** **

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-Q/A**

** **

**(Amendment No. 1)**

** **

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

** **

**For the quarterly period ended June 30, 2002**

** **

**OR**

** **

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

 

**For thetransition periodfrom          to          **

** **

**Commission File No. 0-3930**

** **

| **FRIENDLY  ICE CREAM CORPORATION**                                                                                          |
|------------------------------------------------------------------------------------------------------------------------------|
| (Exact name of  registrant as 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 zip  code, and telephone number, including  area code, of registrant’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  o

 

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

 

| **Class**                     |   | **Outstanding at July 12, 2002** |
|-------------------------------|--------|----------------------------------|
|                          |   |                             |
| Common Stock, $.01 par  value |   | 7,370,763 shares                 |

 

 

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**IntroductoryNote - Restatements**

 

Friendly Ice Cream Corporation (the “Company”) as aresult of an extensive review of its accounting policies determined that itspolicy for recording restaurant advertising expense, included in operatingexpenses, although proper for annual reporting, needed to be revised for theCompany’s quarterly reporting.  Accordingly,the accompanying financial statements and related disclosures have beenrestated to reflect this accounting change. This Form 10-Q/A does not modify orupdate any disclosures except as required to reflect the results of therestatement discussed above on current period and prior period financialinformation.

 

1

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**PART I - FINANCIAL INFORMATION**

 

**Item1.  Financial Statements**

 

**FRIENDLY ICE CREAM CORPORATION AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED BALANCE SHEETS**

 

(In thousands)

 
|                                                                      |   | **June 30,  2002** |       | **December  30,  2001** |       |
|---------------------------------------------------------------------------|--------|--------------------|------------|-------------------------|------------|
|                                                                      |   | **(unaudited)**    |       |                    |       |
| ASSETS                                                                    |   |               | ** ** |                    | ** ** |
| CURRENT  ASSETS:                                                          |   |               | ** ** |                    | ** ** |
| Cash  and cash equivalents                                                |   | $                  | 20,130     |                    | $          | 16,342 |   |
| Accounts  receivable                                                      |   | 12,519             |       | 9,969                   |       |
| Inventories                                                               |   | 18,177             |       | 12,987                  |       |
| Deferred  income taxes                                                    |   | 7,659              |       | 7,659                   |       |
| Prepaid  expenses and other current assets                                |   | 4,316              |       | 3,736                   |       |
| TOTAL  CURRENT ASSETS                                                     |   | 62,801             |       | 50,693                  |       |
| PROPERTY  AND EQUIPMENT, net of accumulated depreciation and amortization |   | 159,998            |       | 169,489                 |       |
| INTANGIBLE  ASSETS AND DEFERRED COSTS, net of accumulated amortization    |   | 20,455             |       | 21,208                  |       |
| OTHER  ASSETS                                                             |   | 13,015             |       | 11,172                  |       |
| TOTAL  ASSETS                                                             |   | $                  | 256,269    |                    | $          | 252,562 |   |
|                                                                      |   |               |       |                    |       |
| LIABILITIES AND STOCKHOLDERS’ DEFICIT                                |   |               | ** ** |                    | ** ** |
| CURRENT  LIABILITIES:                                                     |   |               | ** ** |                    | ** ** |
| Current  maturities of long-term debt                                     |   | $                  | 965        |                    | $          | 1,068 |   |
| Current  maturities of capital lease and finance obligations              |   | 1,790              |       | 1,851                   |       |
| Accounts  payable                                                         |   | 23,041             |       | 20,505                  |       |
| Accrued  salaries and benefits                                            |   | 9,706              |       | 9,436                   |       |
| Accrued  interest payable                                                 |   | 1,980              |       | 1,543                   |       |
| Insurance  reserves                                                       |   | 13,067             |       | 13,333                  |       |
| Restructuring  reserves                                                   |   | 1,600              |       | 3,056                   |       |
| Other  accrued expenses                                                   |   | 16,850             |       | 19,260                  |       |
| TOTAL  CURRENT LIABILITIES                                                |   | 68,999             |       | 70,052                  |       |
| DEFERRED  INCOME TAXES                                                    |   | 12,670             |       | 10,584                  |       |
| CAPITAL  LEASE AND FINANCE OBLIGATIONS, less current maturities           |   | 5,400              |       | 6,267                   |       |
| LONG-TERM  DEBT, less current maturities                                  |   | 232,369            |       | 232,797                 |       |
| OTHER  LONG-TERM LIABILITIES                                              |   | 29,217             |       | 28,876                  |       |
| COMMITMENTS  AND CONTINGENCIES                                            |   |               |       |                    |       |
| STOCKHOLDERS’  DEFICIT:                                              |   |               |       |                    |       |
| Common  stock                                                             |   | 74                 |       | 74                      |       |
| Additional  paid-in capital                                               |   | 139,511            |       | 139,290                 |       |
| Accumulated  deficit                                                      |   | (231,971           | )          | (235,378                | )          |
| TOTAL  STOCKHOLDERS’ DEFICIT                                         |   | (92,386            | )          | (96,014                 | )          |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ DEFICIT                         |   | $                  | 256,269    |                    | $          | 252,562 |   |

 

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

 

2

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**FRIENDLYICE CREAM CORPORATION AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

(Unaudited)

(In thousands, except pershare data)

 
|                                                             |   | **For the Three Months Ended** |    | **For the Six Months Ended** |   |
|------------------------------------------------------------------|--------|--------------------------------|---------|------------------------------|--------|
|                                                             |   | **June 30,  2002**             |    | **July 1,  2001**            |   | **June 30,  2002** |   | **July 1,  2001** |   |
|                                                             |   |                           |    |                         |   |   |   |   |   |
| REVENUES                                                         |   | $                              | 155,994 |                         | $      | 151,823 |   | $ | 287,480 |   | $ | 277,542 |   |
|                                                             |   |                           |    |                         |   |   |   |   |   |
| COSTS AND  EXPENSES:                                             |   |                           |    |                         |   |   |   |   |   |
| Cost of sales                                                    |   | 52,890                         |    | 52,857                       |   | 98,884 |   | 94,917 |   |
| Labor and benefits                                               |   | 42,243                         |    | 41,334                       |   | 80,161 |   | 81,010 |   |
| Operating  expenses                                              |   | 33,297                         |    | 31,608                       |   | 59,695 |   | 56,552 |   |
| General and  administrative expenses                             |   | 8,681                          |    | 9,345                        |   | 17,280 |   | 18,677 |   |
| Reduction of  restructuring reserve                              |   | (400                           | )       | —                       |   | (400 | ) | — |   |
| Write-downs of  property and equipment                           |   | 311                            |    | 68                           |   | 431 |   | 68 |   |
| Depreciation and  amortization                                   |   | 6,387                          |    | 7,097                        |   | 13,073 |   | 14,649 |   |
| Gain on  franchise sales of restaurant operations and properties |   | —                         |    | (3,823                       | )      | — |   | (3,823 | ) |
| Loss (gain) on  sales of other property and equipment, net       |   | 129                            |    | (261                         | )      | 641 |   | (2,242 | ) |
|                                                             |   |                           |    |                         |   |   |   |   |   |
| OPERATING INCOME                                                 |   | 12,456                         |    | 13,598                       |   | 17,715 |   | 17,734 |   |
|                                                             |   |                           |    |                         |   |   |   |   |   |
| Interest  expense, net                                           |   | 6,215                          |    | 6,918                        |   | 12,552 |   | 14,503 |   |
|                                                             |   |                           |    |                         |   |   |   |   |   |
| INCOME BEFORE  PROVISION FOR INCOME TAXES                        |   | 6,241                          |    | 6,680                        |   | 5,163 |   | 3,231 |   |
|                                                             |   |                           |    |                         |   |   |   |   |   |
| Provision for  income taxes                                      |   | (2,426                         | )       | (2,639                       | )      | (1,756 | ) | (1,125 | ) |
|                                                             |   |                           |    |                         |   |   |   |   |   |
| NET INCOME                                                       |   | $                              | 3,815   |                         | $      | 4,041 |   | $ | 3,407 |   | $ | 2,106 |   |
|                                                             |   |                           |    |                         |   |   |   |   |   |
| BASIC NET INCOME  PER SHARE                                      |   | $                              | 0.52    |                         | $      | 0.55 |   | $ | 0.46 |   | $ | 0.29 |   |
|                                                             |   |                           |    |                         |   |   |   |   |   |
| DILUTED NET  INCOME PER SHARE                                    |   | $                              | 0.49    |                         | $      | 0.55 |   | $ | 0.44 |   | $ | 0.29 |   |
|                                                             |   |                           |    |                         |   |   |   |   |   |
| WEIGHTED AVERAGE  SHARES:                                        |   |                           |    |                         |   |   |   |   |   |
| Basic                                                            |   | 7,366                          |    | 7,364                        |   | 7,359 |   | 7,370 |   |
| Diluted                                                          |   | 7,722                          |    | 7,370                        |   | 7,668 |   | 7,377 |   |

 

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

 

3

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**FRIENDLYICE CREAM CORPORATION AND SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

(Unaudited)

(In thousands)

 
|                                                                               |   | **For the Six Months Ended** |   |
|------------------------------------------------------------------------------------|--------|------------------------------|--------|
|                                                                               |   | **June 30,  2002**           |   | **July 1,  2001** |   |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                             |   |                         |   |   |   |
| Net income                                                                         |   | $                            | 3,407  |   | $ | 2,106 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |   |                         |   |   |   |
| Stock  compensation expense                                                        |   | 133                          |   | 168 |   |
| Depreciation and  amortization                                                     |   | 13,073                       |   | 14,649 |   |
| Write-downs of  property and equipment                                             |   | 431                          |   | 68 |   |
| Deferred income  tax expense                                                       |   | 2,086                        |   | 1,125 |   |
| Loss (gain) on  sales of other property and equipment, net                         |   | 641                          |   | (6,023 | ) |
| Changes in  operating assets and liabilities:                                      |   |                         |   |   |   |
| Accounts  receivable                                                               |   | (2,550                       | )      | (5,656 | ) |
| Inventories                                                                        |   | (5,190                       | )      | (3,875 | ) |
| Other assets                                                                       |   | (2,669                       | )      | (542 | ) |
| Accounts payable                                                                   |   | 2,536                        |   | 4,623 |   |
| Accrued expenses  and other long-term liabilities                                  |   | (3,221                       | )      | (3,520 | ) |
| NET CASH  PROVIDED BY OPERATING ACTIVITIES                                         |   | 8,677                        |   | 3,123 |   |
|                                                                               |   |                         |   |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                             |   |                         |   |   |   |
| Purchases of  property and equipment                                               |   | (4,811                       | )      | (5,726 | ) |
| Proceeds from  sales of property and equipment                                     |   | 1,293                        |   | 19,868 |   |
| NET CASH (USED  IN) PROVIDED BY INVESTING ACTIVITIES                               |   | (3,518                       | )      | 14,142 |   |
|                                                                               |   |                         |   |   |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                             |   |                         |   |   |   |
| Proceeds from  borrowings                                                          |   | —                       |   | 34,000 |   |
| Repayments of  debt                                                                |   | (531                         | )      | (54,404 | ) |
| Repayments of  capital lease and finance obligations                               |   | (928                         | )      | (1,099 | ) |
| Stock options  exercised                                                           |   | 88                           |   | — |   |
| NET CASH USED IN  FINANCING ACTIVITIES                                             |   | (1,371                       | )      | (21,503 | ) |
|                                                                               |   |                         |   |   |   |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                              |   | 3,788                        |   | (4,238 | ) |
|                                                                               |   |                         |   |   |   |
| CASH AND CASH  EQUIVALENTS, BEGINNING OF PERIOD                                    |   | 16,342                       |   | 14,584 |   |
|                                                                               |   |                         |   |   |   |
| CASH AND CASH  EQUIVALENTS, END OF PERIOD                                          |   | $                            | 20,130 |   | $ | 10,346 |   |
|                                                                               |   |                         |   |   |   |
| SUPPLEMENTAL  DISCLOSURES:                                                         |   |                         |   |   |   |
| Cash paid  (refunded) during the period for:                                       |   |                         |   |   |   |
| Interest                                                                           |   | $                            | 11,648 |   | $ | 15,498 |   |
| Income taxes                                                                       |   | (18                          | )      | 3 |   |
| Capital lease  obligations terminated                                              |   | —                       |   | 151 |   |
| Note received  from sale of property and equipment                                 |   | —                       |   | 4,250 |   |

