**SECURITIES ANDEXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

**(Mark One)**

 
| **ý**                                            | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934**  |
|-------------------------------------------------------|---------------------------------------------------------------------------------------------------------|
|                                                  |                                                                                                    |
| **For the  quarterly period ended July 3, 2005** |
| ** **                                            |
| **OR**                                                |
| **o**                                                 | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934** |

 

**For the transition periodfrom                 to                 **

 

**Commission File No. 001-13579**

 

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**FRIENDLY ICECREAM CORPORATION**

(Exact Name of Registrant as Specified in ItsCharter)

 
| **Massachusetts**                                               | ** ** | **04-2053130**                     |
|-----------------------------------------------------------------|------------|------------------------------------|
| (State or Other Jurisdiction of  Incorporation or Organization) |       | (IRS Employer  Identification No.) |

 
| **1855 Boston Road  Wilbraham, Massachusetts** | ** ** | **01095**  |
|------------------------------------------------|------------|------------|
| (Address of Principal Executive  Offices)      |       | (Zip Code) |

 

**(413) 543-2400**

(Registrant’s Telephone Number, Including Area Code)

 

**NotApplicable**

(Former name, former address and former fiscal year,if changed since last report)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. Yes ý  No o

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Exchange Act Rule 12b-2). Yes ý   No o

 

Indicate the number of shares outstanding of each of theissuer’s classes of common stock as of the latest practicable date.

 

| **Class**                    | ** ** | **Outstanding  at July 22, 2005** |
|------------------------------|------------|----------------------------------------|
|                         |       |                                   |
| Common Stock, $.01 par value |       | 7,775,173 shares                       |

 

 

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**PART I – FINANCIALINFORMATION**

 

**Item 1.****  Financial Statements**

 

**FRIENDLY ICE CREAM CORPORATIONAND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED BALANCESHEETS**

(Unaudited)

(In thousands)

 
| ** **                                                                | ** ** | **July 3,** | ** ** | **January 2,** | ** ** |
|---------------------------------------------------------------------------|------------|------------------|------------|---------------------|------------|
| ** **                                                                | ** ** | **2005**         | ** ** | **2005**            | ** ** |
|                                                                      |       |             |       |                |       |
| ASSETS                                                                    |       |             |       |                |       |
| CURRENT ASSETS:                                                           |       |             |       |                |       |
| Cash and cash equivalents                                                 |       | $                | 15,385     |                | $          | 13,405 |   |
| Restricted cash                                                           |       | 1,306            |       | 1,711               |       |
| Accounts receivable, net                                                  |       | 14,681           |       | 10,448              |       |
| Inventories                                                               |       | 16,276           |       | 17,545              |       |
| Deferred income taxes                                                     |       | 6,853            |       | 6,853               |       |
| Prepaid expenses and other  current assets                                |       | 6,078            |       | 4,382               |       |
| TOTAL CURRENT ASSETS                                                      |       | 60,579           |       | 54,344              |       |
| DEFERRED INCOME TAXES                                                     |       | 10,718           |       | 10,619              |       |
| PROPERTY AND EQUIPMENT, net of  accumulated depreciation and amortization |       | 151,038          |       | 156,412             |       |
| INTANGIBLE ASSETS AND DEFERRED  COSTS, net of accumulated amortization    |       | 19,589           |       | 20,510              |       |
| OTHER ASSETS                                                              |       | 7,108            |       | 6,999               |       |
| TOTAL ASSETS                                                              |       | $                | 249,032    |                | $          | 248,884 |   |
|                                                                      |       |             |       |                |       |
| LIABILITIES AND STOCKHOLDERS’  DEFICIT                               |       |             |       |                |       |
| CURRENT LIABILITIES:                                                      |       |             |       |                |       |
| Current maturities of long-term  debt                                     |       | $                | 1,175      |                | $          | 5,224 |   |
| Current maturities of capital  lease and finance obligations              |       | 1,484            |       | 1,533               |       |
| Accounts payable                                                          |       | 24,000           |       | 21,536              |       |
| Accrued salaries and benefits                                             |       | 10,666           |       | 8,740               |       |
| Accrued interest payable                                                  |       | 1,169            |       | 1,427               |       |
| Insurance reserves                                                        |       | 11,588           |       | 9,927               |       |
| Restructuring reserves                                                    |       | 410              |       | 1,078               |       |
| Other accrued expenses                                                    |       | 19,577           |       | 18,582              |       |
| TOTAL CURRENT LIABILITIES                                                 |       | 70,069           |       | 68,047              |       |
| CAPITAL LEASE AND FINANCE  OBLIGATIONS, less current maturities           |       | 6,666            |       | 7,380               |       |
| LONG-TERM DEBT, less current  maturities                                  |       | 225,087          |       | 225,752             |       |
| ACCRUED PENSION COST                                                      |       | 17,675           |       | 17,532              |       |
| OTHER LONG-TERM LIABILITIES                                               |       | 34,634           |       | 35,199              |       |
| COMMITMENTS AND CONTINGENCIES STOCKHOLDERS’  DEFICIT:                |       |             |       |                |       |
| Common stock                                                              |       | 78               |       | 77                  |       |
| Additional paid-in capital                                                |       | 143,512          |       | 143,115             |       |
| Accumulated other comprehensive  loss                                     |       | (20,672          | )          | (20,670             | )          |
| Accumulated deficit                                                       |       | (228,017         | )          | (227,548            | )          |
| TOTAL STOCKHOLDERS’ DEFICIT                                          |       | (105,099         | )          | (105,026            | )          |
| TOTAL LIABILITIES AND  STOCKHOLDERS’ DEFICIT                         |       | $                | 249,032    |                | $          | 248,884 |   |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

1

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## **FRIENDLY ICE CREAM CORPORATIONAND SUBSIDIARIES**

##  

**CONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS**

(Unaudited)

(In thousands, except per share data)

 
| ** **                                                       | ** ** | **For the  Three Months Ended** | ** ** | **For the Six  Months Ended** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                                       | ** ** | **July 3,**                | ** ** | **June 27,**             | ** ** | **July 3,** | ** ** | **June 27,** | ** ** |
| ** **                                                       | ** ** | **2005**                        | ** ** | **2004**                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                       | ** ** | ** **                      | ** ** | **(Restated)**                | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
| REVENUES:                                                        |       |                            |       |                          |       |   |   |   |   |
| Restaurant                                                       |       | $                               | 112,799    |                          | $          | 114,441 |   | $ | 208,891 |   | $ | 218,794 |   |
| Foodservice                                                      |       | 31,748                          |       | 29,820                        |       | 57,054 |   | 53,163 |   |
| Franchise                                                        |       | 3,876                           |       | 3,255                         |       | 7,126 |   | 6,313 |   |
| TOTAL REVENUES                                                   |       | 148,423                         |       | 147,516                       |       | 273,071 |   | 278,270 |   |
|                                                             |       |                            |       |                          |       |   |   |   |   |
| COSTS AND EXPENSES:                                              |       |                            |       |                          |       |   |   |   |   |
| Cost of sales                                                    |       | 55,502                          |       | 55,959                        |       | 103,257 |   | 101,547 |   |
| Labor and benefits                                               |       | 39,903                          |       | 42,155                        |       | 76,436 |   | 82,089 |   |
| Operating expenses                                               |       | 28,495                          |       | 27,894                        |       | 53,016 |   | 53,025 |   |
| General and administrative  expenses                             |       | 10,528                          |       | 9,754                         |       | 19,977 |   | 20,451 |   |
| Restructuring expenses                                           |       | —                          |       | —                        |       | — |   | 2,627 |   |
| Gain on litigation settlement                                    |       | —                          |       | —                        |       | — |   | (3,644 | ) |
| Write-downs of property and  equipment                           |       | 289                             |       | 91                            |       | 289 |   | 91 |   |
| Depreciation and amortization                                    |       | 5,809                           |       | 5,682                         |       | 12,133 |   | 11,399 |   |
| Gain on franchise sales of  restaurant operations and properties |       | (1,219                          | )          | (7                            | )          | (2,528 | ) | (913 | ) |
| Loss on disposals of other  property and equipment, net          |       | 298                             |       | 337                           |       | 368 |   | 508 |   |
|                                                             |       |                            |       |                          |       |   |   |   |   |
| OPERATING INCOME                                                 |       | 8,818                           |       | 5,651                         |       | 10,123 |   | 11,090 |   |
|                                                             |       |                            |       |                          |       |   |   |   |   |
| OTHER EXPENSES:                                                  |       |                            |       |                          |       |   |   |   |   |
| Interest expense, net                                            |       | 5,233                           |       | 5,368                         |       | 10,531 |   | 11,432 |   |
| Other (income) expense,  principally debt retirement costs       |       | (4                              | )          | 2,343                         |       | (16 | ) | 9,235 |   |
|                                                             |       |                            |       |                          |       |   |   |   |   |
| INCOME (LOSS) BEFORE (PROVISION FOR)  BENEFIT FROM INCOME TAXES  |       | 3,589                           |       | (2,060                        | )          | (392 | ) | (9,577 | ) |
|                                                             |       |                            |       |                          |       |   |   |   |   |
| (Provision for) benefit from  income taxes                       |       | (1,072                          | )          | 640                           |       | (77 | ) | 2,915 |   |
|                                                             |       |                            |       |                          |       |   |   |   |   |
| NET INCOME (LOSS)                                                |       | $                               | 2,517      |                          | $          | (1,420 | ) | $ | (469 | ) | $ | (6,662 | ) |
|                                                             |       |                            |       |                          |       |   |   |   |   |
| BASIC NET INCOME (LOSS) PER SHARE                                |       | $                               | 0.32       |                          | $          | (0.19 | ) | $ | (0.06 | ) | $ | (0.88 | ) |
|                                                             |       |                            |       |                          |       |   |   |   |   |
| DILUTED NET INCOME (LOSS) PER  SHARE                             |       | $                               | 0.32       |                          | $          | (0.19 | ) | $ | (0.06 | ) | $ | (0.88 | ) |
|                                                             |       |                            |       |                          |       |   |   |   |   |
| WEIGHTED AVERAGE SHARES:                                         |       |                            |       |                          |       |   |   |   |   |
| Basic                                                            |       | 7,753                           |       | 7,611                         |       | 7,735 |   | 7,569 |   |
| Diluted                                                          |       | 7,893                           |       | 7,611                         |       | 7,735 |   | 7,569 |   |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

2

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**FRIENDLY ICE CREAM CORPORATION AND SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

(Unaudited)

(In thousands)

 
| ** **                                                                       | ** ** | **For the Six  Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                       | ** ** | **July 3,**              | ** ** | **June 27,** | ** ** |
| ** **                                                                       | ** ** | **2005**                      | ** ** | **2004** | ** ** |
| ** **                                                                       | ** ** | ** **                    | ** ** | **(Restated)** | ** ** |
| CASH FLOWS FROM OPERATING  ACTIVITIES:                                           |       |                          |       |   |   |
| Net loss                                                                         |       | $                             | (469       | ) | $ | (6,662 | ) |
| Adjustments to reconcile net loss  to net cash provided by operating activities: |       |                          |       |   |   |
| Stock compensation expense                                                       |       | 68                            |       | 380 |   |
| Depreciation and amortization                                                    |       | 12,133                        |       | 11,399 |   |
| Write-offs of deferred financing  costs                                          |       | —                        |       | 2,445 |   |
| Write-downs of property and  equipment                                           |       | 289                           |       | 91 |   |
| Deferred income tax benefit                                                      |       | (99                           | )          | (2,915 | ) |
| Gain on disposals of other  property and equipment, net                          |       | (2,166                        | )          | (405 | ) |
| Changes in operating assets and  liabilities:                                    |       |                          |       |   |   |
| Accounts receivable                                                              |       | (4,233                        | )          | (4,016 | ) |
| Inventories                                                                      |       | 1,269                         |       | (2,038 | ) |
| Other assets                                                                     |       | (1,200                        | )          | (4,103 | ) |
| Accounts payable                                                                 |       | 2,464                         |       | 5,013 |   |
| Accrued expenses and other  long-term liabilities                                |       | 3,234                         |       | 1,048 |   |
| NET CASH PROVIDED BY OPERATING  ACTIVITIES                                       |       | 11,290                        |       | 237 |   |
|                                                                             |       |                          |       |   |   |
| CASH FLOWS FROM INVESTING  ACTIVITIES:                                           |       |                          |       |   |   |
| Purchases of property and  equipment                                             |       | (7,309                        | )          | (8,262 | ) |
| Proceeds from sales of property  and equipment                                   |       | 3,359                         |       | 3,378 |   |
| Purchases of marketable  securities                                              |       | (345                          | )          | (905 | ) |
| Proceeds from sales of marketable  securities                                    |       | 143                           |       | 89 |   |
| NET CASH USED IN INVESTING  ACTIVITIES                                           |       | (4,152                        | )          | (5,700 | ) |
|                                                                             |       |                          |       |   |   |
| CASH FLOWS FROM FINANCING  ACTIVITIES:                                           |       |                          |       |   |   |
| Proceeds from issuance of New  Senior Notes                                      |       | —                        |       | 175,000 |   |
| Proceeds from borrowings under  revolving credit facility                        |       | 16,250                        |       | 11,000 |   |
| Repayments of debt                                                               |       | (20,964                       | )          | (187,527 | ) |
| Payments of deferred financing  costs                                            |       | (11                           | )          | (6,625 | ) |
| Principal payments of capital  lease and finance obligations                     |       | (763                          | )          | (554 | ) |
| Stock options exercised                                                          |       | 330                           |       | 749 |   |
| NET CASH USED IN FINANCING  ACTIVITIES                                           |       | (5,158                        | )          | (7,957 | ) |
|                                                                             |       |                          |       |   |   |
| NET INCREASE (DECREASE) IN CASH  AND CASH EQUIVALENTS                            |       | 1,980                         |       | (13,420 | ) |
|                                                                             |       |                          |       |   |   |
| CASH AND CASH EQUIVALENTS,  BEGINNING OF PERIOD                                  |       | 13,405                        |       | 25,631 |   |
|                                                                             |       |                          |       |   |   |
| CASH AND CASH EQUIVALENTS, END OF  PERIOD                                        |       | $                             | 15,385     |   | $ | 12,211 |   |
|                                                                             |       |                          |       |   |   |
| SUPPLEMENTAL DISCLOSURES:                                                        |       |                          |       |   |   |
| Cash paid during the period for:                                                 |       |                          |       |   |   |
| Interest                                                                         |       | $                             | 10,275     |   | $ | 11,975 |   |
| Income taxes                                                                     |       | 50                            |       | 16 |   |
| Capital lease obligations  incurred                                              |       | —                        |       | 2,280 |   |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

3

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**FRIENDLY ICE CREAM CORPORATIONAND SUBSIDIARIES**

 

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

 

(Unaudited)

 

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

 

*Interim Financial Information –*

 

The accompanying condensed consolidated financialstatements as of July 3, 2005 and for the three and six months ended July 3,2005 and June 27, 2004 are unaudited, but have been prepared in accordancewith generally accepted accounting principles (“GAAP”) for interim financialinformation and with the instructions to Form 10-Q and Article 10 ofRegulation S-X.  Accordingly, they do notinclude all of the information and footnotes required by GAAP for completefinancial statements.  In the opinion ofmanagement, all adjustments which are necessary for a fair presentation of theconsolidated financial position, results of operations, cash flows andcomprehensive income (loss) of Friendly Ice Cream Corporation (“FICC”) andsubsidiaries (unless the context indicates otherwise, collectively, the “Company”)have been included. Such adjustments consist solely of normal recurringaccruals. Operating results for the three and six month periods ended July 3,2005 and June 27, 2004 are not necessarily indicative of the results thatmay be expected for the entire year due, in part, to the seasonality of theCompany’s business. Historically, higher revenues and operating income havebeen experienced during the second and third fiscal quarters. The Company’sconsolidated financial statements, including the notes thereto, which arecontained in the 2004 Annual Report on Form 10-K/A for the fiscal yearended January 2, 2005 (“2004 Annual Report on Form 10-K/A”), shouldbe read in conjunction with these condensed consolidated financial statements.Capitalized terms not otherwise defined herein should be referenced to the 2004Annual Report on Form 10-K/A.

 

*Use of Estimates in the Preparation of Financial Statements -*

 

The preparation of financial statements in conformity withaccounting 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, incometax valuation allowances and pension and post-retirement medical and lifeinsurance benefits expense. Actual amounts could differ significantly from theestimates.

