,545         |       |
| Deferred income  taxes                                                    |       | 6,853        |       | 6,853          |       |
| Prepaid expenses  and other current assets                                |       | 4,622        |       | 4,382          |       |
| TOTAL CURRENT  ASSETS                                                     |       | 52,367       |       | 54,344         |       |
| DEFERRED INCOME  TAXES                                                    |       | 11,622       |       | 10,619         |       |
| PROPERTY AND  EQUIPMENT, net of accumulated depreciation and amortization |       | 152,499      |       | 156,412        |       |
| INTANGIBLE  ASSETS AND DEFERRED COSTS, net of accumulated amortization    |       | 20,055       |       | 20,510         |       |
| OTHER ASSETS                                                              |       | 7,030        |       | 6,999          |       |
| TOTAL ASSETS                                                              |       | $            | 243,573    |           | $          | 248,884 |   |
|                                                                      |       |         |       |           |       |
| LIABILITIES AND STOCKHOLDERS’ DEFICIT                                |       |         |       |           |       |
| CURRENT  LIABILITIES:                                                     |       |         |       |           |       |
| Current  maturities of long-term debt                                     |       | $            | 1,160      |           | $          | 5,224 |   |
| Current  maturities of capital lease and finance obligations              |       | 1,539        |       | 1,533          |       |
| Accounts payable                                                          |       | 21,314       |       | 21,536         |       |
| Accrued salaries  and benefits                                            |       | 9,796        |       | 8,740          |       |
| Accrued interest  payable                                                 |       | 4,709        |       | 1,427          |       |
| Insurance  reserves                                                       |       | 10,899       |       | 9,927          |       |
| Restructuring  reserves                                                   |       | 668          |       | 1,078          |       |
| Other accrued  expenses                                                   |       | 16,586       |       | 18,582         |       |
| TOTAL CURRENT  LIABILITIES                                                |       | 66,671       |       | 68,047         |       |
| CAPITAL LEASE  AND FINANCE OBLIGATIONS, less current maturities           |       | 6,997        |       | 7,380          |       |
| LONG-TERM DEBT,  less current maturities                                  |       | 225,410      |       | 225,752        |       |
| ACCRUED PENSION  COST                                                     |       | 17,476       |       | 17,532         |       |
| OTHER LONG-TERM  LIABILITIES                                              |       | 34,906       |       | 35,199         |       |
| COMMITMENTS AND  CONTINGENCIES                                            |       |         |       |           |       |
| STOCKHOLDERS’  DEFICIT                                               |       |         |       |           |       |
| Common stock                                                              |       | 77           |       | 77             |       |
| Additional  paid-in capital                                               |       | 143,251      |       | 143,115        |       |
| Accumulated  other comprehensive loss                                     |       | (20,681      | )          | (20,670        | )          |
| Accumulated  deficit                                                      |       | (230,534     | )          | (227,548       | )          |
| TOTAL  STOCKHOLDERS’ DEFICIT                                         |       | (107,887     | )          | (105,026       | )          |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ DEFICIT                         |       | $            | 243,573    |           | $          | 248,884 |   |

 

The accompanying notesare an integral part of these condensed consolidated financial statements.

 

2

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## **FRIENDLY ICE CREAM CORPORATIONAND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS**

(Unaudited)

(In thousands, except pershare data)

 
| ** **                                                       | ** ** | **For the Three Months Ended** | ** ** |
|------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                       | ** ** | **April 3,**                   | ** ** | **March 28,** | ** ** |
| ** **                                                       | ** ** | **2005**                       | ** ** | **2004** | ** ** |
| ** **                                                       | ** ** | ** **                     | ** ** | **(Restated)** | ** ** |
| REVENUES:                                                        |       |                           |       |   |   |
| Restaurant                                                       |       | $                              | 96,092     |   | $ | 104,353 |   |
| Foodservice                                                      |       | 25,306                         |       | 23,343 |   |
| Franchise                                                        |       | 3,250                          |       | 3,058 |   |
| TOTAL REVENUES                                                   |       | 124,648                        |       | 130,754 |   |
|                                                             |       |                           |       |   |   |
| COSTS AND  EXPENSES:                                             |       |                           |       |   |   |
| Cost of sales                                                    |       | 47,755                         |       | 45,588 |   |
| Labor and  benefits                                              |       | 36,533                         |       | 39,934 |   |
| Operating  expenses                                              |       | 24,521                         |       | 25,131 |   |
| General and  administrative expenses                             |       | 9,449                          |       | 10,697 |   |
| Restructuring  expenses                                          |       | —                         |       | 2,627 |   |
| Gain on  litigation settlement                                   |       | —                         |       | (3,644 | ) |
| Depreciation and  amortization                                   |       | 6,324                          |       | 5,717 |   |
| Gain on  franchise sales of restaurant operations and properties |       | (1,309                         | )          | (906 | ) |
| Loss on  disposals of other property and equipment, net          |       | 70                             |       | 171 |   |
|                                                             |       |                           |       |   |   |
| OPERATING INCOME                                                 |       | 1,305                          |       | 5,439 |   |
|                                                             |       |                           |       |   |   |
| OTHER EXPENSES:                                                  |       |                           |       |   |   |
| Interest  expense, net                                           |       | 5,298                          |       | 6,064 |   |
| Other (income)  expense, principally debt retirement costs       |       | (12                            | )          | 6,892 |   |
|                                                             |       |                           |       |   |   |
| LOSS BEFORE  BENEFIT FROM INCOME TAXES                           |       | (3,981                         | )          | (7,517 | ) |
|                                                             |       |                           |       |   |   |
| Benefit from  income taxes                                       |       | 995                            |       | 2,275 |   |
|                                                             |       |                           |       |   |   |
| NET LOSS                                                         |       | $                              | (2,986     | ) | $ | (5,242 | ) |
|                                                             |       |                           |       |   |   |
| BASIC AND  DILUTED NET LOSS PER SHARE                            |       | $                              | (0.39      | ) | $ | (0.70 | ) |
|                                                             |       |                           |       |   |   |
| WEIGHTED AVERAGE  BASIC AND DILUTED SHARES                       |       | 7,717                          |       | 7,520 |   |

 

 

The accompanying notesare an integral part of these condensed consolidated financial statements.

 

3

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**FRIENDLYICE CREAM CORPORATION AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

(Unaudited)

(In thousands)

 
| ** **                                                                                 | ** ** | **For the Three Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                 | ** ** | **April 3,**                   | ** ** | **March 28,** | ** ** |
| ** **                                                                                 | ** ** | **2005**                       | ** ** | **2004** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                     |       |                           |       |   |   |
| Net loss                                                                                   |       | $                              | (2,986     | ) | $ | (5,242 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in) operating activities: |       |                           |       |   |   |
| Stock  compensation expense                                                                |       | —                         |       | 333 |   |
| Depreciation and  amortization                                                             |       | 6,324                          |       | 5,717 |   |
| Write-offs of  deferred financing costs                                                    |       | —                         |       | 1,788 |   |
| Deferred income  tax benefit                                                               |       | (995                           | )          | (2,275 | ) |
| Gain on  disposals of other property and equipment, net                                    |       | (1,243                         | )          | (735 | ) |
| Changes in  operating assets and liabilities:                                              |       |                           |       |   |   |
| Accounts  receivable                                                                       |       | (1,958                         | )          | (5,797 | ) |
| Inventories                                                                                |       | 1,679                          |       | (1,146 | ) |
| Other assets                                                                               |       | 92                             |       | (2,946 | ) |
| Accounts payable                                                                           |       | (222                           | )          | (570 | ) |
| Accrued expenses  and other long-term liabilities                                          |       | 2,555                          |       | 973 |   |
| NET CASH  PROVIDED BY (USED IN) OPERATING ACTIVITIES                                       |       | 3,246                          |       | (9,900 | ) |
|                                                                                       |       |                           |       |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                     |       |                           |       |   |   |
| Purchases of  property and equipment                                                       |       | (2,408                         | )          | (2,255 | ) |
| Proceeds from  sales of property and equipment                                             |       | 1,706                          |       | 2,897 |   |
| Purchases of  marketable securities                                                        |       | (183                           | )          | — |   |
| Proceeds from  sales of marketable securities                                              |       | 42                             |       | — |   |
| NET CASH (USED  IN) PROVIDED BY INVESTING ACTIVITIES                                       |       | (843                           | )          | 642 |   |
|                                                                                       |       |                           |       |   |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                     |       |                           |       |   |   |
| Proceeds from  issuance of New Senior Notes                                                |       | —                         |       | 175,000 |   |
| Proceeds from  revolving credit facility                                                   |       | 15,250                         |       | — |   |
| Repayments of  debt                                                                        |       | (19,656                        | )          | (128,112 | ) |
| Payments related  to deferred financing costs                                              |       | (11                            | )          | (6,625 | ) |
| Repayments of  capital lease and finance obligations                                       |       | (377                           | )          | (230 | ) |
| Stock options  exercised                                                                   |       | 136                            |       | 244 |   |
| NET CASH (USED  IN) PROVIDED BY FINANCING ACTIVITIES                                       |       | (4,658                         | )          | 40,277 |   |
|                                                                                       |       |                           |       |   |   |
| NET (DECREASE)  INCREASE IN CASH AND CASH EQUIVALENTS                                      |       | (2,255                         | )          | 31,019 |   |
|                                                                                       |       |                           |       |   |   |
| CASH AND CASH  EQUIVALENTS, BEGINNING OF PERIOD                                            |       | 13,405                         |       | 25,631 |   |
|                                                                                       |       |                           |       |   |   |
| CASH AND CASH  EQUIVALENTS, END OF PERIOD                                                  |       | $                              | 11,150     |   | $ | 56,650 |   |
|                                                                                       |       |                           |       |   |   |
| SUPPLEMENTAL  DISCLOSURES:                                                                 |       |                           |       |   |   |
| Cash paid  (refunded) during the period for:                                               |       |                           |       |   |   |
| Interest                                                                                   |       | $                              | 1,755      |   | $ | 4,927 |   |
| Income taxes                                                                               |       | (5                             | )          | 7 |   |
| Capital lease  obligations incurred                                                        |       | —                         |       | 2,280 |   |

 

 

The accompanying notesare an integral part of these condensed consolidated financial statements.

 

4

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** **

**FRIENDLYICE CREAM CORPORATION AND SUBSIDIARIES**

** **

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

(Unaudited)

 

**1. BASIS OF PRESENTATION ANDSIGNIFICANT ACCOUNTING POLICIES**

 

*InterimFinancial Information —*

 

The accompanyingcondensed consolidated financial statements as of April 3, 2005 and for thethree months ended April 3, 2005 and March 28, 2004 are unaudited, but havebeen prepared in accordance with generally accepted accounting principles (“GAAP”)for interim financial information and with the instructions to Form 10-Q andArticle 10 of Regulation S-X.  Accordingly,they do not include all of the information and footnotes required by GAAP forcomplete financial statements.  In theopinion of management, all adjustments which are necessary for a fairpresentation of the consolidated financial position, results of operations,cash flows and comprehensive loss of Friendly Ice Cream Corporation (“FICC”)and subsidiaries (unless the context indicates otherwise, collectively, the “Company”)have been included. Such adjustments consist solely of normal recurringaccruals. Operating results for the three month periods ended April 3, 2005 andMarch 28, 2004 are not necessarily indicative of the results that may beexpected for the entire year due, in part, to the seasonality of the Company’sbusiness. Historically, higher revenues and operating income have beenexperienced during the second and third fiscal quarters. The Company’sconsolidated financial statements, including the notes thereto, which arecontained in the 2004 Annual Report on Form 10-K/A for the fiscal year endedJanuary 2, 2005 (“2004 Annual Report on Form 10-K/A”) should be read inconjunction with these condensed consolidated financial statements. Capitalizedterms not otherwise defined herein should be referenced to the 2004 AnnualReport on Form 10-K/A.

 

*Use ofEstimates in the Preparation of Financial Statements -*

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities and thedisclosure of contingent assets and liabilities at the dates of the financialstatements and the reported amounts of revenues and expenses during thereporting periods. The critical accounting policies and most significantestimates and assumptions relate to revenue recognition, insurance reserves,recoverability of accounts receivable, income tax valuation allowances andpension and post-retirement medical and life insurance benefits expense. Actualamounts could differ significantly from the estimates.

