**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

| **ý** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15 (d) OF THE SECURITIES AND EXCHANGE ACT OF 1934** |
|------------|---------------------------------------------------------------------------------------------------|

 

**For thequarterly period ended September 29, 2002**

** **

**OR**

 

| ** ̈** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15 (d) OF THE SECURITIES AND EXCHANGE ACT OF 1934** |
|------------|----------------------------------------------------------------------------------------------------|

 

**For thetransition period from           to               **

 

** **

**CommissionFile No. 0-3930**

 

**FRIENDLY ICE CREAM CORPORATION**

(Exact name of registrantas specified in its charter)

 

| **Massachusetts**         |   | **5812**                                                  |   | **04-2053130**                        |
|---------------------------|--------|-----------------------------------------------------------|--------|---------------------------------------|
| (State of  Incorporation) |   | (Primary Standard  Industrial Classification Code Number) |   | (I.R.S. Employer  Identification No.) |

 

**1855 Boston Road**

**Wilbraham, Massachusetts 01095**

**(413) 543-2400**

(Address, including zipcode, and telephone number, including

area code, ofregistrant’s principal executive offices)

 

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

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date.

 
| **Class**                    |   | **Outstanding  at October 18, 2002** |
|------------------------------|--------|--------------------------------------|
|                         |   |                                 |
| Common Stock, $.01 par value |   | 7,388,141 shares                     |

 

 

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**PART I — FINANCIAL INFORMATION**

 

**Item1.  Financial Statements**

 

**FRIENDLY ICE CREAM CORPORATION AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED BALANCE SHEETS**

 

(In thousands)

 
|                                                                      |   | **September  29,  2002** |    | **December  30,  2001** |   |
|---------------------------------------------------------------------------|--------|--------------------------|---------|-------------------------|--------|
|                                                                      |   | **(unaudited)**          |    |                    |   |
| ASSETS                                                                    |   |                     |    |                    |   |
| CURRENT ASSETS:                                                           |   |                     |    |                    |   |
| Cash and cash  equivalents                                                |   | $                        | 40,545  |                    | $      | 16,342 |   |
| Accounts  receivable                                                      |   | 10,091                   |    | 9,969                   |   |
| Inventories                                                               |   | 15,246                   |    | 12,987                  |   |
| Deferred income  taxes                                                    |   | 7,659                    |    | 7,659                   |   |
| Prepaid expenses  and other current assets                                |   | 4,225                    |    | 3,736                   |   |
| TOTAL CURRENT  ASSETS                                                     |   | 77,766                   |    | 50,693                  |   |
| PROPERTY AND  EQUIPMENT, net of accumulated depreciation and amortization |   | 156,567                  |    | 169,489                 |   |
| INTANGIBLE  ASSETS AND DEFERRED COSTS, net of accumulated amortization    |   | 19,999                   |    | 21,208                  |   |
| OTHER ASSETS                                                              |   | 13,970                   |    | 11,172                  |   |
| TOTAL ASSETS                                                              |   | $                        | 268,302 |                    | $      | 252,562 |   |
|                                                                      |   |                     |    |                    |   |
| LIABILITIES AND STOCKHOLDERS’ DEFICIT                                |   |                     |    |                    |   |
|                                                                      |   |                     |    |                    |   |
| CURRENT  LIABILITIES:                                                     |   |                     |    |                    |   |
| Current  maturities of long-term debt                                     |   | $                        | 987     |                    | $      | 1,068 |   |
| Current  maturities of capital lease and finance obligations              |   | 1,603                    |    | 1,851                   |   |
| Accounts payable                                                          |   | 25,437                   |    | 20,505                  |   |
| Accrued salaries  and benefits                                            |   | 10,167                   |    | 9,436                   |   |
| Accrued interest  payable                                                 |   | 6,656                    |    | 1,543                   |   |
| Insurance  reserves                                                       |   | 13,386                   |    | 13,333                  |   |
| Restructuring  reserves                                                   |   | 1,445                    |    | 3,056                   |   |
| Other accrued  expenses                                                   |   | 17,089                   |    | 19,260                  |   |
| TOTAL CURRENT  LIABILITIES                                                |   | 76,770                   |    | 70,052                  |   |
| DEFERRED INCOME  TAXES                                                    |   | 14,465                   |    | 10,584                  |   |
| CAPITAL LEASE  AND FINANCE OBLIGATIONS, less current maturities           |   | 5,119                    |    | 6,267                   |   |
| LONG-TERM DEBT,  less current maturities                                  |   | 232,125                  |    | 232,797                 |   |
| OTHER LONG-TERM  LIABILITIES                                              |   | 28,507                   |    | 28,876                  |   |
| COMMITMENTS AND  CONTINGENCIES                                            |   |                     |    |                    |   |
| STOCKHOLDERS’  DEFICIT:                                              |   |                     |    |                    |   |
| Common stock                                                              |   | 74                       |    | 74                      |   |
| Additional paid-in  capital                                               |   | 139,725                  |    | 139,290                 |   |
| Accumulated  deficit                                                      |   | (228,483                 | )       | (235,378                | )      |
| TOTAL  STOCKHOLDERS’ DEFICIT                                         |   | (88,684                  | )       | (96,014                 | )      |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ DEFICIT                         |   | $                        | 268,302 |                    | $      | 252,562 |   |

 

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

 

1

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**FRIENDLY ICE CREAM CORPORATION AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

(Unaudited)

(In thousands, except pershare data)

 
|                                                                    |   | **For the  Three Months Ended** |    | **For the  Nine Months Ended** |   |
|-------------------------------------------------------------------------|--------|---------------------------------|---------|--------------------------------|--------|
|                                                                    |   | **September  29,  2002**        |    | **September  30,  2001**       |   | **September  29,  2002** |   | **September  30,  2001** |   |
|                                                                    |   |                            |    |                           |   |   |   |   |   |
| REVENUES                                                                |   | $                               | 161,129 |                           | $      | 151,373 |   | $ | 448,609 |   | $ | 428,915 |   |
|                                                                    |   |                            |    |                           |   |   |   |   |   |
| COSTS AND  EXPENSES:                                                    |   |                            |    |                           |   |   |   |   |   |
| Cost of sales                                                           |   | 57,023                          |    | 54,840                         |   | 155,907 |   | 149,757 |   |
| Labor and  benefits                                                     |   | 43,457                          |    | 39,674                         |   | 123,618 |   | 120,684 |   |
| Operating  expenses                                                     |   | 33,817                          |    | 32,479                         |   | 93,512 |   | 89,031 |   |
| General and  administrative expenses                                    |   | 9,369                           |    | 8,393                          |   | 26,649 |   | 27,070 |   |
| Reduction of  restructuring reserve                                     |   | —                          |    | —                         |   | (400 | ) | — |   |
| Write-downs of  property and equipment                                  |   | —                          |    | 35                             |   | 431 |   | 103 |   |
| Depreciation and  amortization                                          |   | 6,097                           |    | 7,037                          |   | 19,170 |   | 21,686 |   |
| Loss (gain) on  franchise sales of restaurant operations and properties |   | 21                              |    | (219                           | )      | 21 |   | (4,042 | ) |
| (Gain) loss on  sales of other property and equipment, net              |   | (150                            | )       | (317                           | )      | 491 |   | (2,559 | ) |
|                                                                    |   |                            |    |                           |   |   |   |   |   |
| OPERATING INCOME                                                        |   | 11,495                          |    | 9,451                          |   | 29,210 |   | 27,185 |   |
|                                                                    |   |                            |    |                           |   |   |   |   |   |
| Interest  expense, net                                                  |   | 6,212                           |    | 6,464                          |   | 18,764 |   | 20,967 |   |
|                                                                    |   |                            |    |                           |   |   |   |   |   |
| INCOME BEFORE  PROVISION FOR INCOME TAXES AND EXTRAORDINARY ITEM        |   | 5,283                           |    | 2,987                          |   | 10,446 |   | 6,218 |   |
|                                                                    |   |                            |    |                           |   |   |   |   |   |
| Provision for  income taxes                                             |   | (1,795                          | )       | (1,125                         | )      | (3,551 | ) | (2,250 | ) |
|                                                                    |   |                            |    |                           |   |   |   |   |   |
| INCOME BEFORE  EXTRAORDINARY ITEM                                       |   | 3,488                           |    | 1,862                          |   | 6,895 |   | 3,968 |   |
|                                                                    |   |                            |    |                           |   |   |   |   |   |
| Extraordinary  item, net of income tax benefit of $153                  |   | —                          |    | (221                           | )      | — |   | (221 | ) |
|                                                                    |   |                            |    |                           |   |   |   |   |   |
| NET INCOME                                                              |   | $                               | 3,488   |                           | $      | 1,641 |   | $ | 6,895 |   | $ | 3,747 |   |
|                                                                    |   |                            |    |                           |   |   |   |   |   |
| BASIC NET INCOME  PER SHARE                                             |   |                            |    |                           |   |   |   |   |   |
| Income before  extraordinary item                                       |   | $                               | 0.47    |                           | $      | 0.25 |   | $ | 0.94 |   | $ | 0.54 |   |
| Extraordinary  item, net of income tax benefit                          |   | —                          |    | (0.03                          | )      | — |   | (0.03 | ) |
| Net income                                                              |   | $                               | 0.47    |                           | $      | 0.22 |   | $ | 0.94 |   | $ | 0.51 |   |
|                                                                    |   |                            |    |                           |   |   |   |   |   |
| DILUTED NET  INCOME PER SHARE                                           |   |                            |    |                           |   |   |   |   |   |
| Income before  extraordinary item                                       |   | $                               | 0.46    |                           | $      | 0.25 |   | $ | 0.91 |   | $ | 0.54 |   |
| Extraordinary  item, net of income tax benefit                          |   | —                          |    | (0.03                          | )      | — |   | (0.03 | ) |
| Net income                                                              |   | $                               | 0.46    |                           | $      | 0.22 |   | $ | 0.91 |   | $ | 0.51 |   |
|                                                                    |   |                            |    |                           |   |   |   |   |   |
| WEIGHTED AVERAGE  SHARES:                                               |   |                            |    |                           |   |   |   |   |   |
| Basic                                                                   |   | 7,379                           |    | 7,359                          |   | 7,366 |   | 7,366 |   |
| Diluted                                                                 |   | 7,607                           |    | 7,416                          |   | 7,574 |   | 7,382 |   |

 

 

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

 

2

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**FRIENDLY ICE CREAM CORPORATION AND SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

(Unaudited)

(In thousands)

 
|                                                                               |   | **For the  Nine months Ended** |   |
|------------------------------------------------------------------------------------|--------|--------------------------------|--------|
|                                                                               |   | **September  29, 2002**        |   | **September  30, 2001** |   |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                             |   |                           |   |   |   |
| Net income                                                                         |   | $                              | 6,895  |   | $ | 3,747 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |   |                           |   |   |   |
| Extraordinary  item, net of income tax benefit                                     |   | —                         |   | 221 |   |
| Stock  compensation expense                                                        |   | 302                            |   | 235 |   |
| Depreciation and  amortization                                                     |   | 19,170                         |   | 21,686 |   |
| Write-downs of  property and equipment                                             |   | 431                            |   | 103 |   |
| Deferred income  tax expense                                                       |   | 3,881                          |   | 2,250 |   |
| Loss (gain) on  sales of other property and equipment, net                         |   | 491                            |   | (6,710 | ) |
| Changes in  operating assets and liabilities:                                      |   |                           |   |   |   |
| Accounts  receivable                                                               |   | (122                           | )      | (2,337 | ) |
| Inventories                                                                        |   | (2,259                         | )      | (3,824 | ) |
| Other assets                                                                       |   | (3,533                         | )      | (3,204 | ) |
| Accounts payable                                                                   |   | 4,932                          |   | 1,522 |   |
| Accrued expenses  and other long-term liabilities                                  |   | 1,609                          |   | (1,119 | ) |
| NET CASH  PROVIDED BY OPERATING ACTIVITIES                                         |   | 31,797                         |   | 12,570 |   |
|                                                                               |   |                           |   |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                             |   |                           |   |   |   |
| Purchases of  property and equipment                                               |   | (9,004                         | )      | (8,440 | ) |
| Proceeds from  sales of property and equipment                                     |   | 3,426                          |   | 23,556 |   |
| NET CASH (USED  IN) PROVIDED BY INVESTING ACTIVITIES                               |   | (5,578                         | )      | 15,116 |   |
|                                                                               |   |                           |   |   |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                             |   |                           |   |   |   |
| Proceeds from  borrowings                                                          |   | —                         |   | 51,405 |   |
| Repayments of  debt                                                                |   | (753                           | )      | (84,529 | ) |
| Repayments of  capital lease and finance obligations                               |   | (1,396                         | )      | (1,589 | ) |
| Stock options  exercised                                                           |   | 133                            |   | — |   |
| NET CASH USED IN  FINANCING ACTIVITIES                                             |   | (2,016                         | )      | (34,713 | ) |
|                                                                               |   |                           |   |   |   |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                              |   | 24,203                         |   | (7,027 | ) |
|                                                                               |   |                           |   |   |   |
| CASH AND CASH  EQUIVALENTS, BEGINNING OF PERIOD                                    |   | 16,342                         |   | 14,584 |   |
|                                                                               |   |                           |   |   |   |
| CASH AND CASH  EQUIVALENTS, END OF PERIOD                                          |   | $                              | 40,545 |   | $ | 7,557 |   |
|                                                                               |   |                           |   |   |   |
| SUPPLEMENTAL  DISCLOSURES:                                                         |   |                           |   |   |   |
| Cash paid  (refunded) during the period for:                                       |   |                           |   |   |   |
| Interest                                                                           |   | $                              | 13,030 |   | $ | 16,699 |   |
| Income taxes                                                                       |   | (9                             | )      | 3 |   |
| Capital lease  obligations terminated                                              |   | —                         |   | 170 |   |
| Note received  from sale of property and equipment                                 |   | —                         |   | 4,250 |   |

 

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

 

3

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**FRIENDLY ICE CREAM CORPORATION AND SUBSIDIARIES**

 

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATMENTS**

 

(Unaudited)

 

**1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES**

 

*                                              **Interim Financial Information -*

 

                                                The accompanying condensed consolidatedfinancial statements as of September 29, 2002 and for the third quarters andnine months ended September 29, 2002 and September 30, 2001 are unaudited, but,in the opinion of management, include all adjustments which are necessary for afair presentation of the consolidated financial position, results ofoperations, cash flows and comprehensive income of Friendly Ice CreamCorporation (“FICC”) and subsidiaries (unless the context indicates otherwise,collectively, the “Company”). Such adjustments consist solely of normalrecurring accruals. Operating results for the three and nine month periodsended September 29, 2002 and September 30, 2001 are not necessarily indicativeof the results that may be expected for the entire year due, in part, to theseasonality of the Company’s business. Historically, higher revenues andoperating income have been experienced during the second and third fiscalquarters. The Company’s consolidated financial statements, including the notesthereto, which are contained in the 2001 Annual Report on Form 10-K should beread in conjunction with these condensed consolidated financialstatements.  Capitalized terms nototherwise defined herein should be referenced to the 2001 Annual Report on Form10-K.