 

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

 

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**FRIENDLY ICE CREAM CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

(Unaudited)

 

**1.  BASIS OF PRESENTATION AND SIGNIFICANTACCOUNTING POLICIES**

 

*InterimFinancial Information -*

 

The accompanying condensed consolidated financialstatements as of June 30, 2002 and for the second quarters and six months endedJune 30, 2002 and July 1, 2001 are unaudited, but, in the opinion ofmanagement, include all adjustments which are necessary for a fair presentationof the consolidated financial position, results of operations, cash flows andcomprehensive income of Friendly Ice Cream Corporation (“FICC”) andsubsidiaries (unless the context indicates otherwise, collectively, the“Company”). Such adjustments consist solely of normal recurring accruals.Operating results for the three and six month periods ended June 30, 2002 andJuly 1, 2001 are not necessarily indicative of the results that may be expectedfor the entire year due, in part, to the seasonality of the Company’s business.Historically, higher revenues and operating income have been experienced duringthe second and third fiscal quarters. The Company’s consolidated financialstatements, including the notes thereto, which are contained in the 2001 AnnualReport on Form 10-K should be read in conjunction with these condensedconsolidated financial statements. Capitalized terms not otherwise defined herein should be referenced tothe 2001 Annual Report on Form 10-K.

 

*Use ofEstimates in the Preparation of Financial Statements -*

 

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and the disclosure of contingent assets andliabilities at the dates of the financial statements and the reported amountsof revenues and expenses during the reporting periods. The critical accountingpolicies and most significant estimates and assumptions relate to revenuerecognition, insurance reserves, recoverability of accounts receivable,restructuring reserves, valuation allowances and pension and otherpost-retirement benefits expense. Actual amounts could differ significantlyfrom the estimates.

 

*RevenueRecognition -*

 

The Company’s revenues are derived primarily from theoperation of full-service restaurants, the distribution and sale of frozendesserts through retail and institutional locations and franchising. TheCompany recognizes restaurant revenue upon receipt of payment from the customerand retail revenue upon shipment of product. Reserves for discounts andallowances from retail sales are estimated and accrued when revenue isrecorded. Actual amounts could differ materially from the estimates. Franchiseroyalty income, based on net sales of franchisees, is payable monthly and isrecorded on the accrual method. Initial franchise fees are recorded as revenueupon completion of all significant services, generally upon opening of therestaurant.

 

5

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*InsuranceReserves -*

 

The Company is self-insured through retentions ordeductibles for the majority of its workers’ compensation, automobile, generalliability, employer’s liability, product liability and group health insuranceprograms. Self-insurance amounts vary up to $500,000 per occurrence. Insurancewith third parties, some of which is then reinsured through RIC, is in placefor claims in excess of these self-insured amounts. RIC reinsured 100% of therisk from $500,000 to $1,000,000 per occurrence through September 2, 2000 forthe Company’s workers’ compensation, general liability, employer’s liabilityand product liability insurance. Subsequent to September 2, 2000, the Companydiscontinued its use of RIC as a captive insurer for new claims. The Company’sand RIC’s liability for estimated incurred losses are actuarially determinedand recorded in the accompanying condensed consolidated financial statements onan undiscounted basis. Actual incurred losses may vary from the estimatedincurred losses and could have a material affect on the Company’s insuranceexpense.

 

*RestructuringReserves -*

 

On October 10, 2001, the Company eliminatedapproximately 70 positions at corporate headquarters. In addition,approximately 30 positions in the restaurant construction and fabrication areaswere eliminated by December 30, 2001. The purpose of the reduction was tostreamline functions and reduce redundancy 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$2,536,000 for severance, rent and unusable construction supplies in the yearended December 30, 2001.

 

In March 2000, the Company’s Board of Directorsapproved a restructuring plan that provided for the immediate closing of 81restaurants at the end of March 2000 and the disposition of an additional 70restaurants over the next 24 months. As a result of this plan, the Companyreported a pre-tax restructuring charge of 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 quarterended June 30, 2002 and the year ended December 30, 2001, respectively, sincethe reserve exceeded estimated remaining payments.

 

As of June 30, 2002, the remaining restructuringreserve was $1,600,000. The restructuring reserves may be increased ordecreased based upon remaining payments, which could vary materially from theestimates depending upon the timing of restaurant closings and other factors.

 

6

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*IncomeTaxes -*

 

The Company accounts for income taxes in accordancewith SFAS No. 109, “Accounting for Income Taxes,” which requires recognition ofdeferred tax assets and liabilities for the expected future tax consequences ofevents that have been included in the financial statements or tax returns. Avaluation allowance is recorded for deferred tax assets whose realization isnot likely. As of December 30, 2001 and June 30, 2002, 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.The amount and timing of any future taxable income may affect the usage of suchcarryforwards, which could result in a material change in the valuationallowance.

 

*Pensionand Other Post-Retirement Benefits -*

 

The determination of the Company’s obligation andexpense for pension and other post-retirement benefits is dependent upon theselection of certain assumptions used by actuaries in calculating such amounts.Those assumptions include, among other things, the discount rate, expectedlong-term rate of return on plan assets and rates of increase in compensationand health care costs. In accordance with accounting principles generallyaccepted in the United States, actual results that differ from the assumptionsare accumulated and amortized over future periods and, therefore, generallyaffect the recognized expense and recorded obligation in such future periods.While FICC believes that the assumptions used are appropriate, significantdifferences in actual experience or significant changes in the assumptions maymaterially affect the future pension and other post-retirement obligations andexpense.

 

*Debt -*

 

In December 2001, the Company completed a financialrestructuring plan (the “Refinancing Plan”) which included the repayment of$64,545,000 outstanding under the Old Credit Facility and the repurchase ofapproximately $21,300,000 in Senior Notes for $17,000,000 with the proceedsfrom $55,000,000 in long-term mortgage financing (the “Mortgage Financing”) anda $33,700,000 sale and leaseback transaction (the “Sale/Leaseback Financing”).In addition, FICC secured a new $30,000,000 revolving credit facility of whichup to $20,000,000 is available to support letters of credit. The $30,000,000commitment less outstanding letters of credit is available for borrowing toprovide working capital and for other corporate needs (the “New CreditFacility”).

 

7

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*Inventories-*

 

Inventories are stated at the lower of first-in,first-out cost or market.  Inventoriesas of June 30, 2002 and December 30, 2001 were as follows (in thousands):

 

|              |   | **June 30,  2002** |   | **December  30,  2001** |   |
|-------------------|--------|--------------------|--------|-------------------------|--------|
|              |   |               |   |                    |   |
| Raw  materials    |   | $                  | 916    |                    | $      | 1,269 |   |
| Goods  in process |   | 78                 |   | 73                      |   |
| Finished  goods   |   | 17,183             |   | 11,645                  |   |
|              |   |               |   |                    |   |
| Total             |   | $                  | 18,177 |                    | $      | 12,987 |   |

 

*Reclassifications-*

 

Certain prior year amounts have been reclassified toconform with current year presentation.

 

**2. EARNINGS PER SHARE**

 

Basic net income per share is calculated by dividingnet income by the weighted average number of common shares outstanding duringthe period. Diluted earnings per share is calculated by dividing net income bythe weighted average number of shares of common stock and common stockequivalents outstanding during the period. Common stock equivalents aredilutive stock options and warrants that are assumed exercised for calculationpurposes. The number of common stock options which could dilute basic earningsper share in the future, that were not included in the computation of dilutedincome per share because to do so would have been antidilutive was 55,340 and602,665 for the three months ended June 30, 2002 and July 1, 2001,respectively. The number of common stock options which could dilute basicearnings per share in the future, that were not included in the computation ofdiluted income per share because to do so would have been antidilutive, was308,923 and 602,665 for the six months ended June 30, 2002 and July 1, 2001,respectively.

 

8

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Presented below is the reconciliation between basicand diluted weighted average shares for the three and six months ended June 30,2002 and July 1, 2001 (in thousands):

 
|                                                                    |   | **For the Three Months Ended** |   |
|-------------------------------------------------------------------------|--------|--------------------------------|--------|
|                                                                    |   | **Basic**                      |   | **Diluted** |   |
|                                                                    |   | **June 30, 2002**              |   | **July 1, 2001** |   | **June 30, 2002** |   | **July 1, 2001** |   |
| Weighted average  number of common shares outstanding during the period |   | 7,366                          |   | 7,364 |   | 7,366 |   | 7,364 |   |
| Adjustments:                                                            |   |                           |   |   |   |   |   |   |   |
| Assumed exercise  of stock options                                      |   | —                         |   | — |   | 356 |   | 6 |   |
| Weighted average  number of shares outstanding                          |   | 7,366                          |   | 7,364 |   | 7,722 |   | 7,370 |   |

 
|                                                                    |   | **For the Six Months Ended** |   |
|-------------------------------------------------------------------------|--------|------------------------------|--------|
|                                                                    |   | **Basic**                    |   | **Diluted** |   |
|                                                                    |   | **June 30, 2002**            |   | **July 1, 2001** |   | **June 30, 2002** |   | **July 1, 2001** |   |
| Weighted average  number of common shares outstanding during the period |   | 7,359                        |   | 7,370 |   | 7,359 |   | 7,370 |   |
| Adjustments:                                                            |   |                         |   |   |   |   |   |   |   |
| Assumed exercise  of stock options                                      |   | —                       |   | — |   | 309 |   | 7 |   |
| Weighted average  number of shares outstanding                          |   | 7,359                        |   | 7,370 |   | 7,668 |   | 7,377 |   |

 

**3.  SEGMENT REPORTING**

 

Operating segments are components of an enterpriseabout which separate financial information is available that is evaluatedregularly by the chief operating decision-maker, or decision-making group, indeciding how to allocate resources and in assessing performance. The Company’schief operating decision-maker is the Chairman of the Board and Chief ExecutiveOfficer of the Company. The Company’s operating segments include restaurant,foodservice and franchise. The revenues from these segments include both salesto unaffiliated customers and intersegment sales, which generally are accountedfor on a basis consistent with sales to unaffiliated customers. Intersegmentsales and other intersegment transactions have been eliminated in theaccompanying condensed consolidated financial statements.

 

The Company’s restaurantstarget families with children and adults who desire a reasonably-priced meal ina full-service setting. The Company’s menu offers a broad selection offreshly-prepared foods which appeal to customers throughout all dayparts. Themenu currently features over 100 items comprised of a broad selection ofbreakfast, lunch, dinner and afternoon and evening snack items. Foodserviceoperations manufactures frozen dessert products and distributes suchmanufactured products and purchased finished goods to the Company’s restaurantsand franchised operations. Additionally, it sells frozen dessert products todistributors and retail and institutional locations. The Company’s franchisesegment includes a royalty based on franchise restaurant revenue. In addition,the Company receives rental income from various franchised restaurants. The Companydoes not allocate general and administrative expenses associated with itsheadquarters operations to any business segment. These costs include generaland administrative expenses of the following functions: legal, accounting,personnel not directly related to a segment, information systems and otherheadquarters activities.