 

*Inventories-*

 

Inventories are stated at the lowerof first-in, first-out cost or market and consisted of thefollowing at April 3, 2005 and January 2, 2005 (in thousands):

 

| ** **       | ** ** | **April 3,** | ** ** | **January 2,** | ** ** |
|------------------|------------|--------------|------------|----------------|------------|
| ** **       | ** ** | **2005**     | ** ** | **2005**       | ** ** |
|             |       |         |       |           |       |
| Raw materials    |       | $            | 1,948      |           | $          | 2,685 |   |
| Goods in process |       | 156          |       | 157            |       |
| Finished goods   |       | 13,762       |       | 14,703         |       |
| Total            |       | $            | 15,866     |           | $          | 17,545 |   |

 

5

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*OtherAccrued Expenses-*

 

Other accrued expenses consisted of the following at April 3, 2005 andJanuary 2, 2005 (in thousands):

 

| ** **                     | ** ** | **April 3,** | ** ** | **January 2,** | ** ** |
|--------------------------------|------------|--------------|------------|----------------|------------|
| ** **                     | ** ** | **2005**     | ** ** | **2005**       | ** ** |
|                           |       |         |       |           |       |
| Accrued rent                   |       | $            | 4,355      |           | $          | 4,781 |   |
| Gift cards  outstanding        |       | 2,910        |       | 4,068          |       |
| Accrued meals  and other taxes |       | 2,493        |       | 2,766          |       |
| Accrued advertising            |       | 2,039        |       | 1,824          |       |
| Unearned  revenues             |       | 1,020        |       | 1,056          |       |
| Accrued  construction costs    |       | 915          |       | 1,236          |       |
| Accrued bonus                  |       | 511          |       | 751            |       |
| All other                      |       | 2,343        |       | 2,100          |       |
| Total                          |       | $            | 16,586     |           | $          | 18,582 |   |

 

 

*LeaseGuarantees and Contingencies —*

 

Primarily as a result of the Company’s re-franchisingefforts, the Company remains liable for certain lease assignments andguarantees. These leases have varying terms, the latest of which expires in2020. As of April 3, 2005, the potential amount of undiscounted payments theCompany could be required to make in the event of non-payment by the primarylessees was $7,106,000. The present value of these potential paymentsdiscounted at the Company’s pre-tax cost of debt at April 3, 2005 was$5,500,000. The Company generally has cross-default provisions with franchiseesthat would put them in default of their franchise agreement in the event ofnon-payment under the lease. The Company believes these cross-defaultprovisions significantly reduce the risk that the Company will be required tomake payments under these leases and, historically, the Company has not beenrequired to make such payments. Additionally, as of April 3, 2005, the Companyhas no reason to believe that the franchisees will be unable to fulfill theirobligations. Accordingly, no liability has been recorded for exposure undersuch leases at April 3, 2005 and January 2, 2005.

 

6

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*NetLoss Per Share —*

 

Basic net loss per share is calculated by dividingnet loss by the weighted average number of common shares outstanding during theperiod. Diluted net loss per share is calculated by dividing net loss by theweighted average number of shares of common stock and common stock equivalentsoutstanding during the period. Common stock equivalents are dilutive stockoptions and warrants that are assumed exercised for calculation purposes. Therewere no common stock equivalents included in diluted net loss per share for thethree months ended April 3, 2005 and March 28, 2004.  The number of common stock options whichcould dilute basic earnings per share in the future, that were not included inthe computation of diluted earnings per share because to do so would have beenantidilutive, was 376,000 and 328,000 for the three months ended April 3, 2005and March 28, 2004, respectively.

 

During the quarter ended April 3,2005, the Company granted employee stock options to purchase approximately114,000 shares of common stock at an exercise price equal to the closing marketprice on the date of grant. During the quarter ended April 3, 2005, 29,710employee stock options were exercised. The weighted-average exercise prices ofthe options granted and options exercised were $8.86 and $4.59, respectively.

 

*Stock-BasedCompensation —*

 

The Company accounts for stock-based compensation for employeesunder Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for StockIssued to Employees,” and elected the disclosure-only alternative underSFAS No. 123, “Accounting for Stock-Based Compensation.”  Stock-based compensation cost ofapproximately $222,000 related to modified option awards was included in netloss for the three months ended March 28, 2004 for the Company’s Stock OptionPlan and the Company’s 2003 Incentive Plan. No stock-based compensation costwas included in net loss for the three months ended April 3, 2005 for theCompany’s Stock Option Plan or the Company’s 2003 Incentive Plan, as alloptions granted during this period had an exercise price equal to the marketvalue of the stock on the date of grant.

 

In December 2002, the Financial Accounting StandardsBoard (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No.148, “Accounting for Stock-Based Compensation—Transition and Disclosure,” whichamended SFAS No. 123. SFAS No. 148 allowed for three methods of transition forthose companies that adopt SFAS No. 123’s provisions for fair valuerecognition. SFAS No. 148’s transition guidance and provisions for annualdisclosures were effective for fiscal years ending after December 15, 2002. Inaccordance with SFAS No. 148, the Company continued to disclose the requiredpro-forma information in the notes to the condensed consolidated financialstatements.

 

7

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In accordance with SFAS No. 148, the following tablepresents the effect on net loss and net loss per share had compensation costfor the Company’s stock plans been determined consistent with SFAS No. 123 (inthousands, except per share data):

 

| ** **                                                                                                                          | ** ** | **For the Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                          | ** ** | **April 3,**                   | ** ** | **March 28,** | ** ** |
| ** **                                                                                                                          | ** ** | **2005**                       | ** ** | **2004** | ** ** |
|                                                                                                                                |       |                           |       |   |   |
| Net loss as  reported                                                                                                               |       | $                              | (2,986     | ) | $ | (5,242 | ) |
|                                                                                                                                |       |                           |       |   |   |
| Add stock-based  compensation expense included in reported net loss, net of related income tax  benefit                             |       | —                         |       | 131 |   |
| Less stock-based  compensation expense determined under fair value method for all stock  options, net of related income tax benefit |       | (14                            | )          | (105 | ) |
| Pro forma net  loss                                                                                                                 |       | $                              | (3,000     | ) | $ | (5,216 | ) |
|                                                                                                                                |       |                           |       |   |   |
| Basic and  diluted net loss per share:                                                                                              |       |                           |       |   |   |
| Basic and  diluted net loss per share, as reported                                                                                  |       | $                              | (0.39      | ) | $ | (0.70 | ) |
| Basic and  diluted net loss per share, pro forma                                                                                    |       | $                              | (0.39      | ) | $ | (0.69 | ) |

 

 

*RecentlyIssued Accounting Pronouncements —*

 

On December 16, 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-BasedPayment” (“SFAS No. 123R”), which is a revision of SFAS No. 123, “Accountingfor Stock-Based Compensation.” SFAS No. 123R supersedes APB Opinion No. 25,Accounting for Stock Issued to Employees,” and amends SFAS No. 95, “Statementof Cash Flows.” Generally, the approach in SFAS No. 123R is similar to theapproach described in SFAS No. 123. However, SFAS No. 123R requires allshare-based payments to employees, including grants of employee stock options,to be recognized in the income statement based on their fair values. Pro formadisclosure is no longer an alternative. SFAS No. 123R must be adopted no laterthan the first annual period beginning after June 15, 2005. Early adoption willbe permitted in periods in which financial statements have not yet been issued.SFAS 123R allows companies to choose between the modified-prospective andmodified-retrospective transition alternatives in adopting SFAS 123R. Under themodified-prospective transition method, compensation cost will be recognized infinancial statements issued subsequent to the date of adoption for allshared-based payments granted, modified or settled after the date of adoption,as well as for any unvested awards that were granted prior to the date ofadoption. Under the modified-retrospective transition method, compensation costwill be recognized in a manner consistent with the modified-prospectivetransition method, however, prior period financial statements will also berestated by recognizing compensation cost as previously reported in the proforma disclosures under SFAS 123. The restatement provisions can be applied toeither a) all periods presented or b) to the beginning of the fiscal year inwhich SFAS 123R is adopted. The Company expects to adopt SFAS No. 123R onJanuary 2, 2006 using the modified-prospective method. As the Companypreviously adopted only the pro forma disclosure provisions of SFAS 123, theCompany will recognize compensation cost relating to the unvested portion ofawards granted prior to the date of adoption using the same estimate of thegrant-date fair value and the same attribution method used to determine the proforma disclosures under SFAS 123.

 

8

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As permitted by SFAS No. 123, the Company currently accounts forshare-based payments to employees using APB Opinion No. 25’s intrinsic valuemethod and, as such, generally recognizes no compensation cost for employeestock options.  Accordingly, the adoptionof SFAS No. 123R’s fair value method will have an impact on the Company’sresults of operations, although it will have no impact on the overall financialposition. The impact of the adoption of SFAS No. 123R cannot be determined atthis time because it will depend upon levels of share-based payments granted inthe future. However, had the Company adopted SFAS No. 123R in prior periods,the impact of that standard would have approximated the impact as described inthe disclosure of pro forma net loss and loss per share pursuant to SFAS No.123.  SFAS No. 123R also requires thebenefits of tax deductions in excess of recognized compensation cost to bereported as a financing cash flow, rather than as an operating cash flow asrequired under current literature.  Thisrequirement will reduce net operating cash flows and increase net financingcash flows in periods after adoption. While the Company cannot estimate what those amounts will be in thefuture (because they depend on, among other things, when employees exercisestock options), the amount of operating cash flows recognized in prior yearsfor such excess tax deductions were $0.8 million and $0.2 million in 2004 and2003, respectively.

 

In November 2004, theFASB issued SFAS No. 151, “Inventory Costs, an amendment of Accounting ResearchBulletin No. 43, Chapter 4”. The amendments made by SFAS No. 151 clarify thatabnormal amounts of idle facility expense, freight, handling costs, and wastedmaterials (spoilage) should be recognized as current-period charges and requirethe allocation of fixed production overheads to inventory based on the normalcapacity of the production facilities. SFAS No. 151 is the result of a broadereffort by the FASB to improve the comparability of cross-border financialreporting by working with the International Accounting Standards Board towarddevelopment of a single set of high-quality accounting standards. The guidanceis effective for inventory costs incurred during fiscal years beginning afterJune 15, 2005. The adoption of SFAS No. 151 is not expected to have a materialeffect on the Company’s consolidated financial position or results ofoperations.

 

9

----

 

**2.RESTATEMENT OF FINANCIAL STATEMENTS**

 

Following a review of the Company’slease accounting and leasehold depreciation practices in 2004, the Companyrestated its previously reported financial statements in its 2004 Annual Reporton Form 10-K/A.  The Company hascorrected its computation of straight-line rent expense and the relateddeferred rent liability as well as depreciation expense. Historically, whenaccounting for lease renewal options, rent expense was recorded on astraight-line basis over the non-cancelable lease term. The depreciable livesof certain leasehold improvements and other long-lived assets on thoseproperties were not aligned with the non-cancelable lease term.

 

The Company believed that itsaccounting treatment was permitted under GAAP and that such treatment wasconsistent with the practices of other public companies. Following a review ofits lease accounting treatment and relevant accounting literature, the Companydetermined that it should: i) conform the depreciable lives for buildings onleased land and other leasehold improvements to the shorter of the economiclife of the asset or the lease term used for determining the capital versusoperating lease classification and calculating straight-line rent and ii)include option periods in the depreciable lives assigned to leased buildingsand leasehold improvements and in the calculation of straight-line rent expenseonly in instances in the which the exercise of the option period can bereasonably assured and failure to exercise such options would result in aneconomic penalty. The Company has restated its financial statements in its 2004Annual Report on Form 10-K/A to accelerate depreciation for certain leaseholdimprovements and to record additional rent expense (the “Restatement”).