 

*Inventories -*

 

Inventoriesare stated at the lower of first-in, first-out cost or market and consisted ofthe following at July 3, 2005 and January 2, 2005 (in thousands):

 

| ** **       | ** ** | **July 3,** | ** ** | **January 2,** | ** ** |
|------------------|------------|------------------|------------|---------------------|------------|
| ** **       | ** ** | **2005**         | ** ** | **2005**            | ** ** |
|             |       |             |       |                |       |
| Raw materials    |       | $                | 1,703      |                | $          | 2,685 |   |
| Goods in process |       | 142              |       | 157                 |       |
| Finished goods   |       | 14,431           |       | 14,703              |       |
| Total            |       | $                | 16,276     |                | $          | 17,545 |   |

 

4

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*Other Assets* –

 

Otherassets included notes receivable of $4,490,000 and $4,524,000, which were netof allowances for doubtful accounts totaling $263,000 as of July 3, 2005and January 2, 2005, respectively. As of July 3, 2005, notes receivableincluded a balloon payment of $3,903,460, due from a franchisee on April 15,2006, for a subordinated promissory note. On June 30, 2005, the franchiseerequested that the term of the note be extended for one year, with a newballoon payment of $3,796,303 due on April 15, 2007. On July 29, 2005, theCompany agreed to the extension.

 

Alsoincluded in other assets as of as of July 3, 2005 and January 2, 2005were payments made to fronting insurance carriers of $1,343,000 and $1,402,000,respectively, to establish loss escrow funds.

 

*Other Accrued Expenses -*

 

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

 

| ** **                    | ** ** | **July 3,** | ** ** | **January 2,** | ** ** |
|-------------------------------|------------|------------------|------------|---------------------|------------|
| ** **                    | ** ** | **2005**         | ** ** | **2005**            | ** ** |
|                          |       |             |       |                |       |
| Accrued rent                  |       | $                | 4,515      |                | $          | 4,781 |   |
| Accrued meals and other taxes |       | 2,685            |       | 2,766               |       |
| Gift cards outstanding        |       | 2,583            |       | 4,068               |       |
| Accrued advertising           |       | 2,433            |       | 1,824               |       |
| Accrued construction costs    |       | 2,216            |       | 1,236               |       |
| Unearned revenues             |       | 1,391            |       | 1,056               |       |
| Accrued bonus                 |       | 1,350            |       | 751                 |       |
| All other                     |       | 2,404            |       | 2,100               |       |
| Total                         |       | $                | 19,577     |                | $          | 18,582 |   |

 

 

*Lease Guarantees and Contingencies –*

 

Primarilyas a result of the Company’s re-franchising efforts, the Company remains liablefor certain lease assignments and guarantees. These leases have varying terms,the latest of which expires in 2020. As of July 3, 2005, the potentialamount of undiscounted payments the Company could be required to make in theevent of non-payment by the primary lessees was $6,598,249. The present valueof these potential payments discounted at the Company’s pre-tax cost of debt atJuly 3, 2005 was $5,105,000. The Company generally has cross-defaultprovisions with franchisees that would put the franchisee in default of itsfranchise agreement in the event of non-payment under the lease. The Companybelieves these cross-default provisions significantly reduce the risk that theCompany will be required to make payments under these leases and, historically,the Company has not been required to make such payments. Additionally, as of July 3,2005, the Company has no reason to believe that any franchisee will be unableto fulfill its obligations. Accordingly, no liability had been recorded forexposure under such leases at July 3, 2005 and January 2, 2005.

 

5

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*Income (Loss) Per Share –*

 

Basicnet income (loss) per share is calculated by dividing net income (loss) by theweighted average number of common shares outstanding during the period. Dilutednet income (loss) per share is calculated by dividing net income (loss) by theweighted average number of shares of common stock and common stock equivalentsoutstanding during the period. Common stock equivalents are dilutive stockoptions and warrants that are assumed exercised for calculation purposes. Therewere 140,169 common stock equivalents included in diluted net income per sharefor the three months ended July 3, 2005 and no common stock equivalentsincluded in diluted net loss per share for the six months ended July 3,2005 and the three and six months ended June 27, 2004.  The number of common stock options whichcould dilute basic net income (loss) per share in the future, that were notincluded in the computation of diluted net income (loss) per share because todo so would have been antidilutive, was 129,817 and 284,289 for the threemonths ended July 3, 2005 and June 27, 2004, respectively. The numberof common stock options which could dilute basic net income (loss) per share inthe future, that were not included in the computation of diluted net income(loss) per share because to do so would have been antidilutive, was 284,651 and289,195 for the six months ended July 3, 2005 and June 27, 2004,respectively.

 

During the six months ended July 3, 2005, the Companygranted employee stock options to purchase approximately 120,000 shares ofcommon stock at an exercise price equal to the closing market prices on thedate of grants. During the six months ended July 3, 2005, 60,194 employeestock options were exercised. The weighted-average exercise prices of theoptions granted and options exercised were $8.87 and $5.49, respectively.

 

6

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Presented below is the reconciliation between basic anddiluted weighted average shares for the three and six months ended July 3,2005 and June 27, 2004 (in thousands):

 
| ** **                                                              | ** ** | **For the  Three Months Ended** | ** ** |
|-------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                              | ** ** | **Basic**                       | ** ** | **Diluted** | ** ** |
| ** **                                                              | ** ** | **July 3,**                | ** ** | **June 27,** | ** ** | **July 3,** | ** ** | **June 27,** | ** ** |
| ** **                                                              | ** ** | **2005**                        | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                    |       |                            |       |   |   |   |   |   |   |
| Weighted average number of common  shares outstanding during the period |       | 7,753                           |       | 7,611 |   | 7,753 |   | 7,611 |   |
| Adjustments:                                                            |       |                            |       |   |   |   |   |   |   |
| Assumed exercise of stock options                                       |       | —                          |       | — |   | 140 |   | — |   |
| Weighted average number of shares  outstanding                          |       | 7,753                           |       | 7,611 |   | 7,893 |   | 7,611 |   |

 
| ** **                                                              | ** ** | **For the Six  Months Ended** | ** ** |
|-------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                              | ** ** | **Basic**                     | ** ** | **Diluted** | ** ** |
| ** **                                                              | ** ** | **July 3,**              | ** ** | **June 27,** | ** ** | **July 3,** | ** ** | **June 27,** | ** ** |
| ** **                                                              | ** ** | **2005**                      | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                    |       |                          |       |   |   |   |   |   |   |
| Weighted average number of common  shares outstanding during the period |       | 7,735                         |       | 7,569 |   | 7,735 |   | 7,569 |   |
| Adjustments:                                                            |       |                          |       |   |   |   |   |   |   |
| Assumed exercise of stock options                                       |       | —                        |       | — |   | — |   | — |   |
| Weighted average number of shares  outstanding                          |       | 7,735                         |       | 7,569 |   | 7,735 |   | 7,569 |   |

 

7

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*Stock-Based Compensation –*

 

TheCompany accounts for stock-based compensation for employees under AccountingPrinciples Board (“APB”) Opinion No. 25, “Accounting for Stock Issued toEmployees,” and elected the disclosure-only alternative under Statement ofFinancial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-BasedCompensation.”  Stock-based compensationcost of $68,000 and $222,000 related to modified option awards was included innet loss for the six months ended July 3, 2005 and June 27, 2004,respectively, for the Company’s Stock Option Plan and the Company’s 2003Incentive Plan.

 

In December 2002,the Financial Accounting Standards Board (“FASB”) issued SFAS No. 148, “Accountingfor Stock-Based Compensation–Transition and Disclosure,” which amended SFAS No. 123.SFAS No. 148 allowed for three methods of transition for those companiesthat adopt SFAS No. 123’s provisions for fair value recognition. SFAS No. 148’stransition guidance and provisions for annual disclosures were effective forfiscal years ending after December 15, 2002. In accordance with SFAS No. 148,the Company continued to disclose the required pro-forma information in thenotes to the condensed consolidated financial statements.

 

In accordancewith SFAS No. 148, the following table presents the effect on net income(loss) and net income (loss) per share had compensation cost for the Company’sstock plans been determined consistent with SFAS No. 123 (in thousands,except per share data):

 
| ** **                                                                                                                          | ** ** | **For the  Three Months Ended** | ** ** | **For the Six  Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                                                                                                          | ** ** | **July 3,**                | ** ** | **June 27,**             | ** ** | **July 3,** | ** ** | **June 27,** | ** ** |
| ** **                                                                                                                          | ** ** | **2005**                        | ** ** | **2004**                      | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                                                |       |                            |       |                          |       |   |   |   |   |
| Net income (loss) as reported                                                                                                       |       | $                               | 2,517      |                          | $          | (1,420 | ) | $ | (469 | ) | $ | (6,662 | ) |
|                                                                                                                                |       |                            |       |                          |       |   |   |   |   |
| Add stock-based compensation  expense included in reported net income (loss), net of related income tax  (expense) benefit          |       | 40                              |       | —                        |       | 40 |   | 131 |   |
| Less stock-based compensation  expense determined under fair value method for all stock options, net of  related income tax benefit |       | (50                             | )          | (106                          | )          | (64 | ) | (211 | ) |
| Pro forma net income (loss)                                                                                                         |       | $                               | 2,507      |                          | $          | (1,526 | ) | $ | (493 | ) | $ | (6,742 | ) |
|                                                                                                                                |       |                            |       |                          |       |   |   |   |   |
| Basic net income (loss) per  share, as reported                                                                                     |       | $                               | 0.32       |                          | $          | (0.19 | ) | $ | (0.06 | ) | $ | (0.88 | ) |
| Basic net income (loss) per  share, pro forma                                                                                       |       | $                               | 0.32       |                          | $          | (0.19 | ) | $ | (0.06 | ) | $ | (0.88 | ) |
|                                                                                                                                |       |                            |       |                          |       |   |   |   |   |
| Diluted net income (loss) per  share, as reported                                                                                   |       | $                               | 0.32       |                          | $          | (0.19 | ) | $ | (0.06 | ) | $ | (0.88 | ) |
| Diluted net income (loss) per  share, pro forma                                                                                     |       | $                               | 0.32       |                          | $          | (0.19 | ) | $ | (0.06 | ) | $ | (0.88 | ) |

 

8

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*Recently Issued Accounting Pronouncements–*

 

In June 2005, the FASB’s Emerging Issues Task Forcereached a consensus on Issue No. 05-6, “Determining the AmortizationPeriod for Leasehold Improvements” (“EITF 05-6”). The guidance requires thatleasehold improvements acquired in a business combination or purchasedsubsequent to the inception of a lease be amortized over the lesser of theuseful life of the assets or a term that includes renewals that are reasonablyassured at the date of the business combination or purchase. The guidance iseffective for periods beginning after June 29, 2005. The adoption of EITF05-6 is not expected to have a material effect on the Company’s consolidatedfinancial position or results of operations.

 

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections–A Replacement of APB Opinion No. 20 and FASB Statement No. 3.” SFAS No. 154 applies to all voluntary changes in accounting principle and requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable. SFAS No. 154 requires that a change in depreciation, amortization, or depletion method for long-lived, nonfinancial assets be accounted for as a change of estimate affected by a change in accounting principle. SFAS No. 154 also carries forward without change the guidance in APB Opinion No. 20 with respect to accounting for changes in accounting estimates, changes in the reporting unit and correction of an error in previously issued financial statements. The Company is required to adopt SFAS No. 154 for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 is not expected to have a material effect on the Company’s consolidated financial position or results of operations.

 

On December 16,2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFASNo. 123R”), which is a revision of SFAS No. 123, “Accounting forStock-Based Compensation.” SFAS No. 123R supersedes APB Opinion No. 25,“Accounting for Stock Issued to Employees,” and amends SFAS No. 95, “Statementof Cash Flows.” Generally, the approach in SFAS No. 123R is similar to theapproach described in SFAS No. 123. However, SFAS No. 123R requiresall share-based payments to employees, including grants of employee stockoptions, to be recognized in the income statement based on their fair values.Pro forma disclosure is no longer an alternative. SFAS No. 123R must beadopted no later than the first annual period beginning after June 15,2005. Early adoption will be permitted in periods in which financial statementshave not yet been issued. SFAS No. 123R allows companies to choose betweenthe modified-prospective and modified-retrospective transition alternatives inadopting SFAS No. 123R. Under the modified-prospective transition method,compensation cost will be recognized in financial statements issued subsequentto the date of adoption for all shared-based payments granted, modified orsettled after the date of adoption, as well as for any unvested awards thatwere granted prior to the date of adoption. Under the modified-retrospectivetransition method, compensation cost will be recognized in a manner consistentwith the modified-prospective transition method, however, prior periodfinancial statements will also be restated by recognizing compensation cost aspreviously reported in the pro forma disclosures under SFAS No. 123. Therestatement provisions can be applied to either a) all periods presented or b)to the beginning of the fiscal year in which SFAS No. 123R is adopted. TheCompany expects to adopt SFAS No. 123R on January 2, 2006 using themodified-prospective method. As the Company previously adopted only the pro formadisclosure provisions of SFAS No. 123, the Company will recognizecompensation cost relating to the unvested portion of awards granted prior tothe date of adoption using the same estimate of the grant-date fair value andthe same attribution method used to determine the pro forma disclosures underSFAS No. 123.

 

Aspermitted by SFAS No. 123, the Company currently accounts for share-basedpayments to employees using APB Opinion No. 25’s intrinsic value methodand, as such, generally recognizes no compensation cost for employee stockoptions.  Accordingly, the adoption ofSFAS No. 123R’s fair value method will have an impact on the Company’sresults of operations, although it will have no impact on the overall financialposition. The impact of the adoption of SFAS No. 123R cannot be determinedat this time because it will depend upon levels of share-based payments grantedin the future. However, had the Company adopted SFAS No. 123R in priorperiods, the impact of that standard would have approximated the impact asdescribed in the disclosure of pro forma net income (loss) and net income(loss) per share pursuant to SFAS No. 123. SFAS No. 123R also requires the benefits of tax deductions inexcess of recognized compensation cost to be reported as a financing cash flow,rather than as an operating cash flow as required under currentliterature.  This requirement will reducenet operating cash flows and increase net financing cash flows in

 

9

----

 

periods after adoption. While the Company cannot estimate what those amounts will be in thefuture (because they depend on, among other things, when employees exercisestock options), the amount of operating cash flows recognized in prior yearsfor such excess tax deductions were $818,000 and $165,000 in 2004 and 2003,respectively.

 

In November 2004, the FASB issued SFAS No. 151, “InventoryCosts, an amendment of Accounting Research Bulletin No. 43, Chapter 4”.The amendments made by SFAS No. 151 clarify that abnormal amounts of idlefacility expense, freight, handling costs, and wasted materials (spoilage)should be recognized as current-period charges and require the allocation offixed production overheads to inventory based on the normal capacity of theproduction facilities. SFAS No. 151 is the result of a broader effort bythe FASB to improve the comparability of cross-border financial reporting byworking with the International Accounting Standards Board toward development ofa single set of high-quality accounting standards. The guidance is effectivefor inventory costs incurred during fiscal years beginning after June 15,2005. The adoption of SFAS No. 151 is not expected to have a materialeffect on the Company’s consolidated financial position or results of operations.