 

*                                               **Use of Estimates in thePreparation of Financial Statements -*

 

                                                The preparation of financial statementsin conformity with accounting principles generally accepted in the UnitedStates requires management to make estimates and assumptions that affect thereported amounts of assets and liabilities and the disclosure of contingentassets and liabilities at the dates of the financial statements and thereported amounts of revenues and expenses during the reporting periods. Thecritical accounting policies and most significant estimates and assumptionsrelate to revenue recognition, insurance reserves, recoverability of accountsreceivable, restructuring reserves, valuation allowances and pension and otherpost-retirement benefits expense. Actual amounts could differ significantlyfrom the estimates.

 

                                                *Revenue Recognition -*

 

                                                The Company’s revenues are derivedprimarily from the operation of full-service restaurants, the distribution andsale of frozen desserts through retail and institutional locations andfranchising. The Company recognizes restaurant revenue upon receipt of paymentfrom the customer and retail revenue upon shipment of product. Reserves fordiscounts and allowances from retail sales are estimated and accrued whenrevenue is recorded. Actual amounts could differ materially from the estimates.Franchise royalty income, based on net sales of franchisees, is payable monthlyand is recorded on the accrual method. Initial franchise fees are recorded as revenueupon completion of all significant services, generally upon opening of therestaurant.

 

4

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*                                               **Insurance Reserves -*

 

                                                The Company is self–insured throughretentions or deductibles for the majority of its workers’ compensation,automobile, general liability, employer’s liability, product liability andgroup health insurance programs. Self–insurance amounts vary up to$500,000 per occurrence. Insurance with third parties, some of which is thenreinsured through RIC, is in place for claims in excess of these self–insuredamounts. RIC reinsured 100% of the risk from $500,000 to $1,000,000 peroccurrence through September 2, 2000 for the Company’s workers’ compensation,general liability, employer’s liability and product liability insurance.Subsequent to September 2, 2000, the Company discontinued its use of RIC as acaptive insurer for new claims. The Company’s and RIC’s liability for estimatedincurred losses are actuarially determined and recorded in the accompanyingcondensed consolidated financial statements on an undiscounted basis. Actualincurred losses may vary from the estimated incurred losses and could have amaterial affect on the Company’s insurance expense.

 

                                                *Restructuring Reserves-*

 

                                                On October 10, 2001, the Companyeliminated approximately 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 to streamlinefunctions and reduce redundancy amongst its business segments. As a result ofthe elimination of the positions and the outsourcing of certain functions, theCompany reported a pre-tax restructuring charge of approximately $2,536,000 forseverance, rent and unusable construction supplies in the year ended December30, 2001.

 

                                                In March 2000, the Company’s Board ofDirectors approved a restructuring plan that provided for the immediate closingof 81 restaurants at the end of March 2000 and the disposition of an additional70 restaurants over the next 24 months. As a result of this plan, the Companyreported a pre-tax restructuring charge of approximately $12,100,000 forseverance, rent, utilities and real estate taxes, demarking, lease terminationcosts and certain other costs associated with the closing of the locations,along with a pre-tax write-down of property and equipment for these locationsof approximately $17,000,000 in the year ended December 31, 2000. The Companyreduced the restructuring reserve by $400,000 and $1,900,000 during the ninemonths ended September 29, 2002 and the year ended December 30, 2001,respectively, since the reserve exceeded estimated remaining payments.

 

                                                As of September 29, 2002, the remainingrestructuring reserve was $1,445,000. The restructuring reserves may beincreased or decreased based upon remaining payments, which could varymaterially from the estimates depending upon the timing of restaurant closingsand other factors.

 

5

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*                                               **Income Taxes -*

 

                                                The Company accounts for income taxes inaccordance with Statement of Financial Accounting Standards (“SFAS”) No. 109,“Accounting for Income Taxes,” which requires recognition of deferred taxassets and liabilities for the expected future tax consequences of events thathave been included in the financial statements or tax returns. A valuationallowance is recorded for deferred tax assets whose realization is not likely.As of September 29, 2002 and December 30, 2001, a valuation allowance of$11,295,000 existed related to state NOL carryforwards due to restrictions onthe usage of state NOL carryforwards and short carryforward periods for certainstates. Taxable income by state for future periods is difficult to estimate. Theamount and timing of any future taxable income may affect the usage of suchcarryforwards, which could result in a material change in the valuationallowance.

 

*                                               **Pension and OtherPost-Retirement Benefits -*

 

                                                The determination of the Company’sobligation and expense for pension and other post-retirement benefits isdependent upon the selection of certain assumptions used by actuaries incalculating such amounts. Those assumptions include, among other things, thediscount rate, expected long-term rate of return on plan assets and rates ofincrease in compensation and health care costs. In accordance with accountingprinciples generally accepted in the United States, actual results that differfrom the assumptions are accumulated and amortized over future periods and,therefore, generally affect the recognized expense and recorded obligation insuch future periods. Significant differences in actual experience orsignificant changes in the assumptions may materially affect the future pensionand other post-retirement obligations and expense.

 

*                                               **Stock-BasedCompensation —*

 

                                                The Company accounts for stock–basedcompensation for employees under Accounting Principles Board (“APB”) OpinionNo. 25, “Accounting for Stock Issued to Employees,” and elected the disclosure–onlyalternative under SFAS No. 123, “Accounting for Stock–BasedCompensation.”

 

*Debt-*

 

                                                In December 2001, the Company completed afinancial restructuring plan (the “Refinancing Plan”) which included therepayment of $64,545,000 outstanding under the Old Credit Facility and therepurchase of approximately $21,300,000 in Senior Notes for $17,000,000 withthe proceeds from $55,000,000 in long-term mortgage financing (the “MortgageFinancing”) and a $33,700,000 sale and leaseback transaction (the “Sale/LeasebackFinancing”). In addition, FICC secured a new $30,000,000 revolving creditfacility (the “New Credit Facility”) of which up to $20,000,000 is available tosupport letters of credit. The $30,000,000 commitment less outstanding lettersof credit is available for borrowing to provide working capital and for othercorporate needs.

 

6

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                                                *Inventories -*

 

                                                Inventories are stated at the lower offirst-in, first-out cost or market. Inventories as of September 29, 2002 and December 30, 2001 were asfollows (in thousands):

 

|             |   | **September  29,  2002** |   | **December  30,  2001** |   |
|------------------|--------|--------------------------|--------|-------------------------|--------|
|             |   |                     |   |                    |   |
| Raw materials    |   | $                        | 607    |                    | $      | 1,269 |   |
| Goods in process |   | 147                      |   | 73                      |   |
| Finished goods   |   | 14,492                   |   | 11,645                  |   |
| Total            |   | $                        | 15,246 |                    | $      | 12,987 |   |

* *

*Reclassifications-*

 

                                                Certain prior year amounts have beenreclassified to conform with current year presentation.

 

**2.EARNINGS PER SHARE**

 

                                                Basic net income per share is calculatedby dividing net income by the weighted average number of common sharesoutstanding during the period. Diluted earnings per share is calculated bydividing net income by the weighted average number of shares of common stockand common stock equivalents outstanding during the period. Common stockequivalents are dilutive stock options and warrants that are assumed exercisedfor calculation purposes. The number of common stock options which could dilutebasic earnings per share in the future, that were not included in thecomputation of diluted income per share because to do so would have been antidilutive,was 50,960 and 472,610 for the three months ended September 29, 2002 andSeptember 30, 2001, respectively. The number of common stock options whichcould dilute basic earnings per share in the future, that were not included inthe computation of diluted income per share because to do so would have beenantidilutive, was 84,514 and 569,350 for the nine months ended September 29,2002 and September 30, 2001, respectively.

 

7

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Presented below is thereconciliation between basic and diluted weighted average shares for the threeand nine months ended September 29, 2002 and September 30, 2001 (in thousands):

 
|                                                                    |   | **For the  Three Months Ended** |   |
|-------------------------------------------------------------------------|--------|---------------------------------|--------|
|                                                                    |   | **Basic**                       |   | **Diluted** |   |
|                                                                    |   | **September  29, 2002**         |   | **September  30, 2001** |   | **September  29, 2002** |   | **September  30, 2001** |   |
| Weighted average  number of common shares outstanding during the period |   | 7,379                           |   | 7,359 |   | 7,379 |   | 7,359 |   |
| Adjustments:                                                            |   |                            |   |   |   |   |   |   |   |
| Assumed exercise  of stock options                                      |   | —                          |   | — |   | 228 |   | 57 |   |
| Weighted average  number of shares outstanding                          |   | 7,379                           |   | 7,359 |   | 7,607 |   | 7,416 |   |

 
|                                                                    |   | **For the  Nine months Ended** |   |
|-------------------------------------------------------------------------|--------|--------------------------------|--------|
|                                                                    |   | **Basic**                      |   | **Diluted** |   |
|                                                                    |   | **September  29, 2002**        |   | **September  30, 2001** |   | **September  29, 2002** |   | **September  30, 2001** |   |
| Weighted average  number of common shares outstanding during the period |   | 7,366                          |   | 7,366 |   | 7,366 |   | 7,366 |   |
| Adjustments:                                                            |   |                           |   |   |   |   |   |   |   |
| Assumed exercise  of stock options                                      |   | —                         |   | — |   | 208 |   | 16 |   |
| Weighted average  number of shares outstanding                          |   | 7,366                          |   | 7,366 |   | 7,574 |   | 7,382 |   |

 

**3. SEGMENT REPORTING**

 

                                                Operating segments are components of anenterprise about which separate financial information is available that isevaluated regularly by the chief operating decision-maker, or decision-makinggroup, in deciding how to allocate resources and in assessing performance. TheCompany’s chief operating decision-maker is the Chairman of the Board and ChiefExecutive Officer of the Company. The Company’s operating segments includerestaurant, foodservice and franchise. The revenues from these segments includeboth sales to unaffiliated customers and intersegment sales, which generallyare accounted for on a basis consistent with sales to unaffiliated customers.Intersegment sales and other intersegment transactions have been eliminated inthe accompanying condensed consolidated financial statements.

 

                                                The Company’s restaurants target familieswith children and adults who desire a reasonably–priced meal in a full–servicesetting. The Company’s menu offers a broad selection of freshly–preparedfoods which appeal to customers throughout all dayparts. The menu currentlyfeatures over 100 items comprised of a broad selection of breakfast, lunch,dinner and afternoon and evening snack items. Foodservice operationsmanufactures frozen dessert products and distributes such manufactured productsand purchased finished goods to the Company’s restaurants and franchisedoperations. Additionally, it sells frozen dessert products to distributors andretail and institutional locations. The Company’s franchise segment includes aroyalty based on franchise restaurant revenue. In addition, the Companyreceives rental income from various franchised restaurants. The Company doesnot allocate 

 

8

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general andadministrative expenses associated with its headquarters operations to any businesssegment. These costs include general and administrative expenses of thefollowing functions: legal, accounting, personnel not directly related to asegment, information systems and other headquarters activities.

 

                                                On May 1, 2001, the Company’s foodservicedivision decreased its ice cream pricing to all restaurants. This resulted indecreased total foodservice revenues and decreased external foodservicerevenues of 1.2% and 0.6%, respectively, for the nine months ended September29, 2002.

 

                                                The accounting policies of the operatingsegments are the same as those described in the summary of significantaccounting policies except that the financial results for the foodserviceoperating segment, prior to intersegment eliminations, have been prepared usinga management approach, which is consistent with the basis and manner in whichthe Company’s management internally reviews financial information for thepurpose of assisting in making internal operating decisions. The Companyevaluates performance based on stand-alone operating segment income (loss)before income taxes and generally accounts for intersegment sales and transfersas if the sales or transfers were to third parties, that is, at current marketprices.