 

On May 1, 2001, theCompany’s foodservice division decreased its ice cream pricing to allrestaurants. This resulted in decreased total foodservice revenues of 1.0% and1.9% for the three and six months ended June 30, 2002 and a decrease inexternal foodservice revenues of 0.5% and 1.0% for the three and six monthsended June 30, 2002.

 

The accounting policiesof the operating segments are the same as those described in the summary ofsignificant accounting policies except that the financial results for thefoodservice operating segment, prior to intersegment eliminations, have beenprepared using a management approach, which is consistent with the basis andmanner in which the Company’s management internally reviews financialinformation for the purpose of assisting in making 

 

9

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internal operatingdecisions. The Company evaluates performance based on stand-alone operatingsegment income (loss) before income taxes and generally accounts forintersegment sales and transfers as if the sales or transfers were to thirdparties, that is, at current market prices.

 

EBITDA represents netincome (loss) before (i) (provision for) benefit from income taxes,(ii) interest expense, net, (iii) depreciation and amortization,(iv) write-downs of property and equipment and (v) other non-cash items.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 Six Months Ended** |   |
|---------------------------------------------|--------|--------------------------------|---------|------------------------------|--------|
|                                        |   | **June 30,  2002**             |    | **July 1,  2001**            |   | **June 30,  2002** |   | **July 1,  2001** |   |
|                                        |   | **(in  thousands)**            |    |
| Revenues:                                   |   |                           |    |                         |   |   |   |   |   |
| Restaurant                                  |   | $                              | 121,893 |                         | $      | 118,953 |   | $ | 226,149 |   | $ | 226,098 |   |
| Foodservice                                 |   | 65,900                         |    | 64,248                       |   | 120,033 |   | 112,069 |   |
| Franchise                                   |   | 2,550                          |    | 3,101                        |   | 4,679 |   | 4,662 |   |
| Total                                       |   | $                              | 190,343 |                         | $      | 186,302 |   | $ | 350,861 |   | $ | 342,829 |   |
|                                        |   |                           |    |                         |   |   |   |   |   |
| Intersegment  revenues:                     |   |                           |    |                         |   |   |   |   |   |
| Restaurant                                  |   | $                              | —  |                         | $      | — |   | $ | — |   | $ | — |   |
| Foodservice                                 |   | (34,349                        | )       | (34,479                      | )      | (63,381 | ) | (65,287 | ) |
| Franchise                                   |   | —                         |    | —                       |   | — |   | — |   |
| Total                                       |   | $                              | (34,349 | )                            | $      | (34,479 | ) | $ | (63,381 | ) | $ | (65,287 | ) |
|                                        |   |                           |    |                         |   |   |   |   |   |
| External  revenues:                         |   |                           |    |                         |   |   |   |   |   |
| Restaurant                                  |   | $                              | 121,893 |                         | $      | 118,953 |   | $ | 226,149 |   | $ | 226,098 |   |
| Foodservice                                 |   | 31,551                         |    | 29,769                       |   | 56,652 |   | 46,782 |   |
| Franchise                                   |   | 2,550                          |    | 3,101                        |   | 4,679 |   | 4,662 |   |
| Total                                       |   | $                              | 155,994 |                         | $      | 151,823 |   | $ | 287,480 |   | $ | 277,542 |   |
|                                        |   |                           |    |                         |   |   |   |   |   |
| EBITDA:                                     |   |                           |    |                         |   |   |   |   |   |
| Restaurant                                  |   | $                              | 15,831  |                         | $      | 14,356 |   | $ | 27,882 |   | $ | 25,201 |   |
| Foodservice                                 |   | 4,792                          |    | 4,809                        |   | 8,466 |   | 7,888 |   |
| Franchise                                   |   | 1,693                          |    | 1,927                        |   | 3,020 |   | 2,422 |   |
| Corporate                                   |   | (3,981                         | )       | (4,435                       | )      | (8,383 | ) | (8,956 | ) |
| Gain  (loss) on property and equipment, net |   | 482                            |    | 4,181                        |   | (33 | ) | 6,064 |   |
| Reduction  of restructure reserve           |   | 400                            |    | —                       |   | 400 |   | — |   |
| Total                                       |   | $                              | 19,217  |                         | $      | 20,838 |   | $ | 31,352 |   | $ | 32,619 |   |
|                                        |   |                           |    |                         |   |   |   |   |   |
| Interest  expense, net-Corporate            |   | $                              | 6,215   |                         | $      | 6,918 |   | $ | 12,552 |   | $ | 14,503 |   |
|                                        |   |                           |    |                         |   |   |   |   |   |
| Depreciation  and amortization:             |   |                           |    |                         |   |   |   |   |   |
| Restaurant                                  |   | $                              | 4,417   |                         | $      | 4,613 |   | $ | 9,044 |   | $ | 9,659 |   |
| Foodservice                                 |   | 656                            |    | 841                          |   | 1,327 |   | 1,695 |   |
| Franchise                                   |   | 66                             |    | 61                           |   | 139 |   | 121 |   |
| Corporate                                   |   | 1,248                          |    | 1,582                        |   | 2,563 |   | 3,174 |   |
| Total                                       |   | $                              | 6,387   |                         | $      | 7,097 |   | $ | 13,073 |   | $ | 14,649 |   |
|                                        |   |                           |    |                         |   |   |   |   |   |
| Other  non-cash expenses:                   |   |                           |    |                         |   |   |   |   |   |
| Corporate                                   |   | $                              | 63      |                         | $      | 75 |   | $ | 133 |   | $ | 168 |   |
| Write-downs  of property and equipment      |   | 311                            |    | 68                           |   | 431 |   | 68 |   |
| Total                                       |   | $                              | 374     |                         | $      | 143 |   | $ | 564 |   | $ | 236 |   |
|                                        |   |                           |    |                         |   |   |   |   |   |
| Income  (loss) before income taxes:         |   |                           |    |                         |   |   |   |   |   |
| Restaurant                                  |   | $                              | 11,414  |                         | $      | 9,743 |   | $ | 18,838 |   | $ | 15,542 |   |
| Foodservice                                 |   | 4,136                          |    | 3,968                        |   | 7,139 |   | 6,193 |   |
| Franchise                                   |   | 1,627                          |    | 1,866                        |   | 2,881 |   | 2,301 |   |
| Corporate                                   |   | (11,507                        | )       | (13,010                      | )      | (23,631 | ) | (26,801 | ) |
| Gain  (loss) on property and equipment, net |   | 171                            |    | 4,113                        |   | (464 | ) | 5,996 |   |
| Reduction  of restructure reserve           |   | 400                            |    | —                       |   | 400 |   | — |   |
| Total                                       |   | $                              | 6,241   |                         | $      | 6,680 |   | $ | 5,163 |   | $ | 3,231 |   |
|                                             |        |                                |         |                              |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

10

----

** **

|                                                                   |   | **June 30,  2002**  |    | **December  30,  2001** |   |
|------------------------------------------------------------------------|--------|---------------------|---------|-------------------------|--------|
|                                                                   |   | **(in  thousands)** |    |
| Capital  expenditures, including assets acquired under capital leases: |   |                |    |                    |   |
| Restaurant                                                             |   | $                   | 3,936   |                    | $      | 10,821 |   |
| Foodservice                                                            |   | 734                 |    | 2,090                   |   |
| Corporate                                                              |   | 141                 |    | 1,011                   |   |
| Total                                                                  |   | $                   | 4,811   |                    | $      | 13,922 |   |
|                                                                   |   |                |    |                    |   |
| Total  assets:                                                         |   |                |    |                    |   |
| Restaurant                                                             |   | $                   | 143,645 |                    | $      | 148,475 |   |
| Foodservice                                                            |   | 43,926              |    | 38,474                  |   |
| Franchise                                                              |   | 9,801               |    | 7,076                   |   |
| Corporate                                                              |   | 58,897              |    | 58,537                  |   |
| Total                                                                  |   | $                   | 256,269 |                    | $      | 252,562 |   |

 

**4.  NEW ACCOUNTING PRONOUNCEMENTS**

 

In August 2001, the Financial Accounting StandardsBoard (“FASB”) issued Statement of Financial Accounting Standards (“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. 142modifies the rules for accounting for goodwill and other intangible assets. Thenew rules became effective for the Company on December 31, 2001. The impact ofadopting SFAS No. 142 on December 31, 2001 had no effect on the Company’sfinancial condition or results of operations and the Company is continuing toamortize its license agreement related to certain trademarked products over theterm of the license agreement.

 

In April 2001, the FASB reached consensus on EmergingIssues Task Force (“EITF”) Issue No. 00-25, “Accounting for Consideration froma Vendor to a Retailer in Connection with the Purchase or Promotion of theVendor’s Products.” EITF Issue No. 00-25 was effective for quarters beginningafter December 15, 2001, with prior financial statements restated ifpracticable. EITF Issue No. 00-25 requires that consideration from a vendor toa retailer be recorded as a reduction in revenue unless certain criteria aremet. Arrangements within the scope of this Issue include slotting fees,cooperative advertising arrangements and buy-downs. As a result of EITF IssueNo. 00-25, certain costs previously recorded as expense have been reclassifiedand offset against revenue for the quarter and six months ended July 1, 2001.

 

11

----

 

**5. RESTRUCTURING RESERVES**

 

The following represents the reserve and activityassociated with the March 2000 and October 2001 restructurings (in thousands):

 

|                             |   | **For the Six Months Ended July 1, 2001**            |   |
|----------------------------------|--------|------------------------------------------------------|--------|
|                             |   | **Restructuring  Reserves as of  December 31, 2000** |   | **Costs Paid** |   | **Restructuring  Reserves as of  July 1, 2001** |   |
| Severance  pay                   |   | $                                                    | 74     |   | $ | (74 | ) | $ | — |   |
| Rent                             |   | 3,585                                                |   | (643 | ) | 2,942 |   |
| Utilities  and real estate taxes |   | 1,105                                                |   | (403 | ) | 702 |   |
| Demarking                        |   | 138                                                  |   | (30 | ) | 108 |   |
| Lease  termination costs         |   | 120                                                  |   | (120 | ) | — |   |
| Inventory                        |   | 5                                                    |   | (5 | ) | — |   |
| Other                            |   | 544                                                  |   | (344 | ) | 200 |   |
| Total                            |   | $                                                    | 5,571  |   | $ | (1,619 | ) | $ | 3,952 |   |

 
|                             |   | **For the Six Months Ended June 30, 2002**           |   |
|----------------------------------|--------|------------------------------------------------------|--------|
|                             |   | **Restructuring  Reserves as of  December 30, 2001** |   | **Expense** |   | **Costs  Paid** |   | **Reserve  Reduction** |   | **Restructuring  Reserves as of  June 30, 2002** |   |
| Severance  pay                   |   | $                                                    | 516    |   | $ | — |   | $ | (473 | ) | $ | (32 | ) | $ | 11 |   |
| Rent                             |   | 1,318                                                |   | — |   | (223 | ) | (314 | ) | 781 |   |
| Utilities  and real estate taxes |   | 185                                                  |   | — |   | (86 | ) | 17 |   | 116 |   |
| Equipment                        |   | 480                                                  |   | — |   | (152 | ) | — |   | 328 |   |
| Outplacement  services           |   | 6                                                    |   | — |   | (6 | ) | — |   | — |   |
| Other                            |   | 551                                                  |   | — |   | (116 | ) | (71 | ) | 364 |   |
| Total                            |   | $                                                    | 3,056  |   | $ | — |   | $ | (1,056 | ) | $ | (400 | ) | $ | 1,600 |   |

 

Based on information currently available, managementbelieves that the restructuring reserve as of June 30, 2002 is adequate and notexcessive.