 

The following is a summary of theimpact of the Restatement on the Company’s condensed consolidated statement ofoperations for the three months ended March 28, 2004 (in thousands):

 
| ** **                             | ** ** | **For the Three Months Ended March 28, 2004** | ** ** |
|----------------------------------------|------------|-----------------------------------------------|------------|
| ** **                             | ** ** | **As Previously**                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                             | ** ** | **Reported**                                  | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
|                                   |       |                                          |       |   |   |   |   |
| Operating  expenses                    |       | $                                             | 25,052     |   | $ | 79 |   | $ | 25,131 |   |
| Depreciation and  amortization         |       | 5,606                                         |       | 111 |   | 5,717 |   |
| Operating income                       |       | 5,629                                         |       | (190 | ) | 5,439 |   |
| Loss before  benefit from income taxes |       | (7,327                                        | )          | (190 | ) | (7,517 | ) |
| Benefit from  income taxes             |       | 2,198                                         |       | 77 |   | 2,275 |   |
| Net loss                               |       |                                          | (5,129     | ) |   | (113 | ) |   | (5,242 | ) |
|                                   |       |                                          |       |   |   |   |   |
| Basic and  diluted net loss per share  |       |                                          | (0.68      | ) |   | (0.02 | ) |   | (0.70 | ) |

 

10

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**3.EMPLOYEE BENEFIT PLANS**

 

The components of net periodic pension benefit for thethree months ended April 3, 2005 and March 28, 2004 were (in thousands):

 

| ** **                       | ** ** | **April 3,** | ** ** | **March 28,** | ** ** |
|----------------------------------|------------|--------------|------------|---------------|------------|
| ** **                       | ** ** | **2005**     | ** ** | **2004**      | ** ** |
| ** **                       | ** ** | ** **   | ** ** | ** **    | ** ** |
| Interest cost                    |       | $            | 1,627      |          | $          | 1,627 |   |
| Expected return  on assets       |       | (2,097       | )          | (2,331        | )          |
| Net  amortization:               |       |         |       |          |       |
| Unrecognized net  actuarial loss |       | 414          |       | 154           |       |
|                             |       |         |       |          |       |
| Net periodic  pension benefit    |       | $            | (56        | )             | $          | (550 | ) |

 

 

The components of the net postretirement medical andlife insurance benefit cost for the three months ended April 3, 2005 and March28, 2004 were (in thousands):

 

| ** **                                              | ** ** | **April 3,** | ** ** | **March 28,** | ** ** |
|---------------------------------------------------------|------------|--------------|------------|---------------|------------|
| ** **                                              | ** ** | **2005**     | ** ** | **2004**      | ** ** |
| ** **                                              | ** ** | ** **   | ** ** | ** **    | ** ** |
| Service cost                                            |       | $            | 40         |          | $          | 28 |   |
| Interest cost                                           |       | 115          |       | 116           |       |
| Recognized  actuarial loss                              |       | 21           |       | 23            |       |
| Net amortization  of unrecognized prior service benefit |       | (36          | )          | (36           | )          |
|                                                    |       |         |       |          |       |
| Net  postretirement benefit cost                        |       | $            | 140        |          | $          | 131 |   |

 

 

On December 8, 2003, the Medicare Prescription Drug,Improvement and Modernization Act of 2003 (the “Act”), which introduced aMedicare prescription drug benefit, as well as a federal subsidy to sponsors ofretiree health care benefit plans that provide a benefit that is at leastactuarially equivalent to the Medicare benefit, was enacted. On May 19, 2004,the FASB issued Financial Staff Position No. 106-2, “Accounting and DisclosureRequirements Related to the Medicare Prescription Drug, Improvement andModernization Act of 2003” (“FSP 106-2”) to discuss certain accounting anddisclosure issues raised by the Act. FSP 106-2 addresses accounting for thefederal subsidy for the sponsors of single employer postretirement health careplans and disclosure requirements for plans for which the employer has not yetbeen able to determine actuarial equivalency. Except for certain nonpublicentities, FSP 106-2 is effective for the first interim or annual periodbeginning after June 15, 2004 (the quarter ended September 26, 2004 for theCompany).

 

11

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Basedon regulations issued by the Centers for Medicare & Medicaid Services, theCompany has concluded that, for certain participants, the benefits provided areat least actuarially equivalent to benefits available through Medicare PartD.  The Company has determined that theeffects of the Act are not significant. Therefore, the reported net benefitcost and the accumulated benefit obligation of the Company’s postretirementmedical and life insurance plan in the accompanying condensed consolidatedfinancial statements and notes thereto does not reflect the effects of the Act.The Company will recognize the effect on the next measurement date, which willbe included in the consolidated financial statements for the year ended January1, 2006.

 

 

**4. SEGMENT REPORTING**

 

Operating segmentsare components of an enterprise about which separate financial information isavailable that is evaluated regularly by the chief operating decision-maker, ordecision-making group, in deciding how to allocate resources and in assessingperformance. The Company’s chief operating decision-maker is the ChiefExecutive Officer and President of the Company. The Company’s operatingsegments include restaurant, foodservice and franchise. The revenues from thesesegments include both sales to unaffiliated customers and inter-segment sales,which generally are accounted for on a basis consistent with sales tounaffiliated customers. Intersegment sales and other inter-segment transactionshave been eliminated in the accompanying condensed consolidated financialstatements.

 

The Company’srestaurants target families with kids and adults who desire a reasonably-pricedmeal in a full-service setting. The Company’s menu offers a broadselection of freshly-prepared foods which appeal to customers throughoutall dayparts. The menu currently features over 100 items comprised of a broadselection of breakfast, lunch, dinner and afternoon and evening snack items.Foodservice operations manufactures premium ice cream dessert products anddistributes such manufactured products and purchased finished goods to theCompany’s restaurants and franchised operations. Additionally, it sells premiumice cream dessert products to distributors and retail and institutionallocations. The Company’s franchise segment includes a royalty based onfranchise restaurant revenue. In addition, the Company receives rental incomefrom various franchised restaurants. The Company does not allocate general andadministrative expenses associated with its headquarters operations to anybusiness segment. These costs include expenses of legal, accounting,information systems and other headquarter functions.

 

The accounting policies of the operating segmentsare the same as those described in the summary of significant accountingpolicies except that the financial results for the foodservice operatingsegment, prior to inter-segment eliminations, have been prepared using amanagement approach, which is consistent with the basis and manner in which theCompany’s management internally reviews financial information for the purposeof assisting in making internal operating decisions. Using this approach, theCompany evaluates performance based on stand-alone operating segment income(loss) before income taxes and generally accounts for inter-segment sales andtransfers as if the sales or transfers were to third parties, that is, atcurrent market prices.

 

12

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EBITDA represents net loss before (i) benefitfrom income taxes, (ii) other (income) expense, principally debt retirementcosts, (iii) interest expense, net, (iv) depreciation andamortization, (v) write-downs of property and equipment, (vi) netperiodic pension benefit and (vii) other non-cash items. The Company hasincluded information concerning EBITDA in this Form 10-Q because the Company’smanagement incentive plan pays bonuses based on achieving EBITDA targets andthe Company believes that such information is used by certain investors as onemeasure of a company’s historical ability to service debt. EBITDA should not beconsidered as an alternative to, or more meaningful than, earnings (loss) fromoperations or other traditional indications of a company’s operatingperformance.

 

| ** **              | ** ** | **For the Three Months Ended** | ** ** |
|-------------------------|------------|--------------------------------|------------|
| ** **              | ** ** | **April 3,**                   | ** ** | **March 28,** | ** ** |
| ** **              | ** ** | **2005**                       | ** ** | **2004** | ** ** |
| ** **              | ** ** | **(in thousands)**             | ** ** |
| Revenues:               |       |                           |       |   |   |
| Restaurant              |       | $                              | 96,092     |   | $ | 104,353 |   |
| Foodservice             |       | 54,163                         |       | 53,362 |   |
| Franchise               |       | 3,250                          |       | 3,058 |   |
| Total                   |       | $                              | 153,505    |   | $ | 160,773 |   |
|                    |       |                           |       |   |   |
| Intersegment  revenues: |       |                           |       |   |   |
| Restaurant              |       | $                              | —     |   | $ | — |   |
| Foodservice             |       | (28,857                        | )          | (30,019 | ) |
| Franchise               |       | —                         |       | — |   |
| Total                   |       | $                              | (28,857    | ) | $ | (30,019 | ) |
|                    |       |                           |       |   |   |
| External  revenues:     |       |                           |       |   |   |
| Restaurant              |       | $                              | 96,092     |   | $ | 104,353 |   |
| Foodservice             |       | 25,306                         |       | 23,343 |   |
| Franchise               |       | 3,250                          |       | 3,058 |   |
| Total                   |       | $                              | 124,648    |   | $ | 130,754 |   |

 

13

----

 
| ** **                                                 | ** ** | **For the Three Months Ended** | ** ** |
|------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                 | ** ** | **April 3,**                   | ** ** | **March 28,** | ** ** |
| ** **                                                 | ** ** | **2005**                       | ** ** | **2004** | ** ** |
| ** **                                                 | ** ** | ** **                     | ** ** | **(Restated)** | ** ** |
| ** **                                                 | ** ** | **(in thousands)**             | ** ** |
|                                                       |       |                           |       |   |   |
| EBITDA:                                                    |       |                           |       |   |   |
| Restaurant                                                 |       | $                              | 6,769      |   | $ | 9,254 |   |
| Foodservice                                                |       | 2,148                          |       | 3,532 |   |
| Franchise                                                  |       | 2,266                          |       | 2,091 |   |
| Corporate                                                  |       | (4,787                         | )          | (5,412 | ) |
| Gain on property  and equipment, net                       |       | 1,233                          |       | 674 |   |
| Restructuring  expenses                                    |       | —                         |       | (2,627 | ) |
| Gain on  litigation settlement                             |       | —                         |       | 3,644 |   |
| Less pension  benefit included in reporting segments       |       | (56                            | )          | (550 | ) |
| Total                                                      |       | $                              | 7,573      |   | $ | 10,606 |   |
|                                                       |       |                           |       |   |   |
| Interest  expense, net-Corporate                           |       | $                              | 5,298      |   | $ | 6,064 |   |
|                                                       |       |                           |       |   |   |
| Other (income)  expense, principally debt retirement costs |       | $                              | (12        | ) | $ | 6,892 |   |
|                                                       |       |                           |       |   |   |
| Depreciation and  amortization:                            |       |                           |       |   |   |
| Restaurant                                                 |       | $                              | 4,643      |   | $ | 3,966 |   |
| Foodservice                                                |       | 823                            |       | 852 |   |
| Franchise                                                  |       | 40                             |       | 47 |   |
| Corporate                                                  |       | 818                            |       | 852 |   |
| Total                                                      |       | $                              | 6,324      |   | $ | 5,717 |   |
|                                                       |       |                           |       |   |   |
| Net periodic  pension benefit                              |       | $                              | (56        | ) | $ | (550 | ) |
|                                                       |       |                           |       |   |   |
| Income (loss)  before benefit from income taxes:           |       |                           |       |   |   |
| Restaurant                                                 |       | $                              | 2,126      |   | $ | 5,288 |   |
| Foodservice                                                |       | 1,325                          |       | 2,680 |   |
| Franchise                                                  |       | 2,226                          |       | 2,044 |   |
| Corporate                                                  |       | (10,891                        | )          | (19,220 | ) |
| Gain on property  and equipment, net                       |       | 1,233                          |       | 674 |   |
| Restructuring  expenses                                    |       | —                         |       | (2,627 | ) |
| Gain on  litigation settlement                             |       | —                         |       | 3,644 |   |
| Total                                                      |       | $                              | (3,981     | ) | $ | (7,517 | ) |

 

14

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| ** **                                                             | ** ** | **For the Three**   | ** ** | **For the Year** | ** ** |
|------------------------------------------------------------------------|------------|---------------------|------------|------------------|------------|
| ** **                                                             | ** ** | **Months Ended**    | ** ** | **Ended**        | ** ** |
| ** **                                                             | ** ** | **April 3,**        | ** ** | **January 2,**   | ** ** |
| ** **                                                             | ** ** | **2005**            | ** ** | **2005**         | ** ** |
| ** **                                                             | ** ** | **(in thousands)**  | ** ** |
| Capital  expenditures, including assets acquired under capital leases: |       |                |       |             |       |
| Restaurant                                                             |       | $                   | 1,977      |             | $          | 20,309 |   |
| Foodservice                                                            |       | 244                 |       | 1,700            |       |
| Corporate                                                              |       | 187                 |       | 1,170            |       |
| Total                                                                  |       | $                   | 2,408      |             | $          | 23,179 |   |
|                                                                   |       |                |       |             |       |
| ** **                                                             | ** ** | **April 3,**        | ** ** | **January  2,**  | ** ** |
| ** **                                                             | ** ** | **2005**            | ** ** | **2005**         | ** ** |
|                                                                   |       | **(in  thousands)** |       |
| Total assets:                                                          |       |                |       |             |       |
| Restaurant                                                             |       | $                   | 141,504    |             | $          | 142,366 |   |
| Foodservice                                                            |       | 40,646              |       | 40,567           |       |
| Franchise                                                              |       | 6,845               |       | 7,726            |       |
| Corporate                                                              |       | 54,578              |       | 58,225           |       |
| Total                                                                  |       | $                   | 243,573    |             | $          | 248,884 |   |

 

15

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**5.RESTRUCTURING RESERVES**

 

During the quarter ended March 28, 2004, the Companyrecorded a pre-tax restructuring charge of $2,627,000 for severance andoutplacement services associated with reduction in force actions taken duringthe first quarter of 2004 that reduced headcount by approximately 20 permanentpositions.