 

                                                EBITDA represents net income (loss)before (i) (provision for) benefit from income taxes, (ii) interestexpense, net, (iii) depreciation and amortization, (iv) extraordinaryitem, (v) write–downs of property and equipment and (vi) other non–cashitems. The Company has included information concerning EBITDA in this Form 10–Qbecause it 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** |    | **For the  Nine months Ended** |   |
|---------------------------------------------|--------|---------------------------------|---------|--------------------------------|--------|
|                                        |   | **September  29, 2002**         |    | **September  30, 2001**        |   | **September  29, 2002** |   | **September  30, 2001** |   |
|                                        |   | **(in  thousands)**             |    |
| Revenues:                                   |   |                            |    |                           |   |   |   |   |   |
| Restaurant                                  |   | $                               | 124,885 |                           | $      | 118,931 |   | $ | 351,034 |   | $ | 345,029 |   |
| Foodservice                                 |   | 69,276                          |    | 64,263                         |   | 189,309 |   | 176,332 |   |
| Franchise                                   |   | 2,663                           |    | 2,535                          |   | 7,342 |   | 7,197 |   |
| Total                                       |   | $                               | 196,824 |                           | $      | 185,729 |   | $ | 547,685 |   | $ | 528,558 |   |
|                                        |   |                            |    |                           |   |   |   |   |   |
| Intersegment  revenues:                     |   |                            |    |                           |   |   |   |   |   |
| Restaurant                                  |   | $                               | —  |                           | $      | — |   | $ | — |   | $ | — |   |
| Foodservice                                 |   | (35,695                         | )       | (34,356                        | )      | (99,076 | ) | (99,643 | ) |
| Franchise                                   |   | —                          |    | —                         |   | — |   | — |   |
| Total                                       |   | $                               | (35,695 | )                              | $      | (34,356 | ) | $ | (99,076 | ) | $ | (99,643 | ) |
|                                        |   |                            |    |                           |   |   |   |   |   |
| External  revenues:                         |   |                            |    |                           |   |   |   |   |   |
| Restaurant                                  |   | $                               | 124,885 |                           | $      | 118,931 |   | $ | 351,034 |   | $ | 345,029 |   |
| Foodservice                                 |   | 33,581                          |    | 29,907                         |   | 90,233 |   | 76,689 |   |
| Franchise                                   |   | 2,663                           |    | 2,535                          |   | 7,342 |   | 7,197 |   |
| Total                                       |   | $                               | 161,129 |                           | $      | 151,373 |   | $ | 448,609 |   | $ | 428,915 |   |
|                                        |   |                            |    |                           |   |   |   |   |   |
| EBITDA:                                     |   |                            |    |                           |   |   |   |   |   |
| Restaurant                                  |   | $                               | 15,494  |                           | $      | 15,425 |   | $ | 43,376 |   | $ | 40,626 |   |
| Foodservice                                 |   | 5,099                           |    | 2,616                          |   | 13,565 |   | 10,505 |   |
| Franchise                                   |   | 1,796                           |    | 1,482                          |   | 4,816 |   | 3,903 |   |
| Corporate                                   |   | (4,771                          | )       | (2,878                         | )      | (13,154 | ) | (11,834 | ) |
| Gain (loss) on  property and equipment, net |   | 143                             |    | (55                            | )      | 110 |   | 6,009 |   |
| Reduction of  restructure reserve           |   | —                          |    | —                         |   | 400 |   | — |   |
| Total                                       |   | $                               | 17,761  |                           | $      | 16,590 |   | $ | 49,113 |   | $ | 49,209 |   |
|                                        |   |                            |    |                           |   |   |   |   |   |
| Interest  expense, net-Corporate            |   | $                               | 6,212   |                           | $      | 6,464 |   | $ | 18,764 |   | $ | 20,967 |   |
|                                        |   |                            |    |                           |   |   |   |   |   |
| Depreciation and  amortization:             |   |                            |    |                           |   |   |   |   |   |
| Restaurant                                  |   | $                               | 4,545   |                           | $      | 4,618 |   | $ | 13,589 |   | $ | 14,277 |   |
| Foodservice                                 |   | 1,142                           |    | 834                            |   | 2,469 |   | 2,529 |   |
| Franchise                                   |   | 63                              |    | 62                             |   | 202 |   | 183 |   |
| Corporate                                   |   | 347                             |    | 1,523                          |   | 2,910 |   | 4,697 |   |
| Total                                       |   | $                               | 6,097   |                           | $      | 7,037 |   | $ | 19,170 |   | $ | 21,686 |   |
|                                        |   |                            |    |                           |   |   |   |   |   |
| Other non-cash expenses:                    |   |                            |    |                           |   |   |   |   |   |
| Corporate                                   |   | $                               | 169     |                           | $      | 67 |   | $ | 302 |   | $ | 235 |   |
| Write-downs of  property and equipment      |   | —                          |    | 35                             |   | 431 |   | 103 |   |
| Total                                       |   | $                               | 169     |                           | $      | 102 |   | $ | 733 |   | $ | 338 |   |
|                                        |   |                            |    |                           |   |   |   |   |   |
| Income (loss)  before income taxes:         |   |                            |    |                           |   |   |   |   |   |
| Restaurant                                  |   | $                               | 10,949  |                           | $      | 10,807 |   | $ | 29,787 |   | $ | 26,349 |   |
| Foodservice                                 |   | 3,957                           |    | 1,782                          |   | 11,096 |   | 7,976 |   |
| Franchise                                   |   | 1,733                           |    | 1,420                          |   | 4,614 |   | 3,720 |   |
| Corporate                                   |   | (11,499                         | )       | (10,932                        | )      | (35,130 | ) | (37,733 | ) |
| Gain (loss) on  property and equipment, net |   | 143                             |    | (90                            | )      | (321 | ) | 5,906 |   |
| Reduction of  restructure reserve           |   | —                          |    | —                         |   | 400 |   | — |   |
| Total                                       |   | $                               | 5,283   |                           | $      | 2,987 |   | $ | 10,446 |   | $ | 6,218 |   |

 

9

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|                                                                   |   | **September  29, 2002** |    | **December  30, 2001** |   |
|------------------------------------------------------------------------|--------|-------------------------|---------|------------------------|--------|
|                                                                   |   | **(in  thousands)**     |    |
| Capital  expenditures, including assets acquired under capital leases: |   |                    |    |                   |   |
| Restaurant                                                             |   | $                       | 7,475   |                   | $      | 10,821 |   |
| Foodservice                                                            |   | 948                     |    | 2,090                  |   |
| Corporate                                                              |   | 581                     |    | 1,011                  |   |
| Total                                                                  |   | $                       | 9,004   |                   | $      | 13,922 |   |
|                                                                   |   |                    |    |                   |   |
| Total assets:                                                          |   |                    |    |                   |   |
| Restaurant                                                             |   | $                       | 141,192 |                   | $      | 148,475 |   |
| Foodservice                                                            |   | 39,517                  |    | 38,474                 |   |
| Franchise                                                              |   | 8,504                   |    | 7,076                  |   |
| Corporate                                                              |   | 79,089                  |    | 58,537                 |   |
| Total                                                                  |   | $                       | 268,302 |                   | $      | 252,562 |   |

 

**4. NEW ACCOUNTING PRONOUNCEMENTS**

 

In July 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (“EITF”) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The principal difference between SFAS No. 146 and EITF 94-3 relates to the timing of liability recognition. Under SFAS No. 146, a liability for a cost associated with an exit or disposal activity is recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost was recognized at the date of an entity’s commitment to an exit plan. The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS No. 146 is not expected to have a material impact on the Company’s financial position or results of operations.

 

In April 2002, the FASB issued SFAS No. 145, “Rescission of SFAS Nos. 4, 44, and 64, Amendment of SFAS No. 13, and Technical Corrections.” SFAS No. 4 required all gains and losses from the extinguishment of debt to be reported as extraordinary items and SFAS No. 64 related to the same matter. SFAS No. 145 requires gains and losses from certain debt extinguishment not to be reported as extraordinary items when the use of debt extinguishment is part of a risk management strategy. SFAS No. 44 was issued to establish transitional requirements for motor carriers. Those transitions are completed, therefore SFAS No. 145 rescinds SFAS No. 44. SFAS No. 145 also amends SFAS No. 13 requiring sale-leaseback accounting for certain lease modifications. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002. The provisions relating to sale-leaseback accounting are effective for transactions after May 15, 2002. The adoption of SFAS No. 145 is not expected to have a material impact on the Company’s financial position or results of operations.

 

10

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                                                In August 2001, the FASB issued SFAS No.144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No.144 modifies the rules for accounting for the impairment or disposal oflong-lived assets. The impact of adopting SFAS No. 144 on December 31, 2001 hadno material effect on the Company’s financial condition or results ofoperations.

 

                                                In June 2001, the FASB issued SFAS No.142, “Goodwill and Other Intangibles. “ SFAS No. 142 modifies the rules for accounting for goodwill and otherintangible assets. The new rules became effective for the Company on December31, 2001. The impact of adopting SFAS No. 142 in 2002 had no effect on theCompany’s financial condition or results of operations and the Company iscontinuing to amortize its license agreement related to certain trademarkedproducts over the term of the license agreement.

 

                                                In April 2001, the FASB reached consensuson EITF Issue No. 00-25, “Accounting for Consideration from a Vendor to aRetailer in Connection with the Purchase or Promotion of the Vendor’sProducts.” EITF Issue No. 00-25 was effective for quarters beginning afterDecember 15, 2001, with prior financial statements restated if practicable.EITF Issue No. 00-25 requires that consideration from a vendor to a retailer berecorded as a reduction in revenue unless certain criteria are met.Arrangements within the scope of this Issue include slotting fees, cooperativeadvertising arrangements and buy-downs. The Company adopted EITF Issue No.00-25 during 2001 and, as a result, certain costs previously recorded asexpense were reclassified and offset against revenue for the quarter and ninemonths ended September 30, 2001.

 

11

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**5.RESTRUCTURING RESERVES**

 

                                                The following represents the reserve andactivity associated with the March 2000 and October 2001 restructurings (inthousands):

 

 
|                             |   | **For the  Nine months Ended September 29, 2002**   |   |
|----------------------------------|--------|-----------------------------------------------------|--------|
|                             |   | **Restructuring  Reserves as of December 30, 2001** |   | **Costs Paid** |   | **Reserve  Reduction** |   | **Restructuring  Reserves as of September 29, 2002** |   |
| Severance pay                    |   | $                                                   | 516    |   | $ | (473 | ) | $ | (43 | ) | $ | — |   |
| Rent                             |   | 1,318                                               |   | (320 | ) | (298 | ) | 700 |   |
| Utilities and  real estate taxes |   | 185                                                 |   | (89 | ) | (3 | ) | 93 |   |
| Equipment                        |   | 480                                                 |   | (197 | ) | 219 |   | 502 |   |
| Outplacement  services           |   | 6                                                   |   | (6 | ) | — |   | — |   |
| Other                            |   | 551                                                 |   | (126 | ) | (275 | ) | 150 |   |
| Total                            |   | $                                                   | 3,056  |   | $ | (1,211 | ) | $ | (400 | ) | $ | 1,445 |   |

 
|                             |   | **For the  Nine months Ended September 30, 2001**   |   |
|----------------------------------|--------|-----------------------------------------------------|--------|
|                             |   | **Restructuring  Reserves as of December 31, 2000** |   | **Costs Paid** |   | **Restructuring  Reserves as of September 30, 2001** |   |
| Severance pay                    |   | $                                                   | 74     |   | $ | (74 | ) | $ | — |   |
| Rent                             |   | 3,585                                               |   | (900 | ) | 2,685 |   |
| Utilities and  real estate taxes |   | 1,105                                               |   | (519 | ) | 586 |   |
| Demarking                        |   | 138                                                 |   | (126 | ) | 12 |   |
| Lease  termination costs         |   | 120                                                 |   | (120 | ) | — |   |
| Inventory                        |   | 5                                                   |   | (5 | ) | — |   |
| Other                            |   | 544                                                 |   | (169 | ) | 375 |   |
| Total                            |   | $                                                   | 5,571  |   | $ | (1,913 | ) | $ | 3,658 |   |

 

Based on informationcurrently available, management believes that the restructuring reserve as ofSeptember 29, 2002 is adequate and not excessive.

 

12

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**6. FRANCHISE TRANSACTIONS**

 

**                                               **In 2000, the Company and its firstfranchisee, Davco, agreed to terminate Davco’s rights as the exclusivedeveloper of new Friendly’s restaurants in Maryland, Delaware, the District ofColumbia and northern Virginia, effective December 28, 2000. Davco has theright to close up to 16 existing franchised locations and will operate theremaining 32 locations under their respective existing franchise agreementsuntil such time as a new franchisee is found for those locations. The existingfranchise agreements for the 32 locations were modified as of December 29, 2001to allow early termination subject to liquidated damages on 22 of the 32franchise agreements. Effective August 6, 2001, Davco transferred its rights tothree franchised locations to a third party. Davco closed two restaurantsduring the year ended December 30, 2001. During the nine months ended September29, 2002, Davco transferred its rights to 24 additional franchised locations tosix separate third parties and closed six restaurants.

 

**7. SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION**

 

                                                FICC’s obligations related to the SeniorNotes are guaranteed fully and unconditionally by one of FICC’s wholly ownedsubsidiaries. There are no restrictions on FICC’s ability to obtain dividendsor other distributions of funds from this subsidiary, except those imposed byapplicable law. The following supplemental financial information sets forth, ona condensed consolidating basis, balance sheets, statements of operations andstatements of cash flows for FICC (the “Parent Company”), Friendly’sRestaurants Franchise, Inc. (the “Guarantor Subsidiary”) and Friendly’sInternational, Inc., Restaurant Insurance Corporation, and the three LLCsubsidiaries created in 2001, Friendly’s Realty I, LLC, Friendly’s Realty II,LLC and Friendly’s Realty III, LLC (collectively, the “Non–guarantorSubsidiaries”). All of the LLCs’ assets are owned by the LLCs, which areseparate entities with separate creditors which will be entitled to besatisfied out of the LLCs’ assets. Separate complete financial statements andother disclosures of the Guarantor Subsidiary as of September 29, 2002 andSeptember 30, 2001 and for the nine months ended September 29, 2002 and September30, 2001 are not presented because management has determined that suchinformation is not material to investors.

 

                                                Investments in subsidiaries are accountedfor by the Parent Company on the equity method for purposes of the supplementalconsolidating presentation. Earnings of the subsidiaries are, therefore,reflected in the Parent Company’s investment accounts and earnings. Theprincipal elimination entries eliminate the Parent Company’s investments insubsidiaries and intercompany balances and transactions.