 

10

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**2. RESTATEMENT OF FINANCIAL STATEMENTS**

 

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

 

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

 

11

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The following is a summary of theimpact of the Restatement on the Company’s condensed consolidated statement ofoperations for the three and six months ended June 27, 2004 (inthousands):

 
| ** **                             | ** ** | **For the  Three Months Ended June 27, 2004** | ** ** |
|----------------------------------------|------------|----------------------------------------------------|------------|
| ** **                             | ** ** | **As  Previously**                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                             | ** ** | **Reported**                                       | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
|                                   |       |                                               |       |   |   |   |   |
| Operating expenses                     |       | $                                                  | 27,806     |   | $ | 88 |   | $ | 27,894 |   |
| Depreciation and amortization          |       | 5,570                                              |       | 112 |   | 5,682 |   |
| Operating income                       |       | 5,851                                              |       | (200 | ) | 5,651 |   |
| Loss before benefit from income  taxes |       | (1,860                                             | )          | (200 | ) | (2,060 | ) |
| Benefit from income taxes              |       | 558                                                |       | 82 |   | 640 |   |
| Net loss                               |       | (1,302                                             | )          | (118 | ) | (1,420 | ) |
|                                   |       |                                               |       |   |   |   |   |
| Basic and diluted net loss per  share  |       | (0.17                                              | )          | (0.02 | ) | (0.19 | ) |
|                                        |            |                                                    |            |  |  |  |  |  |  |  |

 
| ** **                             | ** ** | **For the Six  Months Ended June 27, 2004** | ** ** |
|----------------------------------------|------------|--------------------------------------------------|------------|
| ** **                             | ** ** | **As  Previously**                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                             | ** ** | **Reported**                                     | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
|                                   |       |                                             |       |   |   |   |   |
| Operating expenses                     |       | $                                                | 52,858     |   | $ | 167 |   | $ | 53,025 |   |
| Depreciation and amortization          |       | 11,176                                           |       | 223 |   | 11,399 |   |
| Operating income                       |       | 11,480                                           |       | (390 | ) | 11,090 |   |
| Loss before benefit from income  taxes |       | (9,187                                           | )          | (390 | ) | (9,577 | ) |
| Benefit from income taxes              |       | 2,756                                            |       | 159 |   | 2,915 |   |
| Net loss                               |       | (6,431                                           | )          | (231 | ) | (6,662 | ) |
|                                   |       |                                             |       |   |   |   |   |
| Basic and diluted net loss per  share  |       | (0.85                                            | )          | (0.03 | ) | (0.88 | ) |
|                                        |            |                                                  |            |  |  |  |  |  |  |  |

 

12

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**3. EMPLOYEE BENEFIT PLANS**

 

Thecomponents of net periodic pension expense (benefit) for the three and sixmonths ended July 3, 2005 and June 27, 2004 were (in thousands):

 
| ** **                              | ** ** | **For the  Three Months Ended** | ** ** | **For the Six  Months Ended** | ** ** |
|-----------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                              | ** ** | **July 3,**                | ** ** | **June 27,**             | ** ** | **July 3,** | ** ** | **June 27,** | ** ** |
| ** **                              | ** ** | **2005**                        | ** ** | **2004**                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                              | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest cost                           |       | $                               | 1,715      |                          | $          | 1,675 |   | $ | 3,342 |   | $ | 3,302 |   |
| Expected return on assets               |       | (2,047                          | )          | (2,364                        | )          | (4,144 | ) | (4,695 | ) |
| Net amortization:                       |       |                            |       |                          |       |   |   |   |   |
| Unrecognized net actuarial loss         |       | 531                             |       | 182                           |       | 945 |   | 335 |   |
|                                    |       |                            |       |                          |       |   |   |   |   |
| Net periodic pension expense  (benefit) |       | $                               | 199        |                          | $          | (507 | ) | $ | 143 |   | $ | (1,058 | ) |

 

Thecomponents of the net postretirement medical and life insurance benefit costfor the three and six months ended July 3, 2005 and June 27, 2004were (in thousands):

 
| ** **                                              | ** ** | **For the  Three Months Ended** | ** ** | **For the Six  Months Ended** | ** ** |
|---------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                              | ** ** | **July 3,**                | ** ** | **June 27,**             | ** ** | **July 3,** | ** ** | **June 27,** | ** ** |
| ** **                                              | ** ** | **2005**                        | ** ** | **2004**                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                              | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service cost                                            |       | $                               | 41         |                          | $          | 28 |   | $ | 81 |   | $ | 56 |   |
| Interest cost                                           |       | 115                             |       | 116                           |       | 230 |   | 232 |   |
| Recognized actuarial loss                               |       | 20                              |       | 23                            |       | 41 |   | 45 |   |
| Net amortization of unrecognized  prior service benefit |       | (35                             | )          | (35                           | )          | (71 | ) | (71 | ) |
|                                                    |       |                            |       |                          |       |   |   |   |   |
| Net postretirement benefit cost                         |       | $                               | 141        |                          | $          | 132 |   | $ | 281 |   | $ | 262 |   |

 

On December 8,2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003(the “Act”), which introduced a Medicare prescription drug benefit, as well asa federal subsidy to sponsors of retiree health care benefit plans that providea benefit that is at least actuarially equivalent to the Medicare benefit, wasenacted. On May 19, 2004, the FASB issued Financial Staff Position No. 106-2,“Accounting and Disclosure Requirements Related to the Medicare PrescriptionDrug, Improvement and Modernization Act of 2003” (“FSP 106-2”) to discusscertain accounting and disclosure issues raised by the Act. FSP 106-2 addressesaccounting for the federal subsidy for the sponsors of single employerpostretirement health care plans and disclosure requirements for plans for whichthe employer has not yet been able to determine actuarial equivalency. Exceptfor certain nonpublic entities, FSP 106-2 is effective for the first interim orannual period beginning after June 15, 2004 (the quarter ended September 26,2004 for the Company).

 

13

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Based on regulationsissued by the Centers for Medicare & Medicaid Services, the Companyhas concluded that, for certain participants, the benefits provided are atleast actuarially equivalent to benefits available through Medicare Part D.  The Company has determined that the effectsof the Act are not significant. Therefore, the reported net benefit cost andthe accumulated benefit obligation of the Company’s postretirement medical andlife insurance plan in the accompanying condensed consolidated financialstatements and notes thereto does not reflect the effects of the Act. TheCompany will recognize the effect on the next measurement date, which will beincluded in the consolidated financial statements for the year ended January 1,2006.

 

**4. WRITE-DOWNS OF PROPERTY**

 

Inaccordance with SFAS No. 144, “Accounting for the Impairment or Disposalof Long-Lived Assets,” which was adopted in 2002, the Company reviewslong-lived assets related to each restaurant to be held and used in thebusiness quarterly for impairment, or whenever events or changes incircumstances indicate that the carrying amount of a restaurant may not berecoverable. The Company evaluates restaurants using a “two-year history of cashflow” as the primary indicator of potential impairment. Based on the bestinformation available, the Company writes down an impaired restaurant to itsestimated fair market value, which becomes its new cost basis. Estimated fairmarket value is based on the Company’s experience selling similar propertiesand local market conditions, less costs to sell forproperties to be disposed of. In addition, restaurants scheduled for closingare reviewed for impairment and depreciable lives are adjusted. The impairmentevaluation is based on the estimated cash flows from continuing use through theexpected disposal date and the expected terminal value.  SFAS No. 144 requires a long-lived assetto be disposed of other than by sale to be classified as held and used until itis disposed of.

 

Considerablemanagement judgment is necessary to estimate future cash flows, including cashflows from continuing use, terminal value, closure costs and sublease income.Accordingly, actual results could vary from estimates.

 

Duringthe quarter ended July 3, 2005, the Company identified two restaurantproperties to be disposed of other than by sale.  The Company determined that the carryingvalue of these restaurant properties exceeded their estimated undiscounted cashflows and the carrying values were reduced by an aggregate of $289,000accordingly. During the six months ended June 27, 2004, the Companydetermined that the carrying value of a vacant restaurant land parcel and thecarrying value of one restaurant property exceeded their estimated fair valuesless cost to sell.  The carrying valueswere reduced by an aggregate of $91,000.

 

14

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Thetable below identifies the components of the “Loss on disposals of otherproperty and equipment, net” as shown on the condensed consolidated statementsof operations (in thousands):

 
| ** **                                              | ** ** | **For the  Three Months Ended** | ** ** | **For the Six  Months Ended** | ** ** |
|---------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                              | ** ** | **July 3,**                | ** ** | **June 27,**             | ** ** | **July 3,** | ** ** | **June 27,** | ** ** |
| ** **                                              | ** ** | **2005**                        | ** ** | **2004**                      | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                    |       |                            |       |                          |       |   |   |   |   |
| Restaurant equipment assets  retired due to remodeling  |       | $                               | 220        |                          | $          | 173 |   | $ | 220 |   | $ | 173 |   |
| Restaurant equipment assets  retired due to replacement |       | 43                              |       | 87                            |       | 95 |   | 159 |   |
| Loss on property not held for  disposition              |       | 26                              |       | 62                            |       | 40 |   | 63 |   |
| All other                                               |       | 9                               |       | 15                            |       | 13 |   | 113 |   |
| Loss on disposals of other  property and equipment, net |       | $                               | 298        |                          | $          | 337 |   | $ | 368 |   | $ | 508 |   |

 

**5. SEGMENT REPORTING**

 

Operating segments are components of an enterprise aboutwhich separate financial information is available that is evaluated regularlyby the chief operating decision-maker, or decision-making group, in decidinghow to allocate resources and in assessing performance.The Company’s chief operating decision-maker is the Chief Executive Officer andPresident of the Company. The Company’s operating segments include restaurant,foodservice and franchise. The revenues from these segments include both salesto unaffiliated customers and inter-segment sales, which generally areaccounted for on a basis consistent with sales to unaffiliated customers.Intersegment sales and other inter-segment transactions have been eliminated inthe accompanying condensed consolidated financial statements.

 

The Company’s restaurants target families with kids andadults who desire a reasonably-priced meal in a full-service setting. TheCompany’s menu offers a broad selection of freshly-prepared foods which appealto customers throughout all dayparts. The menu currently features over 100items comprised of a broad selection of breakfast, lunch, dinner and afternoonand evening snack items. Foodservice operations manufacturespremium ice cream dessert products and distributes such manufactured productsand purchased finished goods to the Company’s restaurants and franchisedoperations. Additionally, it sells premium ice cream dessert products to distributorsand retail and institutional locations. The Company’s franchise segmentincludes a royalty based on franchise restaurant revenue. In addition, theCompany 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 expensesof legal, accounting, information systems and other headquarterfunctions.

 

15

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Theaccounting policies of the operating segments are the same as those describedin the summary of significant accounting policies except that the financialresults for the foodservice operating segment, prior to inter-segmenteliminations, have been prepared using a management approach, which isconsistent with the basis and manner in which the Company’s managementinternally reviews financial information for the purpose of assisting in makinginternal operating decisions. Using this approach, the Company evaluatesperformance based on stand-alone operating segment income (loss) before incometaxes and generally accounts for inter-segment sales and transfers as if thesales or transfers were to third parties, that is, at current market prices.

 

EBITDArepresents net income (loss) before (i) provision for (benefit from)income taxes, (ii) other (income) expense, principally debt retirementcosts, (iii) interest expense, net, (iv) depreciation andamortization, (v) write-downs of property and equipment, (vi) netperiodic pension expense (benefit) and (vii) other non-cash items. TheCompany has included information concerning EBITDA in this Form 10-Qbecause the Company’s management incentive plan pays bonuses based on achievingEBITDA targets and the Company believes that such information is used bycertain investors as one measure of a company’s historical ability to servicedebt. EBITDA should not be considered as an alternative to, or more meaningfulthan, income (loss) from operations or other traditional indications of acompany’s operating performance.

 
| ** **             | ** ** | **For the  Three Months Ended** | ** ** | **For the Six  Months Ended** | ** ** |
|------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **             | ** ** | **July 3,**                | ** ** | **June 27,**             | ** ** | **July 3,** | ** ** | **June 27,** | ** ** |
| ** **             | ** ** | **2005**                        | ** ** | **2004**                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **             | ** ** | **(in  thousands)**             | ** ** | **(in  thousands)**           | ** ** |
| Revenues:              |       |                            |       |                          |       |   |   |   |   |
| Restaurant             |       | $                               | 112,799    |                          | $          | 114,441 |   | $ | 208,891 |   | $ | 218,794 |   |
| Foodservice            |       | 65,220                          |       | 63,915                        |       | 119,384 |   | 117,277 |   |
| Franchise              |       | 3,876                           |       | 3,255                         |       | 7,126 |   | 6,313 |   |
| Total                  |       | $                               | 181,895    |                          | $          | 181,611 |   | $ | 335,401 |   | $ | 342,384 |   |
|                   |       |                            |       |                          |       |   |   |   |   |
| Intersegment revenues: |       |                            |       |                          |       |   |   |   |   |
| Restaurant             |       | $                               | —     |                          | $          | — |   | $ | — |   | $ | — |   |
| Foodservice            |       | (33,472                         | )          | (34,095                       | )          | (62,330 | ) | (64,114 | ) |
| Franchise              |       | —                          |       | —                        |       | — |   | — |   |
| Total                  |       | $                               | (33,472    | )                             | $          | (34,095 | ) | $ | (62,330 | ) | $ | (64,114 | ) |
|                   |       |                            |       |                          |       |   |   |   |   |
| External revenues:     |       |                            |       |                          |       |   |   |   |   |
| Restaurant             |       | $                               | 112,799    |                          | $          | 114,441 |   | $ | 208,891 |   | $ | 218,794 |   |
| Foodservice            |       | 31,748                          |       | 29,820                        |       | 57,054 |   | 53,163 |   |
| Franchise              |       | 3,876                           |       | 3,255                         |       | 7,126 |   | 6,313 |   |
| Total                  |       | $                               | 148,423    |                          | $          | 147,516 |   | $ | 273,071 |   | $ | 278,270 |   |

 

16

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| ** **                                                             | ** ** | **For the  Three Months Ended** | ** ** | **For the Six  Months Ended** | ** ** |
|------------------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                                             | ** ** | **July 3,**                | ** ** | **June 27,**             | ** ** | **July 3,** | ** ** | **June 27,** | ** ** |
| ** **                                                             | ** ** | **2005**                        | ** ** | **2004**                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                             | ** ** | ** **                      | ** ** | **(Restated)**                | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
| ** **                                                             | ** ** | **(in  thousands)**             | ** ** | **(in  thousands)**           | ** ** |
|                                                                   |       |                            |       |                          |       |   |   |   |   |
| EBITDA:                                                                |       |                            |       |                          |       |   |   |   |   |
| Restaurant                                                             |       | $                               | 12,303     |                          | $          | 11,336 |   | $ | 19,072 |   | $ | 20,590 |   |
| Foodservice                                                            |       | 4,234                           |       | 2,870                         |       | 6,382 |   | 6,403 |   |
| Franchise                                                              |       | 2,845                           |       | 2,311                         |       | 5,112 |   | 4,402 |   |
| Corporate                                                              |       | (5,376                          | )          | (4,714                        | )          | (10,163 | ) | (10,127 | ) |
| Gain (loss) on property and equipment,  net                            |       | 910                             |       | (379                          | )          | 2,142 |   | 295 |   |
| Restructuring expenses                                                 |       | —                          |       | —                        |       | — |   | (2,627 | ) |
| Gain on litigation settlement                                          |       | —                          |       | —                        |       | — |   | 3,644 |   |
| Net Periodic pension expense  (benefit) included in reporting segments |       | 199                             |       | (507                          | )          | 143 |   | (1,058 | ) |
| Total                                                                  |       | $                               | 15,115     |                          | $          | 10,917 |   | $ | 22,688 |   | $ | 21,522 |   |
|                                                                   |       |                            |       |                          |       |   |   |   |   |
| Interest expense, net-Corporate                                        |       | $                               | 5,233      |                          | $          | 5,368 |   | $ | 10,531 |   | $ | 11,432 |   |
|                                                                   |       |                            |       |                          |       |   |   |   |   |
| Other (income) expense,  principally debt retirement costs             |       | $                               | (4         | )                             | $          | 2,343 |   | $ | (16 | ) | $ | 9,235 |   |
|                                                                   |       |                            |       |                          |       |   |   |   |   |
| Depreciation and amortization:                                         |       |                            |       |                          |       |   |   |   |   |
| Restaurant                                                             |       | $                               | 4,168      |                          | $          | 3,959 |   | $ | 8,812 |   | $ | 7,925 |   |
| Foodservice                                                            |       | 804                             |       | 837                           |       | 1,627 |   | 1,688 |   |
| Franchise                                                              |       | 40                              |       | 68                            |       | 79 |   | 116 |   |
| Corporate                                                              |       | 797                             |       | 818                           |       | 1,615 |   | 1,670 |   |
| Total                                                                  |       | $                               | 5,809      |                          | $          | 5,682 |   | $ | 12,133 |   | $ | 11,399 |   |
|                                                                   |       |                            |       |                          |       |   |   |   |   |
| Other non-cash expense (income):                                       |       |                            |       |                          |       |   |   |   |   |
| Net periodic pension expense  (benefit)                                |       | $                               | 199        |                          | $          | (507 | ) | $ | 143 |   | $ | (1,058 | ) |
| Write-downs of property and  equipment                                 |       | 289                             |       | 91                            |       | 289 |   | 91 |   |
| Total                                                                  |       | $                               | 488        |                          | $          | (416 | ) | $ | 432 |   | $ | (967 | ) |
|                                                                   |       |                            |       |                          |       |   |   |   |   |
| Income (loss) before (provision  for) benefit from income taxes:       |       |                            |       |                          |       |   |   |   |   |
| Restaurant                                                             |       | $                               | 8,135      |                          | $          | 7,377 |   | $ | 10,260 |   | $ | 12,665 |   |
| Foodservice                                                            |       | 3,430                           |       | 2,033                         |       | 4,755 |   | 4,715 |   |
| Franchise                                                              |       | 2,805                           |       | 2,243                         |       | 5,033 |   | 4,286 |   |
| Corporate                                                              |       | (11,402                         | )          | (13,243                       | )          | (22,293 | ) | (32,464 | ) |
| Gain (loss) on property and  equipment, net                            |       | 621                             |       | (470                          | )          | 1,853 |   | 204 |   |
| Restructuring expenses                                                 |       | —                          |       | —                        |       | — |   | (2,627 | ) |
| Gain on litigation settlement                                          |       | —                          |       | —                        |       | — |   | 3,644 |   |
| Total                                                                  |       | $                               | 3,589      |                          | $          | (2,060 | ) | $ | (392 | ) | $ | (9,577 | ) |

