**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

**(Mark One)**
| **x** | **QUARTERLY REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE**

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

 

**For the quarterlyperiod ended April 1, 2007**
| **OR**     |
|------------|
| ** ** |
| **o**      | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE**

**SECURITIES  EXCHANGE ACT OF 1934** |

 

For the transition period from             to             

**Commission File No. 001-13579**

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**FRIENDLY ICE CREAM CORPORATION**

(Exact Name of Registrantas Specified in Its Charter)

| **Massachusetts**                         |   | **04-2053130**       |
|-------------------------------------------|--------|----------------------|
| (State or Other  Jurisdiction of          |   | (IRS Employer        |
| Incorporation or  Organization)           |   | Identification  No.) |
|                                      |   |                 |
| **1855  Boston Road**                     |   | ** **           |
| **Wilbraham,  Massachusetts**             |   | **01095**            |
| (Address of  Principal Executive Offices) |   | (Zip Code)           |

 

**(413) 731-4000**

(Registrant’sTelephone 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) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes x  No o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act.

| Large Accelerated Filer o |   | Accelerated  Filer x |   | Non-Accelerated  Filer o |
|--------------------------------|--------|---------------------------|--------|-------------------------------|

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes o  No x

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock asof the latest practicable date.

| Class                         | ** ** | **Outstanding at April 30, 2007** |
|-------------------------------|------------|-----------------------------------|
| Common Stock,  $.01 par value |       | 8,162,232 shares                  |

 

 

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**PART I — FINANCIAL INFORMATION**

**Item1.  Financial Statements**

**FRIENDLYICE CREAM CORPORATION AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCE SHEETS**(Unaudited)(In thousands)
| ** **                                                                | ** ** | **April 1,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                | ** ** | **2007**          | ** ** | **2006**              | ** ** |
|                                                                      |       |              |       |                  |       |
| ASSETS                                                                    |       |              |       |                  |       |
| CURRENT ASSETS:                                                           |       |              |       |                  |       |
| Cash and cash  equivalents                                                |       | $                 | 21,860     |                  | $          | 25,077 |   |
| Restricted cash                                                           |       | 380               |       | 517                   |       |
| Accounts  receivable, net                                                 |       | 12,264            |       | 11,435                |       |
| Inventories                                                               |       | 15,967            |       | 17,059                |       |
| Assets held for  sale                                                     |       | 896               |       | 896                   |       |
| Prepaid expenses  and other current assets                                |       | 3,375             |       | 3,127                 |       |
| TOTAL CURRENT ASSETS                                                      |       | 54,742            |       | 58,111                |       |
| DEFERRED INCOME TAXES                                                     |       | 928               |       | 928                   |       |
| PROPERTY AND EQUIPMENT,  net of accumulated depreciation and amortization |       | 133,997           |       | 137,425               |       |
| INTANGIBLE ASSETS AND  DEFERRED COSTS, net of accumulated amortization    |       | 17,350            |       | 17,783                |       |
| OTHER ASSETS                                                              |       | 5,889             |       | 5,920                 |       |
| TOTAL ASSETS                                                              |       | $                 | 212,906    |                  | $          | 220,167 |   |
|                                                                      |       |              |       |                  |       |
| LIABILITIES AND  STOCKHOLDERS’ DEFICIT                               |       |              |       |                  |       |
| CURRENT LIABILITIES:                                                      |       |              |       |                  |       |
| Current  maturities of long-term debt                                     |       | $                 | 1,592      |                  | $          | 1,563 |   |
| Current  maturities of capital lease and finance obligations              |       | 1,583             |       | 1,541                 |       |
| Accounts payable                                                          |       | 20,532            |       | 22,247                |       |
| Accrued salaries  and benefits                                            |       | 9,394             |       | 8,230                 |       |
| Accrued interest  payable                                                 |       | 4,825             |       | 1,173                 |       |
| Insurance  reserves                                                       |       | 12,514            |       | 11,462                |       |
| Other accrued  expenses                                                   |       | 16,296            |       | 22,475                |       |
| TOTAL CURRENT  LIABILITIES                                                |       | 66,736            |       | 68,691                |       |
| CAPITAL LEASE AND  FINANCE OBLIGATIONS, less current maturities           |       | 4,270             |       | 4,682                 |       |
| LONG-TERM DEBT, less  current maturities                                  |       | 222,236           |       | 222,650               |       |
| LIABILITY FOR PENSION  BENEFITS                                           |       | 20,639            |       | 20,302                |       |
| OTHER LONG-TERM  LIABILITIES                                              |       | 31,845            |       | 30,738                |       |
| COMMITMENTS AND  CONTINGENCIES                                            |       |              |       |                  |       |
| STOCKHOLDERS’ DEFICIT:                                               |       |              |       |                  |       |
| Common stock                                                              |       | 82                |       | 81                    |       |
| Additional  paid-in capital                                               |       | 146,647           |       | 146,398               |       |
| Accumulated  other comprehensive loss                                     |       | (23,514           | )          | (23,514               | )          |
| Accumulated  deficit                                                      |       | (256,035          | )          | (249,861              | )          |
| TOTAL STOCKHOLDERS’  DEFICIT                                         |       | (132,820          | )          | (126,896              | )          |
| TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIT                          |       | $                 | 212,906    |                  | $          | 220,167 |   |

 

The accompanyingnotes are an integral part of these condensed consolidated financialstatements.