 

13

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**Supplemental Condensed Consolidating Balance Sheet**

**As of September 29, 2002**

(In thousands)

 
|                                                       |   | **Parent  Company** |    | **Guarantor  Subsidiary** |   | **Non-guarantor  Subsidiaries** |   | **Eliminations** |   | **Consolidated** |   |
|------------------------------------------------------------|--------|---------------------|---------|---------------------------|--------|---------------------------------|--------|------------------|--------|------------------|--------|
|                                                       |   |                |    |                      |   |                            |   |             |   |             |   |
| Assets                                                     |   |                |    |                      |   |                            |   |             |   |             |   |
|                                                       |   |                |    |                      |   |                            |   |             |   |             |   |
| Current assets:                                            |   |                |    |                      |   |                            |   |             |   |             |   |
| Cash and cash  equivalents                                 |   | $                   | 36,581  |                      | $      | 1,069                           |   | $                | 2,895  |             | $      | — |   | $ | 40,545 |   |
| Accounts  receivable, net                                  |   | 8,802               |    | 1,289                     |   | —                          |   | —           |   | 10,091           |   |
| Inventories                                                |   | 15,246              |    | —                    |   | —                          |   | —           |   | 15,246           |   |
| Deferred income  taxes                                     |   | 7,448               |    | 99                        |   | —                          |   | 112              |   | 7,659            |   |
| Prepaid expenses  and other current assets                 |   | 9,469               |    | 1,110                     |   | 7,953                           |   | (14,307          | )      | 4,225            |   |
| Total current  assets                                      |   | 77,546              |    | 3,567                     |   | 10,848                          |   | (14,195          | )      | 77,766           |   |
| Deferred income  taxes                                     |   | —              |    | 350                       |   | 1,327                           |   | (1,677           | )      | —           |   |
| Property and  equipment, net                               |   | 106,295             |    | —                    |   | 50,272                          |   | —           |   | 156,567          |   |
| Intangible  assets and deferred costs, net                 |   | 17,231              |    | —                    |   | 2,768                           |   | —           |   | 19,999           |   |
| Investments in  subsidiaries                               |   | 5,859               |    | —                    |   | —                          |   | (5,859           | )      | —           |   |
| Other assets                                               |   | 13,055              |    | 6,125                     |   | 915                             |   | (6,125           | )      | 13,970           |   |
|                                                       |   |                |    |                      |   |                            |   |             |   |             |   |
| Total assets                                               |   | $                   | 219,986 |                      | $      | 10,042                          |   | $                | 66,130 |             | $      | (27,856 | ) | $ | 268,302 |   |
|                                                       |   |                |    |                      |   |                            |   |             |   |             |   |
| Liabilities and Stockholders’ (Deficit) Equity        |   |                |    |                      |   |                            |   |             |   |             |   |
|                                                       |   |                |    |                      |   |                            |   |             |   |             |   |
| Current  liabilities:                                      |   |                |    |                      |   |                            |   |             |   |             |   |
| Current  maturities of long-term obligations               |   | $                   | 9,380   |                      | $      | —                          |   | $                | 986    |             | $      | (7,776 | ) | $ | 2,590 |   |
| Accounts payable                                           |   | 25,437              |    | —                    |   | —                          |   | —           |   | 25,437           |   |
| Accrued expenses                                           |   | 44,323              |    | —                    |   | 8,106                           |   | (6,446           | )      | 48,743           |   |
| Total current  liabilities                                 |   | 79,140              |    | 2,760                     |   | 9,092                           |   | (14,222          | )      | 76,770           |   |
| Deferred income  taxes                                     |   | 16,030              |    | —                    |   | —                          |   | (1,565           | )      | 14,465           |   |
| Long-term  obligations, less current maturities            |   | 183,845             |    | —                    |   | 53,399                          |   | —           |   | 237,244          |   |
| Other long-term  liabilities                               |   | 29,655              |    | 903                       |   | 4,159                           |   | (6,210           | )      | 28,507           |   |
| Stockholders’  (deficit) equity                       |   | (88,684             | )       | 6,379                     |   | (520                            | )      | (5,859           | )      | (88,684          | )      |
| Total  liabilities and stockholders’ (deficit) equity |   | $                   | 219,986 |                      | $      | 10,042                          |   | $                | 66,130 |             | $      | (27,856 | ) | $ | 268,302 |   |

 

14

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**Supplemental Condensed ConsolidatingStatement of Operations**

**For the Three Months Ended September29, 2002**

(In thousands)

 
|                                                                                                    |   | **Parent  Company** |    | **Guarantor  Subsidiary** |   | **Non-guarantor  Subsidiaries** |   | **Eliminations** |   | **Consolidated** |   |
|---------------------------------------------------------------------------------------------------------|--------|---------------------|---------|---------------------------|--------|---------------------------------|--------|------------------|--------|------------------|--------|
|                                                                                                    |   |                |    |                      |   |                            |   |             |   |             |   |
| Revenues                                                                                                |   | $                   | 158,918 |                      | $      | 2,211                           |   | $                | — |             | $      | — |   | $ | 161,129 |   |
| Costs and  expenses:                                                                                    |   |                |    |                      |   |                            |   |             |   |             |   |
| Cost of sales                                                                                           |   | 57,023              |    | —                    |   | —                          |   | —           |   | 57,023           |   |
| Labor and  benefits                                                                                     |   | 43,457              |    | —                    |   | —                          |   | —           |   | 43,457           |   |
| Operating  expenses and write-downs of property and equipment                                           |   | 35,551              |    | —                    |   | (1,734                          | )      | —           |   | 33,817           |   |
| General and  administrative expenses                                                                    |   | 8,204               |    | 1,165                     |   | —                          |   | —           |   | 9,369            |   |
| Depreciation and  amortization                                                                          |   | 5,515               |    | —                    |   | 582                             |   | —           |   | 6,097            |   |
| Loss on  franchise sales of restaurant operations and properties                                        |   | 21                  |    | —                    |   | —                          |   | —           |   | 21               |   |
| (Gain) loss on  sales of other property and equipment, net                                              |   | (219                | )       | —                    |   | 69                              |   | —           |   | (150             | )      |
| Interest  expense, net                                                                                  |   | 5,027               |    | —                    |   | 1,185                           |   | —           |   | 6,212            |   |
|                                                                                                    |   |                |    |                      |   |                            |   |             |   |             |   |
| Income (loss)  before provision for income taxes and equity in net income of consolidated  subsidiaries |   | 4,339               |    | 1,046                     |   | (102                            | )      | —           |   | 5,283            |   |
|                                                                                                    |   |                |    |                      |   |                            |   |             |   |             |   |
| Provision for  income taxes                                                                             |   | (1,312              | )       | (429                      | )      | (54                             | )      | —           |   | (1,795           | )      |
|                                                                                                    |   |                |    |                      |   |                            |   |             |   |             |   |
| Income (loss)  before equity in net income of consolidated subsidiaries                                 |   | 3,027               |    | 617                       |   | (156                            | )      | —           |   | 3,488            |   |
|                                                                                                    |   |                |    |                      |   |                            |   |             |   |             |   |
| Equity in net  income of consolidated subsidiaries                                                      |   | 461                 |    | —                    |   | —                          |   | (461             | )      | —           |   |
|                                                                                                    |   |                |    |                      |   |                            |   |             |   |             |   |
| Net income  (loss)                                                                                      |   | $                   | 3,488   |                      | $      | 617                             |   | $                | (156   | )                | $      | (461 | ) | $ | 3,488 |   |

 

15

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**Supplemental Condensed ConsolidatingStatement of Operations**

**For the Nine Months Ended September29, 2002**

(In thousands)

 
|                                                                                                    |   | **Parent  Company** |    | **Guarantor  Subsidiary** |   | **Non-guarantor  Subsidiaries** |   | **Eliminations** |   | **Consolidated** |   |
|---------------------------------------------------------------------------------------------------------|--------|---------------------|---------|---------------------------|--------|---------------------------------|--------|------------------|--------|------------------|--------|
|                                                                                                    |   |                |    |                      |   |                            |   |             |   |             |   |
| Revenues                                                                                                |   | $                   | 442,409 |                      | $      | 6,200                           |   | $                | — |             | $      | — |   | $ | 448,609 |   |
| Costs and  expenses:                                                                                    |   |                |    |                      |   |                            |   |             |   |             |   |
| Cost of sales                                                                                           |   | 155,907             |    | —                    |   | —                          |   | —           |   | 155,907          |   |
| Labor and  benefits                                                                                     |   | 123,618             |    | —                    |   | —                          |   | —           |   | 123,618          |   |
| Operating  expenses and write-downs of property and equipment                                           |   | 99,167              |    | —                    |   | (5,224                          | )      | —           |   | 93,943           |   |
| General and  administrative expenses                                                                    |   | 23,156              |    | 3,493                     |   | —                          |   | —           |   | 26,649           |   |
| Reduction of  restructure reserve                                                                       |   | (400                | )       | —                    |   | —                          |   | —           |   | (400             | )      |
| Depreciation and  amortization                                                                          |   | 17,417              |    | —                    |   | 1,753                           |   | —           |   | 19,170           |   |
| Loss on  franchise sales of restaurant operations and properties                                        |   | 21                  |    | —                    |   | —                          |   | —           |   | 21               |   |
| Loss on sales of  other property and equipment, net                                                     |   | 422                 |    | —                    |   | 69                              |   | —           |   | 491              |   |
| Interest  expense, net                                                                                  |   | 15,244              |    | —                    |   | 3,520                           |   | —           |   | 18,764           |   |
|                                                                                                    |   |                |    |                      |   |                            |   |             |   |             |   |
| Income (loss)  before provision for income taxes and equity in net income of consolidated  subsidiaries |   | 7,857               |    | 2,707                     |   | (118                            | )      | —           |   | 10,446           |   |
|                                                                                                    |   |                |    |                      |   |                            |   |             |   |             |   |
| Provision for  income taxes                                                                             |   | (2,210              | )       | (1,110                    | )      | (231                            | )      | —           |   | (3,551           | )      |
|                                                                                                    |   |                |    |                      |   |                            |   |             |   |             |   |
| Income (loss)  before equity in net income of consolidated subsidiaries                                 |   | 5,647               |    | 1,597                     |   | (349                            | )      | —           |   | 6,895            |   |
|                                                                                                    |   |                |    |                      |   |                            |   |             |   |             |   |
| Equity in net  income of consolidated subsidiaries                                                      |   | 1,248               |    | —                    |   | —                          |   | (1,248           | )      | —           |   |
|                                                                                                    |   |                |    |                      |   |                            |   |             |   |             |   |
| Net income  (loss)                                                                                      |   | $                   | 6,895   |                      | $      | 1,597                           |   | $                | (349   | )                | $      | (1,248 | ) | $ | 6,895 |   |

 

16

----

 

**Supplemental Condensed ConsolidatingStatement of Cash Flows**

**For the Nine Months Ended September29, 2002**

(In thousands)

 
|                                            |   | **Parent  Company** |   | **Guarantor  Subsidiary** |   | **Non-guarantor  Subsidiaries** |   | **Eliminations** |   | **Consolidated** |   |
|-------------------------------------------------|--------|---------------------|--------|---------------------------|--------|---------------------------------|--------|------------------|--------|------------------|--------|
| Net cash  provided by operating activities      |   | $                   | 29,482 |                      | $      | 965                             |   | $                | 2,559  |             | $      | (1,209 | ) | $ | 31,797 |   |
|                                            |   |                |   |                      |   |                            |   |             |   |             |   |
| Cash flows from  investing activities:          |   |                |   |                      |   |                            |   |             |   |             |   |
| Purchases of  property and equipment            |   | (9,004              | )      | —                    |   | —                          |   | —           |   | (9,004           | )      |
| Proceeds from  sales of property and equipment  |   | 3,426               |   | —                    |   | —                          |   | —           |   | 3,426            |   |
| Net cash used in  investing activities          |   | (5,578              | )      | —                    |   | —                          |   | —           |   | (5,578           | )      |
|                                            |   |                |   |                      |   |                            |   |             |   |             |   |
| Cash flows from  financing activities:          |   |                |   |                      |   |                            |   |             |   |             |   |
| Repayments of  obligations                      |   | (2,572              | )      | —                    |   | (615                            | )      | 1,038            |   | (2,149           | )      |
| Stock options  exercised                        |   | 133                 |   | —                    |   | —                          |   | —           |   | 133              |   |
| Reinsurance  deposits received                  |   | —              |   | —                    |   | 2,024                           |   | (2,024           | )      | —           |   |
| Reinsurance  payments made from deposits        |   | —              |   | —                    |   | (2,195                          | )      | 2,195            |   | —           |   |
| Net cash used in  financing activities          |   | (2,439              | )      | —                    |   | (786                            | )      | 1,209            |   | (2,016           | )      |
|                                            |   |                |   |                      |   |                            |   |             |   |             |   |
| Net increase in  cash and cash equivalents      |   | 21,465              |   | 965                       |   | 1,773                           |   | —           |   | 24,203           |   |
|                                            |   |                |   |                      |   |                            |   |             |   |             |   |
| Cash and cash  equivalents, beginning of period |   | 15,116              |   | 104                       |   | 1,122                           |   | —           |   | 16,342           |   |
|                                            |   |                |   |                      |   |                            |   |             |   |             |   |
| Cash and cash  equivalents, end of period       |   | $                   | 36,581 |                      | $      | 1,069                           |   | $                | 2,895  |             | $      | — |   | $ | 40,545 |   |
|                                            |   |                |   |                      |   |                            |   |             |   |             |   |
| Supplemental  disclosures:                      |   |                |   |                      |   |                            |   |             |   |             |   |
| Interest paid                                   |   | $                   | 9,780  |                      | $      | —                          |   | $                | 3,250  |             | $      | — |   | $ | 13,030 |   |
| Income taxes  (refunded) paid                   |   | (1,029              | )      | 1,020                     |   | —                          |   | —           |   | (9               | )      |

 

17

----

 

**SupplementalCondensed Consolidating Balance Sheet**

**As ofDecember 30, 2001**

 