 

On October 10, 2001, the Company eliminatedapproximately 70 positions at corporate headquarters. In addition,approximately 30 positions in the restaurant construction and fabrication areaswere eliminated by December 30, 2001. The purpose of the reduction was tostreamline functions and reduce redundancy among its business segments. As aresult of the elimination of the positions and the outsourcing of certainfunctions, the Company reported a pre-tax restructuring charge of $2,536,000for severance, rent and unusable construction supplies in the year endedDecember 30, 2001.

 

In March 2000, the Company’s Board of Directorsapproved a restructuring plan that provided for the immediate closing of 81restaurants at the end of March 2000 and the disposition of an additional 70restaurants over the next 24 months. As a result of this plan, the Companyreported a pre-tax restructuring charge of $12,056,000 for severance, rent,utilities and real estate taxes, demarking, lease termination costs and certainother costs associated with the closing of the locations, along with a pre-taxwrite-down of property and equipment for these locations of approximately$17,000,000 in the year ended December 31, 2000. The Company reduced therestructuring reserve by $400,000 and $1,900,000 during the years endedDecember 29, 2002 and December 30, 2001, respectively, since the reserveexceeded estimated remaining payments.

 

16

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The followingrepresents the reserve and activity associated with the March 2004, October2001 and March 2000 restructurings (in thousands):

 
| ** **    | ** ** | **For the Three Months Ended April 3, 2005** | ** ** |
|---------------|------------|----------------------------------------------|------------|
| ** **    | ** ** | **Restructuring**                            | ** ** | ** ** | ** ** | ** ** | ** ** | **Restructuring** | ** ** |
| ** **    | ** ** | **Reserves as of**                           | ** ** | ** ** | ** ** | ** ** | ** ** | **Reserves as of** | ** ** |
| ** **    | ** ** | **January 2, 2005**                          | ** ** | **Expense** | ** ** | **Costs Paid** | ** ** | **April 3, 2005** | ** ** |
|          |       |                                         |       |   |   |   |   |   |   |
| Rent          |       | $                                            | 92         |   | $ | — |   | $ | (32 | ) | $ | 60 |   |
| Severence pay |       | 952                                          |       | — |   | (344 | ) | 608 |   |
| Other         |       | 34                                           |       | — |   | (34 | ) | — |   |
| Total         |       | $                                            | 1,078      |   | $ | — |   | $ | (410 | ) | $ | 668 |   |

 
| ** **                       | ** ** | **For the Three Months Ended March 28, 2004** | ** ** |
|----------------------------------|------------|-----------------------------------------------|------------|
| ** **                       | ** ** | **Restructuring**                             | ** ** | ** ** | ** ** | ** ** | ** ** | **Restructuring** | ** ** |
| ** **                       | ** ** | **Reserves as of**                            | ** ** | ** ** | ** ** | ** ** | ** ** | **Reserves as of** | ** ** |
| ** **                       | ** ** | **December 28, 2003**                         | ** ** | **Expense** | ** ** | **Costs Paid** | ** ** | **March 28, 2004** | ** ** |
|                             |       |                                          |       |   |   |   |   |   |   |
| Rent                             |       | $                                             | 319        |   | $ | — |   | $ | (65 | ) | $ | 254 |   |
| Utilities and  real estate taxes |       | 40                                            |       | — |   | (14 | ) | 26 |   |
| Severence pay                    |       | —                                        |       | 2,549 |   | (295 | ) | 2,254 |   |
| Outplacement  services           |       | —                                        |       | 78 |   | (13 | ) | 65 |   |
| Other                            |       | 82                                            |       | — |   | (15 | ) | 67 |   |
| Total                            |       | $                                             | 441        |   | $ | 2,627 |   | $ | (402 | ) | $ | 2,666 |   |

 

 

Based on informationcurrently available, management believes that the restructuring reserves as ofApril 3, 2005 were adequate and not excessive.

 

17

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**6.SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION**

 

FICC’s obligationsrelated to its $175 million 8.375% senior notes (the “New Senior Notes”) issuedin March 2004 are guaranteed fully and unconditionally by one of FICC’s whollyowned subsidiaries. There are no restrictions on FICC’s ability to obtaindividends or other distributions of funds from this subsidiary, except thoseimposed by applicable law. The following supplemental financial informationsets forth, on a condensed consolidating basis, balance sheets, statements ofoperations and statements of cash flows for FICC (the “Parent Company”),Friendly’s Restaurants Franchise, Inc. (the “Guarantor Subsidiary”) andFriendly’s International, Inc., Restaurant Insurance Corporation, Friendly’sRealty I, LLC, Friendly’s Realty II, LLC and Friendly’s Realty III, LLC(collectively, the “Non-guarantor Subsidiaries”). All of the LLCs’ assetswere owned by the LLCs, which are separate entities with separate creditorswhich will be entitled to be satisfied out of the LLCs’ assets. Separatecomplete financial statements and other disclosures of the Guarantor Subsidiaryas of April 3, 2005 and January 2, 2005 and for the three months ended April 3,2005 and March 28, 2004 were not presented because management has determinedthat such information is not material to investors.

 

Investments insubsidiaries are accounted for by the Parent Company on the equity method forpurposes of the supplemental consolidating presentation. Earnings of thesubsidiaries are, therefore, reflected in the Parent Company’s investmentaccounts and earnings. The principal elimination entries eliminate the ParentCompany’s investments in subsidiaries and intercompany balances andtransactions.

 

18

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**SupplementalCondensed Consolidating Balance Sheet**

**As ofApril 3, 2005**

(In thousands)

 
| ** **                                                 | ** ** | ** **  | ** ** | ** **     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                 | ** ** | **Parent**  | ** ** | **Guarantor**  | ** ** | **guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                 | ** ** | **Company** | ** ** | **Subsidiary** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Assets                                                     |       |        |       |           |       |             |       |             |       |             |       |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Current assets:                                            |       |        |       |           |       |             |       |             |       |             |       |
| Cash and cash  equivalents                                 |       | $           | 8,578      |           | $          | 826              |       | $                | 1,746      |             | $          | — |   | $ | 11,150 |   |
| Restricted cash                                            |       | —      |       | —         |       | 1,470            |       | —           |       | 1,470            |       |
| Accounts  receivable, net                                  |       | 10,531      |       | 1,875          |       | —           |       | —           |       | 12,406           |       |
| Inventories                                                |       | 15,866      |       | —         |       | —           |       | —           |       | 15,866           |       |
| Deferred income  taxes                                     |       | 6,705       |       | 18             |       | —           |       | 130              |       | 6,853            |       |
| Prepaid expenses  and other current assets                 |       | 9,276       |       | 592            |       | 7,782            |       | (13,028          | )          | 4,622            |       |
| Total current  assets                                      |       | 50,956      |       | 3,311          |       | 10,998           |       | (12,898          | )          | 52,367           |       |
| Deferred income  taxes                                     |       | 11,386      |       | 366            |       | —           |       | (130             | )          | 11,622           |       |
| Property and  equipment, net                               |       | 107,480     |       | —         |       | 45,019           |       | —           |       | 152,499          |       |
| Intangibles and  deferred costs, net                       |       | 17,831      |       | —         |       | 2,224            |       | —           |       | 20,055           |       |
| Investments in  subsidiaries                               |       | (2,492      | )          | —         |       | —           |       | 2,492            |       | —           |       |
| Other assets                                               |       | 6,115       |       | 2,046          |       | 915              |       | (2,046           | )          | 7,030            |       |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Total assets                                               |       | $           | 191,276    |           | $          | 5,723            |       | $                | 59,156     |             | $          | (12,582 | ) | $ | 243,573 |   |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Liabilities and  Stockholders’ (Deficit) Equity       |       |        |       |           |       |             |       |             |       |             |       |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Current  liabilities:                                      |       |        |       |           |       |             |       |             |       |             |       |
| Current  maturities of long-term obligations               |       | $           | 9,315      |           | $          | —           |       | $                | 1,160      |             | $          | (7,776 | ) | $ | 2,699 |   |
| Accounts payable                                           |       | 21,314      |       | —         |       | —           |       | —           |       | 21,314           |       |
| Accrued expenses                                           |       | 40,039      |       | 2,349          |       | 5,223            |       | (4,953           | )          | 42,658           |       |
| Total current  liabilities                                 |       | 70,668      |       | 2,349          |       | 6,383            |       | (12,729          | )          | 66,671           |       |
| Long-term obligations,  less current maturities            |       | 181,997     |       | —         |       | 50,410           |       | —           |       | 232,407          |       |
| Other long-term  liabilities                               |       | 46,498      |       | 945            |       | 7,284            |       | (2,345           | )          | 52,382           |       |
| Stockholders’  (deficit) equity                       |       | (107,887    | )          | 2,429          |       | (4,921           | )          | 2,492            |       | (107,887         | )          |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Total liabilities  and stockholders’ (deficit) equity |       | $           | 191,276    |           | $          | 5,723            |       | $                | 59,156     |             | $          | (12,582 | ) | $ | 243,573 |   |

 

19

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**SupplementalCondensed Consolidating Statement of Operations**

**For theThree Months Ended April 3, 2005**

(In thousands)

 
| ** **                                                                                                             | ** ** | ** **  | ** ** | ** **     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                                             | ** ** | **Parent**  | ** ** | **Guarantor**  | ** ** | **guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                                                                             | ** ** | **Company** | ** ** | **Subsidiary** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Revenues.                                                                                                              |       | $           | 122,176    |           | $          | 2,472            |       | $                | —     |             | $          | — |   | $ | 124,648 |   |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Costs and expenses:                                                                                                    |       |        |       |           |       |             |       |             |       |             |       |
| Cost of sales                                                                                                          |       | 47,755      |       | —         |       | —           |       | —           |       | 47,755           |       |
| Labor and  benefits                                                                                                    |       | 36,533      |       | —         |       | —           |       | —           |       | 36,533           |       |
| Operating  expenses                                                                                                    |       | 26,260      |       | —         |       | (1,739           | )          | —           |       | 24,521           |       |
| General and  administrative expenses                                                                                   |       | 8,293       |       | 1,156          |       | —           |       | —           |       | 9,449            |       |
| Depreciation and  amortization                                                                                         |       | 5,766       |       | —         |       | 558              |       | —           |       | 6,324            |       |
| Gain on  franchise sales of restaurant operations and properties                                                       |       | (1,309      | )          | —         |       | —           |       | —           |       | (1,309           | )          |
| Loss on  disposals of other property and equipment, net                                                                |       | 70          |       | —         |       | —           |       | —           |       | 70               |       |
| Interest  expense, net                                                                                                 |       | 4,179       |       | —         |       | 1,119            |       | —           |       | 5,298            |       |
| Other income                                                                                                           |       | (12         | )          | —         |       | —           |       | —           |       | (12              | )          |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| (Loss) income  before benefit from (provision for) income taxes and equity in net income of consolidated  subsidiaries |       | (5,359      | )          | 1,316          |       | 62               |       | —           |       | (3,981           | )          |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Benefit from  (provision for) income taxes                                                                             |       | 1,586       |       | (540           | )          | (51              | )          | —           |       | 995              |       |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| (Loss) income  before equity in net income of consolidated subsidiaries                                                |       | (3,773      | )          | 776            |       | 11               |       | —           |       | (2,986           | )          |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Equity in net  income of consolidated subsidiaries                                                                     |       | 787         |       | —         |       | —           |       | (787             | )          | —           |       |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Net (loss)  income                                                                                                     |       | $           | (2,986     | )              | $          | 776              |       | $                | 11         |             | $          | (787 | ) | $ | (2,986 | ) |

 

20

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** Supplemental Condensed Consolidating Statementof Cash Flows**