 

17

----

 

| ** **                                                             | ** ** | **For the Six**     | ** ** | **For the Year**    | ** ** |
|------------------------------------------------------------------------|------------|---------------------|------------|---------------------|------------|
| ** **                                                             | ** ** | **Months Ended**    | ** ** | **Ended**           | ** ** |
| ** **                                                             | ** ** | **July 3,**    | ** ** | **January 2,** | ** ** |
| ** **                                                             | ** ** | **2005**            | ** ** | **2005**            | ** ** |
| ** **                                                             | ** ** | **(in  thousands)** | ** ** |
| Capital expenditures, including  assets acquired under capital leases: |       |                |       |                |       |
| Restaurant                                                             |       | $                   | 6,222      |                | $          | 20,309 |   |
| Foodservice                                                            |       | 784                 |       | 1,700               |       |
| Corporate                                                              |       | 303                 |       | 1,170               |       |
| Total                                                                  |       | $                   | 7,309      |                | $          | 23,179 |   |

 

| ** **    | ** ** | **July 3,**    | ** ** | **January 2,** | ** ** |
|---------------|------------|---------------------|------------|---------------------|------------|
| ** **    | ** ** | **2005**            | ** ** | **2005**            | ** ** |
| ** **    | ** ** | **(in  thousands)** | ** ** |
| Total assets: |       |                |       |                |       |
| Restaurant    |       | $                   | 140,483    |                | $          | 142,366 |   |
| Foodservice   |       | 43,914              |       | 40,567              |       |
| Franchise     |       | 7,545               |       | 7,726               |       |
| Corporate     |       | 57,090              |       | 58,225              |       |
| Total         |       | $                   | 249,032    |                | $          | 248,884 |   |

 

18

----

 

**6. RESTRUCTURING RESERVES**

 

InMarch 2004, the Company recorded a pre-tax restructuring charge of $2,627,000for severance and outplacement services associated with reduction in forceactions taken during the first quarter of 2004 that reduced headcount byapproximately 20 permanent positions.

 

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

 

In March 2000,the Company’s Board of Directors approved a restructuring plan that providedfor the immediate closing of 81 restaurants at the end of March 2000 andthe disposition of an additional 70 restaurants over the next 24 months. As aresult of this plan, the Company reported a pre-tax restructuring charge of$12,056,000 for severance, rent, utilities and real estate taxes, demarking,lease termination costs and certain other costs associated with the closing ofthe locations, along with a pre-tax write-down of property and equipment forthese locations of approximately $17,000,000 in the year ended December 31,2000. The Company reduced the restructuring reserve by $400,000 and $1,900,000during the years ended December 29, 2002 and December 30, 2001,respectively, since the reserve exceeded estimated remaining payments.

 

19

----

 

The following represents the reserve and activityassociated with the March 2004, October 2001 and March 2000restructurings (in thousands):

 
| ** **    | ** ** | **For the Six  Months Ended July 3, 2005** | ** ** |
|---------------|------------|-------------------------------------------------|------------|
| ** **    | ** ** | **Restructuring**                               | ** ** | ** ** | ** ** | ** ** | ** ** | **Restructuring** | ** ** |
| ** **    | ** ** | **Reserves as  of**                             | ** ** | ** ** | ** ** | ** ** | ** ** | **Reserves as  of** | ** ** |
| ** **    | ** ** | **January 2,  2005**                       | ** ** | **Expense** | ** ** | **Costs Paid** | ** ** | **July 3,  2005** | ** ** |
|          |       |                                            |       |   |   |   |   |   |   |
| Rent          |       | $                                               | 92         |   | $ | — |   | $ | (36 | ) | $ | 56 |   |
| Severence pay |       | 952                                             |       | — |   | (598 | ) | 354 |   |
| Other         |       | 34                                              |       | — |   | (34 | ) | — |   |
| Total         |       | $                                               | 1,078      |   | $ | — |   | $ | (668 | ) | $ | 410 |   |

 
| ** **                      | ** ** | **For the Six  Months Ended June 27, 2004** | ** ** |
|---------------------------------|------------|--------------------------------------------------|------------|
| ** **                      | ** ** | **Restructuring**                                | ** ** | ** ** | ** ** | ** ** | ** ** | **Restructuring** | ** ** |
| ** **                      | ** ** | **Reserves as  of**                              | ** ** | ** ** | ** ** | ** ** | ** ** | **Reserves as  of** | ** ** |
| ** **                      | ** ** | **December 28,  2003**                      | ** ** | **Expense** | ** ** | **Costs Paid** | ** ** | **June 27,  2004** | ** ** |
|                            |       |                                             |       |   |   |   |   |   |   |
| Rent                            |       | $                                                | 319        |   | $ | — |   | $ | (119 | ) | $ | 200 |   |
| Utilities and real estate taxes |       | 40                                               |       | — |   | (13 | ) | 27 |   |
| Severence pay                   |       | —                                           |       | 2,549 |   | (762 | ) | 1,787 |   |
| Outplacement services           |       | —                                           |       | 78 |   | (78 | ) | — |   |
| Other                           |       | 82                                               |       | — |   | (41 | ) | 41 |   |
| Total                           |       | $                                                | 441        |   | $ | 2,627 |   | $ | (1,013 | ) | $ | 2,055 |   |
|                                 |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |  |

 

Based on information currently available, managementbelieves that the restructuring reserves as of July 3, 2005 were adequateand not excessive.

 

20

----

 

**7. SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIALINFORMATION**

 

FICC’s obligations related to its $175,000,000 8.375%senior notes (the “New Senior Notes”) issued in March 2004 are guaranteedfully and unconditionally by one of FICC’s wholly owned subsidiaries. There areno restrictions on FICC’s ability to obtain dividends or other distributions offunds from this subsidiary, except those imposed by applicable law. Thefollowing supplemental financial information sets forth, on a condensedconsolidating basis, balance sheets, statements of operations and statements ofcash flows for FICC (the “Parent Company”), Friendly’s Restaurants Franchise, Inc.(the “Guarantor Subsidiary”) and Friendly’s International, Inc.,Restaurant Insurance Corporation, Friendly’s Realty I, LLC, Friendly’s RealtyII, LLC and Friendly’s Realty III, LLC (collectively, the “Non-guarantorSubsidiaries”). All of the LLCs’ assets were 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 July 3, 2005 and January 2,2005 and for the three and six months ended July 3, 2005 and June 27,2004 are not presented because management has determined that such informationis not material to investors.

 

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

 

21

----

 

**Supplemental CondensedConsolidating Balance Sheet**

**As of July 3, 2005**

(In thousands)

 
| ** **                                                 | ** ** | ** **  | ** ** | ** **     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                 | ** ** | **Parent**  | ** ** | **Guarantor**  | ** ** | **guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                 | ** ** | **Company** | ** ** | **Subsidiary** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Assets                                                     |       |        |       |           |       |             |       |             |       |             |       |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Current assets:                                            |       |        |       |           |       |             |       |             |       |             |       |
| Cash and cash equivalents                                  |       | $           | 11,954     |           | $          | 1,389            |       | $                | 2,042      |             | $          | — |   | $ | 15,385 |   |
| Restricted cash                                            |       | —      |       | —         |       | 1,306            |       | —           |       | 1,306            |       |
| Accounts receivable, net                                   |       | 12,389      |       | 2,292          |       | —           |       | —           |       | 14,681           |       |
| Inventories                                                |       | 16,276      |       | —         |       | —           |       | —           |       | 16,276           |       |
| Deferred income taxes                                      |       | 6,705       |       | 18             |       | —           |       | 130              |       | 6,853            |       |
| Prepaid expenses and other current  assets                 |       | 11,439      |       | 1,412          |       | 7,782            |       | (14,555          | )          | 6,078            |       |
| Total current assets                                       |       | 58,763      |       | 5,111          |       | 11,130           |       | (14,425          | )          | 60,579           |       |
| Deferred income taxes                                      |       | 10,482      |       | 366            |       | —           |       | (130             | )          | 10,718           |       |
| Property and equipment, net                                |       | 106,524     |       | —         |       | 44,514           |       | —           |       | 151,038          |       |
| Intangibles and deferred costs,  net                       |       | 17,416      |       | —         |       | 2,173            |       | —           |       | 19,589           |       |
| Investments in subsidiaries                                |       | (1,537      | )          | —         |       | —           |       | 1,537            |       | —           |       |
| Other assets                                               |       | 6,193       |       | 2,962          |       | 915              |       | (2,962           | )          | 7,108            |       |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Total assets                                               |       | $           | 197,841    |           | $          | 8,439            |       | $                | 58,732     |             | $          | (15,980 | ) | $ | 249,032 |   |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Liabilities and Stockholders’  (Deficit) Equity       |       |        |       |           |       |             |       |             |       |             |       |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Current liabilities:                                       |       |        |       |           |       |             |       |             |       |             |       |
| Current maturities of long-term  obligations               |       | $           | 9,260      |           | $          | —           |       | $                | 1,175      |             | $          | (7,776 | ) | $ | 2,659 |   |
| Accounts payable                                           |       | 24,000      |       | —         |       | —           |       | —           |       | 24,000           |       |
| Accrued expenses                                           |       | 40,540      |       | 3,897          |       | 5,414            |       | (6,441           | )          | 43,410           |       |
| Total current liabilities                                  |       | 73,800      |       | 3,897          |       | 6,589            |       | (14,217          | )          | 70,069           |       |
| Long-term obligations, less  current maturities            |       | 181,666     |       | —         |       | 50,087           |       | —           |       | 231,753          |       |
| Other long-term liabilities                                |       | 47,474      |       | 1,016          |       | 7,119            |       | (3,300           | )          | 52,309           |       |
| Stockholders’ (deficit) equity                        |       | (105,099    | )          | 3,526          |       | (5,063           | )          | 1,537            |       | (105,099         | )          |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Total liabilities and  stockholders’ (deficit) equity |       | $           | 197,841    |           | $          | 8,439            |       | $                | 58,732     |             | $          | (15,980 | ) | $ | 249,032 |   |

 

22

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**Supplemental CondensedConsolidating Statement of Operations**

**For the Three Months Ended July 3,2005**

(In thousands)

 
| ** **                                                       | ** ** | ** **  | ** ** | ** **     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                       | ** ** | **Parent**  | ** ** | **Guarantor**  | ** ** | **guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                       | ** ** | **Company** | ** ** | **Subsidiary** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                             |       |        |       |           |       |             |       |             |       |             |       |
| Revenues                                                         |       | $           | 145,409    |           | $          | 3,014            |       | $                | —     |             | $          | — |   | $ | 148,423 |   |
|                                                             |       |        |       |           |       |             |       |             |       |             |       |
| Costs and expenses:                                              |       |        |       |           |       |             |       |             |       |             |       |
| Cost of sales                                                    |       | 55,502      |       | —         |       | —           |       | —           |       | 55,502           |       |
| Labor and benefits                                               |       | 39,903      |       | —         |       | —           |       | —           |       | 39,903           |       |
| Operating expenses and write-downs  of property and equipment    |       | 30,543      |       | —         |       | (1,759           | )          | —           |       | 28,784           |       |
| General and administrative expenses                              |       | 9,374       |       | 1,154          |       | —           |       | —           |       | 10,528           |       |
| Depreciation and amortization                                    |       | 5,252       |       | —         |       | 557              |       | —           |       | 5,809            |       |
| Gain on franchise sales of  restaurant operations and properties |       | (1,219      | )          | —         |       | —           |       | —           |       | (1,219           | )          |
| Loss on disposals of other  property and equipment, net          |       | 298         |       | —         |       | —           |       | —           |       | 298              |       |
| Interest expense, net                                            |       | 4,107       |       | —         |       | 1,126            |       | —           |       | 5,233            |       |
| Other income                                                     |       | (4          | )          | —         |       | —           |       | —           |       | (4               | )          |
|                                                             |       |        |       |           |       |             |       |             |       |             |       |
| Income before provision for  income                              |       |        |       |           |       |             |       |             |       |             |       |
| taxes and equity in net income of consolidated  subsidiaries     |       | 1,653       |       | 1,860          |       | 76               |       | —           |       | 3,589            |       |
|                                                             |       |        |       |           |       |             |       |             |       |             |       |
| Provision for income taxes                                       |       | (254        | )          | (762           | )          | (56              | )          | —           |       | (1,072           | )          |
|                                                             |       |        |       |           |       |             |       |             |       |             |       |
| Income before equity in net  income of consolidated subsidiaries |       | 1,399       |       | 1,098          |       | 20               |       | —           |       | 2,517            |       |
|                                                             |       |        |       |           |       |             |       |             |       |             |       |
| Equity in net income of  consolidated subsidiaries               |       | 1,118       |       | —         |       | —           |       | (1,118           | )          | —           |       |
|                                                             |       |        |       |           |       |             |       |             |       |             |       |
| Net income                                                       |       | $           | 2,517      |           | $          | 1,098            |       | $                | 20         |             | $          | (1,118 | ) | $ | 2,517 |   |

 

23

----

 

**Supplemental CondensedConsolidating Statement of Operations**

**For the Six Months Ended July 3,2005**

(In thousands)

 
| ** **                                                                                                             | ** ** | ** **  | ** ** | ** **     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                                             | ** ** | **Parent**  | ** ** | **Guarantor**  | ** ** | **guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                                                                             | ** ** | **Company** | ** ** | **Subsidiary** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Revenues                                                                                                               |       | $           | 267,585    |           | $          | 5,486            |       | $                | —     |             | $          | — |   | $ | 273,071 |   |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Costs and expenses:                                                                                                    |       |        |       |           |       |             |       |             |       |             |       |
| Cost of sales                                                                                                          |       | 103,257     |       | —         |       | —           |       | —           |       | 103,257          |       |
| Labor and benefits                                                                                                     |       | 76,436      |       | —         |       | —           |       | —           |       | 76,436           |       |
| Operating expenses and write-downs  of property and equipment                                                          |       | 56,803      |       | —         |       | (3,498           | )          | —           |       | 53,305           |       |
| General and administrative expenses                                                                                    |       | 17,667      |       | 2,310          |       | —           |       | —           |       | 19,977           |       |
| Depreciation and amortization                                                                                          |       | 11,018      |       | —         |       | 1,115            |       | —           |       | 12,133           |       |
| Gain on franchise sales of  restaurant operations and properties                                                       |       | (2,528      | )          | —         |       | —           |       | —           |       | (2,528           | )          |
| Loss on disposals of other  property and equipment, net                                                                |       | 368         |       | —         |       | —           |       | —           |       | 368              |       |
| Interest expense, net                                                                                                  |       | 8,286       |       | —         |       | 2,245            |       | —           |       | 10,531           |       |
| Other income                                                                                                           |       | (16         | )          | —         |       | —           |       | —           |       | (16              | )          |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| (Loss) income before benefit from  (provision for) income taxes and equity in net income of consolidated  subsidiaries |       | (3,706      | )          | 3,176          |       | 138              |       | —           |       | (392             | )          |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Benefit from (provision for) income  taxes                                                                             |       | 1,332       |       | (1,302         | )          | (107             | )          | —           |       | (77              | )          |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| (Loss) income before equity in  net income of consolidated subsidiaries                                                |       | (2,374      | )          | 1,874          |       | 31               |       | —           |       | (469             | )          |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Equity in net income of  consolidated subsidiaries                                                                     |       | 1,905       |       | —         |       | —           |       | (1,905           | )          | —           |       |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Net (loss) income                                                                                                      |       | $           | (469       | )              | $          | 1,874            |       | $                | 31         |             | $          | (1,905 | ) | $ | (469 | ) |

 

24

----

 