(In thousands)

 
|                                                       |   | **Parent  Company** |    | **Guarantor  Subsidiary** |   | **Non-guarantor  Subsidiaries** |   | **Eliminations** |   | **Consolidated** |   |
|------------------------------------------------------------|--------|---------------------|---------|---------------------------|--------|---------------------------------|--------|------------------|--------|------------------|--------|
|                                                       |   |                |    |                      |   |                            |   |             |   |             |   |
| Assets                                                     |   |                |    |                      |   |                            |   |             |   |             |   |
|                                                       |   |                |    |                      |   |                            |   |             |   |             |   |
| Current assets:                                            |   |                |    |                      |   |                            |   |             |   |             |   |
| Cash and cash  equivalents                                 |   | $                   | 15,116  |                      | $      | 104                             |   | $                | 1,122  |             | $      | — |   | $ | 16,342 |   |
| Accounts  receivable, net                                  |   | 9,468               |    | 501                       |   | —                          |   | —           |   | 9,969            |   |
| Inventories                                                |   | 12,987              |    | —                    |   | —                          |   | —           |   | 12,987           |   |
| Deferred income  taxes                                     |   | 7,448               |    | 99                        |   | —                          |   | 112              |   | 7,659            |   |
| Prepaid expenses  and other current assets                 |   | 8,704               |    | 1,002                     |   | 3,560                           |   | (9,530           | )      | 3,736            |   |
| Total current  assets                                      |   | 53,723              |    | 1,706                     |   | 4,682                           |   | (9,418           | )      | 50,693           |   |
| Deferred income  taxes                                     |   | —              |    | 350                       |   | 1,327                           |   | (1,677           | )      | —           |   |
| Property and  equipment, net                               |   | 117,564             |    | —                    |   | 51,925                          |   | —           |   | 169,489          |   |
| Intangibles and  deferred costs, net                       |   | 18,271              |    | —                    |   | 2,937                           |   | —           |   | 21,208           |   |
| Investments in  subsidiaries                               |   | 5,061               |    | —                    |   | —                          |   | (5,061           | )      | —           |   |
| Other assets                                               |   | 10,258              |    | 4,863                     |   | 6,229                           |   | (10,178          | )      | 11,172           |   |
| Total assets                                               |   | $                   | 204,877 |                      | $      | 6,919                           |   | $                | 67,100 |             | $      | (26,334 | ) | $ | 252,562 |   |
|                                                       |   |                |    |                      |   |                            |   |             |   |             |   |
| Liabilities and Stockholders’ (Deficit) Equity        |   |                |    |                      |   |                            |   |             |   |             |   |
|                                                       |   |                |    |                      |   |                            |   |             |   |             |   |
| Current  liabilities:                                      |   |                |    |                      |   |                            |   |             |   |             |   |
| Current  maturities of long-term obligations               |   | $                   | 5,489   |                      | $      | —                          |   | $                | 930    |             | $      | (3,500 | ) | $ | 2,919 |   |
| Accounts payable                                           |   | 20,505              |    | —                    |   | —                          |   | —           |   | 20,505           |   |
| Accrued expenses                                           |   | 43,853              |    | 1,042                     |   | 7,491                           |   | (5,758           | )      | 46,628           |   |
| Total current  liabilities                                 |   | 69,847              |    | 1,042                     |   | 8,421                           |   | (9,258           | )      | 70,052           |   |
| Deferred income  taxes                                     |   | 12,149              |    | —                    |   | —                          |   | (1,565           | )      | 10,584           |   |
| Long-term  obligations, less current maturities            |   | 190,308             |    | —                    |   | 54,070                          |   | (5,314           | )      | 239,064          |   |
| Other long-term  liabilities                               |   | 28,587              |    | 1,095                     |   | 4,330                           |   | (5,136           | )      | 28,876           |   |
| Stockholders’  (deficit) equity                       |   | (96,014             | )       | 4,782                     |   | 279                             |   | (5,061           | )      | (96,014          | )      |
| Total  liabilities and stockholders’ (deficit) equity |   | $                   | 204,877 |                      | $      | 6,919                           |   | $                | 67,100 |             | $      | (26,334 | ) | $ | 252,562 |   |

 

18

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**Supplemental Condensed Consolidating Statement of Operations**

**For the Three Months Ended September 30, 2001**

(In thousands)

 
|                                                                                                                 |   | **Parent  Company** |    | **Guarantor  Subsidiary** |   | **Non-guarantor  Subsidiaries** |   | **Eliminations** |   | **Consolidated** |   |
|----------------------------------------------------------------------------------------------------------------------|--------|---------------------|---------|---------------------------|--------|---------------------------------|--------|------------------|--------|------------------|--------|
|                                                                                                                 |   |                |    |                      |   |                            |   |             |   |             |   |
| Revenues                                                                                                             |   | $                   | 149,299 |                      | $      | 2,074                           |   | $                | — |             | $      | — |   | $ | 151,373 |   |
| Costs and  expenses:                                                                                                 |   |                |    |                      |   |                            |   |             |   |             |   |
| Cost of sales                                                                                                        |   | 54,840              |    | —                    |   | —                          |   | —           |   | 54,840           |   |
| Labor and  benefits                                                                                                  |   | 39,674              |    | —                    |   | —                          |   | —           |   | 39,674           |   |
| Operating expenses  and write-downs of property and equipment                                                        |   | 32,513              |    | —                    |   | 1                               |   | —           |   | 32,514           |   |
| General and  administrative expenses                                                                                 |   | 7,224               |    | 1,169                     |   | —                          |   | —           |   | 8,393            |   |
| Depreciation and  amortization                                                                                       |   | 7,037               |    | —                    |   | —                          |   | —           |   | 7,037            |   |
| Gain on  franchise sales of restaurant operations and properties                                                     |   | (219                | )       | —                    |   | —                          |   | —           |   | (219             | )      |
| Gain on sales of  other property and equipment, net                                                                  |   | (317                | )       | —                    |   | —                          |   | —           |   | (317             | )      |
| Interest expense  (income), net                                                                                      |   | 6,640               |    | —                    |   | (176                            | )      | —           |   | 6,464            |   |
|                                                                                                                 |   |                |    |                      |   |                            |   |             |   |             |   |
| Income before  provision for income taxes, extraordinary item and equity in net income of  consolidated subsidiaries |   | 1,907               |    | 905                       |   | 175                             |   | —           |   | 2,987            |   |
|                                                                                                                 |   |                |    |                      |   |                            |   |             |   |             |   |
| Provision for  income taxes                                                                                          |   | (692                | )       | (372                      | )      | (61                             | )      | —           |   | (1,125           | )      |
|                                                                                                                 |   |                |    |                      |   |                            |   |             |   |             |   |
| Income before  extraordinary item and equity in net income of consolidated subsidiaries                              |   | 1,215               |    | 533                       |   | 114                             |   | —           |   | 1,862            |   |
|                                                                                                                 |   |                |    |                      |   |                            |   |             |   |             |   |
| Extraordinary  item, net of income tax benefit                                                                       |   | (221                | )       | —                    |   | —                          |   | —           |   | (221             | )      |
|                                                                                                                 |   |                |    |                      |   |                            |   |             |   |             |   |
| Income before  equity in net income of consolidated subsidiaries                                                     |   | 994                 |    | 533                       |   | 114                             |   | —           |   | 1,641            |   |
|                                                                                                                 |   |                |    |                      |   |                            |   |             |   |             |   |
| Equity in net  income of consolidated subsidiaries                                                                   |   | 647                 |    | —                    |   | —                          |   | (647             | )      | —           |   |
|                                                                                                                 |   |                |    |                      |   |                            |   |             |   |             |   |
| Net income                                                                                                           |   | $                   | 1,641   |                      | $      | 533                             |   | $                | 114    |             | $      | (647 | ) | $ | 1,641 |   |

 

19

----

 

**Supplemental Condensed ConsolidatingStatement of Operations**

**For the Nine months Ended September30, 2001**

 (In thousands)

 
|                                                                                                                 |   | **Parent  Company** |    | **Guarantor  Subsidiary** |   | **Non-guarantor  Subsidiaries** |   | **Eliminations** |   | **Consolidated** |   |
|----------------------------------------------------------------------------------------------------------------------|--------|---------------------|---------|---------------------------|--------|---------------------------------|--------|------------------|--------|------------------|--------|
|                                                                                                                 |   |                |    |                      |   |                            |   |             |   |             |   |
| Revenues                                                                                                             |   | $                   | 422,924 |                      | $      | 5,991                           |   | $                | — |             | $      | — |   | $ | 428,915 |   |
| Costs and  expenses:                                                                                                 |   |                |    |                      |   |                            |   |             |   |             |   |
| Cost of sales                                                                                                        |   | 149,757             |    | —                    |   | —                          |   | —           |   | 149,757          |   |
| Labor and  benefits                                                                                                  |   | 120,684             |    | —                    |   | —                          |   | —           |   | 120,684          |   |
| Operating  expenses and write-downs of property and equipment                                                        |   | 89,144              |    | —                    |   | (10                             | )      | —           |   | 89,134           |   |
| General and  administrative expenses                                                                                 |   | 23,585              |    | 3,485                     |   | —                          |   | —           |   | 27,070           |   |
| Depreciation and  amortization                                                                                       |   | 21,686              |    | —                    |   | —                          |   | —           |   | 21,686           |   |
| Gain on  franchise sales of restaurant operations and properties                                                     |   | (4,042              | )       | —                    |   | —                          |   | —           |   | (4,042           | )      |
| Gain on sales of  other property and equipment, net                                                                  |   | (2,559              | )       | —                    |   | —                          |   | —           |   | (2,559           | )      |
| Interest expense  (income), net                                                                                      |   | 21,540              |    | —                    |   | (573                            | )      | —           |   | 20,967           |   |
|                                                                                                                 |   |                |    |                      |   |                            |   |             |   |             |   |
| Income before  provision for income taxes, extraordinary item and equity in net income of  consolidated subsidiaries |   | 3,129               |    | 2,506                     |   | 583                             |   | —           |   | 6,218            |   |
|                                                                                                                 |   |                |    |                      |   |                            |   |             |   |             |   |
| Provision for  income taxes                                                                                          |   | (1,017              | )       | (1,028                    | )      | (205                            | )      | —           |   | (2,250           | )      |
|                                                                                                                 |   |                |    |                      |   |                            |   |             |   |             |   |
| Income before  extraordinary item and equity in net income of consolidated subsidiaries                              |   | 2,112               |    | 1,478                     |   | 378                             |   | —           |   | 3,968            |   |
|                                                                                                                 |   |                |    |                      |   |                            |   |             |   |             |   |
| Extraordinary  item, net of income tax benefit                                                                       |   | (221                | )       | —                    |   | —                          |   | —           |   | (221             | )      |
|                                                                                                                 |   |                |    |                      |   |                            |   |             |   |             |   |
| Income before  equity in net income of consolidated subsidiaries                                                     |   | 1,891               |    | 1,478                     |   | 378                             |   | —           |   | 3,747            |   |
|                                                                                                                 |   |                |    |                      |   |                            |   |             |   |             |   |
| Equity in net  income of consolidated subsidiaries                                                                   |   | 1,856               |    | —                    |   | —                          |   | (1,856           | )      | —           |   |
|                                                                                                                 |   |                |    |                      |   |                            |   |             |   |             |   |
| Net income                                                                                                           |   | $                   | 3,747   |                      | $      | 1,478                           |   | $                | 378    |             | $      | (1,856 | ) | $ | 3,747 |   |

 

20

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**Supplemental Condensed ConsolidatingStatement of Cash Flows**

**For the Nine months Ended September30, 2001**

(In thousands)

 
|                                                   |   | **Parent  Company** |   | **Guarantor  Subsidiary** |   | **Non-guarantor  Subsidiaries** |   | **Eliminations** |   | **Consolidated** |   |
|--------------------------------------------------------|--------|---------------------|--------|---------------------------|--------|---------------------------------|--------|------------------|--------|------------------|--------|
| Net cash  provided by (used in) operating activities   |   | $                   | 12,639 |                      | $      | (15                             | )      | $                | 2,240  |             | $      | (2,294 | ) | $ | 12,570 |   |
|                                                   |   |                |   |                      |   |                            |   |             |   |             |   |
| Cash flows from  investing activities:                 |   |                |   |                      |   |                            |   |             |   |             |   |
| Purchases of  property and equipment                   |   | (8,440              | )      | —                    |   | —                          |   | —           |   | (8,440           | )      |
| Proceeds from  sales of property and equipment         |   | 23,556              |   | —                    |   | —                          |   | —           |   | 23,556           |   |
| Net cash  provided by investing activities             |   | 15,116              |   | —                    |   | —                          |   | —           |   | 15,116           |   |
|                                                   |   |                |   |                      |   |                            |   |             |   |             |   |
| Cash flows from  financing activities:                 |   |                |   |                      |   |                            |   |             |   |             |   |
| Proceeds from  borrowings                              |   | 51,405              |   | —                    |   | —                          |   | —           |   | 51,405           |   |
| Repayments of  obligations                             |   | (86,118             | )      | —                    |   | —                          |   | —           |   | (86,118          | )      |
| Reinsurance  deposits received                         |   | —              |   | —                    |   | 505                             |   | (505             | )      | —           |   |
| Reinsurance  payments made from deposits               |   | —              |   | —                    |   | (2,799                          | )      | 2,799            |   | —           |   |
| Net cash used in  financing activities                 |   | (34,713             | )      | —                    |   | (2,294                          | )      | 2,294            |   | (34,713          | )      |
|                                                   |   |                |   |                      |   |                            |   |             |   |             |   |
| Net decrease in  cash and cash equivalents             |   | (6,958              | )      | (15                       | )      | (54                             | )      | —           |   | (7,027           | )      |
|                                                   |   |                |   |                      |   |                            |   |             |   |             |   |
| Cash and cash  equivalents, beginning of period        |   | 13,619              |   | 33                        |   | 932                             |   | —           |   | 14,584           |   |
|                                                   |   |                |   |                      |   |                            |   |             |   |             |   |
| Cash and cash  equivalents, end of period              |   | $                   | 6,661  |                      | $      | 18                              |   | $                | 878    |             | $      | — |   | $ | 7,557 |   |
|                                                   |   |                |   |                      |   |                            |   |             |   |             |   |
| Supplemental  disclosures:                             |   |                |   |                      |   |                            |   |             |   |             |   |
| Interest paid  (received)                              |   | $                   | 17,273 |                      | $      | —                          |   | $                | (574   | )                | $      | — |   | $ | 16,699 |   |
| Income taxes  paid                                     |   | 1                   |   | 2                         |   | —                          |   | —           |   | 3                |   |
| Capital lease  obligations terminated                  |   | 170                 |   | —                    |   | —                          |   | —           |   | 170              |   |
| Note received  from the sale of property and equipment |   | 4,250               |   | —                    |   | —                          |   | —           |   | 4,250            |   |

 

21

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

 

                                                *The following discussion should be read in conjunction withthe Condensed Consolidated Financial Statements of the Company and the notesthereto included elsewhere herein.*

 

                                                **Forward Looking Statements**

 

                                                Statements contained herein that are nothistorical facts constitute “forward looking statements” as that term isdefined in the Private Securities Litigation Reform Act of 1995. All forwardlooking statements are subject to risks and uncertainties which could causeresults to differ materially from those anticipated. These factors include theCompany’s highly competitive business environment, exposure to commodityprices, risks associated with the foodservice industry, the ability to retainand attract new employees, government regulations, the Company’s highgeographic concentration in the Northeast and its attendant weather patterns,conditions needed to meet restaurant re–imaging and new opening targetsand risks associated with improved service and other initiatives. Other factorsthat may cause actual results to differ from the forward looking statementscontained herein and that may affect the Company’s prospects in general areincluded in the Company’s other filings with the Securities and ExchangeCommission.

 

                                                **Overview**

 

                                                Friendly’s owns and operates 389restaurants, franchises 156 full-service restaurants and six non-traditionalunits and manufactures a full line of frozen desserts distributed through morethan 3,500 supermarkets and other retail locations in 17 states. Therestaurants offer a wide variety of reasonably-priced breakfast, lunch anddinner menu items as well as the frozen dessert products.