**For theThree Months Ended April 3, 2005**

(In thousands)

 
| ** **                                           | ** ** | ** **  | ** ** | ** **     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                           | ** ** | **Parent**  | ** ** | **Guarantor**  | ** ** | **guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                           | ** ** | **Company** | ** ** | **Subsidiary** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                 |       |        |       |           |       |             |       |             |       |             |       |
| Net cash  provided by (used in) operating activities |       | $           | 3,638      |           | $          | (534             | )          | $                | 383        |             | $          | (241 | ) | $ | 3,246 |   |
|                                                 |       |        |       |           |       |             |       |             |       |             |       |
| Cash flows from  investing activities:               |       |        |       |           |       |             |       |             |       |             |       |
| Purchases of  property and equipment                 |       | (2,408      | )          | —         |       | —           |       | —           |       | (2,408           | )          |
| Proceeds from  sales of property and equipment       |       | 1,706       |       | —         |       | —           |       | —           |       | 1,706            |       |
| Purchases of  marketable securities                  |       | (183        | )          | —         |       | —           |       | —           |       | (183             | )          |
| Proceeds from  sales of marketable securities        |       | 42          |       |           |       |             |       |             |       | 42               |       |
| Return of  investment in subsidiary                  |       | 162         |       | —         |       | —           |       | (162             | )          | —           |       |
| Net cash used in  investing activities               |       | (681        | )          | —         |       | —           |       | (162             | )          | (843             | )          |
|                                                 |       |        |       |           |       |             |       |             |       |             |       |
| Cash flows from  financing activities:               |       |        |       |           |       |             |       |             |       |             |       |
| Proceeds from  revolving credit facility             |       | 15,250      |       | —         |       | —           |       | —           |       | 15,250           |       |
| Repayments of  obligations                           |       | (19,627     | )          | —         |       | (406             | )          | —           |       | (20,033          | )          |
| Payments related  to deferred financing costs        |       | (11         | )          | —         |       | —           |       | —           |       | (11              | )          |
| Stock options  exercised                             |       | 136         |       | —         |       | —           |       | —           |       | 136              |       |
| Reinsurance  payments made from deposits             |       | —      |       | —         |       | (241             | )          | 241              |       | —           |       |
| Dividends paid                                       |       | —      |       | —         |       | (162             | )          | 162              |       | —           |       |
| Net cash used in  financing activities               |       | (4,252      | )          | —         |       | (809             | )          | 403              |       | (4,658           | )          |
|                                                 |       |        |       |           |       |             |       |             |       |             |       |
| Net decrease in  cash and cash equivalents           |       | (1,295      | )          | (534           | )          | (426             | )          | —           |       | (2,255           | )          |
|                                                 |       |        |       |           |       |             |       |             |       |             |       |
| Cash and cash  equivalents, beginning of period      |       | 9,873       |       | 1,360          |       | 2,172            |       | —           |       | 13,405           |       |
|                                                 |       |        |       |           |       |             |       |             |       |             |       |
| Cash and cash  equivalents, end of period            |       | $           | 8,578      |           | $          | 826              |       | $                | 1,746      |             | $          | — |   | $ | 11,150 |   |
|                                                 |       |        |       |           |       |             |       |             |       |             |       |
| Supplemental  disclosures:                           |       |        |       |           |       |             |       |             |       |             |       |
| Interest paid                                        |       | $           | 198        |           | $          | —           |       | $                | 1,557      |             | $          | — |   | $ | 1,755 |   |
| Income taxes  (refunded) paid                        |       | (2,552      | )          | 2,495          |       | 52               |       | —           |       | (5               | )          |

 

21

----

 

**Supplemental Condensed Consolidating Balance Sheet**

**As of January 2, 2005**

(In thousands)

 
| ** **                                                 | ** ** | ** **  | ** ** | ** **     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                 | ** ** | **Parent**  | ** ** | **Guarantor**  | ** ** | **guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                 | ** ** | **Company** | ** ** | **Subsidiary** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Assets                                                     |       |        |       |           |       |             |       |             |       |             |       |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Current assets:                                            |       |        |       |           |       |             |       |             |       |             |       |
| Cash and cash  equivalents                                 |       | $           | 9,873      |           | $          | 1,360            |       | $                | 2,172      |             | $          | — |   | $ | 13,405 |   |
| Restricted cash                                            |       | —      |       | —         |       | 1,711            |       | —           |       | 1,711            |       |
| Accounts  receivable, net                                  |       | 8,548       |       | 1,900          |       | —           |       | —           |       | 10,448           |       |
| Inventories                                                |       | 17,545      |       | —         |       | —           |       | —           |       | 17,545           |       |
| Deferred income  taxes                                     |       | 6,705       |       | 18             |       | —           |       | 130              |       | 6,853            |       |
| Prepaid expenses  and other current assets                 |       | 10,991      |       | 2,512          |       | 7,782            |       | (16,903          | )          | 4,382            |       |
| Total current  assets                                      |       | 53,662      |       | 5,790          |       | 11,665           |       | (16,773          | )          | 54,344           |       |
| Deferred income  taxes                                     |       | 10,383      |       | 366            |       | —           |       | (130             | )          | 10,619           |       |
| Property and  equipment, net                               |       | 110,887     |       | —         |       | 45,525           |       | —           |       | 156,412          |       |
| Intangibles and deferred  costs, net                       |       | 18,234      |       | —         |       | 2,276            |       | —           |       | 20,510           |       |
| Investments in  subsidiaries                               |       | (3,117      | )          | —         |       | —           |       | 3,117            |       | —           |       |
| Other assets                                               |       | 6,083       |       | 1,216          |       | 915              |       | (1,215           | )          | 6,999            |       |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Total assets                                               |       | $           | 196,132    |           | $          | 7,372            |       | $                | 60,381     |             | $          | (15,001 | ) | $ | 248,884 |   |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Liabilities and  Stockholders’ (Deficit) Equity       |       |        |       |           |       |             |       |             |       |             |       |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Current  liabilities:                                      |       |        |       |           |       |             |       |             |       |             |       |
| Current  maturities of long-term obligations               |       | $           | 13,309     |           | $          | —           |       | $                | 1,224      |             | $          | (7,776 | ) | $ | 6,757 |   |
| Accounts payable                                           |       | 21,536      |       | —         |       | —           |       | —           |       | 21,536           |       |
| Accrued expenses                                           |       | 38,085      |       | 4,829          |       | 5,650            |       | (8,810           | )          | 39,754           |       |
| Total current  liabilities                                 |       | 72,930      |       | 4,829          |       | 6,874            |       | (16,586          | )          | 68,047           |       |
| Long-term  obligations, less current maturities            |       | 182,380     |       | —         |       | 50,752           |       | —           |       | 233,132          |       |
| Other long-term  liabilities                               |       | 45,848      |       | 891            |       | 7,524            |       | (1,532           | )          | 52,731           |       |
| Stockholders’  (deficit) equity                       |       | (105,026    | )          | 1,652          |       | (4,769           | )          | 3,117            |       | (105,026         | )          |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Total  liabilities and stockholders’ (deficit) equity |       | $           | 196,132    |           | $          | 7,372            |       | $                | 60,381     |             | $          | (15,001 | ) | $ | 248,884 |   |

 

22

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**SupplementalCondensed Consolidating Statement of Operations**

**For theThree Months Ended March 28, 2004**

**(Restated)**

(In thousands)

 
| ** **                                                                                                             | ** ** | ** **  | ** ** | ** **     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                                             | ** ** | **Parent**  | ** ** | **Guarantor**  | ** ** | **guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                                                                             | ** ** | **Company** | ** ** | **Subsidiary** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Revenues                                                                                                               |       | $           | 128,190    |           | $          | 2,564            |       | $                | —     |             | $          | — |   | $ | 130,754 |   |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Costs and  expenses:                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Cost of sales                                                                                                          |       | 45,588      |       | —         |       | —           |       | —           |       | 45,588           |       |
| Labor and  benefits                                                                                                    |       | 39,934      |       | —         |       | —           |       | —           |       | 39,934           |       |
| Operating  expenses                                                                                                    |       | 26,867      |       | —         |       | (1,736           | )          | —           |       | 25,131           |       |
| General and  administrative expenses                                                                                   |       | 9,542       |       | 1,155          |       | —           |       | —           |       | 10,697           |       |
| Restructuring  expenses                                                                                                |       | 2,627       |       | —         |       | —           |       | —           |       | 2,627            |       |
| Gain on litigation  settlement                                                                                         |       | (3,644      | )          | —         |       | —           |       | —           |       | (3,644           | )          |
| Depreciation and  amortization                                                                                         |       | 5,154       |       | —         |       | 563              |       | —           |       | 5,717            |       |
| Gain on  franchise sales of restaurant operations and properties                                                       |       | (906        | )          | —         |       | —           |       | —           |       | (906             | )          |
| Loss on  disposals of other property and equipment, net                                                                |       | 168         |       | —         |       | 3                |       | —           |       | 171              |       |
| Interest  expense, net                                                                                                 |       | 4,933       |       | —         |       | 1,131            |       | —           |       | 6,064            |       |
| Other expense,  principally debt retirement costs                                                                      |       | 6,892       |       | —         |       | —           |       | —           |       | 6,892            |       |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| (Loss) income  before benefit from (provision for) income taxes and equity in net income of consolidated  subsidiaries |       | (8,965      | )          | 1,409          |       | 39               |       | —           |       | (7,517           | )          |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Benefit from  (provision for) income taxes                                                                             |       | 2,902       |       | (578           | )          | (49              | )          | —           |       | 2,275            |       |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| (Loss) income  before equity in net income of consolidated subsidiaries                                                |       | (6,063      | )          | 831            |       | (10              | )          | —           |       | (5,242           | )          |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Equity in net  income of consolidated subsidiaries                                                                     |       | 821         |       | —         |       | —           |       | (821             | )          | —           |       |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Net (loss)  income                                                                                                     |       | $           | (5,242     | )              | $          | 831              |       | $                | (10        | )                | $          | (821 | ) | $ | (5,242 | ) |

 

23

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**SupplementalCondensed Consolidating Statement of Cash Flows**

**For theThree Months Ended March 28, 2004**

(In thousands)

 
| ** **                                            | ** ** | ** **  | ** ** | ** **     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
|-------------------------------------------------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                            | ** ** | **Parent**  | ** ** | **Guarantor**  | ** ** | **guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                            | ** ** | **Company** | ** ** | **Subsidiary** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                  |       |        |       |           |       |             |       |             |       |             |       |
| Net cash (used  in) provided by operating activities  |       | $           | (9,362     | )              | $          | (1,102           | )          | $                | 945        |             | $          | (381 | ) | $ | (9,900 | ) |
|                                                  |       |        |       |           |       |             |       |             |       |             |       |
| Cash flows from  investing activities:                |       |        |       |           |       |             |       |             |       |             |       |
| Purchases of  property and equipment                  |       | (2,255      | )          | —         |       | —           |       | —           |       | (2,255           | )          |
| Proceeds from  sales of property and equipment        |       | 2,897       |       | —         |       | —           |       | —           |       | 2,897            |       |
| Return of  investment in subsidiary                   |       | 183         |       | —         |       | —           |       | (183             | )          | —           |       |
| Net cash  provided by investing activities            |       | 825         |       | —         |       | —           |       | (183             | )          | 642              |       |
|                                                  |       |        |       |           |       |             |       |             |       |             |       |
| Cash flows from  financing activities:                |       |        |       |           |       |             |       |             |       |             |       |
| Proceeds from  issuance of New Senior Notes           |       | 175,000     |       | —         |       | —           |       | —           |       | 175,000          |       |
| Repayments of  obligations                            |       | (128,063    | )          | —         |       | (279             | )          | —           |       | (128,342         | )          |
| Payments related  to deferred financing costs         |       | (6,625      | )          | —         |       | —           |       | —           |       | (6,625           | )          |
| Stock options  exercised                              |       | 244         |       | —         |       | —           |       | —           |       | 244              |       |
| Reinsurance  payments made from deposits              |       | —      |       | —         |       | (381             | )          | 381              |       | —           |       |
| Dividends paid                                        |       | —      |       | —         |       | (183             | )          | 183              |       | —           |       |
| Net cash  provided by (used in) financing activities  |       | 40,556      |       | —         |       | (843             | )          | 564              |       | 40,277           |       |
|                                                  |       |        |       |           |       |             |       |             |       |             |       |
| Net increase  (decrease) in cash and cash equivalents |       | 32,019      |       | (1,102         | )          | 102              |       | —           |       | 31,019           |       |
|                                                  |       |        |       |           |       |             |       |             |       |             |       |
| Cash and cash  equivalents, beginning of period       |       | 21,640      |       | 2,173          |       | 1,818            |       | —           |       | 25,631           |       |
|                                                  |       |        |       |           |       |             |       |             |       |             |       |
| Cash and cash  equivalents, end of period             |       | $           | 53,659     |           | $          | 1,071            |       | $                | 1,920      |             | $          | — |   | $ | 56,650 |   |
|                                                  |       |        |       |           |       |             |       |             |       |             |       |
| Supplemental  disclosures:                            |       |        |       |           |       |             |       |             |       |             |       |
| Interest paid                                         |       | $           | 3,794      |           | $          | —           |       | $                | 1,133      |             | $          | — |   | $ | 4,927 |   |
| Income taxes  (refunded) paid                         |       | (1,502      | )          | 1,460          |       | 49               |       | —           |       | 7                |       |
| Capital lease  obligations incurred                   |       | 2,280       |       | —         |       | —           |       | —           |       | 2,280            |       |