**Supplemental CondensedConsolidating Statement of Cash Flows**

**For the Six Months Ended July 3,2005**

(In thousands)

 
| ** **                                                | ** ** | ** **  | ** ** | ** **     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
|-----------------------------------------------------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                | ** ** | **Parent**  | ** ** | **Guarantor**  | ** ** | **guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                | ** ** | **Company** | ** ** | **Subsidiary** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                      |       |        |       |           |       |             |       |             |       |             |       |
| Net cash provided by operating  activities                |       | $           | 10,354     |           | $          | 29               |       | $                | 1,312      |             | $          | (405 | ) | $ | 11,290 |   |
|                                                      |       |        |       |           |       |             |       |             |       |             |       |
| Cash flows from investing  activities:                    |       |        |       |           |       |             |       |             |       |             |       |
| Purchases of property and  equipment                      |       | (7,309      | )          | —         |       | —           |       | —           |       | (7,309           | )          |
| Proceeds from sales of property and  equipment            |       | 3,359       |       | —         |       | —           |       | —           |       | 3,359            |       |
| Purchases of marketable  securities                       |       | (345        | )          | —         |       | —           |       | —           |       | (345             | )          |
| Proceeds from sales of marketable  securities             |       | 143         |       | —         |       | —           |       | —           |       | 143              |       |
| Return of investment in  subsidiary                       |       | 324         |       | —         |       | —           |       | (324             | )          | —           |       |
| Net cash used in investing  activities                    |       | (3,828      | )          | —         |       | —           |       | (324             | )          | (4,152           | )          |
|                                                      |       |        |       |           |       |             |       |             |       |             |       |
| Cash flows from financing activities:                     |       |        |       |           |       |             |       |             |       |             |       |
| Proceeds from borrowings under revolving  credit facility |       | 16,250      |       | —         |       | —           |       | —           |       | 16,250           |       |
| Repayments of obligations                                 |       | (21,014     | )          | —         |       | (713             | )          | —           |       | (21,727          | )          |
| Payments of deferred financing  costs                     |       | (11         | )          | —         |       | —           |       | —           |       | (11              | )          |
| Stock options exercised                                   |       | 330         |       | —         |       | —           |       | —           |       | 330              |       |
| Reinsurance deposits received                             |       | —      |       | —         |       | 114              |       | (114             | )          | —           |       |
| Reinsurance payments made from deposits                   |       | —      |       | —         |       | (519             | )          | 519              |       | —           |       |
| Dividends paid                                            |       | —      |       | —         |       | (324             | )          | 324              |       | —           |       |
| Net cash used in financing  activities                    |       | (4,445      | )          | —         |       | (1,442           | )          | 729              |       | (5,158           | )          |
|                                                      |       |        |       |           |       |             |       |             |       |             |       |
| Net increase (decrease) in cash  and cash equivalents     |       | 2,081       |       | 29             |       | (130             | )          | —           |       | 1,980            |       |
|                                                      |       |        |       |           |       |             |       |             |       |             |       |
| Cash and cash equivalents,  beginning of period           |       | 9,873       |       | 1,360          |       | 2,172            |       | —           |       | 13,405           |       |
|                                                      |       |        |       |           |       |             |       |             |       |             |       |
| Cash and cash equivalents, end of  period                 |       | $           | 11,954     |           | $          | 1,389            |       | $                | 2,042      |             | $          | — |   | $ | 15,385 |   |
|                                                      |       |        |       |           |       |             |       |             |       |             |       |
| Supplemental disclosures:                                 |       |        |       |           |       |             |       |             |       |             |       |
| Interest paid                                             |       | $           | 7,790      |           | $          | —           |       | $                | 2,485      |             | $          | — |   | $ | 10,275 |   |
| Income taxes (refunded) paid                              |       | (2,607      | )          | 2,552          |       | 105              |       | —           |       | 50               |       |

 

25

----

 

**Supplemental CondensedConsolidating Balance Sheet**

**As of January 2, 2005**

(In thousands)

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

 

26

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**Supplemental CondensedConsolidating Statement of Operations**

**For the Three Months Ended June 27,2004**

**(Restated)**

(In thousands)

 
| ** **                                                                                                             | ** ** | ** **  | ** ** | ** **     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                                             | ** ** | **Parent**  | ** ** | **Guarantor**  | ** ** | **guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                                                                             | ** ** | **Company** | ** ** | **Subsidiary** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Revenues                                                                                                               |       | $           | 144,863    |           | $          | 2,653            |       | $                | —     |             | $          | — |   | $ | 147,516 |   |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Costs and expenses:                                                                                                    |       |        |       |           |       |             |       |             |       |             |       |
| Cost of sales                                                                                                          |       | 55,959      |       | —         |       | —           |       | —           |       | 55,959           |       |
| Labor and benefits                                                                                                     |       | 42,155      |       | —         |       | —           |       | —           |       | 42,155           |       |
| Operating expenses and write-downs  of property and equipment                                                          |       | 29,721      |       | —         |       | (1,736           | )          | —           |       | 27,985           |       |
| General and administrative expenses                                                                                    |       | 8,599       |       | 1,155          |       | —           |       | —           |       | 9,754            |       |
| Depreciation and amortization                                                                                          |       | 5,118       |       | —         |       | 564              |       | —           |       | 5,682            |       |
| Gain on franchise sales of  restaurant operations and properties                                                       |       | (7          | )          | —         |       | —           |       | —           |       | (7               | )          |
| Loss on disposals of other  property and equipment, net                                                                |       | 337         |       | —         |       | —           |       | —           |       | 337              |       |
| Interest expense, net                                                                                                  |       | 4,244       |       | —         |       | 1,124            |       | —           |       | 5,368            |       |
| Other expenses, principally debt  retirement costs                                                                     |       | 2,343       |       | —         |       | —           |       | —           |       | 2,343            |       |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| (Loss) income before benefit from  (provision for) income taxes and equity in net income of consolidated  subsidiaries |       | (3,606      | )          | 1,498          |       | 48               |       | —           |       | (2,060           | )          |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Benefit from (provision for) income  taxes                                                                             |       | 1,302       |       | (614           | )          | (48              | )          | —           |       | 640              |       |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| (Loss) income before equity in  net income of consolidated subsidiaries                                                |       | (2,304      | )          | 884            |       | —           |       | —           |       | (1,420           | )          |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Equity in net income of  consolidated subsidiaries                                                                     |       | 884         |       | —         |       | —           |       | (884             | )          | —           |       |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Net (loss) income                                                                                                      |       | $           | (1,420     | )              | $          | 884              |       | $                | —     |             | $          | (884 | ) | $ | (1,420 | ) |

 

27

----

 

**Supplemental CondensedConsolidating Statement of Operations**

**For the Six Months Ended June 27,2004**

**(Restated)**

(In thousands)

 
| ** **                                                                                                             | ** ** | ** **  | ** ** | ** **     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                                             | ** ** | **Parent**  | ** ** | **Guarantor**  | ** ** | **guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                                                                             | ** ** | **Company** | ** ** | **Subsidiary** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Revenues                                                                                                               |       | $           | 273,053    |           | $          | 5,217            |       | $                | —     |             | $          | — |   | $ | 278,270 |   |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Costs and expenses:                                                                                                    |       |        |       |           |       |             |       |             |       |             |       |
| Cost of sales                                                                                                          |       | 101,547     |       | —         |       | —           |       | —           |       | 101,547          |       |
| Labor and benefits                                                                                                     |       | 82,089      |       | —         |       | —           |       | —           |       | 82,089           |       |
| Operating expenses and write-downs  of property and equipment                                                          |       | 56,588      |       | —         |       | (3,472           | )          | —           |       | 53,116           |       |
| General and administrative expenses                                                                                    |       | 18,141      |       | 2,310          |       | —           |       | —           |       | 20,451           |       |
| Restructuring expenses                                                                                                 |       | 2,627       |       | —         |       | —           |       | —           |       | 2,627            |       |
| Gain on litigation settlement                                                                                          |       | (3,644      | )          | —         |       | —           |       | —           |       | (3,644           | )          |
| Depreciation and amortization                                                                                          |       | 10,272      |       | —         |       | 1,127            |       | —           |       | 11,399           |       |
| Gain on franchise sales of  restaurant operations and properties                                                       |       | (913        | )          | —         |       | —           |       | —           |       | (913             | )          |
| Loss on disposals of other  property and equipment, net                                                                |       | 505         |       | —         |       | 3                |       | —           |       | 508              |       |
| Interest expense, net                                                                                                  |       | 9,177       |       | —         |       | 2,255            |       | —           |       | 11,432           |       |
| Other expenses, principally debt  retirement costs                                                                     |       | 9,235       |       | —         |       | —           |       | —           |       | 9,235            |       |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| (Loss) income before benefit from  (provision for) income taxes and equity in net income of consolidated  subsidiaries |       | (12,571     | )          | 2,907          |       | 87               |       | —           |       | (9,577           | )          |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Benefit from (provision for) income  taxes                                                                             |       | 4,204       |       | (1,192         | )          | (97              | )          | —           |       | 2,915            |       |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| (Loss) income before equity in  net income of consolidated subsidiaries                                                |       | (8,367      | )          | 1,715          |       | (10              | )          | —           |       | (6,662           | )          |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Equity in net income of  consolidated subsidiaries                                                                     |       | 1,705       |       | —         |       | —           |       | (1,705           | )          | —           |       |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Net (loss) income                                                                                                      |       | $           | (6,662     | )              | $          | 1,715            |       | $                | (10        | )                | $          | (1,705 | ) | $ | (6,662 | ) |

 

28

----

 

**Supplemental CondensedConsolidating Statement of Cash Flows**

**For the Six Months Ended June 27,2004**

(In thousands)

 
| ** **                                                | ** ** | ** **  | ** ** | ** **     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
|-----------------------------------------------------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                | ** ** | **Parent**  | ** ** | **Guarantor**  | ** ** | **guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                | ** ** | **Company** | ** ** | **Subsidiary** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                      |       |        |       |           |       |             |       |             |       |             |       |
| Net cash (used in) provided by  operating activities      |       | $           | (92        | )              | $          | (765             | )          | $                | 604        |             | $          | 490 |   | $ | 237 |   |
|                                                      |       |        |       |           |       |             |       |             |       |             |       |
| Cash flows from investing  activities:                    |       |        |       |           |       |             |       |             |       |             |       |
| Purchases of property and  equipment                      |       | (8,262      | )          | —         |       | —           |       | —           |       | (8,262           | )          |
| Proceeds from sales of property and  equipment            |       | 3,378       |       | —         |       | —           |       | —           |       | 3,378            |       |
| Purchases of marketable  securities                       |       | (905        | )          | —         |       | —           |       | —           |       | (905             | )          |
| Proceeds from sales of marketable  securities             |       | 89          |       | —         |       | —           |       | —           |       | 89               |       |
| Return of investment in  subsidiary                       |       | 367         |       | —         |       | —           |       | (367             | )          | —           |       |
| Net cash used in investing  activities                    |       | (5,333      | )          | —         |       | —           |       | (367             | )          | (5,700           | )          |
|                                                      |       |        |       |           |       |             |       |             |       |             |       |
| Cash flows from financing  activities:                    |       |        |       |           |       |             |       |             |       |             |       |
| Proceeds from issuance of New Senior  Notes               |       | 175,000     |       | —         |       | —           |       | —           |       | 175,000          |       |
| Proceeds from borrowings under revolving  credit facility |       | 11,000      |       | —         |       | —           |       | —           |       | 11,000           |       |
| Repayments of obligations                                 |       | (187,531    | )          | —         |       | (550             | )          | —           |       | (188,081         | )          |
| Payments of deferred financing  costs                     |       | (6,625      | )          | —         |       | —           |       | —           |       | (6,625           | )          |
| Stock options exercised                                   |       | 749         |       | —         |       | —           |       | —           |       | 749              |       |
| Reinsurance deposits received                             |       | —      |       | —         |       | 1,131            |       | (1,131           | )          | —           |       |
| Reinsurance payments made from deposits                   |       | —      |       | —         |       | (641             | )          | 641              |       | —           |       |
| Dividends paid                                            |       | —      |       | —         |       | (367             | )          | 367              |       | —           |       |
| Net cash used in financing  activities                    |       | (7,407      | )          | —         |       | (427             | )          | (123             | )          | (7,957           | )          |
|                                                      |       |        |       |           |       |             |       |             |       |             |       |
| Net (decrease) increase in cash  and cash equivalents     |       | (12,832     | )          | (765           | )          | 177              |       | —           |       | (13,420          | )          |
|                                                      |       |        |       |           |       |             |       |             |       |             |       |
| Cash and cash equivalents,  beginning of period           |       | 21,640      |       | 2,173          |       | 1,818            |       | —           |       | 25,631           |       |
|                                                      |       |        |       |           |       |             |       |             |       |             |       |
| Cash and cash equivalents, end of  period                 |       | $           | 8,808      |           | $          | 1,408            |       | $                | 1,995      |             | $          | — |   | $ | 12,211 |   |
|                                                      |       |        |       |           |       |             |       |             |       |             |       |
| Supplemental disclosures:                                 |       |        |       |           |       |             |       |             |       |             |       |
| Interest paid                                             |       | $           | 9,702      |           | $          | —           |       | $                | 2,273      |             | $          | — |   | $ | 11,975 |   |
| Income taxes (refunded) paid                              |       | (1,591      | )          | 1,508          |       | 99               |       | —           |       | 16               |       |
| Capital lease obligations  incurred                       |       | 2,280       |       | —         |       | —           |       | —           |       | 2,280            |       |

 

29

----

 

**Item 2. Management’s Discussionand Analysis of Financial Condition and Results of Operations**

 

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

 

**Forward Looking Statements**

 

Statements contained herein that are not historical factsconstitute “forward looking statements” as that term is defined in the PrivateSecurities Litigation Reform Act of 1995. Words such as “believes,” “plans,” “anticipates,” “expects,” “will” andsimilar expressions are intended to identify forward looking statements.* *Forwardlooking statements include, but are not limited to, statements relating to thesufficiency of the Company’s capital resources, changes in commodity prices,anticipated capital expenditures and the Company’s plans with respect torestaurant openings, closings, reimagings and re-franchisings.  All forward looking statements are subject toknown and unknown risks, uncertainties and other factors which could causeactual results to differ materially from those anticipated. These factorsinclude: the Company’s highly competitive business environment; exposure tofluctuating commodity prices; risks associated with the foodservice industry,such as changes in consumer tastes and adverse publicity resulting from foodquality, illness, injury or other health concerns; the ability to retain andattract new employees; government regulations; the Company’s high geographicconcentration in the Northeast and its attendant weather patterns; conditionsneeded to meet restaurant re-imaging and new opening targets; risks anduncertainties arising out of accounting adjustments; the Company’s ability toservice its debt and other obligations; the Company’s ability to meet ongoingfinancial covenants contained in the Company’s debt instruments, loanagreements, leases and other long-term commitments; and costs 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.**TheCompany is not obligated to update any forward looking statements, whether as aresult of new information, future events or otherwise.

 

**Overview**

 

The Company’s revenues are derivedprimarily from the operation of full-service restaurants, the distribution andsale of premium ice cream desserts through retail and institutional locationsand franchising. As of July 3, 2005, Friendly’s operated 332 full-servicerestaurants, franchised 198 full-service restaurants and seven non-traditionalunits and manufactured a full line of premium ice cream desserts distributedthrough more than 4,500 supermarkets and other retail locations in 13 states.

 

30

----

 

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

 
| ** **            | ** ** | **For the  Three Months Ended** | ** ** | **For the Six  Months Ended** | ** ** |
|-----------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **            | ** ** | **July 3,**                | ** ** | **June 27,**             | ** ** | **July 3,** | ** ** | **June 27,** | ** ** |
| ** **            | ** ** | **2005**                        | ** ** | **2004**                      | ** ** | **2005** | ** ** | **2004** | ** ** |
|                  |       |                            |       |                          |       |   |   |   |   |
| Company Units:        |       |                            |       |                          |       |   |   |   |   |
| Beginning of period   |       | 337                             |       | 362                           |       | 347 |   | 380 |   |
| Openings              |       | 1                               |       | —                        |       | 1 |   | — |   |
| Refranchised closings |       | (3                              | )          | (1                            | )          | (10 | ) | (18 | ) |
| Closings              |       | (3                              | )          | (1                            | )          | (6 | ) | (2 | ) |
| End of period         |       | 332                             |       | 360                           |       | 332 |   | 360 |   |
|                  |       |                            |       |                          |       |   |   |   |   |
| Franchised Units:     |       |                            |       |                          |       |   |   |   |   |
| Beginning of period   |       | 201                             |       | 182                           |       | 195 |   | 163 |   |
| Refranchised openings |       | 3                               |       | 1                             |       | 10 |   | 18 |   |
| Openings              |       | 1                               |       | 3                             |       | 2 |   | 5 |   |
| Closings              |       | —                          |       | —                        |       | (2 | ) | — |   |
| End of period         |       | 205                             |       | 186                           |       | 205 |   | 186 |   |

 

***Three months ended July 3, 2005compared with three months ended June 27, 2004***

 

*Revenues:*

 

*Total Revenues -* Total revenues increased $0.9 million, or 0.6%, to $148.4 million for thethree months ended July 3, 2005 from $147.5 million for the same period in2004.