 

                                                Following is a summary of theCompany-owned and franchised units:

 

|                    |   | **For the  Three Months Ended** |   | **For the  Nine months Ended** |   |
|-------------------------|--------|---------------------------------|--------|--------------------------------|--------|
|                    |   | **September  29,**              |   | **September  30,**             |   | **September  29,** |   | **September  30,** |   |
|                    |   | **2002**                        |   | **2001**                       |   | **2002** |   | **2001** |   |
| Company Units:          |   |                            |   |                           |   |   |   |   |   |
| Beginning of  period    |   | 390                             |   | 403                            |   | 393 |   | 449 |   |
| Openings                |   | —                          |   | —                         |   | — |   | — |   |
| Re-franchised           |   | —                          |   | (6                             | )      | — |   | (39 | ) |
| Closings                |   | (1                              | )      | (3                             | )      | (4 | ) | (16 | ) |
| End of period           |   | 389                             |   | 394                            |   | 389 |   | 394 |   |
|                    |   |                            |   |                           |   |   |   |   |   |
| Franchised Units:       |   |                            |   |                           |   |   |   |   |   |
| Beginning of  period    |   | 165                             |   | 163                            |   | 167 |   | 127 |   |
| Re-franchised  openings |   | —                          |   | 6                              |   | — |   | 39 |   |
| Openings                |   | 1                               |   | 1                              |   | 4 |   | 4 |   |
| Closings                |   | (4                              | )      | (4                             | )      | (9 | ) | (4 | ) |
| End of period           |   | 162                             |   | 166                            |   | 162 |   | 166 |   |

 

22

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*Revenues:*

 

                                                Total revenues increased $9.7 million, or6.4%, to $161.1 million for the third quarter ended September 29, 2002 from$151.4 million for the same quarter in 2001. Restaurant revenues increased $6.0million, or 5.0%, to $124.9 million for the third quarter of 2002 from $118.9million for the same quarter in 2001. Restaurant revenues increased by $6.0million in the 2002 period as compared to the 2001 period largely due to a 7.0%increase in comparable restaurant revenues from the 2001 quarter to the 2002quarter. Partially offsetting this increase was the closing of sevenunder-performing restaurants and the re-franchising of eight additionallocations over the past 15 months. Closing of restaurants accounted for $0.7million of the restaurant revenue decline in the 2002 period as compared to the2001 period and re-franchising reduced restaurant revenues by an additional$2.0 million in the 2002 period as compared to the 2001 period. Revenues fromthe one location open less than one year were $0.5 million. Foodservice (productsales to franchisees, retail and institutional) revenues increased by $3.7million, or 12.3%, to $33.6 million for the third quarter ended September 29,2002 from $29.9 million for the same quarter in 2001. Product sales tofranchised restaurants grew by $1.3 million and increases in sales tofoodservice retail supermarket customers contributed $2.4 million. Franchiserevenue increased $0.2 million, or 5.0%, to $2.7 million for the third quarterended September 29, 2002 compared to $2.5 million for the same quarter in 2001.The increase is largely the result of an increase in royalty revenue due to anincrease in comparable franchised restaurant revenues in the 2002 period whencompared to the same period in 2001. There were 162 franchise units open atSeptember 29, 2002 compared to 166 franchise units open at September 30, 2001.

 

                                                Total revenues increased $19.7 million,or 4.6%, to $448.6 million for the nine months ended September 29, 2002 from$428.9 million for the same period in 2001. Restaurant revenues were $351.0million and $345.0 million for the nine-month periods ended September 29, 2002and September 30, 2001, respectively. Restaurant revenues benefited from a 7.3%increase in comparable restaurant revenues from the 2001 period to the 2002 period.Offsetting this increase was lost revenues associated with the closing of 20under-performing restaurants and the re-franchising of an additional 41locations over the past 21 months. Closing of restaurants reduced restaurantrevenues by $3.3 million in the 2002 period as compared to the 2001 period andre-franchising reduced restaurant revenues by an additional $16.1 million inthe 2002 period as compared to the 2001 period. Revenues from the one locationopen less than one year were $1.2 million. Foodservice (product sales tofranchisees, retail and institutional) revenues increased by $13.5 million, or17.7%, to $90.2 million for the nine months ended September 29, 2002 from $76.7million for the same period in 2001. Product sales to franchised restaurantsgrew by $7.4 million and increases in sales to foodservice retail supermarketcustomers contributed $6.1 million. On May 1, 2001, the Company’s foodservicedivision decreased its ice cream pricing to all restaurants. This resulted indecreased foodservice revenues of 0.6% for the nine months ended September 29,2002. Franchise revenues were $7.3 million and $7.2 million for the nine monthsended September 29, 2002 and September 30, 2001, respectively. Included was adecrease of $0.9 million in initial fees recorded as 42 new locations wereadded in the nine months ended September 30, 2001. This decrease was offset byan increase in royalty revenue as comparable franchised restaurant revenuesrose in the 2002 period when compared to the same period in 2001. There were162 franchise units open at September 29, 2002 compared to 166 franchise unitsopen at September 30, 2001.

 

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*Cost of sales:*

 

                                                Cost of sales were$57.0 million and $54.8 million for the quarters ended September 29, 2002 andSeptember 30, 2001, respectively. Cost of sales as a percentage of totalrevenues decreased to 35.4% for the quarter ended September 29, 2002 from 36.2%for the same period in 2001. The lower food cost as a percentage of totalrevenue was due in part to lower cream prices in the current period. Cream isthe principal ingredient used in making ice cream. The Company expects thatcream prices will continue to be lower during the remainder of 2002 whencompared to 2001. Partially offsetting the cream benefit was a shift in salesmix from Company-owned restaurant sales to Foodservice sales. Foodservice salesto franchisees and retail customers have a higher food cost as a percentage ofrevenue than sales in Company-owned restaurants to restaurant patrons.  At Company-owned restaurants, cost of salesas a percentage of restaurant revenues improved.

 

                                                Cost of salesincreased $6.1 million, or 4.1%, to $155.9 million for the nine months endedSeptember 29, 2002 from $149.8 million for the same period in 2001. Cost ofsales as a percentage of total revenues were 34.8% and 34.9% for the ninemonths ended September 29, 2002 and September 30, 2001, respectively. The costof cream, the principal ingredient used in making ice cream, was lower in 2002when compared to 2001. The Company expects that cream prices will continue tobe lower during the remainder of 2002 when compared to 2001. Partiallyoffsetting the cream benefit was a shift in sales mix from Company-ownedrestaurant sales to Foodservice sales. Foodservice sales to franchisees andretail customers have a higher food cost as a percentage of revenue than salesin Company-owned restaurants to restaurant patrons.  At Company-owned restaurants, cost of sales as a percentage ofrestaurant revenues improved.

 

                                                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. The Companybelieves that cream prices will be slightly lower in 2002 than in 2001. A $0.10increase in the cost of a pound of AA butter adversely affects the Company’sannual cost of sales by approximately $1.1 million, which may be offset by aprice increase or other factors. To minimize risk, alternative supply sourcescontinue to be pursued. However, no assurance can be given that the Companywill be able to offset any cost increases in the future and future increases incream prices could have a material adverse effect on the Company’s results ofoperations.

 

*                                               **Labor and benefits:*

 

                                                Labor and benefits increased $3.8million, or 9.5%, to $43.5 million for the third quarter ended September 29,2002 from $39.7 million for the same quarter in 2001. Labor and benefits as apercentage of total revenues increased to 27.0% for the third quarter endedSeptember 29, 2002 from 26.2% for the same quarter in 2001. The higher labor costas a percentage of total revenue was the result of the cost of initiativesaimed at improving customer service and rising costs for fringe benefits. Laborand benefits as a percentage of restaurant revenues was 34.8% and 33.4% for thequarters ended September 29, 2002 and September 30, 2001, respectively.

 

 

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Labor and benefits increased $2.9 million, or 2.4%, to$123.6 million for the nine months ended September 29, 2002 from $120.7 millionfor the same period in 2001. Labor and benefits as a percentage of totalrevenues decreased to 27.6% for the nine months ended September 29, 2002 from28.1% for the same period in 2001. The lower labor cost as apercentage of total revenue is partially the result of revenue increasesderived from additional franchised locations and higher sales to foodserviceretail supermarket customers, which do not have any associated restaurant laborand benefits. Labor and benefits as a percentage of restaurant revenues increased to 35.2% for the nine monthsended September 29, 2002 from 35.0% for the same period in 2001.  During the quarter ended June 30, 2002, theCompany introduced a training program called “Friendly you bet we are.” Thecost of this program and the ongoing initiatives to improve customer servicehad an unfavorable impact on the year on year comparison. Fringe benefit costswere also higher in the 2002 period.  The closing of 20under-performing Company-owned units over the past 21 months had a favorableimpact on the relationship of restaurant labor and benefits to restaurant salesas well as to total revenues.

 

*                                               **Operating expenses:*

 

                                                Operating expensesincreased $1.3 million, or 4.1%, to $33.8 million for the third quarter endedSeptember 29, 2002 from $32.5 million for the same quarter in 2001. Operatingexpenses as a percentage of total revenues were 21.0% and 21.5% for the thirdquarters ended September 29, 2002 and September 30, 2001, respectively. Thedecrease as a percentage of total revenues resulted from lower restaurantutility and advertising costs. Partially offsetting those benefits were highercosts for restaurant rent associated with the December 2001 sale/leasebacktransaction in the 2002 period when compared to the 2001 period.

 

                                                Operating expensesincreased $4.5 million, or 5.0%, to $93.5 million for the nine months endedSeptember 29, 2002 from $89.0 million for the same period in 2001. Operatingexpenses as a percentage of total revenues were 20.8% for the nine months endedSeptember 29, 2002 and September 30, 2001. The increased dollars resulted fromhigher costs for restaurant rent associated with the December 2001sale/leaseback transaction and higher costs for foodservice retail sellingexpense in the 2002 period when compared to the 2001 period. Restaurant utilitycosts were lower in the 2002 period when compared to 2001.

 

*                                               **General and administrative expenses:*

 

                                                General and administrativeexpenses were $9.4 million and $8.4 million for the third quarters endedSeptember 29, 2002 and September 30, 2001, respectively. General andadministrative expenses as a percentage of total revenues increased to 5.8% forthe third quarter ended September 29, 2002 from 5.5% for the same period in2001. The increase in expense is primarily the result of an increase in bonusexpense and a reduction in the benefit realized from the over-funded pensionplan in the 2002 period when compared to the same period in 2001.

 

                                                General andadministrative expenses were $26.6 million and $27.1 million for the ninemonths ended September 29, 2002 and September 30, 2001, respectively. Generaland administrative expenses as a percentage of total revenues decreased to 5.9%for the nine months ended September 29, 2002 from 6.3% for the same period in2001. The decrease in expense is primarily the result of the elimination ofcertain management and administrative positions associated with the Company’sclosing of 20 locations and the re-franchising of 41 locations over the past 21months. In October 2001, the Company eliminated approximately 70 positions atcorporate headquarters. The Company also has a hiring freeze at its corporateheadquarters. Bonus expense was higher in the 2002 period when compared to thesame period in 2001. The benefit resulting from the over-funded pension planwas lower in the 2002 period when compared to the same period in 2001.

 

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*EBITDA:*

 

                                                As a result of the above and the gains(losses) on franchise and other property sales below, EBITDA (EBITDA representsnet income (loss) before (i) (provision for) benefit from income taxes,(ii) interest expense, net, (iii) depreciation and amortization,(iv) extraordinary item, (v) write–downs of property and equipmentand (vi) other non–cash items) increased $1.2 million, or 7.1%, to $17.8million for the quarter ended September 29, 2002 from $16.6 million for thesame quarter in 2001. EBITDA as a percentage of total revenues was 11.0% forthe 2002 and 2001 periods.

 

                                                EBITDA decreased $0.1 million, or 0.2%,to $49.1 million for the nine months ended September 29, 2002 from $49.2million for the same period in 2001. EBITDA as a percentage of total revenues was 10.9% and 11.5% for thenine months ended September 29, 2002 and September 30, 2001, respectively.

 

                                                W*rite-downs of property and equipment:*

 

                                                Write-downs of property and equipmentwere $0.4 million and $0.1 million for the nine months ended September 29, 2002and September 30, 2001, respectively.

 

*                                               **Depreciation and amortization:*

 

                                                Depreciation andamortization decreased $0.9 million, or 13.4%, to $6.1 million for the thirdquarter ended September 29, 2002 from $7.0 million for the same quarter in2001. Depreciation and amortization as a percentage of total revenues was 3.8%and 4.6% in the 2002 and 2001 quarters, respectively. The reduction reflectsthe impact on depreciation associated with the December 2001 sale/leasebacktransaction whereby the real property at 44 restaurants was sold and sevenlocations were closed and eight locations were re-franchised over the past 15months.

 

                                                Depreciation and amortization decreased$2.5 million, or 11.6%, to $19.2 million for the nine months ended September29, 2002 from $21.7 million for the same period in 2001. Depreciation andamortization as a percentage of total revenues was 4.3% and 5.1% in the 2002and 2001 periods, respectively. The reduction reflects the impacton depreciation associated with the December 2001 sale/leaseback transactionwhereby the real property at 44 restaurants was sold and 20 locations were closed and 41 locationswere re-franchised over the past 21 months.

 

*                                               **Gain on franchise salesof restaurant operations and properties:*

 

*                                               *Gain on franchise sales of restaurantoperations and properties was $0.2 million and $4.0 million for the thirdquarter and nine months ended September 30, 2001, respectively. The 2001 gainwas primarily the result of the gain of $4.3 million associated with the sale of37 restaurants to a franchisee during the nine months ended September 30, 2001.

 

*                                               **(Loss) gain on sales of other property and equipment, net:*

 

*                                               *The gain on sales of other property andequipment, net was $0.2 million and $0.3 million for the quarters ended September29, 2002 and September 30, 2001, respectively. The loss on sales of otherproperty and equipment, net was $0.5 million for the nine months endedSeptember 29, 2002 as compared to a gain of $2.6 million for the nine monthsended September 30, 2001. The loss during the nine-month period in 2002resulted from the sale of idle land and two closed locations as well as thedisposal of equipment being replaced as part of the Company’s re-imagingprojects. These losses were largely offset by a gain of $1.3 million on thesale of six closed locations.  The gainin 2001 resulted from the sale of 21 closed locations during the nine-monthperiod ended September 30, 2001.