 

12

----

 

**6.  FRANCHISE TRANSACTIONS**

 

In 2000, the Company and its first franchisee, Davco,agreed to terminate Davco’s rights as the exclusive developer of new Friendly’srestaurants in Maryland, Delaware, the District of Columbia and northernVirginia, effective December 28, 2000. Davco has the right to close up to 16existing franchised locations and will operate the remaining 32 locations undertheir respective existing franchise agreements until such time as a newfranchisee is found for those locations. The existing franchise agreements forthe 32 locations were modified as of December 29, 2001 to allow earlytermination subject to liquidated damages on 22 of the 32 franchise agreements.Effective August 6, 2001, Davco transferred its rights to three franchisedlocations to a third party. Davco closed two units during the year endedDecember 30, 2001. During the six months ended June 30, 2002, Davco transferredits rights to eight additional franchised locations to three separate thirdparties.

 

**7.  SUPPLEMENTAL CONDENSED CONSOLIDATINGFINANCIAL INFORMATION**

 

FICC’s obligation related to the Senior Notes areguaranteed fully and unconditionally by one of FICC’s wholly owned subsidiaries.There are no restrictions on FICC’s ability to obtain dividends or otherdistributions of funds from this subsidiary, except those imposed by applicablelaw. The following supplemental financial information sets forth, on acondensed 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 June 30, 2002 and July 1,2001 and for the six months ended June 30, 2002 and July 1, 2001 are notpresented because management has determined that such information is notmaterial to investors.

 

Investments in subsidiaries are accounted for by theParent 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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**SupplementalCondensed Consolidating Balance Sheet**

**As of June 30, 2002**

(In thousands)

 
|                                                       |   | **Parent  Company** |    | **Guarantor  Subsidiary** |   | **Non-  guarantor  Subsidiaries** |   | **Eliminations** |   | **Consolidated** |   |
|------------------------------------------------------------|--------|---------------------|---------|---------------------------|--------|-----------------------------------|--------|------------------|--------|------------------|--------|
|                                                       |   |                |    |                      |   |                              |   |             |   |             |   |
| Assets                                                     |   |                |    |                      |   |                              |   |             |   |             |   |
|                                                       |   |                |    |                      |   |                              |   |             |   |             |   |
| Current assets:                                            |   |                |    |                      |   |                              |   |             |   |             |   |
| Cash and cash  equivalents                                 |   | $                   | 15,405  |                      | $      | 2,286                             |   | $                | 2,439  |             | $      | — |   | $ | 20,130 |   |
| Accounts  receivable, net                                  |   | 10,981              |    | 1,538                     |   | —                            |   | —           |   | 12,519           |   |
| Inventories                                                |   | 18,177              |    | —                    |   | —                            |   | —           |   | 18,177           |   |
| Deferred income  taxes                                     |   | 7,448               |    | 99                        |   | —                            |   | 112              |   | 7,659            |   |
| Prepaid expenses  and other current assets                 |   | 9,078               |    | 681                       |   | 3,504                             |   | (8,947           | )      | 4,316            |   |
| Total current  assets                                      |   | 61,089              |    | 4,604                     |   | 5,943                             |   | (8,835           | )      | 62,801           |   |
| Deferred income  taxes                                     |   | —              |    | 350                       |   | 1,327                             |   | (1,677           | )      | —           |   |
| Property and  equipment, net                               |   | 109,130             |    | —                    |   | 50,868                            |   | —           |   | 159,998          |   |
| Intangible  assets and deferred costs, net                 |   | 17,632              |    | —                    |   | 2,823                             |   | —           |   | 20,455           |   |
| Investments in  subsidiaries                               |   | 5,567               |    | —                    |   | —                            |   | (5,567           | )      | —           |   |
| Other assets                                               |   | 12,100              |    | 5,356                     |   | 6,229                             |   | (10,670          | )      | 13,015           |   |
|                                                       |   |                |    |                      |   |                              |   |             |   |             |   |
| Total assets                                               |   | $                   | 205,518 |                      | $      | 10,310                            |   | $                | 67,190 |             | $      | (26,749 | ) | $ | 256,269 |   |
|                                                       |   |                |    |                      |   |                              |   |             |   |             |   |
| Liabilities and  Stockholders’ (Deficit) Equity       |   |                |    |                      |   |                              |   |             |   |             |   |
|                                                       |   |                |    |                      |   |                              |   |             |   |             |   |
| Current  liabilities:                                      |   |                |    |                      |   |                              |   |             |   |             |   |
| Current  maturities of long-term obligations               |   | $                   | 5,290   |                      | $      | —                            |   | $                | 965    |             | $      | (3,500 | ) | $ | 2,755 |   |
| Accounts payable                                           |   | 23,041              |    | —                    |   | —                            |   | —           |   | 23,041           |   |
| Accrued expenses                                           |   | 36,848              |    | 3,646                     |   | 8,041                             |   | (5,332           | )      | 43,203           |   |
| Total current  liabilities                                 |   | 65,179              |    | 3,646                     |   | 9,006                             |   | (8,832           | )      | 68,999           |   |
| Deferred income  taxes                                     |   | 14,235              |    | —                    |   | —                            |   | (1,565           | )      | 12,670           |   |
| Long-term  obligations, less current maturities            |   | 189,441             |    | —                    |   | 53,642                            |   | (5,314           | )      | 237,769          |   |
| Other long-term  liabilities                               |   | 29,049              |    | 903                       |   | 4,736                             |   | (5,471           | )      | 29,217           |   |
| Stockholders’  (deficit) equity                       |   | (92,386             | )       | 5,761                     |   | (194                              | )      | (5,567           | )      | (92,386          | )      |
| Total  liabilities and stockholders’ (deficit) equity |   | $                   | 205,518 |                      | $      | 10,310                            |   | $                | 67,190 |             | $      | (26,749 | ) | $ | 256,269 |   |

 

14

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**Supplemental Condensed Consolidating Statement of Operations**

**For the Three Months Ended June 30, 2002**

(In thousands)

 
|                                                                                                    |   | **Parent  Company** |    | **Guarantor  Subsidiary** |   | **Non-  guarantor  Subsidiaries** |   | **Eliminations** |   | **Consolidated** |   |
|---------------------------------------------------------------------------------------------------------|--------|---------------------|---------|---------------------------|--------|-----------------------------------|--------|------------------|--------|------------------|--------|
|                                                                                                    |   |                |    |                      |   |                              |   |             |   |             |   |
| Revenues                                                                                                |   | $                   | 153,792 |                      | $      | 2,202                             |   | $                | — |             | $      | — |   | $ | 155,994 |   |
| Costs and  expenses:                                                                                    |   |                |    |                      |   |                              |   |             |   |             |   |
| Cost of sales                                                                                           |   | 52,890              |    | —                    |   | —                            |   | —           |   | 52,890           |   |
| Labor and  benefits                                                                                     |   | 42,243              |    | —                    |   | —                            |   | —           |   | 42,243           |   |
| Operating  expenses and write-downs of property and equipment                                           |   | 35,349              |    | —                    |   | (1,741                            | )      | —           |   | 33,608           |   |
| Reduction of  restructure reserve                                                                       |   | (400                | )       | —                    |   | —                            |   | —           |   | (400             | )      |
| General and  administrative expenses                                                                    |   | 7,517               |    | 1,164                     |   | —                            |   | —           |   | 8,681            |   |
| Depreciation and  amortization                                                                          |   | 5,803               |    | —                    |   | 584                               |   | —           |   | 6,387            |   |
| Loss on sales of  other property and equipment, net                                                     |   | 129                 |    | —                    |   | —                            |   | —           |   | 129              |   |
| Interest expense                                                                                        |   | 5,043               |    | —                    |   | 1,172                             |   | —           |   | 6,215            |   |
|                                                                                                    |   |                |    |                      |   |                              |   |             |   |             |   |
| Income (loss)  before provision for income taxes and equity in net income of consolidated  subsidiaries |   | 5,218               |    | 1,038                     |   | (15                               | )      | —           |   | 6,241            |   |
|                                                                                                    |   |                |    |                      |   |                              |   |             |   |             |   |
| Provision for  income taxes                                                                             |   | (1,942              | )       | (426                      | )      | (58                               | )      | —           |   | (2,426           | )      |
|                                                                                                    |   |                |    |                      |   |                              |   |             |   |             |   |
| Income (loss)  before equity in net income of consolidated subsidiaries                                 |   | 3,276               |    | 612                       |   | (73                               | )      | —           |   | 3,815            |   |
|                                                                                                    |   |                |    |                      |   |                              |   |             |   |             |   |
| Equity in net  income of consolidated subsidiaries                                                      |   | 539                 |    | —                    |   | —                            |   | (539             | )      | —           |   |
|                                                                                                    |   |                |    |                      |   |                              |   |             |   |             |   |
| Net income (loss)                                                                                       |   | $                   | 3,815   |                      | $      | 612                               |   | $                | (73    | )                | $      | (539 | ) | $ | 3,815 |   |

 

15

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**Supplemental Condensed Consolidating Statement of Operations**

**For the Six Months Ended June 30, 2002**

(In thousands)

 
|                                                                                                    |   | **Parent  Company** |    | **Guarantor  Subsidiary** |   | **Non-  guarantor  Subsidiaries** |   | **Eliminations** |   | **Consolidated** |   |
|---------------------------------------------------------------------------------------------------------|--------|---------------------|---------|---------------------------|--------|-----------------------------------|--------|------------------|--------|------------------|--------|
|                                                                                                    |   |                |    |                      |   |                              |   |             |   |             |   |
| Revenues                                                                                                |   | $                   | 283,491 |                      | $      | 3,989                             |   | $                | — |             | $      | — |   | $ | 287,480 |   |
| Costs and  expenses:                                                                                    |   |                |    |                      |   |                              |   |             |   |             |   |
| Cost of sales                                                                                           |   | 98,884              |    | —                    |   | —                            |   | —           |   | 98,884           |   |
| Labor and  benefits                                                                                     |   | 80,161              |    | —                    |   | —                            |   | —           |   | 80,161           |   |
| Operating  expenses and write-downs of property and equipment                                           |   | 63,616              |    | —                    |   | (3,490                            | )      | —           |   | 60,126           |   |
| General and  administrative expenses                                                                    |   | 14,952              |    | 2,328                     |   | —                            |   | —           |   | 17,280           |   |
| Reduction of  restructure reserve                                                                       |   | (400                | )       | —                    |   | —                            |   | —           |   | (400             | )      |
| Depreciation and  amortization                                                                          |   | 11,902              |    | —                    |   | 1,171                             |   | —           |   | 13,073           |   |
| Loss on sales of  other property and equipment, net                                                     |   | 641                 |    | —                    |   | —                            |   | —           |   | 641              |   |
| Interest expense                                                                                        |   | 10,217              |    | —                    |   | 2,335                             |   | —           |   | 12,552           |   |
|                                                                                                    |   |                |    |                      |   |                              |   |             |   |             |   |
| Income (loss)  before provision for income taxes and equity in net income of consolidated  subsidiaries |   | 3,518               |    | 1,661                     |   | (16                               | )      | —           |   | 5,163            |   |
|                                                                                                    |   |                |    |                      |   |                              |   |             |   |             |   |
| Provision for  income taxes                                                                             |   | (898                | )       | (681                      | )      | (177                              | )      | —           |   | (1,756           | )      |
|                                                                                                    |   |                |    |                      |   |                              |   |             |   |             |   |
| Income (loss)  before equity in net income of consolidated subsidiaries                                 |   | 2,620               |    | 980                       |   | (193                              | )      | —           |   | 3,407            |   |
|                                                                                                    |   |                |    |                      |   |                              |   |             |   |             |   |
| Equity in net  income of consolidated subsidiaries                                                      |   | 787                 |    | —                    |   | —                            |   | (787             | )      | —           |   |
|                                                                                                    |   |                |    |                      |   |                              |   |             |   |             |   |
| Net income  (loss)                                                                                      |   | $                   | 3,407   |                      | $      | 980                               |   | $                | (193   | )                | $      | (787 | ) | $ | 3,407 |   |