 

24

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**Item 2.Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

 

*Thefollowing discussion should be read in conjunction with the CondensedConsolidated Financial Statements of the Company and the notes thereto includedelsewhere herein.*

 

**ForwardLooking Statements**

 

Statements contained herein that are not historicalfacts constitute “forward looking statements” as that term is defined in thePrivate Securities Litigation Reform Act of 1995. Words such as “believes,” “plans,” “anticipates,” “expects,” “will” andsimilar expressions are intended to identify forward looking statements.* *Allforward looking statements are subject to known and unknown risks,uncertainties and other factors which could cause actual results to differmaterially from those anticipated. Forward looking statements include, but arenot limited to, statements relating to the sufficiency of the Company’s capitalresources, changes in commodity prices, anticipated capital expenditures andthe Company’s plans with respect to restaurant openings, closings, reimagingsand re-franchisings.  These factorsinclude: the Company’s highly competitive business environment; exposure tocommodity prices; risks associated with the foodservice industry, such aschanges in consumer tastes and adverse publicity resulting from food quality,illness, injury or other health concerns; the ability to retain and attract newemployees; government regulations; the Company’s high geographic concentrationin the Northeast and its attendant weather patterns; conditions needed to meetrestaurant re-imaging and new opening targets; risks and uncertaintiesarising out of accounting adjustments; the Company’s ability to service itsdebt and other obligations; the Company’s ability to meet ongoing financialcovenants contained in the Company’s debt instruments, loan agreements, leasesand other long-term commitments; and costs associated with improved service andother initiatives. Other factors that may cause actual results to differ fromthe forward looking statements contained herein and that may affect the Company’sprospects in general are included in the Company’s other filings with theSecurities and Exchange Commission.**The Company is not obligated to update anyforward looking statements, whether as a result of new information, futureevents or otherwise.

 

**Overview**

 

The Company’s revenues are derivedprimarily from the operation of full-service restaurants, thedistribution and sale of premium ice cream desserts through retail andinstitutional locations and franchising. As of April 3, 2005, Friendly’soperated 337 full-service restaurants, franchised 194 full-service restaurantsand seven non-traditional units and manufactured a full line of premium icecream desserts distributed through more than 4,500 supermarkets and otherretail locations in 13 states.

 

25

----

 

Following is asummary of the Company-operated and franchised units:

 
| ** **             | ** ** | **For the Three Months Ended** | ** ** |
|------------------------|------------|--------------------------------|------------|
| ** **             | ** ** | **April 3,**                   | ** ** | **March 28,** | ** ** |
| ** **             | ** ** | **2005**                       | ** ** | **2004** | ** ** |
|                   |       |                           |       |   |   |
| Company Units:         |       |                           |       |   |   |
| Beginning of  period   |       | 347                            |       | 380 |   |
| Refranchised  closings |       | (7                             | )          | (17 | ) |
| Closings               |       | (3                             | )          | (1 | ) |
| End of period          |       | 337                            |       | 362 |   |
|                   |       |                           |       |   |   |
| Franchised  Units:     |       |                           |       |   |   |
| Beginning of  period   |       | 195                            |       | 163 |   |
| Refranchised  openings |       | 7                              |       | 17 |   |
| Openings               |       | —                         |       | 2 |   |
| Closings               |       | (1                             | )          | — |   |
| End of period          |       | 201                            |       | 182 |   |

 

 

***Three months ended April 3, 2005 compared with three monthsended March 28, 2004***

 

*Revenues:*

 

*Total Revenues -* Total revenues decreased $6.2 million,or 4.7%, to $124.6 million for the first quarter ended April 3, 2005 from$130.8 million for the same quarter in 2004.

 

*Restaurant Revenues -* Restaurant revenues decreased $8.3million, or 7.9%, to $96.1 million for the three months ended April 3, 2005from $104.4 million for the same period in 2004. Comparable Company-operated restaurant revenues decreased 3.3% fromthe 2004 quarter to the 2005 quarter as declines occurred in all dayparts withthe largest occurring during the breakfast and evening snack periods.Restaurant revenues were impacted by an unfavorable shift in the timing of theyear-end holiday period.  New Year’s Daywas included in the three months ended March 28, 2004 and is not included inthe 2005 quarter.  The estimated impacton Company-operated restaurants due to the timing of the holiday representedapproximately one-half of the 3.3% decline in first quarter comparablerestaurant sales.  Operating days lostdue to weather closings were greater in 2005 when compared to 2004 as mostmarkets in New England recorded higher than normal snowfall.  Additionally, the closing of 13 locations andthe re-franchising of 34 locations over the past 15 months resulted in declinesof $1.4 million and $4.4 million, respectively, in restaurant revenues in thefirst quarter of 2005 as compared to the same period in 2004. These declineswere partially offset by increased revenues of $1.3 million in the firstquarter of 2005 as compared to the same period in 2004 due to the opening offour new restaurants over the past 15 months. There were no new restaurantopenings during the first quarter of 2005; however, two mall restaurants wereremodeled during the quarter.

 

26

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*FoodserviceRevenues -* Foodservice (product sales to franchisees and retailcustomers) revenues increased $2.0 million, or 8.4% to $25.3 million for thequarter ended April 3, 2005 from $23.3 million for the quarter ended March 28,2004. This increase was primarily due to a $1.8 million increase in franchisedrestaurant product revenue resulting from the increased number of franchisedrestaurants in the first quarter of 2005 compared to the same period in2004.  Sales to foodservice retailsupermarket customers increased $0.2 million in the first quarter of 2005compared to the same period in 2004. During the quarter ended March 28, 2004,the Company reduced the size of its retail supermarket ice cream container to a56-ounce product from a 64-ounce product. Case volume in the Company’s retail supermarket business remainedrelatively unchanged for the quarter ended April 3, 2005 when compared to thequarter ended March 28, 2004.

 

*FranchiseRevenues -* Franchise royalty and fee revenues increased $0.2 million,or 6.3%, to $3.3 million for the three months ended April 3, 2005 compared to$3.1 million for the same period in 2004.

 

Royalties on franchised sales increased $0.3 million in the firstquarter of 2005 as compared to the same period in 2004. Comparable franchisedrevenues grew 1.9% from the quarter ended March 28, 2004 to the quarter endedApril 3, 2005. The opening of eight new franchise restaurants and 34re-franchised restaurants during the last 15 months increased royalty revenuesby $0.3 million while the closing of four under-performing locations during thesame period had little impact.

 

Initial franchise fees declined by $0.4 millionduring the three months ended April 3, 2005 when compared to the same period in2004 due to the refranchising of 17 Company-operated locations and the openingof two new locations during the quarter ended March 28, 2004 versus sevenre-franchise openings during the quarter ended April 3, 2005.

 

Additionally, an increase in rental income forleased and subleased franchise locations of $0.3 million contributed to thehigher revenues. There were 201 and 182 franchise units open at April 3, 2005and March 28, 2004, respectively.

 

*Cost of sales:*

 

Cost of sales increased$2.2 million, or 4.8%, to $47.8 million for the first quarter ended April 3,2005 from $45.6 million for the same period in 2004. Cost of sales as apercentage of total revenues was 38.3% and 34.9% for the quarters ended April3, 2005 and March 28, 2004, respectively. A shift in sales mix from Company-operated restaurant sales tofoodservice sales added to the increase in cost. Foodservice sales tofranchisees and retail supermarket customers (20.3% and 17.9% of total revenuesfor the three months ended April 3, 2005 and March 28, 2004, respectively) have ahigher food cost as a percentage of revenue than sales in Company-operatedrestaurants to restaurant patrons. Foodservice retail sales promotionalallowances, recorded as offsets to revenues, increased by 1.6% in the 2005quarter as a percentage of gross retail sales when compared to the 2004 quarteras a result of a more competitive climate in the northeast. This increase alsohad an unfavorable impact on the overall cost of sales as a percentage of totalrevenues. These increases were partially offset by the growth in franchise revenues, which reduced cost ofsales as a percentage of total revenues by 0.1% for the quarter ended April 3, 2005when compared to the 2004 quarter.

 

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Restaurant cost of sales as apercentage of restaurant revenues increased to 27.4% in the first quarter of2005 from 26.4% in the first quarter of 2004. The increase in the 2005 quarterwhen compared to the 2004 quarter was in part due to stronger dinner sales whencompared to breakfast in the current period. Breakfast products have a lowerfood cost than lunch and dinner products. The relatively high price of butterin December 2004 resulted in unfavorable cream costs in the first quarter of2005, as the market price of butter is generally reflected in the Company’scost of sales approximately 30 days later. Additionally, in the 2005 period, market losses of $0.2 million wererealized due to unfavorable positions on options for butter futures contractswhile market gains of $0.8 million were realized in the 2004 period.

 

For the remainder of 2005, theCompany expects that cream prices will be lower than the prices experienced in2004.  Additionally, the results derivedfrom options for butter futures contracts are more likely to be unfavorable in2005 when compared to the gains experienced in 2004.

 

The table below shows the average monthly price of a pound of AAbutter. The prices represented were obtained from market quotes provided by theUSDA’s Agricultural Marketing Service.

 

| **Month:**       | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
|------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| January          |       | 1.5775   |       | $        | 1.4320     |     | $          | 1.0815   |       | $        | 1.3454     |     | $          | 1.2531 |   | $ | 0.9090 |   |
| February         |       | 1.6145   |       | 1.7132   |       | 1.0405   |       | 1.2427   |       | 1.3852   |       | 0.9245   |       |
| March            |       | 1.5527   |       | 2.1350   |       | 1.0915   |       | 1.2473   |       | 1.5708   |       | 1.0200   |       |
| April            |       |     |       | 2.2204   |       | 1.0906   |       | 1.1712   |       | 1.8217   |       | 1.0691   |       |
| May              |       |     |       | 2.0363   |       | 1.0919   |       | 1.0590   |       | 1.8713   |       | 1.2450   |       |
| June             |       |     |       | 1.9300   |       | 1.1142   |       | 1.0427   |       | 1.9783   |       | 1.2440   |       |
| July             |       |     |       | 1.7458   |       | 1.1985   |       | 1.0302   |       | 1.8971   |       | 1.1790   |       |
| August           |       |     |       | 1.5408   |       | 1.1708   |       | 0.9752   |       | 2.0880   |       | 1.1933   |       |
| September        |       |     |       | 1.7656   |       | 1.1731   |       | 0.9635   |       | 2.0563   |       | 1.1727   |       |
| October          |       |     |       | 1.6475   |       | 1.1846   |       | 1.0315   |       | 1.4070   |       | 1.1462   |       |
| November         |       |     |       | 1.9238   |       | 1.2057   |       | 1.0425   |       | 1.3481   |       | 1.6490   |       |
| December         |       |     |       | 1.7083   |       | 1.2969   |       | 1.1198   |       | 1.2793   |       | 1.3700   |       |
| Mathematical Avg |       |     |       | $        | 1.8166     |     | $          | 1.1450   |       | $        | 1.1059     |     | $          | 1.6630 |   | $ | 1.1768 |   |

 

The cost of cream, the principalingredient used in making ice cream, affects cost of sales as a percentage oftotal revenues, especially in foodservice’s retail business. A $0.10 increasein the cost of a pound of AA butter adversely affects the Company’s annual costof sales by approximately $1.0 million. This adverse impact may be offset by price increases or other factors.However, no assurance can be given that the Company will be able to offset anycost increases in the future and future increases in cream prices could have amaterial adverse effect on the Company’s results of operations. To minimizerisk, alternative supply sources continue to be pursued.

 

The Company purchases butter option contracts tominimize the impact of increases in the cost of cream. When available, optionson butter futures are purchased to cover up to 50% of the cream needs of themanufacturing plant.  Option contractsare offered in the months of March, May, July, September, October and December;however, there is often not enough open interest in them to allow the Companyto buy even very limited coverage without paying an exorbitant premium.