 

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*                                               **Interest expense, net:*

 

                                                Interest expense, netof capitalized interest and interest income, decreased by $0.3 million, or3.9%, to $6.2 million for the third quarter ended September 29, 2002 from $6.5million for the same period in 2001. The decrease is primarily impacted by thedecrease in the average outstanding debt in the 2002 quarter compared to the2001 quarter as a result of the Refinancing Plan.

 

                                                Interest expense, netof capitalized interest and interest income, decreased by $2.2 million, or10.5%, to $18.8 million for the nine months ended September 29, 2002 from $21.0million for the same period in 2001. The decrease is primarily impacted by thedecrease in the average outstanding debt in the 2002 period compared to the2001 period as a result of the Refinancing Plan. Total outstanding debt,including capital lease and finance obligations, was reduced from $263.9million at September 30, 2001 to $239.8 million at September 29, 2002.

 

                                                *Provision for incometaxes:*

 

                                                The provision for income taxes was $1.8million, or 34.0%, and $1.1 million, or 37.7%, for the third quarters endedSeptember 29, 2002 and September 30, 2001, respectively. The provision forincome taxes was $3.6 million, or 34.0%, and $2.3 million, or 36.2%, for thenine months ended September 29, 2002 and September 30, 2001, respectively. The Company recordsincome taxes based on the effective rate expected for the year with any changesin the valuation allowance reflected in the period of change.

 

                                                *Extraordinary item:*

 

*                                               *The Companyrecognized $0.2 million of expense, net of the related income tax benefit of$0.2 million, in 2001 related to previously deferred financing costs associatedwith Tranche A of the term loans, which was prepaid and extinguished during thequarter ended September 30, 2001.

 

                                                *Net income:*

 

                                                Net income was $3.5million and $1.6 million for the third quarters ended September 29, 2002 andSeptember 30, 2001, respectively. Net income was $6.9 million and $4.0 millionfor the nine months ended September 29, 2002 and September 30, 2001,respectively, for the reasons discussed above.

 

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**Liquidity and Capital Resources**

 

                                                The Company’s primary sources ofliquidity and capital resources are cash generated from operations andborrowings under its revolving credit facility. Net cash provided by operatingactivities was $31.8 million and $12.6 million for the nine months endedSeptember 29, 2002 and September 30, 2001, respectively. During the nine monthsended September 29, 2002, inventories increased $2.3 million in anticipation ofstrong retail sales in the fourth quarter and a continued effort to buildmanufactured inventory to take advantage of lower cream prices. Other assetsincreased $3.5 million primarily as a result of a pension benefit recordedduring the current year. Accounts payable increased $4.9 million primarily as aresult in increased inventory purchases and the timing of other paymentsincluding construction. Accrued expenses and other long-term liabilitiesincreased $1.6 million as a result of an increase in accrued interest of $5.1million related to the timing of interest payment dates. This increase waspartially offset by $1.2 million of payments made against the restructuringreserve and $1.3 million of payments made for accrued construction costs and a$1.5 million reduction in the gift certificate liability as a result ofredemptions of year-end gift certificate sales. During the nine months endedSeptember 30, 2001, inventories increased $3.8 million as a result of increasedretail promotional activity expected for the fourth quarter.  Accounts payable increased $1.5 millionprimarily as a result of increased inventory purchases. Accounts receivableincreased $2.3 million primarily due to increased retail supermarket salesalong with the increase in volume of foodservice product sales to franchisees.Accrued expenses and other long-term liabilities decreased $1.1 million as aresult of $2.3 million of payments made against the captive insurance company’sreserves for workers compensation claims and $1.9 million of payments madeagainst the restructuring reserve. These decreases were offset by an increase in accrued interest of $3.6million related to the timing of interest payment dates. Available borrowingsunder the revolving credit facility were $15.7 million as of September 29,2002. Total letters of credit issued and outstanding were $14.3 million andthere were no revolving credit loans outstanding.

 

                                                Additional sources of liquidity consistof capital and operating leases for financing leased restaurant locations (inmalls and shopping centers and land or building leases), restaurant equipment,manufacturing equipment, distribution vehicles and computer equipment.Additionally, sales of under-performing existing restaurant properties and otherassets (to the extent FICC’s and its subsidiaries’ debt instruments, if any,permit) are sources of cash. The amount of debt financing that FICC will beable to incur is limited by the terms of its New Credit Facility and SeniorNotes.

 

                                                Net cash (used in) provided by investingactivities was ($5.6 million) and $15.1 million for the nine months endedSeptember 29, 2002 and September 30, 2001, respectively. Capital expendituresfor restaurant operations were approximately $7.5 million and $6.2 million forthe nine months ended September 29, 2002 and September 30, 2001, respectively.Capital expenditures were offset by proceeds from the sales of property andequipment of $3.4 million and $23.6 million in the 2002 period and the 2001period, respectively. The decrease in proceeds was primarily due to the receiptof $18.0 million in 2001 related to sales of restaurants to franchisees.

 

                                                The Company had working capital of $1.0million as of September 29, 2002 versus a working capital deficit of $19.4million as of December 30, 2001. The Company is able to operate with asubstantial 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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In December 2001, theCompany completed a financial restructuring plan (the “Refinancing Plan”) whichincluded the repayment of the $64.5 million outstanding under the Old CreditFacility and the repurchase of approximately $21.3 million in Senior Notes withthe proceeds from $55.0 million in long-term mortgage financing (the “MortgageFinancing”) and a $33.7 million sale and leaseback transaction (the“Sale/Leaseback Financing”). In addition, FICC secured a new $30.0 millionrevolving credit facility (the “New Credit Facility”) of which up to $20.0 millionis available to support letters of credit. The $30.0 million commitment lessoutstanding letters of credit is available for borrowing to provide workingcapital and for other corporate needs. As of September 29, 2002, $15.7 millionwas available for additional borrowings under the New Credit Facility. Therefinancing improved the Company’s financial condition by reducing total debtby approximately $30.8 million and by extending the average life of theCompany’s debt.

 

                                                Three new limited liability corporations(“LLCs”) were organized in connection with the Mortgage Financing. Friendly IceCream Corporation is the sole member of each LLC. FICC sold 75 of its operatingFriendly’s restaurants to the LLCs in exchange for the proceeds from theMortgage Financing. Promissory notes were issued for each of the 75 properties.Each LLC is a separate entity with separate creditors which will be entitled tobe satisfied out of such LLC’s assets. Each LLC is a borrower under theMortgage Financing.

 

                                                The Mortgage Financing has a maturitydate of January 1, 2022 and is amortized over 20 years. Interest on $10.0million of the Mortgage Financing is variable and is the sum of the 30-dayLIBOR rate in effect (1.82% at September 29, 2002) plus 6% on an annual basis.Changes in the interest rate are calculated monthly and recognized annuallywhen the monthly payment amount is adjusted. Changes in the monthly paymentamounts owed due to interest rate changes are reflected in the principalbalances which are re-amortized over the remaining life of the mortgages. Theremaining $45.0 million of the Mortgage Financing bears interest at a fixedannual rate of 10.16%. Each promissory note may be prepaid in full. Thevariable rate notes are subject to prepayment penalties during the first fiveyears. The fixed rate notes may not be prepaid without the Company providingthe note holders with a yield maintenance premium.

 

                                                The Mortgage Financing requires theCompany to maintain an annual fixed charge coverage ratio, as defined, of atleast 1.10 to 1 and each LLC to maintain a fixed charge coverage ratio, asdefined, on an aggregate restaurant basis of at least 1.25 to 1.

 

                                                The New Credit Facility is secured bysubstantially all of the assets of FICC and two of its six subsidiaries, Friendly’sRestaurants Franchise Inc. and Friendly’s International Inc. These twosubsidiaries also guaranty FICC’s obligations under the New Credit Facility.The New Credit Facility expires on December 17, 2004. As of September 29, 2002,there were no revolving credit loans outstanding.

 

                                                The revolving credit loans bear interestat the Company’s option at either (a) the Base Rate plus the applicable marginas in effect from time to time (the “Base Rate”) (6.75% at September 29, 2002)or (b) the Eurodollar rate plus the applicable margin as in effect from time totime (the “Eurodollar Rate”) (5.76% at September 29, 2002).

 

                                                As of September 29, 2002 and December 30,2001, total letters of credit issued and outstanding were $14.3 million and$14.6 million, respectively.

 

                                                The New Credit Facility has an annual“clean-up” provision which obligates the Company to repay in full all revolvingcredit loans on or before September 30 (or, if September 30 is not a businessday, as defined, then the next business day) of each year and maintain a zerobalance on such revolving credit for at least 30 consecutive days, to includeSeptember 30, immediately following the date of such repayment.

 

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The New CreditFacility includes certain restrictive covenants including limitations onindebtedness, limitations on restricted payments such as dividends and stockrepurchases and limitations on sales of assets and of subsidiary stock.Additionally, the New Credit Facility limits the amount which the Company mayspend on capital expenditures, restricts the use of proceeds, as defined, fromasset sales and requires the Company to comply with certain financialcovenants.

 

                                                In connection with the Refinancing Plan,in December 2001 the Company entered into and accounted for the Sale/LeasebackFinancing which provided approximately $33.7 million of proceeds to theCompany. The Company sold 44 properties operating as Friendly’s Restaurants andentered into a master lease with the buyer to lease the 44 properties for aninitial term of 20 years under a triple net lease. There are four five-yearrenewal options and lease payments are subject to escalator provisions everyfive years based upon increases in the Consumer Price Index. A gain of $11.3 millionwas deferred and was included in other accrued expenses and other long-termliabilities in the accompanying condensed consolidated balance sheets. Thedeferred gain is being amortized in proportion to the rent charged to expenseover the initial lease term.

 

                                                The $200 million Senior Notes issued inconnection with the November 1997 Recapitalization (the “Senior Notes”)are unsecured senior obligations of FICC, guaranteed on an unsecured seniorbasis by FICC’s Friendly’s Restaurants Franchise, Inc. subsidiary, but areeffectively subordinated to all secured indebtedness of FICC, including theindebtedness incurred under the New Credit Facility. The Senior Notes mature onDecember 1, 2007. Interest on the Senior Notes is payable at 10.50% perannum semi–annually on June 1 and December 1 of each year. Inconnection with the Refinancing Plan, FICC repurchased approximately $21.3million in aggregate principal amount of the Senior Notes for $17.0 million.The gain of $4.3 million ($2.5 million net of tax) was recorded as anextraordinary item in the consolidated statement of operations for the yearended December 30, 2001. The remaining Senior Notes are redeemable, in whole orin part, at FICC’s option any time on or after December 1, 2002 atredemption prices from 105.25% to 100.00%, based on the redemption date.

 

                                                The Company anticipates requiring capitalin the future principally to maintain existing restaurant and plant facilitiesand to continue to renovate and re-image existing restaurants. Capital expendituresfor 2002 are anticipated to be $18.0 million in the aggregate, of which $15.0million is expected to be spent on restaurant operations. The Company’s actual2002 capital expenditures may vary from these estimated amounts. The Companybelieves that the combination of the funds anticipated to be generated fromoperating activities and borrowing availability under the New Credit Facilitywill be sufficient to meet the Company’s anticipated operating requirements,capital requirements and obligations associated with the restructuring.

 

                                                The following represents the contractualobligations and commercial commitments of the Company as of September 29, 2002(in thousands):

 
|                          |   |      |    | **Payments  due by Period** |   |
|-------------------------------|--------|-----------|---------|-----------------------------|--------|
| **Contractual  Obligations:** |   | **Total** |    | **2002**                    |   | **2003-2004** |   | **2005-2006** |   | **Thereafter** |   |
| Long-term debt                |   | $         | 233,112 |                        | $      | 243 |   | $ | 2,107 |   | $ | 2,583 |   | $ | 228,179 |   |
| Capital lease  obligations    |   | 6,722     |    | 460                         |   | 1,933 |   | 1,037 |   | 3,292 |   |
| Operating leases              |   | 154,361   |    | 16,839                      |   | 29,587 |   | 24,070 |   | 83,865 |   |
| Purchase  commitments         |   | 66,113    |    | 31,688                      |   | 34,352 |   | 65 |   | 8 |   |
|                               |        |           |         |                             |        |  |  |  |  |  |  |  |  |  |  |  |

 
|                               |   |      |   | **Amount of  Commitment Expiration by Period** |   |
|------------------------------------|--------|-----------|--------|------------------------------------------------|--------|
| **Other  Commercial Commitments:** |   | **Total** |   | **2002**                                       |   | **2003-2004** |   | **2005-2006** |   | **Thereafter** |   |
| Revolving credit  facility         |   | $         | 15,660 |                                           | $      | — |   | $ | 15,660 |   | $ | — |   | $ | — |   |
| Letters of  credit                 |   | 14,340    |   | —                                         |   | 14,340 |   | — |   | — |   |
|                                    |        |           |        |                                                |        |  |  |  |  |  |  |  |  |  |  |  |

 

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                                                **Seasonality**

 

                                                Due to the seasonality of frozen dessertconsumption, and the effect from time to time of weather on patronage of therestaurants, the Company’s revenues and EBITDA are typically higher in itssecond and third fiscal quarters.

 

**                                               ****Geographic Concentration**

 

                                                Approximately 89% of the Company–ownedrestaurants 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.

 

**Significant Known Events, Trends orUncertainties Expected to Impact 2002 Comparisons with 2001**

 

**Pension Plan Funded Status**

 

                                                Certain of our employees are coveredunder a noncontributory defined benefit pension plan. As disclosed in our 2001Form 10-K, as of our 2001 measurement date (i.e., the Company’s fiscal 2001year end), this plan had a projected benefit obligation of $85.3 million and afair value of plan assets of $100.1 million. As a result of the overall declinein market interest rates, we will use a lower discount rate to measure ourprojected benefit obligation as of our 2002 measurement date. This will resultin an increase to our projected benefit obligation. Stock market declinesexperienced since the 2001 measurement date have reduced the fair value of ourplan assets. As a result of the higher projected benefit obligation and thedecline in the fair value of our plan assets, we expect our pension plan to beunderfunded as of our 2002 measurement date as compared to an over-funding asof our 2001 measurement date. Though we have not yet determined the exactamount of such underfunding, we currently estimate the amount of underfundingwill be approximately $18.0 million. We do not believe the underfunded status ofthe pension plan will materially affect our results of operations, financialposition or cash flows. Moreover, given the sensitivity of the projectedbenefit obligation to changes in discount rates, future changes in marketinterest rates may significantly reduce our pension plan underfunding.