 

16

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**Supplemental Condensed Consolidating Statement of Cash Flows**

**For the Six Months Ended June 30, 2002**

(In thousands)

 
|                                                 |   | **Parent  Company** |   | **Guarantor  Subsidiary** |   | **Non-  guarantor  Subsidiaries** |   | **Eliminations** |   | **Consolidated** |   |
|------------------------------------------------------|--------|---------------------|--------|---------------------------|--------|-----------------------------------|--------|------------------|--------|------------------|--------|
| Net cash provided by operating activities            |   | $                   | 4,785  |                      | $      | 2,182                             |   | $                | 1,304  |             | $      | 406 |   | $ | 8,677 |   |
|                                                 |   |                |   |                      |   |                              |   |             |   |             |   |
| Cash flows from  investing activities:               |   |                |   |                      |   |                              |   |             |   |             |   |
| Purchases of  property and equipment                 |   | (4,811              | )      | —                    |   | —                            |   | —           |   | (4,811           | )      |
| Proceeds from  sales of property and equipment       |   | 1,293               |   | —                    |   | —                            |   | —           |   | 1,293            |   |
| Net cash used in  investing activities               |   | (3,518              | )      | —                    |   | —                            |   | —           |   | (3,518           | )      |
|                                                 |   |                |   |                      |   |                              |   |             |   |             |   |
| Cash flows from  financing activities:               |   |                |   |                      |   |                              |   |             |   |             |   |
| Repayments of  obligations                           |   | (1,066              | )      | —                    |   | (393                              | )      | —           |   | (1,459           | )      |
| Stock options  exercised                             |   | 88                  |   | —                    |   | —                            |   | —           |   | 88               |   |
| Reinsurance  deposits received                       |   | —              |   | —                    |   | 2,024                             |   | (2,024           | )      | —           |   |
| Reinsurance  payments made from deposits             |   | —              |   | —                    |   | (1,618                            | )      | 1,618            |   | —           |   |
| Net cash (used  in) provided by financing activities |   | (978                | )      | —                    |   | 13                                |   | (406             | )      | (1,371           | )      |
|                                                 |   |                |   |                      |   |                              |   |             |   |             |   |
| Net increase in  cash and cash equivalents           |   | 289                 |   | 2,182                     |   | 1,317                             |   | —           |   | 3,788            |   |
|                                                 |   |                |   |                      |   |                              |   |             |   |             |   |
| Cash and cash  equivalents, beginning of period      |   | 15,116              |   | 104                       |   | 1,122                             |   | —           |   | 16,342           |   |
|                                                 |   |                |   |                      |   |                              |   |             |   |             |   |
| Cash and cash  equivalents, end of period            |   | $                   | 15,405 |                      | $      | 2,286                             |   | $                | 2,439  |             | $      | — |   | $ | 20,130 |   |
|                                                 |   |                |   |                      |   |                              |   |             |   |             |   |
| Supplemental  disclosures:                           |   |                |   |                      |   |                              |   |             |   |             |   |
| Interest paid                                        |   | $                   | 9,758  |                      | $      | —                            |   | $                | 1,890  |             | $      | — |   | $ | 11,648 |   |
| Income taxes  (refunded) paid                        |   | (1,030              | )      | 1,012                     |   | —                            |   | —           |   | (18              | )      |

 

17

----

 

**Supplemental Condensed ConsolidatingBalance Sheet**

**As of December 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 July 1, 2001**

(In thousands)

 
|                                                                                             |   | **Parent  Company** |    | **Guarantor  Subsidiary** |   | **Non-  guarantor  Subsidiaries** |   | **Eliminations** |   | **Consolidated** |   |
|--------------------------------------------------------------------------------------------------|--------|---------------------|---------|---------------------------|--------|-----------------------------------|--------|------------------|--------|------------------|--------|
|                                                                                             |   |                |    |                      |   |                              |   |             |   |             |   |
| Revenues                                                                                         |   | $                   | 149,099 |                      | $      | 2,724                             |   | $                | — |             | $      | — |   | $ | 151,823 |   |
| Costs and  expenses:                                                                             |   |                |    |                      |   |                              |   |             |   |             |   |
| Cost of sales                                                                                    |   | 52,857              |    | —                    |   | —                            |   | —           |   | 52,857           |   |
| Labor and  benefits                                                                              |   | 41,334              |    | —                    |   | —                            |   | —           |   | 41,334           |   |
| Operating  expenses and write-downs of property and equipment                                    |   | 31,678              |    | —                    |   | (2                                | )      | —           |   | 31,676           |   |
| General and  administrative expenses                                                             |   | 8,188               |    | 1,157                     |   | —                            |   | —           |   | 9,345            |   |
| Depreciation and  amortization                                                                   |   | 7,097               |    | —                    |   | —                            |   | —           |   | 7,097            |   |
| Gain on  franchise sales of restaurant operations and properties                                 |   | (3,823              | )       | —                    |   | —                            |   | —           |   | (3,823           | )      |
| Gain on sales of  other property and equipment, net                                              |   | (261                | )       | —                    |   | —                            |   | —           |   | (261             | )      |
| Interest expense  (income)                                                                       |   | 7,094               |    | —                    |   | (176                              | )      | —           |   | 6,918            |   |
|                                                                                             |   |                |    |                      |   |                              |   |             |   |             |   |
| Income before  provision for income taxes and equity in net income of consolidated  subsidiaries |   | 4,935               |    | 1,567                     |   | 178                               |   | —           |   | 6,680            |   |
|                                                                                             |   |                |    |                      |   |                              |   |             |   |             |   |
| Provision for  income taxes                                                                      |   | (1,934              | )       | (642                      | )      | (63                               | )      | —           |   | (2,639           | )      |
|                                                                                             |   |                |    |                      |   |                              |   |             |   |             |   |
| Income before  equity in net income of consolidated subsidiaries                                 |   | 3,001               |    | 925                       |   | 115                               |   | —           |   | 4,041            |   |
|                                                                                             |   |                |    |                      |   |                              |   |             |   |             |   |
| Equity in net  income of consolidated subsidiaries                                               |   | 1,040               |    | —                    |   | —                            |   | (1,040           | )      | —           |   |
|                                                                                             |   |                |    |                      |   |                              |   |             |   |             |   |
| Net income                                                                                       |   | $                   | 4,041   |                      | $      | 925                               |   | $                | 115    |             | $      | (1,040 | ) | $ | 4,041 |   |

 

19

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**Supplemental Condensed Consolidating Statement of Operations**

**For the Six Months Ended July 1, 2001**

 (In thousands)

 
|                                                                                             |   | **Parent  Company** |    | **Guarantor  Subsidiary** |   | **Non-  guarantor  Subsidiaries** |   | **Eliminations** |   | **Consolidated** |   |
|--------------------------------------------------------------------------------------------------|--------|---------------------|---------|---------------------------|--------|-----------------------------------|--------|------------------|--------|------------------|--------|
|                                                                                             |   |                |    |                      |   |                              |   |             |   |             |   |
| Revenues                                                                                         |   | $                   | 273,625 |                      | $      | 3,917                             |   | $                | — |             | $      | — |   | $ | 277,542 |   |
| Costs and  expenses:                                                                             |   |                |    |                      |   |                              |   |             |   |             |   |
| Cost of sales                                                                                    |   | 94,917              |    | —                    |   | —                            |   | —           |   | 94,917           |   |
| Labor and  benefits                                                                              |   | 81,010              |    | —                    |   | —                            |   | —           |   | 81,010           |   |
| Operating  expenses and write-downs of property and equipment                                    |   | 56,631              |    | —                    |   | (11                               | )      | —           |   | 56,620           |   |
| General and  administrative expenses                                                             |   | 16,361              |    | 2,316                     |   | —                            |   | —           |   | 18,677           |   |
| Depreciation and  amortization                                                                   |   | 14,649              |    | —                    |   | —                            |   | —           |   | 14,649           |   |
| Gain on  franchise sales of restaurant operations and properties                                 |   | (3,823              | )       | —                    |   | —                            |   | —           |   | (3,823           | )      |
| Gain on sales of  other property and equipment, net                                              |   | (2,242              | )       | —                    |   | —                            |   | —           |   | (2,242           | )      |
| Interest expense  (income)                                                                       |   | 14,900              |    | —                    |   | (397                              | )      | —           |   | 14,503           |   |
|                                                                                             |   |                |    |                      |   |                              |   |             |   |             |   |
| Income before  provision for income taxes and equity in net income of consolidated  subsidiaries |   | 1,222               |    | 1,601                     |   | 408                               |   | —           |   | 3,231            |   |
|                                                                                             |   |                |    |                      |   |                              |   |             |   |             |   |
| Provision for  income taxes                                                                      |   | (325                | )       | (656                      | )      | (144                              | )      | —           |   | (1,125           | )      |
|                                                                                             |   |                |    |                      |   |                              |   |             |   |             |   |
| Income before  equity in net income of consolidated subsidiaries                                 |   | 897                 |    | 945                       |   | 264                               |   | —           |   | 2,106            |   |
|                                                                                             |   |                |    |                      |   |                              |   |             |   |             |   |
| Equity in net  income of consolidated subsidiaries                                               |   | 1,209               |    | —                    |   | —                            |   | (1,209           | )      | —           |   |
|                                                                                             |   |                |    |                      |   |                              |   |             |   |             |   |
| Net income                                                                                       |   | $                   | 2,106   |                      | $      | 945                               |   | $                | 264    |             | $      | (1,209 | ) | $ | 2,106 |   |

 

20

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**Supplemental Condensed Consolidating Statement of Cash Flows**

**For the Six Months Ended July 1, 2001**

(In thousands)

 
|                                                   |   | **Parent  Company** |   | **Guarantor  Subsidiary** |   | **Non-  guarantor  Subsidiaries** |   | **Eliminations** |   | **Consolidated** |   |
|--------------------------------------------------------|--------|---------------------|--------|---------------------------|--------|-----------------------------------|--------|------------------|--------|------------------|--------|
| Net cash provided by (used in) operating activities    |   | $                   | 2,750  |                      | $      | (24                               | )      | $                | 1,688  |             | $      | (1,291 | ) | $ | 3,123 |   |
|                                                   |   |                |   |                      |   |                              |   |             |   |             |   |
| Cash flows from  investing activities:                 |   |                |   |                      |   |                              |   |             |   |             |   |
| Purchases of  property and equipment                   |   | (5,726              | )      | —                    |   | —                            |   | —           |   | (5,726           | )      |
| Proceeds from  sales of property and equipment         |   | 19,868              |   | —                    |   | —                            |   | —           |   | 19,868           |   |
| Net cash  provided by investing activities             |   | 14,142              |   | —                    |   | —                            |   | —           |   | 14,142           |   |
|                                                   |   |                |   |                      |   |                              |   |             |   |             |   |
| Cash flows from  financing activities:                 |   |                |   |                      |   |                              |   |             |   |             |   |
| Proceeds from  borrowings                              |   | 34,000              |   | —                    |   | —                            |   | —           |   | 34,000           |   |
| Repayments of  obligations                             |   | (55,503             | )      | —                    |   | —                            |   | —           |   | (55,503          | )      |
| Reinsurance  deposits received                         |   | —              |   | —                    |   | 505                               |   | (505             | )      | —           |   |
| Reinsurance  payments made from deposits               |   | —              |   | —                    |   | (1,796                            | )      | 1,796            |   | —           |   |
| Net cash used in  financing activities                 |   | (21,503             | )      | —                    |   | (1,291                            | )      | 1,291            |   | (21,503          | )      |
|                                                   |   |                |   |                      |   |                              |   |             |   |             |   |
| Net (decrease)  increase in cash and cash equivalents  |   | (4,611              | )      | (24                       | )      | 397                               |   | —           |   | (4,238           | )      |
|                                                   |   |                |   |                      |   |                              |   |             |   |             |   |
| Cash and cash  equivalents, beginning of period        |   | 13,619              |   | 33                        |   | 932                               |   | —           |   | 14,584           |   |
|                                                   |   |                |   |                      |   |                              |   |             |   |             |   |
| Cash and cash  equivalents, end of period              |   | $                   | 9,008  |                      | $      | 9                                 |   | $                | 1,329  |             | $      | — |   | $ | 10,346 |   |
|                                                   |   |                |   |                      |   |                              |   |             |   |             |   |
| Supplemental  disclosures:                             |   |                |   |                      |   |                              |   |             |   |             |   |
| Interest paid  (received)                              |   | $                   | 15,895 |                      | $      | —                            |   | $                | (397   | )                | $      | — |   | $ | 15,498 |   |
| Income taxes  paid                                     |   | 1                   |   | 2                         |   | —                            |   | —           |   | 3                |   |
| Capital lease  obligations terminated                  |   | 151                 |   | —                    |   | —                            |   | —           |   | 151              |   |
| Note received  from the sale of property and equipment |   | 4,250               |   | —                    |   | —                            |   | —           |   | 4,250            |   |