 

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*Labor and benefits:*

 

Labor and benefits decreased $3.4 million, or 8.5%, to $36.5 millionfor the three months ended April 3, 2005 from $39.9 million for the threemonths ended March 28, 2004. Labor and benefits as a percentage of totalrevenues decreased to 29.3% in the 2005 quarter from 30.5% in the 2004 quarter.As a percentage of restaurant revenues, labor and benefits decreased to 38.0%in the 2005 quarter from 38.3% in the 2004 quarter. The decrease in labor andbenefits was primarily due to the restructuring of the restaurant managementteam, with fewer guest service supervisors and more servers, resulting in loweraverage hourly rates.  Revenue increasesderived from franchised locations, which do not have any associated restaurantlabor and benefits, also contributed to the lower restaurant labor and benefitsas a percentage of total revenues. Partially offsetting these benefits were increases in unemploymenttaxes, workers compensation insurance costs and group insurance costs in the2005 period when compared to the 2004 period.

 

*Operating expenses:*

 

Operating expenses decreased $0.6 million, or 2.4%, to $24.5 millionfor the three months ended April 3, 2005 from $25.1 million for the threemonths ended March 28, 2004. Operating expenses as a percentage of totalrevenues were 19.7% and 19.2% in the 2005 and 2004 periods, respectively. Theincreaseas a percent of sales resulted from higher costs for snow removal, maintenance,restaurant supplies, heating and electricity in the 2005 period when comparedto the 2004 period. Advertising costs as a percentage of total revenues were lower in the 2005period when compared to the same period in 2004.

 

*General and administrative expenses:*

 

General and administrative expenses were $9.4 million and $10.7 millionfor the quarters ended April 3, 2005 and March 28, 2004, respectively. Generaland administrative expenses as a percentage of total revenues decreased to 7.6%in the 2005 period from 8.2% in the 2004 period. The decrease is primarily theresult of the staff reduction in March 2004 and lower costs for recruitment,restaurant mystery shopping service, bonuses and legal fees. The 2004 periodalso included a charge for future rents associated with a vacated trainingfacility.

 

*Restructuringexpenses:*

 

Restructuring expenses of $2.6 million related toseverance and other benefits associated with reduction in force actions takenduring the first quarter of 2004 that reduced headcount by approximately 20permanent positions.

 

*Gain onlitigation settlement:*

 

In January 2004, a settlement was reached in a lawsuitfiled by the Company against a former administrator of one of the Company’s benefitplans.  The settlement was based on theadministrator’s alleged failure to adhere to the terms of a contract andresulted in a one-time payment to the Company of approximately $3.8 million,which was received on April 2, 2004. As a result of this lawsuit, the Companyincurred professional fees of approximately $0.5 million which were included inthe consolidated statement of operations for the year ended December 28, 2003and an additional $0.2 million in professional fees, which were offset against thepayment in the accompanying condensed consolidated statement of operations forthe three months ended March 28, 2004.

 

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*Depreciation and amortization:*

 

Depreciation and amortization was $6.3 million and$5.7 million for the quarters ended April 3, 2005 and March 28, 2004,respectively. Depreciation and amortization as a percentage of total revenueswas 5.1% and 4.4% in the 2005 and 2004 quarters, respectively. The increase indepreciation expense is primarily the result of the opening of four newrestaurants over the last 15 months and the reduction of the lives of leaseholdimprovement assets as a result of management decisions to close certain leasedproperties sooner than previously anticipated.

 

*Gain on franchise sales of restaurant operationsand properties:*

 

Gain on franchise sales of restaurant operations andproperties was $1.3 million and $0.9 million in the quarters ended April 3,2005 and March 28, 2004, respectively. During the first quarter ended April 3,2005, the Company recognized a gain of $1.3 million associated with the sale ofcertainequipment assets, lease and sublease rights and franchise rights in oneexisting Friendly’s restaurant. During the first quarter ended March 28, 2004, theCompany recognized a gain of $0.7 million associated with the sale of certain equipmentassets, lease and sublease rights and franchise rights in 10 existing Friendly’srestaurants.  Additionally in the firstquarter of 2004, theCompany sold the real property and equipment for one franchised location andassigned the lease and sold the equipment for a second franchised location tothe existing franchisee, resulting in a gain of $0.2 million.

 

*Loss ondisposals of other property and equipment, net:*

 

The loss on disposals of otherproperty and equipment, net, was $0.1 million and $0.2 million for the quartersended April 3, 2005 and March 28, 2004, respectively.  The table below identifies the components of the losson disposals of other property and equipment, net as shown on the accompanyingcondensed consolidated statements of operations (in thousands):

 
| ** **                                              | ** ** | **For the Three Months Ended** | ** ** |
|---------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                              | ** ** | **April 3,**                   | ** ** | **March 28,** | ** ** |
| ** **                                              | ** ** | **2005**                       | ** ** | **2004** | ** ** |
| ** **                                              | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Restaurant  equipment assets retired due to replacement |       | $                              | (52        | ) | $ | (72 | ) |
| Loss due to  restaurant fire                            |       | —                         |       | (14 | ) |
| All other                                               |       | (18                            | )          | (85 | ) |
| Loss on  disposals of other property and equipment, net |       | $                              | (70        | ) | $ | (171 | ) |

 

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*Interest expense, net:*

 

Interest expense, net of capitalized interest and interest income was$5.3 million and $6.1 million for the quarters ended April 3, 2005 and March28, 2004, respectively. The decrease in interest expense in the first quarterof 2005 compared to the same period in 2004 is primarily due to reduced amountsof debt and lower interest rates on such debt. Total outstanding debt,including capital lease and finance obligations, decreased from $284.7 millionat March 28, 2004 to $235.1 million at April 3, 2005. The decrease in the totaloutstanding debt was due to the refinancing of $176.0 million of the Company’s101⁄2% senior notes (the “Senior Notes”). In March 2004, $127.8 million ofaggregate principal amount of the Senior Notes were purchased in a cash tenderoffer with the proceeds from the issuance of $175.0 million of New Senior Noteswith a lower interest rate. In April 2004, the remaining $48.2 million ofSenior Notes were redeemed in accordance with the Senior Notes indenture at103.5% of the principal amount. Interest associated with capital lease obligationsincreased $0.1 million with the rollout of a new point of sale register system in300 restaurants during 2004.

 

*Other (income) expense, principally debt retirementcosts:*

 

Other (income) expense, principally debtretirement costsrepresents the $5.1 million premium and the write off of unamortized deferredfinancing costs of approximately $1.8 million in connection with the cash tender offer for the$176.0 million of Senior Notes in 2004. In March 2004, $127.8 million ofaggregate principal amount of Senior Notes were purchased pursuant to thetender offer and in April 2004, the remaining $48.2 million of Senior Noteswere redeemed in accordance with the Senior Notes indenture at 103.5% of theprincipal amount.

 

*Benefit from income taxes:*

 

The benefit from income taxes was $1.0 million, or25.0%, for the three months ended April 3, 2005. At this time, the Companyestimates that the effective tax rate for 2005 will be 25.0%. The Companyrecords income taxes based on the effective rate for the year with any changesin valuation allowance reflected in the period of change. The benefit fromincome taxes was $2.3 million, or 30.3%, for the three months ended March 28,2004.

 

The tax rate for the 2004 fiscal year was 68.8%, asthe final benefit from income taxes for 2004 included a $2.2 million reversalof income tax accruals recorded in prior years. These accruals related to taxmatters that, based upon additional information obtained during the fourthquarter of 2004, were no longer necessary. The reversal was recorded in the fourth quarter of 2004.

 

*Net loss:*

 

Net loss was $3.0 million and $5.2 million for thefirst quarters ended April 3, 2005 and March 28, 2004, respectively, for thereasons discussed above.

 

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**Liquidity and Capital Resources**

 

*General:*

 

The Company’s primary sources of liquidity and capitalresources are cash generated from operations and, if needed, borrowings underits revolving credit facility. Additional sources of liquidityconsist of capital and operating leases for financing leased restaurantlocations (in malls and shopping centers and land or building leases),restaurant equipment, manufacturing equipment, distribution vehicles andcomputer equipment. Additionally, sales of under-performing existing restaurantproperties and other assets (to the extent FICC’s and its subsidiaries’ debtinstruments permit) are sources of cash. The amount of debt financing that FICCwill be able to incur is limited by the terms of its New Credit Facility andNew Senior Notes indenture. Below was the financing status of the Company’s operating restaurantsat April 3, 2005:

 

| Owned and  mortgaged                |   | 64  |   |
|-------------------------------------|--------|-----|--------|
| Sold and leased  back               |   | 61  |   |
| Owned land and  building            |   | 26  |   |
| Leased land,  owned building        |   | 76  |   |
| Leased land and  building           |   | 110 |   |
| Total  Company-operated restaurants |   | 337 |   |

 

The restaurants above not identified as owned andmortgaged or sold and leased back secure the Company’s obligations under theNew Credit Facility. In addition to the 64 properties identified as owned andmortgaged, the Company owns an additional 11 properties in this category, 10 ofwhich are now operated by franchisees and one that was closed in March 2005. Ofthe 26 restaurant properties identified as owned land and building, six wereavailable to be sold, if necessary, and of the 76 restaurant propertiesidentified as leased land, owned building, two were available to be mortgaged,if necessary.

 

*OperatingCash Flows:*

 

Net cash provided by operating activities was $3.2million for the three months ended April 3, 2005 compared to net cash used inoperating activities of $9.9 million for the three months ended March 28, 2004.The increase of $13.1 in cash provided by operating activities was largely dueto changes in operating assets and liabilities. During the first three monthsof 2005, inventory levels were reduced by $1.7 million while inventoriesincreased by $1.1 million during the first three months of 2004 as the Companyanticipated rising cream prices in the second quarter of 2004. Accountsreceivable at March 28, 2004 included a settlement for $3.8 million reached inJanuary 2004 in a lawsuit filed by the Company against a former administratorof one of the Company’s benefit plans. The settlement was based on the administrator’s alleged failure toadhere to the terms of a contract and resulted in a one-time payment on April2, 2004. The timing of rent payments, fees for retail supermarket shelf spaceand interest payments in the first quarter of 2005 versus the first quarter of2004 provided an improvement of $1.4 million, $1.1 million and $2.2 million,respectively.

 

The Company had a working capital deficit of $14.3million and $13.7 million as of April 3, 2005 and January 2, 2005,respectively. The working capital needs of companies engaged in the restaurantindustry are generally low and as a result, restaurants are frequently able tooperate with a working capital deficit because: (i) restaurant operations areconducted primarily on a cash (and cash equivalent) basis with a low level ofaccounts receivable; (ii) rapid turnover allows a limited investment ininventories; and (iii) cash from sales is usually received before relatedexpenses for food, supplies and payroll are paid.

 

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*Investing CashFlows:*

 

Net cash used in investing activities was $0.8million for the first quarter ended April 3, 2005 as compared to net cashprovided by investing activities of $0.6 million for the first quarter endedMarch 28, 2004.

 

During the three months ended April 3, 2005 andMarch 28, 2004, the Company spent $2.4 million and $2.3 million, respectively,on capital expenditures, of which $1.6 million and $1.0 million was for themaintenance of existing restaurants. Capital expenditures were offset byproceeds from the sales of property and equipment of $1.7 million and $2.9million for the quarters ended April 3, 2005 and March 28, 2004, respectively.The proceeds were primarily the result of re-franchising transactions.

 

During the first quarter of 2005, the Companycompleted one re-franchising transaction in which an existing franchiseepurchased one existing Company restaurant and agreed to develop a total ofthree new restaurants in future years. Gross proceeds from this transaction were $1.8 million, of which $30,000was for franchise fees and $1.7 million was for the sale of certain assets andleasehold rights.  In addition, theCompany completed three transactions in which three former employees receivedfranchises to operate six existing restaurants with options to purchase therestaurants within two years.  If theoptions are exercised, one franchisee will also agree to develop two newrestaurants in future years.  Proceedsfrom option transactions will be recognized upon purchase.

 

During the first quarter of 2004, the Company completed onere-franchising transaction in which a franchisee purchased a total of 10existing restaurants and agreed to develop a total of 10 new restaurants infuture years.  Gross proceeds fromthe sale were $3.2 million of which $0.3 million was for franchise fees for theinitial 10 restaurants. Inaddition, the Company sold the real property and equipment for one franchisedlocation and assigned the lease and sold the equipment for a second franchisedlocation to the existing franchisee. Gross proceeds from the sale were$0.5 million, of which $0.1 million was for franchise fees and $0.4 million wasfor the sale of assets and lease assignment.

 

*Financing CashFlows:*

 

Net cash used in financing activities was $4.7million for the first quarter ended April 3, 2005 as compared to net cashprovided by financing activities of $40.3 million for the first quarter endedMarch 28, 2004.