 

*Restaurant Revenues -* Restaurant revenues decreased $1.6 million, or1.4%, to $112.8 million for the three months ended July 3, 2005 from $114.4million for the same period in 2004. Comparable Company-operated restaurantrevenues increased 3.4%, from the 2004 quarter to the 2005 quarter. Five andseven locations were re-imaged during the three months ended July 3, 2005and June 27, 2004, respectively. The closing of 15 locations and the re-franchising of 20 locations overthe past 15 months resulted in declines of $2.1 million and $5.1 million,respectively, in restaurant revenues in the second quarter of 2005 as comparedto the same period in 2004. These declines were partially offset by increasedrevenues of $1.6 million in the second quarter of 2005 as compared to the sameperiod in 2004 due to the opening of five new restaurants over the past 15months. There was one new restaurant opened during the second quarter of 2005.

 

*Foodservice Revenues -* Foodservice (product sales to franchisees andretail customers) revenues increased $1.9 million, or 6.5% to $31.7 million forthe three months ended July 3, 2005 from $29.8 million for the three monthsended June 27, 2004. This increase was primarily due to a $1.9 millionincrease in franchised restaurant product revenue resulting from the increasednumber of franchised restaurants in the second quarter of 2005 compared to thesame period in 2004.  Sales tofoodservice retail supermarket customers and case volume in the Company’sretail supermarket business increased 0.3% and 3.3%, respectively, for thethree months ended July 3, 2005 when compared to the three months ended June 27,2004. Case volume increased primarily as a result of higher volume ofindividual sundae cups and the introduction of decorative cakes.

 

31

----

 

*Franchise Revenues -* Franchise royalty and fee revenues increased $0.6million, or 19.0%, to $3.9 million for the three months ended July 3, 2005compared to $3.3 million for the same period in 2004.

 

Royaltieson franchised sales increased $0.4 million for the three months ended July 3,2005 as compared to the same period in 2004. Comparable franchised revenuesgrew 5.4% from the three months ended June 27, 2004 to the three monthsended July 3, 2005. The opening of eight new franchise restaurants and 20re-franchised restaurants during the last 15 months increased royalty revenuesby $0.2 million while the closing of five under-performing locations during thesame period had little impact.

 

Initialfranchise fees remained relatively unchanged during the three months ended July 3,2005 when compared to the same period in 2004. For the three months ended June 27,2004, one Company-operated location was refranchised and two new restaurantsand one cafe were opened compared to the three months ended July 3, 2005in which three Company-operated locations were refranchised and two newlocations were opened.

 

Additionally,an increase in rental income for leased and subleased franchise locations of$0.2 million due primarily to an increased number of leased and subleasedfranchised locations contributed to the higher revenues for the three months endedJuly 3, 2005 compared to the same period in 2004. There were 205 and 186franchise units open at July 3, 2005 and June 27, 2004, respectively.

 

*Cost of sales:*

 

Cost of sales decreased $0.5 million, or 0.8%, to $55.5million for the three months ended July 3, 2005 from $56.0 million for thesame period in 2004. Cost of sales as a percentage of total revenues was 37.4%and 37.9% for the three months ended July 3, 2005 and June 27, 2004,respectively.  Lower cream prices duringthe current quarter when compared to the same quarter in 2004 was the primaryreason for the reduction in the percentage of cost of sales to total revenues.A decline in market losses realized due to unfavorable positions on commodityoption contracts also reduced cost of sales as a percentage of total revenues,as market losses of $0.2 million were realized in the 2004 period andinsignificant market losses were realized in the current period.  The Company enters into commodity optioncontracts from time to time to manage dairy cost pressures. The Company’scommodity option contracts do not meet hedge accounting criteria as defined bySFAS No. 133, “Accounting for Derivative Instruments and HedgingActivities,” and its related amendment, SFAS No. 138, “Accounting forCertain Derivative Instruments and Certain Hedging Activities”, and,accordingly, are marked to market each period with the resulting gains orlosses recognized in cost of sales.

 

The growth in franchise revenues reduced cost of sales as apercentage of total revenues by 0.2% for the three months ended July 3,2005 when compared to the 2004 period because franchise revenues have onlylimited costs associated with such revenues. The $0.5 million decrease in costof sales for the three months ended July 3, 2005 compared to the sameperiod in 2004 was partially offset by a shift in sales mix fromCompany-operated restaurant sales to foodservice sales, which added to theincrease in cost. Foodservice sales to franchisees and retail supermarketcustomers (21.4% and 20.2% of total revenues for the three months ended July 3,2005 and June 27, 2004, respectively) have a higher cost as a percentageof revenue than sales in Company-operated restaurants to restaurant patrons.Foodservice retail sales promotional allowances, recorded as offsets torevenues, increased by 0.8% in the 2005 quarter as a percentage of sales tofoodservice retail supermarket customers when compared to the 2004 quarter as aresult of a more competitive climate in the northeast. This increase also hadan unfavorable impact on the overall cost of sales as a percentage of totalrevenues.

 

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Restaurant cost of sales as a percentage of restaurantrevenues decreased to 26.6% in the second quarter of 2005 from 27.3% in thesecond quarter of 2004. The decrease in the 2005 quarter when compared to the2004 quarter was in part due to lower cream prices in the current period whencompared the same period a year ago and fewer free dessert promotions in the2005 quarter.

 

For theremainder of 2005, the Company expects that cream prices will be lower than theprices experienced in 2004.  A tableshowing the average monthly price of a pound of AA butter obtained from marketquotes provided by the USDA’s Agricultural Marketing Service is includedelsewhere herein.

 

*Labor and benefits:*

 

Laborand benefits decreased $2.3 million, or 5.3%, to $39.9 million for the threemonths ended July 3, 2005 from $42.2 million for the three months ended June 27,2004. Labor and benefits as a percentage of total revenues decreased to 26.9%in the 2005 quarter from 28.6% in the 2004 quarter. As a percentage ofrestaurant revenues, labor and benefits decreased to 35.4% in the 2005 quarterfrom 36.8% in the 2004 quarter. The decrease in labor and benefits wasprimarily due to the restructuring of the restaurant management team, withfewer guest service supervisors and more servers, resulting in lower averagehourly rates. Restaurant general manager bonuses were also lower during the2005 period when compared to the same period in 2004 due primarily to a changein the bonus plan.  Revenue increasesderived from franchised locations, which do not have any associated restaurantlabor and benefits, also contributed to the lower labor and benefits as apercentage of total revenues.  Partiallyoffsetting these benefits were increases in pension expense, unemployment taxesand workers compensation insurance costs in the 2005 period when compared tothe 2004 period.

 

*Operating expenses:*

 

Operatingexpenses increased $0.6 million, or 2.2%, to $28.5 million for the three monthsended July 3, 2005 from $27.9 million for the three months ended June 27,2004. Operating expenses as a percentage of total revenues were 19.2% and 18.9%in the 2005 and 2004 periods, respectively. The increase resulted from higher restaurant costs for maintenance,occupancy and supplies in the 2005 period when compared to the 2004 period. Anincrease in rent expense for leased and subleased franchise locations of $0.3million also contributed to the higher operating expenses in the 2005 periodwhen compared to the 2004 period. Total advertising costs as a percentage oftotal revenues were lower in the 2005 period when compared to the same periodin 2004.

 

*General and administrative expenses:*

 

Generaland administrative expenses were $10.5 million and $9.8 million for the threemonths ended July 3, 2005 and June 27, 2004, respectively. Generaland administrative expenses as a percentage of total revenues increased to 7.1%in the 2005 period from 6.6% in the 2004 period. The increase is primarily theresult of increases in headquarter and field supervisor bonus expense,severance costs and professional fees. This increase was partially offset bylower costs for recruitment and restaurant mystery shopping service.

 

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W*rite-downs of property andequipment:*

 

Write-downsof property and equipment were $0.3 million and $0.1 million in the threemonths ended July 3, 2005 and June 27, 2004, respectively. During thethree months ended July 3, 2005, the Company identified two restaurantproperties to be disposed of other than by sale and determined that thecarrying value of these restaurant properties exceeded their estimatedundiscounted cash flows.  The carryingvalues were reduced by an aggregate of $0.3 million accordingly. During thethree months ended June 27, 2004, it was determined that the carryingvalue of one property and a vacant land parcel exceeded their estimated fairvalues less costs to sell and the carrying values were reduced by an aggregateof $0.1 million accordingly.

 

*Depreciation and amortization:*

 

Depreciation and amortization was $5.8 million and $5.7million for the three months ended July 3, 2005 and June 27, 2004,respectively. Depreciation and amortization as a percentage of total revenueswas 3.9% in the 2005 and 2004 quarters.

 

*Gain on franchise sales of restaurant operations and properties:*

 

Gainon franchise sales of restaurant operations and properties was $1.2 million inthe three months ended July 3, 2005 associated with the sale of certainequipment assets, lease and sublease rights and franchise rights in threeexisting Friendly’s restaurants.

 

*Loss on disposals of other property andequipment, net:*

 

The loss on disposals of other property and equipment, net,was $0.3 for the three months ended July 3, 2005 and June 27,2004.  The table below identifies thecomponents of the loss on disposals of other property and equipment, net asshown on the accompanying condensed consolidated statements of operations (inthousands):

 
| ** **                                              | ** ** | **For the  Three Months Ended** | ** ** |
|---------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                              | ** ** | **July 3,**                | ** ** | **June 27,** | ** ** |
| ** **                                              | ** ** | **2005**                        | ** ** | **2004** | ** ** |
| ** **                                              | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Restaurant equipment assets  retired due to remodeling  |       | $                               | 220        |   | $ | 173 |   |
| Restaurant equipment assets  retired due to replacement |       | 43                              |       | 87 |   |
| Loss on property not held for  disposition              |       | 26                              |       | 62 |   |
| All other                                               |       | 9                               |       | 15 |   |
| Loss on disposals of other  property and equipment, net |       | $                               | 298        |   | $ | 337 |   |

 

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*Interest expense, net:*

 

Interestexpense, net of capitalized interest and interest income, was $5.2 million and$5.4 million for the three months ended July 3, 2005 and June 27,2004, respectively. The decrease in interest expense in the second quarter of2005 compared to the same period in 2004 is primarily due to reduced amounts ofdebt and lower interest rates on such debt.

 

*Other (income) expense, principally debt retirement costs:*

 

Other (income) expense, principally debt retirementcosts for the three months endedJune 27, 2004 represents the $1.7 million premium and the write-off ofunamortized deferred financing costs of $0.6 million in connection with thetender offer for the $176.0 million of Senior Notes. In March 2004, $127.8million of aggregate principal amount of Senior Notes were purchased pursuantto the tender offer and in April 2004, the remaining $48.2 million ofSenior Notes were redeemed in accordance with the Senior Notes indenture at103.5% of the principal amount.

 

*Provision for (benefit from) income taxes:*

 

Theprovision for income taxes was $1.1 million, an effective tax rate of 29.9%,for the three months ended July 3, 2005. At this time, the Companyestimates that the effective tax rate for 2005 will be 25.0%. During the secondquarter of 2005, the Company increased the provision for income taxes by $0.2million due to certain items discussed with the Internal Revenue Service (“IRS”).  Currently, the IRS is auditing the Company’sfiscal years 2002 through 2004. The Company records income taxes based on theeffective rate for the year with any changes in valuation allowance reflectedin the period of change.

 

Thebenefit from income taxes was $0.6 million, an effective tax rate of 31.1%, forthe three months ended June 27, 2004. The tax rate for the 2004 fiscal year was 68.8%, as the final benefitfrom income taxes for 2004 included a $2.2 million reversal of income taxaccruals recorded in prior years. These accruals related to tax matters that,based upon additional information obtained during the fourth quarter of 2004,were no longer necessary.  The reversalwas recorded in the fourth quarter of 2004.

 

*Net income (loss):*

 

Netincome was $2.5 million for the three months ended July 3, 2005 ascompared to net loss of $1.4 million for the three months ended June 27,2004 for the reasons discussed above.

 

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***Six months ended July 3, 2005 comparedwith six months ended June 27, 2004***

 

*Revenues:*

 

*Total Revenues -* Total revenues decreased $5.2 million, or 1.9%, to $273.1 million for thesix months ended July 3, 2005 from $278.3 million for the same period in2004.

 

*Restaurant Revenues -* Restaurant revenues decreased $9.9 million, or4.5%, to $208.9 million for the six months ended July 3, 2005 from $218.8million for the same period in 2004. Comparable Company-operated restaurantrevenues increased 0.2% from the 2004 period to the 2005 period. During thefirst quarter of 2005, restaurant revenues were impacted by an unfavorableshift in the timing of the year-end holiday period.  New Year’s Day was included in the six monthsended June 27, 2004 but was not included in the 2005 period.  The estimated impact on Company-operatedrestaurants due to the timing of the holiday reduced the six-month comparablerestaurant sales increase by 1.3%.  Operatingdays lost due to weather closings were greater in 2005 when compared to 2004 asmost markets in New England recorded higher than normal snowfall.  Additionally, the closing of 16 locations andthe re-franchising of 37 locations over the past 18 months resulted in declinesof $3.4 million and $9.5 million, respectively, in restaurant revenues in thesix months ended July 3, 2005 as compared to the same period in 2004.These declines were partially offset by increased revenues of $2.9 million inthe six months ended July 3, 2005 as compared to the same period in 2004due to the opening of five new restaurants over the past 18 months. There wasone new restaurant opened during the six months ended July 3, 2005.

 

*Foodservice Revenues -* Foodservice (product sales to franchisees andretail customers) revenues increased $3.9 million, or 7.3%, to $57.1 millionfor the six months ended July 3, 2005 from $53.2 million for the sixmonths ended June 27, 2004. This increase was primarily due to a $3.7million increase in franchised restaurant product revenue resulting from theincreased number of franchised restaurants in the six months ended July 3,2005 compared to the same period in 2004. Sales to foodservice retail supermarket customers increased $0.2million, or 1.1%, during the six months ended July 3, 2005 compared to thesame period in 2004. Case volume in the Company’s retail supermarket businessincreased 1.9% for the six months ended July 3, 2005 when compared to thesix months ended June 27, 2004 primarily as a result of higher volume ofindividual sundae cups and the introduction of decorative cakes.

 

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*Franchise Revenues -* Franchise royalty and fee revenues increased $0.8million, or 12.9%, to $7.1 million for the six months ended July 3, 2005compared to $6.3 million for the same period in 2004.

 

Royaltieson franchised sales increased $0.7 million in the six months ended July 3,2005 as compared to the same period in 2004. Comparable franchised revenues grew3.5% from the six months ended June 27, 2004 to the six months ended July 3,2005. The opening of 10 new franchise restaurants and 37 re-franchisedrestaurants during the last 18 months increased royalty revenues by $0.5million while the closing of five under-performing locations during the sameperiod had little impact.

 

Initialfranchise fees declined by $0.4 million during the six months ended July 3,2005 when compared to the same period in 2004 due to the refranchising of 18Company-operated locations, the opening of four new restaurants and the openingof one new cafe during the six months ended June 27, 2004 versus therefranchising of 10 Company-operated locations and the opening of two newlocations during the six months ended July 3, 2005.

 

Additionally,an increase in rental income for leased and subleased franchise locations of$0.5 million due primarily to an increased number of leased and subleasedfranchised locations contributed to the higher revenues in the six months endedJuly 3, 2005 compared to the six months ended June 27, 2004.  There were 205 and 186 franchise units openat July 3, 2005 and June 27, 2004, respectively.

 

*Cost of sales:*

 

Cost of sales increased $1.8 million, or 1.7%, to $103.3million for the six months ended July 3, 2005 from $101.5 million for thesame period in 2004. Cost of sales as a percentage of total revenues was 37.8%and 36.5% for the six months ended July 3, 2005 and June 27, 2004,respectively.  A shift in sales mix fromCompany-operated restaurant sales to foodservice sales added to the increase incost. Foodservice sales to franchisees and retail supermarket customers (20.9%and 19.1% of total revenues for the six months ended July 3, 2005 and June 27,2004, respectively) have a higher food cost as a percentage of revenue thansales in Company-operated restaurants to restaurant patrons. Foodservice retailsales promotional allowances, recorded as offsets to revenues, increased by1.1% in the 2005 period as a percentage of gross retail sales when compared tothe 2004 period as a result of a more competitive climate in the northeast.This increase also had an unfavorable impact on the overall cost of sales as apercentage of total revenues. These increases were partially offset by thegrowth in franchise revenues, which reduced cost of sales as a percentage oftotal revenues by 0.2% for the six months ended July 3, 2005 when comparedto the 2004 period because franchise revenues have only limited costsassociated with such revenues.