 

21

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**Item2.   Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

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

 

**Forward Looking Statements**

 

Statements contained herein that are not historicalfacts constitute “forward looking statements” as that term is defined in thePrivate Securities Litigation Reform Act of 1995. All forward lookingstatements are subject to risks and uncertainties which could cause results todiffer materially from those anticipated. These factors include the Company’shighly competitive business environment, exposure to commodity prices, risksassociated with the foodservice industry, the ability to retain and attract newemployees, government regulations, the Company’s high geographic concentrationin the Northeast and its attendant weather patterns, conditions needed to meetrestaurant re-imaging and new opening targets and risks associated withimproved service and other initiatives. Other factors that may cause actualresults to differ from the forward looking statements contained herein and thatmay affect the Company’s prospects in general are included in the Company’sother filings with the Securities and Exchange Commission.

 

**Overview**

 

Friendly’s owns and operates 390 restaurants, franchises159 full-service restaurants and six non-traditional units and manufactures afull line of frozen desserts distributed through more than 3,500 supermarketsand other retail locations in 17 states. The restaurants offer a wide varietyof reasonably priced breakfast, lunch and dinner menu items as well as thefrozen dessert products.

 

Following is a summary of the Company-owned andfranchised units:

 
|                    |   | **For the  Three Months Ended** |   | **For the  Six Months Ended** |   |
|-------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                    |   | **June 30,  2002**              |   | **July 1,  2001**             |   | **June 30,  2002** |   | **July 1,  2001** |   |
| Company Units:          |   |                            |   |                          |   |   |   |   |   |
| Beginning of  period    |   | 390                             |   | 438                           |   | 393 |   | 449 |   |
| Openings                |   | —                          |   | —                        |   | — |   | — |   |
| Re-franchised           |   | —                          |   | (33                           | )      | — |   | (33 | ) |
| Closings                |   | (—                         | )      | (2                            | )      | (3 | ) | (13 | ) |
| End of period           |   | 390                             |   | 403                           |   | 390 |   | 403 |   |
|                    |   |                            |   |                          |   |   |   |   |   |
| Franchised Units:       |   |                            |   |                          |   |   |   |   |   |
| Beginning of  period    |   | 166                             |   | 128                           |   | 167 |   | 127 |   |
| Re-franchised  openings |   | —                          |   | 33                            |   | — |   | 33 |   |
| Openings                |   | 1                               |   | 2                             |   | 3 |   | 3 |   |
| Closings                |   | (2                              | )      | —                        |   | (5 | ) | — |   |
| End of period           |   | 165                             |   | 163                           |   | 165 |   | 163 |   |

 

22

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*Revenues:*

 

Total revenues increased $4.2 million, or 2.7%, to$156.0 million for the second quarter ended June 30, 2002 from $151.8 millionfor the same quarter in 2001. Restaurant revenues increased $2.9 million, or2.5%, to $121.9 million for the second quarter of 2002 from $119.0 million forthe same quarter in 2001. Restaurant revenues increased by $2.9 million in the2002 period as compared to the 2001 period largely due to a 6.4% increase incomparable restaurant revenues from the 2001 quarter to the 2002 quarter.Partially offsetting this increase was the closing of five under-performingrestaurants and the re-franchising of 41 additional locations over the past 15months. Closing of restaurants accounted for $1.1 million of the restaurantrevenue decline in the 2002 period as compared to the 2001 period andre-franchising reduced restaurant revenues by an additional $3.7 million in the2002 period as compared to the 2001 period. Revenues from the one location openless than one year were $0.4 million. Foodservice (product sales tofranchisees, retail and institutional) revenues increased by $1.8 million, or6.0%, to $31.6 million for the second quarter ended June 30, 2002 from $29.8million for the same quarter in 2001. The increase in the number of franchisedunits and increases in comparable franchised restaurant revenues accounted for$1.7 million of the increase and sales to foodservice retail supermarketcustomers increased by $0.1 million. On May 1, 2001, the Company’s foodservicedivision decreased its ice cream pricing to all restaurants. This resulted indecreased foodservice revenues of 0.5% for the three months ended June 30,2002. Franchise revenue decreased $0.5 million, or 17.7%, to $2.6 million forthe second quarter ended June 30, 2002 compared to $3.1 million for the samequarter in 2001. The decrease is largely the result of $0.9 million in initialfees recorded as 35 new locations were added in the quarter ended July 1, 2001.The reduction in initial fees was partially offset by an increase in royaltyrevenue due to the difference in the number of franchised locations operatingduring each period and the increase in comparable sales. Comparable franchisedrestaurant revenues also rose in the 2002 period when compared to the same periodin 2001. There were 165 franchise units open at June 30, 2002 compared to 163franchise units open at July 1, 2001.

 

Total revenues increased $10.0 million, or 3.6%, to$287.5 million for the six months ended June 30, 2002 from $277.5 million forthe same period in 2001. Restaurant revenues were $226.1 million for thesix-month periods ended June 30, 2002 and July 1, 2001. Restaurant revenuesbenefited from a 7.5% increase in comparable restaurant revenues from the 2001period to the 2002 period. Offsetting this increase was lost revenuesassociated with the closing of 19 under-performing restaurants and there-franchising of 41 additional locations over the past 18 months. Closing ofrestaurants reduced restaurant revenues by $2.6 million in the 2002 period ascompared to the 2001 period and re-franchising reduced restaurant revenues byan additional $14.1 million in the 2002 period as compared to the 2001 period.Revenues from the one location open less than one year were $0.7 million.Foodservice (product sales to franchisees, retail and institutional) revenuesincreased by $9.9 million, or 21.2%, to $56.7 million for the six months endedJune 30, 2002 from $46.8 million for the same period in 2001. The increase inthe number of franchised units and increases in comparable franchisedrestaurant revenues accounted for $6.2 million of the increase and sales tofoodservice retail supermarket customers increased by $3.7 million. On May 1,2001, the Company’s foodservice division decreased its ice cream pricing to allrestaurants. This resulted in decreased foodservice revenues of 1.0% for thesix months ended June 30, 2002. Franchise revenues were $4.7 million for thesix months ended June 30, 2002 and July 1, 2001. Included was a decrease of$0.9 million in initial fees recorded as 35 new locations were added in the sixmonths ended July 1, 2001. This decrease was offset by an increase in royaltyrevenue due to the difference in the number of franchised locations operatingduring each period. Comparable franchised restaurant revenues also rose in the2002 period when compared to the same period in 2001. There were 165 franchiseunits open at June 30, 2002 compared to 163 franchise units open at July 1,2001.

 

23

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*Cost ofsales:*

 

Cost of sales were $52.9 millionfor the quarters ended June 30, 2002 and July 1, 2001. Cost of sales as apercentage of total revenues decreased to 33.9% for the quarter ended June 30,2002 from 34.8% for the same period in 2001. The lower food cost as apercentage of total revenue was due to lower cream prices in the currentperiod. Cream is the principal ingredient used in making ice cream. The Companyexpects that cream prices will continue to be lower during the remainder of2002 when compared to 2001. Partially offsetting the cream benefit was a shiftin sales mix from Company-owned restaurant sales to Foodservice sales and ashift in restaurant sales to entrees with a higher food cost as a percentage ofrevenues. Foodservice sales to franchisees and retail customers have a higherfood cost as a percentage of revenue than sales in Company-owned restaurants torestaurant patrons.

 

Cost of sales increased $4.0million, or 4.2%, to $98.9 million for the six months ended June 30, 2002 from$94.9 million for the same period in 2001. Cost of sales as a percentage oftotal revenues increased to 34.4% for the six months ended June 30, 2002 from34.2% for the same period in 2001. The higher food cost as a percentage oftotal revenue was due to a shift in sales mix from Company-owned restaurantsales to Foodservice sales and a shift in restaurant sales to entrees with ahigher food cost as a percentage of revenues. Foodservice sales to franchiseesand retail customers have a higher food cost as a percentage of revenue thansales in Company-owned restaurants to restaurant patrons. The cost of cream,the principal ingredient used in making ice cream, was lower in 2002 whencompared to 2001. The Company expects that cream prices will continue to be lowerduring the remainder of 2002 when compared to 2001. In May 2001, the Companyraised prices to its retail customers, which decreased cost of sales as apercentage of revenues. To minimize risk, alternative supply sources for creamcontinue to be evaluated.

 

The cost of cream, the principal ingredient used inmaking ice cream, affects cost of sales as a percentage of total revenues,especially in foodservice’s retail business. The Company believes that creamprices will be slightly lower in 2002 than in 2001. A $0.10 increase in thecost of a pound of AA butter adversely affects the Company’s annual cost ofsales by approximately $1.1 million. To minimize risk, alternative supplysources continue 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.

 

*Laborand benefits:*

 

Labor and benefits increased $0.9 million, or 2.2%, to$42.2 million for the second quarter ended June 30, 2002 from $41.3 million forthe same quarter in 2001. Labor and benefits as a percentage of total revenuesdecreased to 27.1% for the second quarter ended June 30, 2002 from 27.2% forthe same quarter in 2001. Thelower labor cost as a percentage of total revenue is the result of revenueincreases derived from additional franchised locations and higher sales tofoodservice retail supermarket customers, which do not have any associatedrestaurant labor and benefits. Labor and benefits as a percentage of restaurantrevenues at 34.7% was the same in both periods. During the quarter ended June30, 2002, the Company introduced a training program called “Friendly you bet weare.” This program was designed to improve customer service at itsCompany-owned restaurants. The cost of this program had an unfavorable impacton restaurant labor as a percentage of revenues during the quarter ended June30, 2002.

 

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Labor and benefits decreased $0.8 million, or 1.0%, to$80.2 million for the six months ended June 30, 2002 from $81.0 million for thesame period in 2001. Labor and benefits as a percentage of total revenuesdecreased to 27.9% for the six months ended June 30, 2002 from 29.2% for thesame period in 2001. The lowerlabor cost as a percentage of total revenue is partially the result of revenueincreases derived from additional franchised locations and higher sales tofoodservice retail supermarket customers, which do not have any associatedrestaurant labor and benefits. Labor and benefits as a percentage of restaurantrevenues decreased to 35.4% for the six months ended June 30, 2002 from35.8% for the same period in 2001.  The closing of 19 under-performing Company-ownedunits over the past 18 months improved the relationship of restaurant labor andbenefits to restaurant sales as well as to total revenues.