 

                                                Additionally, as a result of theunderfunded status of the plan, we will likely be required to record a chargeto stockholders’ deficit. Although we have not yet determined the exact amountof the charge we will record in 2002, we anticipate that it will be less thanthe amount of the underfunding. By comparison, our stockholders’ deficit hasdecreased by more than $7.0 million during the nine months ended September 29,2002.

 

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**Significant Accounting Policies**

 

                                                Financial Reporting Release No. 60 issuedby the Securities and Exchange Commission requires all companies to include adiscussion of critical accounting policies or methods used in the preparationof financial statements. The following is a brief discussion of the moresignificant accounting policies and methods used by the Company. The Company’sconsolidated financial statements, including the notes thereto, which arecontained in the 2001 Annual Report on Form 10-K should be read in conjunctionwith this discussion.

 

*                                               **Use of Estimates in thePreparation of Financial Statements -*

 

                                                The preparation of financial statementsin conformity with accounting principles generally accepted in the UnitedStates requires management to make estimates and assumptions that affect thereported amounts of assets and liabilities and the disclosure of contingentassets and liabilities at the dates of the financial statements and thereported amounts of revenues and expenses during the reporting periods. Thecritical accounting policies and most significant estimates and assumptionsrelate to revenue recognition, insurance reserves, recoverability of accountsreceivable, restructuring reserves, valuation allowances and pension and otherpost-retirement benefits expense. Actual amounts could differ significantlyfrom the estimates.

 

                                                *Revenue Recognition -*

 

                                                The Company’s revenues are derivedprimarily from the operation of full-service restaurants, the distribution andsale of frozen desserts through retail and institutional locations andfranchising. The Company recognizes restaurant revenue upon receipt of paymentfrom the customer and retail revenue upon shipment of product. Reserves fordiscounts and allowances from retail sales are estimated and accrued whenrevenue is recorded. Actual amounts could differ materially from the estimates.Franchise royalty income, based on net sales of franchisees, is payable monthlyand is recorded on the accrual method. Initial franchise fees are recorded asrevenue upon completion of all significant services, generally upon opening ofthe restaurant.

 

*                                               **Insurance Reserves -*

 

                                                The Company is self–insured throughretentions or deductibles for the majority of its workers’ compensation,automobile, general liability, employer’s liability, product liability andgroup health insurance programs. Self–insurance amounts vary up to $0.5million per occurrence. Insurance with third parties, some of which is thenreinsured through RIC, is in place for claims in excess of these self–insuredamounts. RIC reinsured 100% of the risk from $0.5 million to $1.0 million peroccurrence through September 2, 2000 for the Company’s workers’ compensation,general liability, employer’s liability and product liability insurance.Subsequent to September 2, 2000, the Company discontinued its use of RIC as acaptive insurer for new claims. The Company’s and RIC’s liability for estimatedincurred losses are actuarially determined and recorded in the accompanyingcondensed consolidated financial statements on an undiscounted basis. Actualincurred losses may vary from the estimated incurred losses and could have amaterial effect on the Company’s insurance expense.

 

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                                                *Restructuring Reserves-*

 

                                                On October 10, 2001, the Companyeliminated approximately 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 amongst 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 approximately$2.5 million for severance, rent and unusable construction supplies in the yearended December 30, 2001.

 

                                                In March 2000, the Company’s Board ofDirectors approved a restructuring plan that provided for the immediate closingof 81 restaurants at the end of March 2000 and the disposition of an additional70 restaurants over the next 24 months. As a result of this plan, the Companyreported a pre-tax restructuring charge of approximately $12.1 million forseverance, rent, utilities and real estate taxes, demarking, lease terminationcosts and certain other costs associated with the closing of the locations,along with a pre-tax write-down of property and equipment for these locationsof approximately $17.0 million in the year ended December 31, 2000. The Companyreduced the restructuring reserve by $0.4 million and $1.9 million during thenine months ended September 29, 2002 and the year ended December 30, 2001,respectively, since the reserve exceeded estimated remaining payments.

 

                                                As of September 29, 2002, the remainingrestructuring reserve was $1.4 million. The restructuring reserves may beincreased or decreased based upon remaining payments, which could varymaterially from the estimates depending upon the timing of restaurant closingsand other factors.

 

*                                               **Income Taxes -*

 

                                                The Company accounts for income taxes inaccordance with SFAS No. 109, “Accounting for Income Taxes,” which requiresrecognition of deferred tax assets and liabilities for the expected future taxconsequences of events that have been included in the financial statements ortax returns. A valuation allowance is recorded for deferred tax assets whoserealization is not likely. As of December 30, 2001 and September 29, 2002, avaluation allowance of $11.3 million existed related to state NOL carryforwardsdue to restrictions on the usage of state NOL carryforwards and shortcarryforward periods for certain states. Taxable income by state for futureperiods is difficult to estimate. The amount and timing of any future taxableincome may affect the usage of such carryforwards, which could result in amaterial change in the valuation allowance.

 

*                                               **Pension and OtherPost-Retirement Benefits -*

 

                                                The determination of the Company’sobligation and expense for pension and other post-retirement benefits isdependent upon the selection of certain assumptions used by actuaries incalculating such amounts. Those assumptions include, among other things, thediscount rate, expected long-term rate of return on plan assets and rates ofincrease in compensation and health care costs. In accordance with accountingprinciples generally accepted in the United States, actual results that differfrom the assumptions are accumulated and amortized over future periods and,therefore, generally affect the recognized expense and recorded obligation insuch future periods. Significant differences in actual experience orsignificant changes in the assumptions may materially affect the future pensionand other post-retirement obligations and expense.

 

                                                *Stock-BasedCompensation —*

 

                                                The Company accounts for stock–basedcompensation for employees under APB Opinion No. 25, “Accounting for StockIssued to Employees,” and elected the disclosure–only alternative underSFAS No. 123, “Accounting for Stock–Based Compensation.”

 

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                                                **Recently Issued Accounting Pronouncements**

 

In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (“EITF”) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The principal difference between SFAS No. 146 and EITF Issue No. 94-3 relates to the timing of liability recognition. Under SFAS No. 146, a liability for a cost associated with an exit or disposal activity is recognized when the liability is incurred. Under EITF Issue No. 94-3, a liability for an exit cost was recognized at the date of an entity’s commitment to an exit plan. The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS No. 146 is not expected to have a material impact on the Company’s financial position or results of operations.

 

In April 2002, the FASB issued SFAS No. 145, “Rescission of SFAS Nos. 4, 44, and 64, Amendment of SFAS No. 13, and Technical Corrections.” SFAS No. 4 required all gains and losses from the extinguishment of debt to be reported as extraordinary items and SFAS No. 64 related to the same matter. SFAS No. 145 requires gains and losses from certain debt extinguishment not to be reported as extraordinary items when the use of debt extinguishment is part of a risk management strategy. SFAS No. 44 was issued to establish transitional requirements for motor carriers. Those transitions are completed, therefore SFAS No. 145 rescinds SFAS No. 44. SFAS No. 145 also amends SFAS No. 13 requiring sale-leaseback accounting for certain lease modifications. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002. The provisions relating to sale-leaseback accounting are effective for transactions after May 15, 2002. The adoption of SFAS No. 145 is not expected to have a material impact on the Company’s financial position or results of operations.

 

                                                In August 2001, the FASB issued SFAS No.144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No.144 modifies the rules for accounting for the impairment or disposal oflong-lived assets. The impact of adopting SFAS No. 144 on December 31, 2001 hadno material effect on the Company’s financial condition or results ofoperations.

 

In June 2001, the FASB issued SFAS No. 142, “Goodwilland Other Intangibles.” SFAS No. 142 modifies the rules for accounting forgoodwill and other intangible assets. The new rules became effective for theCompany on December 31, 2001. The impact of adopting SFAS No. 142 in 2002 hadno effect on the Company’s financial condition or results of operations and theCompany is continuing to amortize its license agreement related to certaintrademarked products over the term of the license agreement.

 

                                                In April 2001, the FASB reached consensuson EITF Issue No. 00-25, “Accounting for Consideration from a Vendor to aRetailer in Connection with the Purchase or Promotion of the Vendor’sProducts.” EITF Issue No. 00-25 was effective for quarters beginning afterDecember 15, 2001, with prior financial statements restated if practicable.EITF Issue No. 00-25 requires that consideration from a vendor to a retailer berecorded as a reduction in revenue unless certain criteria are met. Arrangementswithin the scope of this Issue include slotting fees, cooperative advertisingarrangements and buy-downs. The Company adopted EITF Issue No. 00-25 during2001 and, as a result, certain costs previously recorded as expense werereclassified and offset against revenue for the quarter and nine months endedSeptember 30, 2001.

 

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**Item 3. Quantitative and Qualitative Disclosures About MarketRisk**

 

**                                               **There has been no material change in theCompany’s market risk exposure since the filing of the Annual Report on Form10-K.

 

**Item 4.Controls and Procedures**

 

As of September 29, 2002,an evaluation was performed under the supervision and with the participation ofthe Company’s management, including the CEO and CFO, of the effectiveness ofthe design and operation of the Company’s disclosure controls andprocedures.  Based on that evaluation,the Company’s management, including the CEO and CFO, concluded that theCompany’s disclosure controls and procedures were effective as of September 29,2002.  There have been no significantchanges in the Company’s internal controls or in other factors that couldsignificantly affect internal controls subsequent to September 29, 2002.

 

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**PART II — OTHER INFORMATION**

 

**Item 4.  Submission ofmatters to a vote of security holders**

 

(a)          An annual meeting of the Company’s shareholders washeld on May 15, 2002.

 

(b)         Not applicable.

 

(c)          The election of two nominees for directors of theCompany was voted upon at the meeting. The number of affirmative votes and thenumber of votes withheld with respect to such approvals are as follows:

 

| **Nominee**                |   | **Affirmative  Votes** |   | **Votes  Withheld** |   |
|----------------------------|--------|------------------------|--------|---------------------|--------|
| Steven L. Ezzes            |   | 5,303,820              |   | 268,086             |   |
| Charles A.  Ledsinger, Jr. |   | 5,328,679              |   | 243,227             |   |

 

There were no mattersvoted upon at the Company’s annual meeting to which broker non-votes applied.

 

**Item 6.  Exhibits andreports on Form 8-K**

 

(a)          Exhibits

 

None

 

(b)         Reports on Form 8-K

 
| **Date of  Event Reported** |   | **Event  Reported**                                                                                  |   |
|-----------------------------|--------|------------------------------------------------------------------------------------------------------|--------|
| May 15, 2002                |   | Item 4 — Changes  in Registrant’s Certifying Accountant                                    |   |
| May 15, 2002                |   | Item 7 — Exhibit  16.1, Letter of Arthur Andersen LLP regarding change in certifying accountant |   |

 

 

**SIGNATURES**

 

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

 
|   | FRIENDLY ICE CREAM CORPORATION |
|--------|--------------------------------|
|   |                           |   |
|   | By:                            | /s/ PAUL V. HOAGLAND |
|   |                           | Name:  Paul  V. Hoagland |
|   |                           | Title:   Senior Vice President, |
|   |                           | Chief Financial Officer, Treasurer and |
|   |                           | Assistant Clerk |

 

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**Certifications**

I, Donald N. Smith, certify that:

 

1.               I have reviewed this quarterly report on Form 10-Qof Friendly Ice Cream Corporation;

 

2.               Based on my knowledge, this quarterly report doesnot contain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodcovered by this quarterly report;

 

3.               Based on my knowledge, the financial statements,and other financial information included in this quarterly report, fairlypresent in all material respects the financial condition, results of operationsand cash flows of the registrant as of, and for, the periods presented in thisquarterly report;

 

4.               The registrant’s other certifying officers and Iare responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and have:

 

a)              designed such disclosure controls and procedures toensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this quarterly report is beingprepared;

 

b)             evaluated the effectiveness of the registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this quarterly report (the “Evaluation Date”); and

 

c)              presented in this quarterly report our conclusions aboutthe effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5.               The registrant’s other certifying officers and Ihave disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent functions):

 

a)              all significant deficiencies in the design or operationof internal controls which could adversely affect the registrant’s ability torecord, process, summarize and report financial data and have identified forthe registrant’s auditors any material weaknesses in internal controls; and

 

b)             any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls; and

 

6.               The registrant’s other certifying officers and Ihave indicated in this quarterly report whether there were significant changesin internal controls or in other factors that could significantly affectinternal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 

Date: October 30, 2002 
|   | /s/  Donald N. Smith |
|--------|--------------------------------|
|   | *Chief Executive Officer*      |

 

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I, Paul V. Hoagland, certify that:

 

1.               I have reviewed this quarterly report on Form 10-Qof Friendly Ice Cream Corporation;

 

2.               Based on my knowledge, this quarterly report doesnot contain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodcovered by this quarterly report;

 

3.               Based on my knowledge, the financial statements,and other financial information included in this quarterly report, fairlypresent in all material respects the financial condition, results of operationsand cash flows of the registrant as of, and for, the periods presented in thisquarterly report;

 

4.               The registrant’s other certifying officers and Iare responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and have:

 

a)              designed such disclosure controls and procedures toensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this quarterly report is beingprepared;

 

b)             evaluated the effectiveness of the registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this quarterly report (the “Evaluation Date”); and

 

c)              presented in this quarterly report our conclusions aboutthe effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5.               The registrant’s other certifying officers and Ihave disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent functions):

 

a)              all significant deficiencies in the design or operationof internal controls which could adversely affect the registrant’s ability torecord, process, summarize and report financial data and have identified forthe registrant’s auditors any material weaknesses in internal controls; and

 

b)             any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls; and

 

6.               The registrant’s other certifying officers and Ihave indicated in this quarterly report whether there were significant changesin internal controls or in other factors that could significantly affectinternal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 

Date: October 30, 2002
|   |   | /s/  Paul V. Hoagland                           |
|--------|--------|-----------------------------------------------------------|
|   |   | *Chief Financial Officer, Treasurer  and Assistant Clerk* |

 

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