 

Restaurant cost of sales as a percentage of restaurantrevenues increased to 27.0% in the six months ended July 3, 2005 from26.8% in the same period of 2004. The increase in the 2005 period when comparedto the 2004 period was in part due to stronger dinner sales when compared tobreakfast in the current period. Breakfast products have a lower food cost thanlunch and dinner products.  Additionally,inefficiencies associated with the introduction of server banking had anunfavorable impact in the 2005 period.

 

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The relatively high price of butter in December 2004resulted in unfavorable cream costs in the first quarter of 2005, as the marketprice of butter is generally reflected in the Company’s cost of salesapproximately 30 days later. During the second quarter of 2005, butter priceshad a favorable impact on the price of cream when compared to the same periodin 2004.  Additionally, in the six monthsended July 3, 2005, market losses of $0.2 million were realized due tounfavorable positions on commodity option contracts while market gains of $0.5million were realized in the same period of 2004. The Company enters intocommodity option contracts from time to time to manage dairy cost pressures.The Company’s commodity option contracts do not meet hedge accounting criteriaas defined by SFAS No. 133, “Accounting for Derivative Instruments andHedging Activities,” and its related amendment, SFAS No. 138, “Accountingfor Certain Derivative Instruments and Certain Hedging Activities”, and,accordingly, are marked to market each period with the resulting gains orlosses recognized in cost of sales.

 

Forthe remainder of 2005, the Company expects that cream prices will be lower thanthe prices experienced in 2004.  However,the results derived from options for butter futures contracts are likely to beunfavorable in 2005 when compared to the gains experienced in 2004.

 

Thetable below shows the average monthly price of a pound of AA butter.  Futures and options on AA butter are tradedon the Chicago Mercantile Exchange and AA butter is the vehicle used to derivethe price of cream.  The pricesrepresented were obtained from market quotes provided by the USDA’sAgricultural Marketing Service.

 
| **Month:**       | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
|------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| January          |       | $        | 1.5775     |     | $          | 1.4320   |       | $        | 1.0815     |     | $          | 1.3454   |       | $ | 1.2531 |   | $ | 0.9090 |   |
| February         |       | 1.6145   |       | 1.7132   |       | 1.0405   |       | 1.2427   |       | 1.3852   |       | 0.9245   |       |
| March            |       | 1.5527   |       | 2.1350   |       | 1.0915   |       | 1.2473   |       | 1.5708   |       | 1.0200   |       |
| April            |       | 1.4933   |       | 2.2204   |       | 1.0906   |       | 1.1712   |       | 1.8217   |       | 1.0691   |       |
| May              |       | 1.4044   |       | 2.0363   |       | 1.0919   |       | 1.0590   |       | 1.8713   |       | 1.2450   |       |
| June             |       | 1.5313   |       | 1.9300   |       | 1.1142   |       | 1.0427   |       | 1.9783   |       | 1.2440   |       |
| July             |       |     |       | 1.7458   |       | 1.1985   |       | 1.0302   |       | 1.8971   |       | 1.1790   |       |
| August           |       |     |       | 1.5408   |       | 1.1708   |       | 0.9752   |       | 2.0880   |       | 1.1933   |       |
| September        |       |     |       | 1.7656   |       | 1.1731   |       | 0.9635   |       | 2.0563   |       | 1.1727   |       |
| October          |       |     |       | 1.6475   |       | 1.1846   |       | 1.0315   |       | 1.4070   |       | 1.1462   |       |
| November         |       |     |       | 1.9238   |       | 1.2057   |       | 1.0425   |       | 1.3481   |       | 1.6490   |       |
| December         |       |     |       | 1.7083   |       | 1.2969   |       | 1.1198   |       | 1.2793   |       | 1.3700   |       |
| Mathematical Avg |       |     |       | $        | 1.8166     |     | $          | 1.1450   |       | $        | 1.1059     |     | $          | 1.6630 |   | $ | 1.1768 |   |
|                  |            |          |            |          |            |          |            |          |            |          |            |          |            |  |  |  |  |  |  |

 

The cost of cream, the principal ingredient used in makingice cream, affects cost of sales as a percentage of total revenues, especiallyin foodservice’s retail business. A $0.10 increase in the cost of a pound of AAbutter adversely affects the Company’s annual cost of sales by approximately$0.9 million.  This adverse impact may beoffset by price increases or other factors. However, no assurance can be giventhat the Company will be able to offset any cost increases in the future andfuture increases in cream prices could have a material adverse effect on theCompany’s results of operations. To minimize risk, alternative supply sourcescontinue to be pursued.

 

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

 

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*Labor and benefits:*

 

Laborand benefits decreased $5.7 million, or 6.9%, to $76.4 million for the sixmonths ended July 3, 2005 from $82.1 million for the six months ended June 27,2004. Labor and benefits as a percentage of total revenues decreased to 28.0%in the 2005 period from 29.5% in the 2004 period. As a percentage of restaurantrevenues, labor and benefits decreased to 36.6% in the 2005 period from 37.5%in the 2004 period. The decrease in labor and benefits was primarily due to therestructuring of the restaurant management team, with fewer guest servicesupervisors and more servers, resulting in lower average hourly rates.  Restaurant general manager bonuses were alsolower during the 2005 period when compared to the same period in 2004 dueprimarily to a change in the bonus plan. Revenue increases derived from franchised locations, which do not haveany associated restaurant labor and benefits, also contributed to the lowerrestaurant labor and benefits as a percentage of total revenues.  Partially offsetting these benefits wereincreases in pension expense, unemployment taxes and workers compensationinsurance costs in the 2005 period when compared to the 2004 period.

 

*Operating expenses:*

 

Operatingexpenses were $53.0 million for the six months ended July 3, 2005 and June 27,2004. Operating expenses as a percentage of total revenues were 19.4% and 19.1%in the 2005 and 2004 periods, respectively. The increase as a percent of totalrevenues resulted from higher restaurant costs for snow removal, maintenance,supplies, occupancy, heating and electricity in the 2005 period when comparedto the 2004 period. Total advertising costs as a percentage of total revenueswere lower in the 2005 period when compared to the same period in 2004.  An increase in rent expense for leased andsubleased franchise locations of $0.6 million also contributed to the higheroperating expenses as a percent of total revenues in the 2005 period whencompared to the 2004 period.

 

*General and administrative expenses:*

 

Generaland administrative expenses were $20.0 million and $20.5 million for the sixmonths ended July 3, 2005 and June 27, 2004, respectively. Generaland administrative expenses as a percentage of total revenues were 7.3% in boththe 2005 and the 2004 periods. The decrease in dollars is primarily the resultof the staff reduction in March 2004 and lower costs for recruitment,restaurant mystery shopping service and rent, partially offset by increasedseverance costs and professional fees. The 2004 period also included a chargefor future rents associated with a vacated training facility.

 

*Restructuring expenses:*

 

Restructuringexpenses of $2.6 million during the six months ended June 27, 2004 relatedto severance and other benefits associated with reduction in force actionstaken during the first quarter of 2004 that reduced headcount by approximately20 permanent positions.

 

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*Gain on litigation settlement:*

 

In January 2004, a settlement was reached in a lawsuitfiled by the Company against a former administrator of one of the Company’sbenefit plans.  The settlement was basedon the administrator’s alleged failure to adhere to the terms of a contract andresulted in a one-time payment to the Company of approximately $3.8 million,which was received on April 2, 2004. As a result of this lawsuit, theCompany incurred professional fees of approximately $0.5 million which wereincluded in the consolidated statement of operations for the year ended December 28,2003 and an additional $0.2 million in professional fees, which were offsetagainst the payment in the accompanying condensed consolidated statement ofoperations for the six months ended June 27, 2004.

 

W*rite-downs of property andequipment:*

 

Write-downsof property and equipment were $0.3 million and $0.1 million in the six monthsended July 3, 2005 and June 27, 2004, respectively. During the sixmonths ended July 3, 2005, the Company identified two restaurantproperties to be disposed of other than by sale and determined that thecarrying value of these restaurant properties exceeded their estimatedundiscounted cash flows.  The carryingvalues were reduced by an aggregate of $0.3 million accordingly. During the sixmonths ended June 27, 2004, it was determined that the carrying value ofone property and a vacant land parcel exceeded their estimated fair values lesscosts to sell and the carrying values were reduced by an aggregate of $0.1million accordingly.

 

*Depreciation and amortization:*

 

Depreciation and amortization was $12.1 million and $11.4million for the six months ended July 3, 2005 and June 27, 2004,respectively. Depreciation and amortization as a percentage of total revenueswas 4.4% and 4.1% in the 2005 and 2004 periods, respectively. The increase indepreciation expense is primarily the result of the opening of five newrestaurants over the last 18 months and the reduction of the lives of leaseholdimprovement assets as a result of management decisions to close certain leasedproperties sooner than previously anticipated.

 

*Gain on franchise sales of restaurant operations and properties:*

 

Gainon franchise sales of restaurant operations and properties was $2.5 million and$0.9 million in the six months ended July 3, 2005 and June 27, 2004,respectively. During the six months ended July 3, 2005, the Companyrecognized a gain of $2.5 million associated with the sale of certain equipmentassets, lease and sublease rights and franchise rights in four existingFriendly’s restaurants to two franchisees. During the six months ended June 27,2004, the Company recognized a gain of $0.7 million associated with the sale ofcertain equipment assets, lease and sublease rights and franchise rights in 10existing Friendly’s restaurants. Additionally in the 2004 period, the Company sold the real property andequipment for one franchised location and assigned the lease and sold theequipment for a second franchised location to the existing franchisee,resulting in a gain of $0.2 million.

 

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*Loss on disposals of other property andequipment, net:*

 

The loss on disposals of other property and equipment, net,was $0.4 million and $0.5 million for the six months ended July 3, 2005and June 27, 2004, respectively. The table below identifies the components of the loss on disposals ofother property and equipment, net as shown on the accompanying condensedconsolidated statements of operations (in thousands):

 
| ** **                                              | ** ** | **For the Six  Months Ended** | ** ** |
|---------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                              | ** ** | **July 3,**              | ** ** | **June 27,** | ** ** |
| ** **                                              | ** ** | **2005**                      | ** ** | **2004** | ** ** |
| ** **                                              | ** ** | ** **                    | ** ** | ** ** | ** ** |
| Restaurant equipment assets  retired due to remodeling  |       | $                             | 220        |   | $ | 173 |   |
| Restaurant equipment assets  retired due to replacement |       | 95                            |       | 159 |   |
| Loss on property not held for  disposition              |       | 40                            |       | 63 |   |
| All other                                               |       | 13                            |       | 113 |   |
| Loss on disposals of other  property and equipment, net |       | $                             | 368        |   | $ | 508 |   |

 

*Interest expense, net:*

 

Interestexpense, net of capitalized interest and interest income was $10.5 million and$11.4 million for the six months ended July 3, 2005 and June 27,2004, respectively. The decrease in interest expense in the first six months of2005 compared to the same period in 2004 is primarily due to reduced amounts ofdebt and lower interest rates on such debt. Total outstanding debt, includingcapital lease and finance obligations, decreased from $235.9 million at June 27,2004 to $234.4 million at July 3, 2005. The decrease in the totaloutstanding debt was due to the refinancing of $176.0 million of the Company’s101⁄2% senior notes (the “Senior Notes”). In March 2004, $127.8 million ofaggregate principal amount of the Senior Notes were purchased in a cash tenderoffer with the proceeds from the issuance of $175.0 million of New Senior Noteswith a lower interest rate. In April 2004, the remaining $48.2 million ofSenior Notes were redeemed in accordance with the Senior Notes indenture at103.5% of the principal amount.

 

*Other (income) expense, principally debt retirement costs:*

 

Other (income) expense, principally debt retirementcosts for the six months ended June 27,2004 represents the $6.8 million premium and the write-off of unamortized deferredfinancing costs of $2.5 million in connection with the tender offer for the$176.0 million of Senior Notes. In March 2004, $127.8 million of aggregateprincipal amount of Senior Notes were purchased pursuant to the tender offerand in April 2004, the remaining $48.2 million of Senior Notes wereredeemed in accordance with the Senior Notes indenture at 103.5% of theprincipal amount.

 

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*Provision for (benefit from) income taxes:*

 

Theprovision for income taxes was $0.1 million, an effective tax rate of 19.6%,for the six months ended July 3, 2005. At this time, the Company estimatesthat the effective tax rate for 2005 will be 25.0%.  During the second quarter of 2005, theCompany reduced the benefit from income taxes by $0.2 million due to certainitems discussed with the IRS.  Currently,the IRS is auditing fiscal years 2002 through 2004. The Company records incometaxes based on the effective rate for the year with any changes in valuationallowance reflected in the period of change.

 

Thebenefit from income taxes was $2.9 million, an effective tax rate of 30.4%, forthe six months ended June 27, 2004. The tax rate for the 2004 fiscal year was 68.8%, as the final benefitfrom income taxes for 2004 included a $2.2 million reversal of income taxaccruals recorded in prior years. These accruals related to tax matters that,based upon additional information obtained during the fourth quarter of 2004,were no longer necessary.  The reversalwas recorded in the fourth quarter of 2004.

 

*Net income (loss):*

 

Netloss was $0.5 million and $6.7 million for the six months ended July 3,2005 and June 27, 2004, respectively, for the reasons discussed above.

 

**Liquidity andCapital Resources**

 

*General:*

 

The Company’s primary sources of liquidity and capitalresources are cash generated from operations and, if needed, borrowings underits revolving credit facility. Additional sources of liquidity consist ofcapital and operating leases for financing leased restaurant locations (inmalls and shopping centers and land or building leases), restaurant equipment,manufacturing equipment, distribution vehicles and computer equipment.Additionally, sales of under-performing existing restaurant properties andother assets (to the extent FICC’s and its subsidiaries’ debt instrumentspermit) are sources of cash. The amount of debt financing that FICC will beable to incur is limited by the terms of its New Credit Facility and New SeniorNotes indenture. Below was the financing status of the Company’s operatingrestaurants at July 3, 2005:

 

| Owned and mortgaged                 |   | 64  |   |
|-------------------------------------|--------|-----|--------|
| Sold and leased back                |   | 60  |   |
| Owned land and building             |   | 26  |   |
| Leased land, owned building         |   | 74  |   |
| Leased land and building            |   | 108 |   |
| Total Company-operated  restaurants |   | 332 |   |

 

The restaurants above not identified as owned and mortgagedor sold and leased back secure the Company’s obligations under the New CreditFacility. Of the 26 restaurant properties identified as owned land andbuilding, six were available to be sold, if necessary, and of the 74 restaurantproperties identified as leased land, owned building, one was available to bemortgaged, if necessary.

 

In addition to the 64 properties identified as owned andmortgaged, the Company owns and mortgages an additional 11 properties in thiscategory, 10 of which are operated by franchisees and one that was closed in March 2005.

 

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*Operating Cash Flows:*

 

Net cash provided by operating activities was $11.3 millionand $0.2 million for the six months ended July 3, 2005 and June 27,2004, respectively. The increase of $11.1 million in cash provided by operatingactivities between the two periods was largely due to the $6.8 million premiumpaid in 2004 in connection with the tender offer for the $176.0 million ofSenior Notes. Additionally, during the first six months of 2005, inventorylevels were reduced by $1.3 million while inventories increased by $2.0 millionduring the first six months of 2004 as the Company anticipated rising creamprices in the third quarter of 2004. The timing of rent payments in the firstsix months of 2005 versus the first six months of 2004 provided an improvementof $1.2 million.  These improvements werepartially offset by the timing of advertising and inventory payments.

 

TheCompany had a working capital deficit of $9.5 million and $13.7 million as of July 3,2005 and January 2, 2005, respectively. The working capital needs ofcompanies engaged in the restaurant industry are generally low and as a result,restaurants are frequently able to operate with a working capital deficitbecause: (i) restaurant operations are conducted primarily on a cash (andcash equivalent) basis with a low level of accounts receivable; (ii) rapidturnover allows a limited investment in inventories; and (iii) cash fromsales is usually received before related expenses for food, supplies andpayroll are paid.

 

*Investing Cash Flows:*

 

Netcash used in investing activities was $4.2 million and $5.7 million for the sixmonths ended July 3, 2005 and June 27, 2004, respectively.