 

*Operatingexpenses:*

 

Operating expenses increased $1.7million, or 5.4%, to $33.3 million for the second quarter ended June 30, 2002from $31.6 million for the same quarter in 2001. Operating expenses as apercentage of total revenues were 21.3% and 20.8% for the second quarters endedJune 30, 2002 and July 1, 2001, respectively. The increase as a percentage oftotal revenues resulted from higher costs for restaurant rent associated withthe December 2001 sale/leaseback transaction and higher costs for foodserviceretail selling expense in the 2002 period when compared to the 2001 period.Additionally, the Company spent more on restaurant maintenance during the 2002period when compared to 2001. Restaurant utility costs were lower in the 2002period when compared to 2001.

 

Operating expenses increased $3.1million, or 5.5%, to $59.7 million for the six months ended June 30, 2002 from$56.6 million for the same period in 2001. Operating expenses as a percentageof total revenues were 20.8% and 20.4% for the six months ended June 30, 2002and July 1, 2001, respectively. The increase as a percentage of total revenuesresulted from higher costs for restaurant rent associated with the December2001 sale/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.

 

*Generaland administrative expenses:*

 

General and administrative expenseswere $8.7 million and $9.3 million for the second quarters ended June 30, 2002and July 1, 2001, respectively. General and administrative expenses as apercentage of total revenues decreased to 5.6% for the second quarter endedJune 30, 2002 from 6.2% for the same period in 2001. The decrease in expense isprimarily the result of the elimination of certain management andadministrative positions associated with the Company’s closing of fivelocations and the re-franchising of 41 locations over the past 15 months. InOctober 2001, the Company eliminated approximately 70 positions at corporateheadquarters. 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.

 

General and administrative expenseswere $17.3 million and $18.7 million for the six months ended June 30, 2002 andJuly 1, 2001, respectively. General and administrative expenses as a percentageof total revenues decreased to 6.0% for the six months ended June 30, 2002 from6.7% for the same period in 2001. The decrease in expense is primarily theresult of the elimination of certain management and administrative positionsassociated with the Company’s closing of 19 locations and the re-franchising of41 locations over the past 18 months. In October 2001, the Company eliminatedapproximately 70 positions at corporate headquarters. The Company also has ahiring freeze at its corporate headquarters. Bonus expense was higher in the2002 period when compared to the same period in 2001.

 

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*EBITDA:*

 

As a result of the above and the gains (losses) onfranchise and other property sales below, EBITDA (EBITDA represents net income(loss) before (i) (provision for) benefit from income taxes, (ii) interestexpense, net, (iii) depreciation and amortization, (iv) write-downsof property and equipment and (v) other non–cash items) decreased $1.6million, or 7.8%, to $19.2 million for the quarter ended June 30, 2002 from$20.8 million for the same quarter in 2001. EBITDA as a percentage of totalrevenues was 12.3% and 13.7% for the 2002 and 2001 periods, respectively.

 

EBITDA decreased $1.9 million, or 6.0%, to $30.7million for the six months ended June 30, 2002 from $32.6 million for the sameperiod in 2001.  EBITDA as a percentageof total revenues was 10.7% and 11.8% for the six months ended June 30, 2002and July 1, 2001, respectively.

 

*W**rite-downsof property and equipment:*

 

Write-downs of property and equipment were $0.3million and $0.1 million for the quarters ended June 30, 2002 and July 1, 2001,respectively. Write-downs of property and equipment were $0.4 million and $0.1million for the six months ended June 30, 2002 and July 1, 2001, respectively.

 

*Depreciationand amortization:*

 

Depreciation and amortizationdecreased $0.7 million, or 10.0%, to $6.4 million for the second quarter endedJune 30, 2002 from $7.1 million for the same quarter in 2001. Depreciation andamortization as a percentage of total revenues was 4.1% and 4.7% in the 2002and 2001 quarters, respectively. The reduction reflects the impact ondepreciation associated with the Company’s closing of five locations and there-franchising of 41 locations over the past 15 months.

 

Depreciation and amortizationdecreased $1.5 million, or 10.8%, to $13.1 million for the six months endedJune 30, 2002 from $14.6 million for the same period in 2001. Depreciation andamortization as a percentage of total revenues was 4.5% and 5.3% in the 2002and 2001 periods, respectively. The reduction reflects the impact ondepreciation associated with the Company’s closing of 19 locations and there-franchising of 41 locations over the past 18 months.

 

*Gainon franchise sales of restaurant operations and properties:*

 

Gain on franchisesales of restaurant operations and properties was $3.8 million for the secondquarter and six months ended July 1, 2001. The gain was primarily the result ofthe sale of 31 restaurants to a franchisee during the second quarter ended July1, 2001.

 

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

 

The loss on sales of other property and equipment, netwas $0.1 million for the quarter ended June 30, 2002 as compared to a gain of$0.3 million for the quarter ended July 1, 2001. The loss on sales of otherproperty and equipment, net was $0.6 million for the six months ended June 30,2002 as compared to a gain of $2.2 million for the six months ended July 1,2001. The loss during the six-month period in 2002 primarily resulted from thesale of idle land and four closed locations. The gain in 2001 resulted from thesale of 18 closed locations during the six-month period ended July 1, 2001.

 

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*Interestexpense, net:*

 

Interest expense, net ofcapitalized interest and interest income, decreased by $0.7 million, or 10.2%,to $6.2 million for the second quarter ended June 30, 2002 from $6.9 millionfor the same period in 2001. The decrease is primarily impacted by the decreasein the average outstanding debt in the 2002 quarter compared to the 2001quarter as a result of the Refinancing Plan.

 

Interest expense, net ofcapitalized interest and interest income, decreased by $1.9 million, or 13.5%,to $12.6 million for the six months ended June 30, 2002 from $14.5 million forthe same period in 2001. The decrease is primarily impacted by the decrease inthe average outstanding debt in the 2002 period compared to the 2001 period asa result of the Refinancing Plan. Total outstanding debt, including capitallease obligations, was reduced from $277.2 million at July 1, 2001 to $240.5million at June 30, 2002.

 

*Provisionfor income taxes:*

 

The provision for income taxes was $2.4 million, or38.9%, and $2.6 million, or 39.5%, for the second quarters ended June 30, 2002and July 1, 2001, respectively. The provision for income taxes was $1.8million, or 34.0%, and $1.1 million, or 34.8%, for the six months ended June30, 2002 and July 1, 2001, respectively. The Company records income taxes based on the effective rate expected forthe year with any changes in the valuation allowance reflected in the period ofchange.

 

*Netincome:*

 

Net income was $3.8 million and$4.0 million for the second quarters ended June 30, 2002 and July 1, 2001,respectively. Net income was $3.4 million and $2.1 million for the six monthsended June 30, 2002 and July 1, 2001, respectively, for the reasons discussedabove.

 

**Liquidity and Capital Resources**

 

The Company’s primary sources of liquidity and capitalresources are cash generated from operations and borrowings under its revolvingcredit facility. Net cash provided by operating activities was $8.7 million and$3.1 million for the six months ended June 30, 2002 and July 1, 2001,respectively. During the six months ended June 30, 2002, inventories increased$5.2 million in an effort to build manufactured inventory to take advantage oflower cream prices. Accrued expenses and other long-term liabilities decreased$3.2 million primarily as a result of $1.1 million of payments made against therestructuring reserve and $1.3 million of payments made for accruedconstruction costs. During the 2001 period, inventories increased $3.9 million asa result of increased retail and restaurant promotional activity during thesummer months.  Accounts payableincreased $4.6 million primarily as a result of increased inventory purchases.Accounts receivable increased $5.7 million primarily due to increased retailsupermarket sales along with the increase in volume of Foodservice productsales to franchisees. Accrued expenses and other long term-liabilitiesdecreased $3.5 million as a result of a $1.5 million reduction in accruedinterest on the revolver and term loans due to the timing of interest paymentsand $1.0 million of payments made against the captive insurance company’sreserves for workers compensation claims. Available borrowings under therevolving credit facility were $16.6 million as of June 30, 2002. Total lettersof credit issued and outstanding were $13.4 million and there were no revolvingcredit loans outstanding.

 

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Additional sources of liquidity consist of capital andoperating leases for financing leased restaurant locations (in malls andshopping centers and land or building leases), restaurant equipment,manufacturing equipment, distribution vehicles and computer equipment.Additionally, sales of under-performing existing restaurant properties andother assets (to the extent FICC’s and its subsidiaries’ debt instruments, ifany, permit) are sources of cash. The amount of debt financing that FICC willbe able to incur is limited by the terms of its New Credit Facility and SeniorNotes.

 

Net cash (used in) provided by investing activitieswas ($3.5 million) and $14.1 million for the six months ended June 30, 2002 andJuly 1, 2001, respectively. Capital expenditures for restaurant operations wereapproximately $3.9 million and $4.0 million for the six months ended June 30,2002 and July 1, 2001, respectively. Capital expenditures were offset byproceeds from the sales of property and equipment of $1.3 million and $19.9million in the 2002 period and the 2001 period, respectively. The decrease inproceeds was primarily due to the receipt of $12.9 million in 2001 related tosales of restaurants to franchisees.

 

The Company had a working capital deficit of $6.2million as of June 30, 2002. The Company is able to operate with a substantialworking capital deficit because: (i) restaurant operations are conductedprimarily on a cash (and cash equivalent) basis with a low level of accountsreceivable; (ii) rapid turnover allows a limited investment in inventories and(iii) cash from sales is usually received before related expenses for food,supplies and payroll are paid.

 

In December 2001, the Company completed a financialrestructuring plan (the “Refinancing Plan”) which included the repayment of the$64.5 million outstanding under the Old Credit Facility and the repurchase ofapproximately $21.3 million in Senior Notes with the proceeds from $55.0million in long-term mortgage financing (the “Mortgage Financing”) and a $33.7million sale and leaseback transaction (the “Sale/Leaseback Financing”). Inaddition, FICC secured a new $30.0 million revolving credit facility of whichup to $20.0 million is available to support letters of credit. The $30.0million commitment less outstanding letters of credit is available forborrowing to provide working capital and for other corporate needs (the “NewCredit Facility”). As of June 30, 2002, $16.6 million was available foradditional borrowings under the New Credit Facility. The refinancing improvedthe Company’s financial condition by reducing total debt by approximately $30.8million and by extending the average life of the Company’s debt.

 

Three new limited liability corporations (“LLCs”) wereorganized in connection with the Mortgage Financing. Friendly Ice CreamCorporation 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 maturity date of January1, 2022 and is amortized over 20 years. Interest on $10.0 million of theMortgage Financing is variable and is the sum of the 30-day LIBOR rate ineffect (1.8388% at June 30, 2002) plus 6% on an annual basis. Changes in theinterest rate are calculated monthly and recognized annually when the monthlypayment amount is adjusted. Changes in the monthly payment amounts owed due tointerest rate changes are reflected in the principal balances which arereamortized over the remaining life of the mortgages. The remaining $45.0million of the Mortgage Financing bears interest at a fixed annual rate of10.16%. Each promissory note may be prepaid in full. The variable rate notesare subject to prepayment penalties during the first five years. The fixed ratenotes may not be prepaid without the Company providing the note holders with ayield maintenance premium.

 

The Mortgage Financing requires the Company tomaintain an annual fixed charge coverage ratio, as defined, of at least 1.10 to1 and each LLC to maintain a fixed charge coverage ratio, as defined, on anaggregate restaurant basis of at least 1.25 to 1.

 

The New Credit Facility is secured by substantiallyall 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 June 30, 2002,there were no revolving credit loans outstanding.

 

The revolving credit loans bear interest at theCompany’s option at either (a) the Base Rate plus the applicable margin as ineffect from time to time (the “Base Rate”) (7.25% at June 30, 2002) or (b) theEurodollar rate plus the applicable margin as in effect from time to time (the“Eurodollar Rate”) (6.28% at June 30, 2002).