 

In February 2004, the Company announced a cashtender offer and consent solicitation for $176 million of its 10.50% seniornotes (the “Senior Notes”) to be financed with the proceeds from a $175 millionprivate offering of new 8.375% senior notes (the “New Senior Notes”), availablecash and an amended revolving credit facility. In March 2004, $127.4 million ofaggregate principal amount of Senior Notes were purchased at the tender offerand consent solicitation price of 104% of the principal amount and $0.4 millionof aggregate principal amount of Senior Notes were purchased at the tender offerprice of 102% of the principal amount. In April 2004, the remaining $48.2million of Senior Notes were redeemed in accordance with the Senior Notesindenture at 103.5% of the principal amount. In connection with the tender offer, the Company wrote off unamortizeddeferred financing costs and incurred other direct expenses of $6.9 millionthat were included in the accompanying condensed consolidated statement ofoperations for the first quarter ended March 28, 2004.  In April 2004, the Company wrote offunamortized deferred financing costs and incurred other direct expenses of $2.3million that were included in the results for the second fiscal quarter endedJune 27, 2004.

 

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The Company has a $35.0 million revolving creditfacility (the “New Credit Facility”). The $35.0 million revolving credit commitment less outstanding lettersof credit is available for borrowing to provide working capital and for othercorporate needs. As of April 3, 2005 and January 2, 2005, total letters ofcredit outstanding were $15.6 million and $15.2 million, respectively. During2005 and 2004, there were no drawings against the letters of credit.  The revolving credit loans bear interest atthe Company’s option at either (a) the Base Rate plus the applicable margin asin effect from time to time (the “Base Rate”) (8.25% at April 3, 2005) or (b)the Eurodollar rate plus the applicable margin as in effect from time to time(the “Eurodollar Rate”) (7.32% at April 3, 2005). As of April 3, 2005 there were no revolving creditloans outstanding. As of January 2, 2005 $4.0 million of revolving creditloans were outstanding. As of April 3, 2005 and January 2, 2005, $19.4 millionand $15.8 million, respectively, was available for borrowing.

 

The New Credit Facility has an annual “clean-up”provision, which obligates the Company to repay in full any and all outstandingrevolving credit loans on or before September 30, 2005 and maintain a zerobalance on such revolving credit for at least 30 consecutive days, to includeSeptember 30, 2005 immediately following the date of such repayment.  Commencing in 2006, the annual “clean-up”provision will change and will require the Company to repay in full any and alloutstanding revolving credit loans on or before June 15 (or if June 15 is not abusiness day, as defined, then the next business day) of each year and maintaina zero balance on such revolving credit for at least 15 consecutive days, toinclude June 15, immediately following the date of such repayment.

 

The New Credit Facility includescertain restrictive covenants including limitations on indebtedness, restrictedpayments such as dividends and stock repurchases and sales of assets and ofsubsidiary stock. Additionally, the New Credit Facility limits the amount whichthe Company may spend on capital expenditures, restricts the use of proceeds,as defined, from asset sales and requires the Company to comply with certainfinancial covenants. On July 23, 2004 and October 19, 2004, the Company obtainedlimited waivers regarding certain financial covenants of its New CreditFacility, which the Company was not in full compliance with as of June 27, 2004and September 26, 2004.  On December 17,2004, the Company amended the New Credit Facility to, among other things, (i)revise certain financial covenants and eliminate the minimum quarterly EBITDArequirement, (ii) amend the Company’s annual capital expenditures limit and(iii) increase the commitment fee from 0.50% to 0.75% of the unused commitmentamount.  The Company was in compliancewith the covenants under the New Credit Facility as of April 3, 2005. See Note7 of the Notes to Consolidated Financial Statements in the Company’s 2004Annual Report on Form 10-K/A for the fiscal year ended January 2, 2005 foradditional information regarding the Company’s long-term debt.

 

The Company anticipates requiring capital in thefuture principally to maintain existing restaurant and plant facilities and tocontinue to renovate and re-image existing restaurants. Capital expendituresfor 2005 are anticipated to be between $20.0 million and $25.0 million in theaggregate, of which between $17.0 million and $21.0 million is expected to bespent on restaurants. The Company’s actual 2005 capital expenditures may varyfrom these estimated amounts. The Company believes that the combination of thefunds generated from operating activities and borrowing availability under itsrevolving credit facility will be sufficient to meet the Company’s anticipatedoperating requirements, debt service requirements, lease obligations, capitalrequirements and obligations associated with the restructurings.

 

There have been no material changes to the Company’scontractual obligations and commitments from those disclosed in the Company’s2004 Annual Report on Form 10-K/A.

 

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**Seasonality**

 

Due to the seasonality of ice cream consumption, and the effect fromtime to time of weather on patronage of the restaurants, the Company’s revenuesand operating income are typically higher in its second and third quarters.

 

**GeographicConcentration**

 

Approximately 98% of the Company-operatedrestaurants are located, and substantially all of its retail sales aregenerated, in the Northeast. As a result, a severe or prolonged economicrecession or changes in demographic mix, employment levels, population density,weather, real estate market conditions or other factors specific to thisgeographic region may adversely affect the Company more than certain of itscompetitors which are more geographically diverse.

 

**CriticalAccounting Estimates**

 

The discussion and analysis of the Company’sconsolidated financial condition and results of operations are based upon theCompany’s interim condensed consolidated financial statements, which have beenprepared in accordance with accounting principles generally accepted in theU.S. The preparation of these condensed consolidated financial statementsrequires the Company to make estimates and judgments that affect the reportedamounts of assets, liabilities, revenues and expenses, and related disclosureof contingent assets and liabilities. On an on-going basis, the Companyevaluates its estimates, including those related to revenue recognition,insurance reserves, recoverability of accounts receivable, income tax valuationallowances and pension and other post-retirement benefits expense.  The Company bases its estimates on historicalexperience and on various other assumptions that are believed to be reasonableunder the circumstances, the results of which form the basis for makingjudgments about the carrying values of assets and liabilities that are notreadily apparent from other sources.

 

The critical accounting estimates that the Companybelieves affect the more significant judgments and estimates used in thepreparation of the Company’s condensed consolidated financial statementspresented in this report are described in the Company’s Management’s Discussionand Analysis of Financial Condition and Results of Operations and in the Notesto the consolidated financial statements included in the Company’s AnnualReport on Form 10-K/A for the fiscal year ended January 2, 2005. There havebeen no material changes to the critical accounting estimates.

 

Actual results may differfrom these estimates under different assumptions or conditions. Any differencesmay have a material impact on the Company’s financial condition and results ofoperations. For a discussion of how these and other factors may affect theCompany’s business, see the “Forward Looking Statement” above and other factorsincluded in the Company’s other filings with the Securities and ExchangeCommission.

 

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**Recently Issued AccountingPronouncements**

 

On December 16, 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-BasedPayment” (“SFAS No. 123R”), which is a revision of SFAS No. 123, “Accountingfor Stock-Based Compensation.” SFAS No. 123R supersedes APB Opinion No. 25,Accounting for Stock Issued to Employees,” and amends SFAS No. 95, “Statementof Cash Flows.” Generally, the approach in SFAS No. 123R is similar to theapproach described in SFAS No. 123. However, SFAS No. 123R requires allshare-based payments to employees, including grants of employee stock options,to be recognized in the income statement based on their fair values. Pro formadisclosure is no longer an alternative. SFAS No. 123R must be adopted no laterthan the first annual period beginning after June 15, 2005. Early adoption willbe permitted in periods in which financial statements have not yet been issued.SFAS 123R allows companies to choose between the modified-prospective andmodified-retrospective transition alternatives in adopting SFAS 123R. Under themodified-prospective transition method, compensation cost will be recognized infinancial statements issued subsequent to the date of adoption for allshared-based payments granted, modified or settled after the date of adoption,as well as for any unvested awards that were granted prior to the date ofadoption. Under the modified-retrospective transition method, compensation costwill be recognized in a manner consistent with the modified-prospectivetransition method, however, prior period financial statements will also berestated by recognizing compensation cost as previously reported in the proforma disclosures under SFAS 123. The restatement provisions can be applied toeither a) all periods presented or b) to the beginning of the fiscal year inwhich SFAS 123R is adopted. The Company expects to adopt SFAS No. 123R onJanuary 2, 2006 using the modified-prospective method. As the Companypreviously adopted only the pro forma disclosure provisions of SFAS 123, theCompany will recognize compensation cost relating to the unvested portion ofawards granted prior to the date of adoption using the same estimate of thegrant-date fair value and the same attribution method used to determine the proforma disclosures under SFAS 123.

 

As permitted by SFAS No. 123, the Company currently accounts forshare-based payments to employees using APB Opinion No. 25’s intrinsic valuemethod and, as such, generally recognizes no compensation cost for employeestock options.  Accordingly, the adoptionof SFAS No. 123R’s fair value method will have an impact on the Company’sresults of operations, although it will have no impact on the overall financialposition. The impact of the adoption of SFAS No. 123R cannot be determined atthis time because it will depend upon levels of share-based payments granted inthe future. However, had the Company adopted SFAS No. 123R in prior periods,the impact of that standard would have approximated the impact as described inthe disclosure of pro forma net loss and loss per share pursuant to SFAS No.123.  SFAS No. 123R also requires thebenefits of tax deductions in excess of recognized compensation cost to bereported as a financing cash flow, rather than as an operating cash flow asrequired under current literature.  Thisrequirement will reduce net operating cash flows and increase net financingcash flows in periods after adoption. While the Company cannot estimate what those amounts will be in thefuture (because they depend on, among other things, when employees exercisestock options), the amount of operating cash flows recognized in prior yearsfor such excess tax deductions were $0.8 million and $0.2 million in 2004 and2003, respectively.

 

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In November 2004, theFASB issued SFAS No. 151, “Inventory Costs, an amendment of Accounting ResearchBulletin No. 43, Chapter 4”. The amendments made by SFAS No. 151 clarify thatabnormal amounts of idle facility expense, freight, handling costs, and wastedmaterials (spoilage) should be recognized as current-period charges and requirethe allocation of fixed production overheads to inventory based on the normalcapacity of the production facilities. SFAS No. 151 is the result of a broadereffort by the FASB to improve the comparability of cross-border financialreporting by working with the International Accounting Standards Board towarddevelopment of a single set of high-quality accounting standards. The guidanceis effective for inventory costs incurred during fiscal years beginning afterJune 15, 2005. The adoption of SFAS No. 151 is not expected to have a materialeffect on the Company’s consolidated financial position or results ofoperations.

 

**Item 3.Quantitative and Qualitative Disclosures About Market Risk**

 

There has been nomaterial change in the Company’s market risk exposure since the filing of the2004 Annual Report on Form 10-K/A.

 

**Item 4.Controls and Procedures**

 

As of April 3, 2005, an evaluation was performedunder the supervision and with the participation of the Company’s management,including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”),of the effectiveness of the design and operation of the Company’s disclosurecontrols and procedures (as defined in Rule 13a-15(e) under the ExchangeAct).  Based on that evaluation, theCompany’s CEO and CFO concluded that the Company’s disclosure controls andprocedures were effective as of April 3, 2005.

 

During the first quarter of 2005,the Company implemented additional review procedures over the selection andmonitoring of appropriate assumptions and factors affecting lease accountingand leasehold depreciation accounting practices.  There were no other changes in the Company’sinternal control over financial reporting that occurred during the Company’slast fiscal quarter that have materially affected, or are reasonably likely tomaterially affect, the Company’s internal control over financial reporting.

 

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**PART II —OTHER INFORMATION**

 

**Item 6.  Exhibits**

 

(a) Exhibits

 

The exhibit indexis incorporated by reference herein.

 

 

**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 

                                                                                      
|   | Friendly  Ice Cream Corporation |
|--------|---------------------------------|
|   |                            |
|   | By:                             | /s/ PAUL V. HOAGLAND |
|   |                            | Name: Paul V. Hoagland |
|   |                            | Title: Executive Vice  President of Administration |
|   |                            | and Chief Financial  Officer |
|   |                            | (Principal Financial  Officer) |
|   |                            |   |
|   | Date:                           | May 2, 2005 |

 

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**EXHIBIT INDEX**

 
| 31.1 |   | Certification pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002 signed by John L. Cutter.                                                                      |
|------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.2 |   | Certification pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002 signed by Paul V. Hoagland.                                                                    |
| 32.1 |   | Certification pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 signed by John L. Cutter and Paul V. Hoagland. |

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* - Management Contractor Compensatory Plan or Arrangement

 

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