 

Duringthe six months ended July 3, 2005 and June 27, 2004, the Companyspent $7.3 million and $8.3 million, respectively, on capital expenditures, ofwhich $4.5 million and $7.6 million, respectively, was for the maintenance ofexisting restaurants. Capital expenditures were offset by proceeds from thesales of property and equipment of $3.4 million for both the six months ended July 3,2005 and June 27, 2004. The proceeds were primarily the result ofre-franchising transactions.

 

Duringthe six months ended July 3, 2005, the Company completed twore-franchising transactions in which two existing franchisees purchased fourexisting Company restaurants and agreed to develop a total of five newrestaurants in future years.  Grossproceeds from these transactions were $3.5 million, of which $0.1 million wasfor franchise fees and $3.4 million was for the sale of certain assets andleasehold rights.  In addition, theCompany completed three transactions in which three former employees receivedfranchises to operate six existing restaurants with options to purchase therestaurants within two years.  If theoptions are exercised, one franchisee will also agree to develop two new restaurantsin future years.  Proceeds from optiontransactions will be recognized upon purchase.

 

Duringthe six months ended June 27, 2004, the Company completed onere-franchising transaction in which a franchisee purchased a total of 10existing restaurants and agreed to develop a total of 10 new restaurants infuture years.  Gross proceeds from thesale were $3.2 million of which $0.3 million was for franchise fees for theinitial 10 restaurants. In addition, the Company sold the real property andequipment for one franchised location and assigned the lease and sold theequipment for a second franchised location to the existing franchisee. Grossproceeds from the sale were $0.5 million, of which $0.1 million was forfranchise fees and $0.4 million was for the sale of assets and lease assignment.

 

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*Financing Cash Flows:*

 

Netcash used in financing activities was $5.2 million and $8.0 million for the sixmonths ended July 3, 2005 and June 27, 2004, respectively.

 

In February 2004,the Company announced a cash tender offer and consent solicitation for $176million of its 10.50% senior notes (the “Senior Notes”) to be financed with theproceeds from a $175 million private offering of new 8.375% senior notes (the “NewSenior Notes”), available cash and an amended revolving credit facility. In March 2004,$127.4 million of aggregate principal amount of Senior Notes were purchased atthe tender offer and consent solicitation price of 104% of the principal amountand $0.4 million of aggregate principal amount of Senior Notes were purchasedat the tender offer price of 102% of the principal amount. In April 2004,the remaining $48.2 million of Senior Notes were redeemed in accordance withthe Senior Notes indenture at 103.5% of the principal amount.  In connection with the tender offer, theCompany wrote off unamortized deferred financing costs and incurred otherdirect expenses of $9.2 million that were included in the accompanyingcondensed consolidated statement of operations for the six months ended June 27,2004.

 

TheCompany has a $35.0 million revolving credit facility (the “New Credit Facility”).  The $35.0 million revolving credit commitmentless outstanding letters of credit is available for borrowing to provideworking capital and for other corporate needs. As of July 3, 2005 and January 2,2005, total letters of credit outstanding were $16.0 million and $15.2 million,respectively. During 2005 and 2004, there were no drawings against the lettersof credit.  The revolving credit loansbear interest at the Company’s option at either (a) the Base Rate plus theapplicable margin as in effect from time to time (the “Base Rate”) (8.75% at July 3,2005) or (b) the Eurodollar rate plus the applicable margin as in effectfrom time to time (the “Eurodollar Rate”) (7.78% at July 3, 2005). As of July 3,2005 there were no revolving credit loans outstanding. As of January 2,2005, $4.0 million of revolving credit loans were outstanding. As of July 3,2005 and January 2, 2005, $19.0 million and $15.8 million, respectively,was available for borrowing.

 

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

 

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The New Credit Facility includes certain restrictivecovenants including limitations on indebtedness, restricted payments such asdividends and stock repurchases and sales of assets and of subsidiary stock.Additionally, the New Credit Facility limits the amount which the Company mayspend on capital expenditures, restricts the use of proceeds, as defined, fromasset sales and requires the Company to comply with certain financialcovenants. On July 23, 2004 and October 19, 2004, the Companyobtained limited waivers regarding certain financial covenants of its NewCredit Facility, which the Company was not in full compliance with as of June 27,2004 and September 26, 2004.  On December 17,2004, the Company amended the New Credit Facility to, among other things, (i) revisecertain financial covenants and eliminate the minimum quarterly EBITDArequirement, (ii) amend the Company’s annual capital expenditures limitand (iii) increase the commitment fee from 0.50% to 0.75% of the unusedcommitment amount.  The Company was incompliance with the covenants under the New Credit Facility as of July 3,2005. See Note 7 of the Notes to Consolidated Financial Statements in theCompany’s 2004 Annual Report on Form 10-K/A for the fiscal year ended January 2,2005 for additional information regarding the Company’s long-term debt.

 

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

 

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

 

**Seasonality**

 

Due tothe seasonality of ice cream consumption, and the effect from time to time ofweather on patronage of the restaurants, the Company’s revenues and operatingincome are typically higher in its second and third quarters.

 

**Geographic Concentration**

 

Approximately98% of the Company-operated restaurants are located, and substantially all ofits retail sales are generated, in the Northeast. As a result, a severe orprolonged economic recession or changes in demographic mix, employment levels,population density, weather, real estate market conditions or other factorsspecific to this geographic region may adversely affect the Company more thancertain of its competitors which are more geographically diverse.

 

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**Critical Accounting Estimates**

 

The discussion and analysis of the Company’s consolidatedfinancial condition and results of operations are based upon the Company’sinterim condensed consolidated financial statements, which have been preparedin accordance with generally accepted accounting principles in the U.S. Thepreparation of these condensed consolidated financial statements requires theCompany to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses, and related disclosure ofcontingent assets and liabilities. On an on-going basis, the Company evaluatesits estimates, including those related to revenue recognition, insurancereserves, recoverability of accounts receivable, income tax valuationallowances and pension and other post-retirement benefits expense.  The Company bases its estimates on historicalexperience and on various other assumptions that are believed to be reasonableunder the circumstances, the results of which form the basis for makingjudgments about the carrying values of assets and liabilities that are notreadily apparent from other sources.

 

The critical accounting estimates that the Company believesaffect the reported amounts of assets, liabilities, revenues and expenses, andthe related disclosure of contingent assets and liabilities in the Company’scondensed consolidated financial statements presented in this report aredescribed in the Company’s Management’s Discussion and Analysis of FinancialCondition and Results of Operations and in the Notes to the consolidatedfinancial statements included in the Company’s Annual Report on Form 10-K/Afor the fiscal year ended January 2, 2005. There have been no materialchanges to the criticalaccounting estimates.

 

Actual results may differ from these estimates underdifferent assumptions or conditions. Any differences may have a material impacton the Company’s financial condition and results of operations. For adiscussion of how these and other factors may affect the Company’s business,see the “Forward Looking Statements” above and other factors included in theCompany’s other filings with the Securities and Exchange Commission.

 

**Recently Issued Accounting Pronouncements**

 

In June 2005, the FASB’s Emerging Issues Task Forcereached a consensus on Issue No. 05-6, “Determining the AmortizationPeriod for Leasehold Improvements” (“EITF 05-6”). The guidance requires thatleasehold improvements acquired in a business combination or purchasedsubsequent to the inception of a lease be amortized over the lesser of theuseful life of the assets or a term that includes renewals that are reasonablyassured at the date of the business combination or purchase. The guidance iseffective for periods beginning after June 29, 2005. The adoption of EITF05-6 is not expected to have a material effect on the Company’s consolidatedfinancial position or results of operations.

 

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections–A Replacement of APB Opinion No. 20 and FASB Statement No. 3.” SFAS No. 154 applies to all voluntary changes in accounting principle and requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable. SFAS No. 154 requires that a change in depreciation, amortization, or depletion method for long-lived, nonfinancial assets be accounted for as a change of estimate affected by a change in accounting principle. SFAS No. 154 also carries forward without change the guidance in APB Opinion No. 20 with respect to accounting for changes in accounting estimates, changes in the reporting unit and correction of an error in previously issued financial statements. The Company is required to adopt SFAS No. 154 for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 is not expected to have a material effect on the Company’s consolidated financial position or results of operations.

 

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On December 16,2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFASNo. 123R”), which is a revision of SFAS No. 123, “Accounting forStock-Based Compensation.” SFAS No. 123R supersedes APB Opinion No. 25,Accounting for Stock Issued to Employees,” and amends SFAS No. 95, “Statementof Cash Flows.” Generally, the approach in SFAS No. 123R is similar to theapproach described in SFAS No. 123. However, SFAS No. 123R requiresall share-based payments to employees, including grants of employee stockoptions, to be recognized in the income statement based on their fair values.Pro forma disclosure is no longer an alternative. SFAS No. 123R must beadopted no later than the first annual period beginning after June 15,2005. Early adoption will be permitted in periods in which financial statementshave not yet been issued. SFAS No. 123R allows companies to choose betweenthe modified-prospective and modified-retrospective transition alternatives inadopting SFAS No. 123R. Under the modified-prospective transition method,compensation cost will be recognized in financial statements issued subsequentto the date of adoption for all shared-based payments granted, modified orsettled after the date of adoption, as well as for any unvested awards thatwere granted prior to the date of adoption. Under the modified-retrospectivetransition method, compensation cost will be recognized in a manner consistentwith the modified-prospective transition method, however, prior periodfinancial statements will also be restated by recognizing compensation cost aspreviously reported in the pro forma disclosures under SFAS No. 123. Therestatement provisions can be applied to either a) all periods presented or b)to the beginning of the fiscal year in which SFAS No. 123R is adopted. TheCompany expects to adopt SFAS No. 123R on January 2, 2006 using themodified-prospective method. As the Company previously adopted only the proforma disclosure provisions of SFAS No. 123, the Company will recognizecompensation cost relating to the unvested portion of awards granted prior tothe date of adoption using the same estimate of the grant-date fair value andthe same attribution method used to determine the pro forma disclosures underSFAS No. 123.

 

Aspermitted by SFAS No. 123, the Company currently accounts for share-basedpayments to employees using APB Opinion No. 25’s intrinsic value methodand, as such, generally recognizes no compensation cost for employee stockoptions.  Accordingly, the adoption ofSFAS No. 123R’s fair value method will have an impact on the Company’sresults of operations, although it will have no impact on the overall financialposition. The impact of the adoption of SFAS No. 123R cannot be determinedat this time because it will depend upon levels of share-based payments grantedin the future. However, had the Company adopted SFAS No. 123R in priorperiods, the impact of that standard would have approximated the impact asdescribed in the disclosure of pro forma net income (loss) and net income (loss)per share pursuant to SFAS No. 123. SFAS No. 123R also requires the benefits of tax deductions inexcess of recognized compensation cost to be reported as a financing cash flow,rather than as an operating cash flow as required under currentliterature.  This requirement will reducenet operating cash flows and increase net financing cash flows in periods afteradoption.  While the Company cannotestimate what those amounts will be in the future (because they depend on,among other things, when employees exercise stock options), the amount of operatingcash flows recognized in prior years for such excess tax deductions were $0.8million and $0.2 million in 2004 and 2003, respectively.

 

In November 2004, the FASB issued SFAS No. 151, “InventoryCosts, an amendment of Accounting Research Bulletin No. 43, Chapter 4”.The amendments made by SFAS No. 151 clarify that abnormal amounts of idlefacility expense, freight, handling costs, and wasted materials (spoilage)should be recognized as current-period charges and require the allocation offixed production overheads to inventory based on the normal capacity of theproduction facilities. SFAS No. 151 is the result of a broader effort bythe FASB to improve the comparability of cross-border financial reporting byworking with the International Accounting Standards Board toward development ofa single set of high-quality accounting standards. The guidance is effectivefor inventory costs incurred during fiscal years beginning after June 15,2005. The adoption of SFAS No. 151 is not expected to have a materialeffect on the Company’s consolidated financial position or results ofoperations.

 

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**Item 3. Quantitative and Qualitative Disclosures AboutMarket Risk**

 

There has been no material change in the Company’s marketrisk exposure since the filing of the 2004 Annual Report on Form 10-K/A.

 

**Item 4. Controls and Procedures**

 

As of July 3,2005, an evaluation was performed under the supervision and with theparticipation of the Company’s management, including the Chief ExecutiveOfficer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness ofthe design and operation of the Company’s disclosure controls and procedures(as defined in Rule 13a-15(e) under the Exchange Act).  Based on that evaluation, the Company’s CEOand CFO concluded that the Company’s disclosure controls and procedures wereeffective as of July 3, 2005.

 

There were no significant changes in the Company’s internalcontrol over financial reporting that occurred during the Company’s last fiscalquarter that have materially affected, or are reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

 

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**PART II – OTHER INFORMATION**

 

**Item 4. Submission of matters to a vote of securityholders**

 

(a)     An annual meetingof the Company’s shareholders was held on May 11, 2005.

 

(b)     Not applicable.

 

(c)     At the AnnualMeeting of Shareholders, the shareholders voted on the following matters:

 

(1)      The election of two Class IIDirectors to serve until the 2008 Annual Meeting of Shareholders; and

 

(2)      The ratification of the appointment of Ernst &Young LLP as the Company’s independent registered public accounting firm forfiscal 2005.

 

The voting results were as follows:

 
| **Directors**   | ** ** | **Affirmative  Votes** | ** ** | **Votes  Withheld** | ** ** |
|-----------------|------------|------------------------|------------|---------------------|------------|
| Steven L. Ezzes |       | 6,220,106              |       | 1,102,378           |       |
| Perry D. Odak   |       | 7,061,813              |       | 260,671             |       |

 

Additional Directors, whose termsof office as Directors continued after the meeting, are as follows:

 
| **Term Expiring in 2006** | ** ** | **Term  Expiring in 2007** | ** ** |
|---------------------------|------------|----------------------------|------------|
| Donald N. Smith           |       | Michael J. Daly            |       |
|                      |       | Burton J. Manning          |       |

 

The proposal to approve theappointment of Ernst & Young LLP as the Company’s independentregistered public accounting firm for fiscal 2005 was approved by theshareholders as follows:

 
| **Affirmative  Votes** | ** ** | **Negative  Votes** | ** ** | **Votes  Withheld** | ** ** |
|------------------------|------------|---------------------|------------|---------------------|------------|
| 6,612,657              |       | 693,222             |       | 16,605              |       |

 

There were no matters voted upon atthe Company’s annual meeting to which broker non-votes applied.

 

**Item 5. Other Information**

 

On May 31, 2005, the Companyentered into a Memorandum of Agreement with Lawrence A. Rusinko, the Company’sformer Senior Vice President of Marketing. The Memorandum of Agreement states the terms of severance that will bepayable by the Company to Mr. Rusinko. Mr. Rusinko will continue to receive base salary payments through May 31,2006, reimbursement of COBRA payments through August 31, 2005, outplacementservices through November 30, 2005, and continued financial planning assistancethrough May 31, 2006.

 

On July 15, 2005, Mr. PaulHoagland, the Company’s Chief Financial Officer, elected to participate in theCompany’s relocation policy applicable to executives and regional directors, inconnection with relocating his principal residence from Hopkinton, MA toWilbraham, MA, the location of the Company’s principal executive offices. Underthe relocation policy, Mr. Hoagland is eligible to receive certain relocationbenefits, including financial and other assistance in selling his current homeand purchasing a new home, transition-related expenses and tax assistance withrespect to such relocation benefits. A copy of the relocation policy is filedas Exhibit 10.2 to this Form 10-Q.

 

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**Item 6.  Exhibits**

 

Exhibits

 

The exhibit index is incorporatedby reference herein.

 

 

**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

 
|   | Friendly Ice Cream  Corporation |
|--------|---------------------------------|
|   |                            |
|   |                            |
|   | By:                             | /s/ PAUL V. HOAGLAND |   |
|   |                            | Name:  Paul V. Hoagland |
|   |                            | Title: Executive Vice  President of Administration |
|   |                            | and Chief Financial  Officer |
|   |                            | (Principal Financial  Officer) |
|   | Date:                           | August 4, 2005 |

 

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**EXHIBIT INDEX**

 

10.1           Agreement between the Company and Lawrence A.Rusinko effective as of May 31, 2005.*

10.2           Domestic Relocation Policy for Executives/RegionalDirectors.*

31.1           Certification pursuant to Section 302 of theSarbanes-Oxley Act of 2002 signed by John L. Cutter.

31.2           Certification pursuant to Section 302 of theSarbanes-Oxley Act of 2002 signed by Paul V. Hoagland.

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

 

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*Management contract or compensatory plan or arrangement

 

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