 

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As of June 30, 2002 and December 30, 2001, totalletters of credit issued and outstanding were $13.4 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 revolving creditloans on or before September 30 (or, if September 30 is not a business day, asdefined, then the next business day) of each year and maintain a zero balanceon such revolving credit for at least 30 consecutive days, to include September30, immediately following the date of such repayment.

 

The New Credit Facility includes certain restrictivecovenants including limitations on indebtedness, limitations on restrictedpayments such as dividends and stock repurchases and limitations on sales ofassets and of subsidiary stock. Additionally, the New Credit Facility limitsthe amount which the Company may spend on capital expenditures, restricts theuse of proceeds, as defined, from asset sales and requires the Company tocomply with certain financial covenants.

 

In connection with the Refinancing Plan, in December2001, the Company entered into and accounted for the Sale/Leaseback Financing,which provided approximately $33.7 million of proceeds to the Company. TheCompany sold 44 properties operating as Friendly’s Restaurants and entered intoa master lease with the buyer to lease the 44 properties for an initial term of20 years under a triple net lease. There are four five-year renewal options andlease payments are subject to escalator provisions every five years based uponincreases in the Consumer Price Index. A gain of $11.3 million was deferred andwas included in other accrued expenses and other long-term liabilities in theaccompanying condensed consolidated balance sheets. The deferred gain is beingamortized in proportion to the rent charged to expense over the initial leaseterm.

 

The $200 million Senior Notes issued in connectionwith the November 1997 Recapitalization (the “Senior Notes”) are unsecuredsenior obligations of FICC, guaranteed on an unsecured senior basis by FICC’sFriendly’s Restaurants Franchise, Inc. subsidiary, but are effectivelysubordinated to all secured indebtedness of FICC, including the indebtednessincurred 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.

 

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The Company anticipates requiring capital in thefuture principally to maintain existing restaurant and plant facilities and tocontinue to renovate and re-image existing restaurants. Capital expendituresfor 2002 are anticipated to be $16.0 million in the aggregate, of which $12.0million 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 contractual obligationsand commercial commitments of the Company as of June 30, 2002 (in thousands):

 
|                       |   |      |    | **Payments  due by Period** |   |
|----------------------------|--------|-----------|---------|-----------------------------|--------|
|                       |   | **Total** |    | **2002**                    |   | **2003-2004** |   | **2005-2006** |   | **Thereafter** |   |
| Contractual Obligations:   |   |      |    |                        |   |   |   |   |   |   |   |
| Long-term debt             |   | $         | 233,334 |                        | $      | 537 |   | $ | 2,124 |   | $ | 2,605 |   | $ | 228,068 |   |
| Capital lease  obligations |   | 10,902    |    | 1,279                       |   | 2,940 |   | 1,817 |   | 4,866 |   |
| Operating leases           |   | 151,352   |    | 15,805                      |   | 28,302 |   | 23,692 |   | 83,553 |   |
| Purchase  commitments      |   | 65,759    |    | 55,787                      |   | 9,899 |   | 65 |   | 8 |   |
|                            |        |           |         |                             |        |  |  |  |  |  |  |  |  |  |  |  |

 
|                           |   |      |   | **Amount of Commitment Expiration by Period** |   |
|--------------------------------|--------|-----------|--------|-----------------------------------------------|--------|
|                           |   | **Total** |   | **2002**                                      |   | **2003-2004** |   | **2005-2006** |   | **Thereafter** |   |
| Other Commercial  Commitments: |   |      |   |                                          |   |   |   |   |   |   |   |
| Revolving credit  facility     |   | $         | 16,575 |                                          | $      | — |   | $ | 16,575 |   | $ | — |   | $ | — |   |
| Letters of  credit             |   | 13,425    |   | —                                        |   | 13,425 |   | — |   | — |   |
|                           |   |      |   |                                          |   |   |   |   |   |   |   |
|                           |   |      |   |                                          |   |   |   |   |   |   |   |
|                                |        |           |        |                                               |        |  |  |  |  |  |  |  |  |  |  |  |

 

**Seasonality**

 

Due to the seasonality of frozen dessert consumption,and the effect from time to time of weather on patronage of the restaurants,the Company’s revenues and EBITDA are typically higher in its second and thirdfiscal quarters.

 

**Geographic Concentration**

 

Approximately 89% of the Company-owned restaurants arelocated, and substantially all of its retail sales are generated, in theNortheast. As a result, a severe or prolonged economic recession or changes indemographic mix, employment levels, population density, weather, real estatemarket conditions or other factors specific to this geographic region mayadversely affect the Company more than certain of its competitors which aremore geographically diverse.

 

**Significant Accounting Policies**

 

Financial Reporting Release No. 60 issued by theSecurities 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.

 

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*Use ofEstimates in the Preparation of Financial Statements -*

 

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and the disclosure of contingent assets andliabilities at the dates of the financial statements and the reported amountsof revenues and expenses during the reporting periods. The critical accountingpolicies and most significant estimates and assumptions relate to revenuerecognition, insurance reserves, recoverability of accounts receivable,restructuring reserves, valuation allowances and pension and otherpost-retirement benefits expense. Actual amounts could differ significantlyfrom the estimates.

 

*RevenueRecognition -*

 

The Company’s revenues are derived primarily from theoperation of full-service restaurants, the distribution and sale of frozendesserts through retail and institutional locations and franchising. TheCompany recognizes restaurant revenue upon receipt of payment from the customerand retail revenue upon shipment of product. Reserves for discounts andallowances from retail sales are estimated and accrued when revenue isrecorded. Actual amounts could differ materially from the estimates. Franchiseroyalty income, based on net sales of franchisees, is payable monthly and isrecorded on the accrual method. Initial franchise fees are recorded as revenueupon completion of all significant services, generally upon opening of therestaurant.

 

*InsuranceReserves -*

 

The Company is self–insured through retentionsor deductibles for the majority of its workers’ compensation, automobile,general liability, employer’s liability, product liability and group healthinsurance programs. Self–insurance amounts vary up to $0.5 million peroccurrence. Insurance with third parties, some of which is then reinsuredthrough 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. Actual incurredlosses may vary from the estimated incurred losses and could have a materialeffect on the Company’s insurance expense.

 

*RestructuringReserves -*

 

On October 10, 2001, the Company eliminatedapproximately 70 positions at corporate headquarters. In addition,approximately 30 positions in the restaurant construction and fabrication areaswere eliminated by December 30, 2001. The purpose of the reduction was tostreamline functions and reduce redundancy 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.

 

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In March 2000, the Company’s Board of Directorsapproved a restructuring plan that provided for the immediate closing of 81restaurants at the end of March 2000 and the disposition of an additional 70restaurants over the next 24 months. As a result of this plan, the Companyreported a pre-tax restructuring charge of 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 thequarter ended June 30, 2002 and the year ended December 30, 2001, respectively,since the reserve exceeded estimated remaining payments.

 

As of June 30, 2002, the remaining restructuringreserve was $1.6 million. The restructuring reserves may be increased ordecreased based upon remaining payments, which could vary materially from theestimates depending upon the timing of restaurant closings and other factors.

 

*IncomeTaxes -*

 

The Company accounts for income taxes in accordancewith SFAS No. 109, “Accounting for Income Taxes,” which requires recognition ofdeferred tax assets and liabilities for the expected future tax consequences ofevents that have been included in the financial statements or tax returns. Avaluation allowance is recorded for deferred tax assets whose realization isnot likely. As of December 30, 2001 and June 30, 2002, a valuation allowance of$11.3 million 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.The amount and timing of any future taxable income may affect the usage of suchcarryforwards, which could result in a material change in the valuationallowance.

 

*Pensionand Other Post-Retirement Benefits -*

 

The determination of the Company’s obligation andexpense for pension and other post-retirement benefits is dependent upon theselection of certain assumptions used by actuaries in calculating such amounts.Those assumptions include, among other things, the discount rate, expectedlong-term rate of return on plan assets and rates of increase in compensationand health care costs. In accordance with accounting principles generallyaccepted in the United States, actual results that differ from the assumptionsare accumulated and amortized over future periods and, therefore, generallyaffect the recognized expense and recorded obligation in such future periods.While FICC believes that the assumptions used are appropriate, significantdifferences in actual experience or significant changes in the assumptions maymaterially affect the future pension and other post-retirement obligations andexpense.

 

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**Recently Issued Accounting Pronouncements**

 

In August 2001, the Financial Accounting StandardsBoard (“FASB”) issued Statement of Financial Accounting Standards (“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. 142modifies the rules for accounting for goodwill and other intangible assets. Thenew rules became effective for the Company on December 31, 2001. The impact ofadopting SFAS No. 142 on December 31, 2001 had no effect on the Company’sfinancial condition or results of operations and the Company is continuing toamortize its license agreement related to certain trademarked products over theterm of the license agreement.

 

In April 2001, the FASB reached consensus on EmergingIssues Task Force (“EITF”) Issue No. 00-25, “Accounting for Consideration froma Vendor to a Retailer in Connection with the Purchase or Promotion of theVendor’s Products.” EITF Issue No. 00-25 was effective for quarters beginningafter December 15, 2001, with prior financial statements restated ifpracticable. EITF Issue No. 00-25 requires that consideration from a vendor toa retailer be recorded as a reduction in revenue unless certain criteria aremet. Arrangements within the scope of this Issue include slotting fees,cooperative advertising arrangements and buy-downs. As a result of EITF IssueNo. 00-25, certain costs previously recorded as expense have been reclassifiedand offset against revenue for the quarter and six months ended July 1, 2001.

 

**Item3.  Quantitative and QualitativeDisclosures About Market Risk**

 

There has been no material change in the Company’smarket risk exposure since the filing of the Annual Report on Form 10-K.

 

**Item 4.Controls and Procedures**

 

As of June 30, 2002, anevaluation 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 and procedures.  Based on that evaluation, the Company’smanagement, including the CEO and CFO, concluded that the Company’s disclosurecontrols and procedures were effective as of June 30, 2002.  There have been no significant changes inthe Company’s internal controls or in other factors that could significantlyaffect internal controls subsequent to June 30, 2002.

 

 

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**PART II - OTHER INFORMATION**

 

**Item4.  Submission of matters to a vote ofsecurity holders**

 

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

 

(b) Not applicable.

 

(c)   The election of two nominees for directorsof the Company was voted upon at the meeting. The number of affirmative votesand the number 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.

 

**Item6.  Exhibits and reports 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 the requirements of the Securities and Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe 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 reviewedthis quarterly report on Form 10-Q/A of Friendly Ice Cream Corporation;

 

2.               Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.               Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.               The registrant’sother certifying officers and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and have:

 

a)              designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b)             evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)              presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.               The registrant’sother certifying officers and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunctions):

 

a)              all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)             any fraud, whether ornot material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.               The registrant’sother certifying officers and I have indicated in this quarterly report whetherthere were significant changes in internal controls or in other factors thatcould significantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

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

 

35

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I, Paul V. Hoagland, certify that:

 

1.               I have reviewedthis quarterly report on Form 10-Q/A of Friendly Ice Cream Corporation;

 

2.               Based on myknowledge, this quarterly report does not contain any untrue statement of a materialfact or omit to state a material fact necessary to make the statements made, inlight of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.               Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.               The registrant’sother certifying officers and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and have:

 

a)              designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b)             evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)              presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.               The registrant’sother certifying officers and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunctions):

 

a)              all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)             any fraud, whether ornot material, that involves management or other employees who have a significantrole in the registrant’s internal controls; and

 

6.               The registrant’sother certifying officers and I have indicated in this quarterly report whetherthere were significant changes in internal controls or in other factors thatcould significantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

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

 

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