 

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##  

## **FRIENDLY ICE CREAM CORPORATION ANDSUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**(Unaudited)(In thousands, except per share data)
| ** **                                                                                                                                                    | ** ** | **For the Three Months Ended** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                                                                                    | ** ** | **April 1,**                                  | ** ** | **April 2,** | ** ** |
| ** **                                                                                                                                                    | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
|                                                                                                                                                          |       |                                               |       |   |   |
| REVENUES:                                                                                                                                                     |       |                                               |       |   |   |
| Restaurant                                                                                                                                                    |       | $                                                  | 93,187     |   | $ | 95,276 |   |
| Foodservice                                                                                                                                                   |       | 25,944                                             |       | 26,894 |   |
| Franchise                                                                                                                                                     |       | 3,495                                              |       | 3,545 |   |
| TOTAL REVENUES                                                                                                                                                |       | 122,626                                            |       | 125,715 |   |
|                                                                                                                                                          |       |                                               |       |   |   |
| COSTS AND EXPENSES:                                                                                                                                           |       |                                               |       |   |   |
| Cost of sales                                                                                                                                                 |       | 47,103                                             |       | 48,385 |   |
| Labor and  benefits                                                                                                                                           |       | 34,397                                             |       | 36,012 |   |
| Operating  expenses                                                                                                                                           |       | 25,012                                             |       | 23,999 |   |
| General and  administrative expenses                                                                                                                          |       | 10,633                                             |       | 11,097 |   |
| Write-downs of  property and equipment                                                                                                                        |       | 206                                                |       | 215 |   |
| Depreciation and  amortization                                                                                                                                |       | 6,160                                              |       | 5,780 |   |
| Gain on franchise sales  of restaurant operations and properties                                                                                              |       | —                                             |       | (866 | ) |
| Loss on disposals of  other property and equipment, net                                                                                                       |       | 35                                                 |       | 109 |   |
|                                                                                                                                                          |       |                                               |       |   |   |
|                                                                                                                                                          |       |                                               |       |   |   |
| OPERATING (LOSS) INCOME                                                                                                                                       |       | (920                                               | )          | 984 |   |
|                                                                                                                                                          |       |                                               |       |   |   |
| Interest expense, net                                                                                                                                         |       | 4,924                                              |       | 5,420 |   |
|                                                                                                                                                          |       |                                               |       |   |   |
| LOSS FROM CONTINUING  OPERATIONS BEFORE PROVISION FOR INCOME TAXES                                                                                            |       | (5,844                                             | )          | (4,436 | ) |
|                                                                                                                                                          |       |                                               |       |   |   |
| Provision for income  taxes                                                                                                                                   |       | (94                                                | )          | — |   |
|                                                                                                                                                          |       |                                               |       |   |   |
| LOSS FROM CONTINUING  OPERATIONS                                                                                                                              |       | (5,938                                             | )          | (4,436 | ) |
|                                                                                                                                                          |       |                                               |       |   |   |
| (LOSS) INCOME FROM  DISCONTINUED OPERATIONS, net of income tax effect  of $0 and $0 for the three months ended April 1, 2007 and April 2, 2006,  respectively |       | (14                                                | )          | 2,616 |   |
|                                                                                                                                                          |       |                                               |       |   |   |
| NET LOSS                                                                                                                                                      |       | $                                                  | (5,952     | ) | $ | (1,820 | ) |
|                                                                                                                                                          |       |                                               |       |   |   |
| BASIC AND DILUTED NET  LOSS PER SHARE:                                                                                                                        |       |                                               |       |   |   |
| Loss from  continuing operations                                                                                                                              |       | $                                                  | (0.73      | ) | $ | (0.56 | ) |
| (Loss) income  from discontinued operations                                                                                                                   |       | (0.00                                              | )          | 0.33 |   |
| Net loss                                                                                                                                                      |       | $                                                  | (0.73      | ) | $ | (0.23 | ) |
|                                                                                                                                                          |       |                                               |       |   |   |
| WEIGHTED AVERAGE  SHARES:                                                                                                                                     |       |                                               |       |   |   |
| Basic and  Diluted                                                                                                                                            |       | 8,122                                              |       | 7,901 |   |

 

The accompanyingnotes are an integral part of these condensed consolidated financialstatements.

 

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**FRIENDLY ICE CREAM CORPORATION AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**(Unaudited)(In thousands)
| ** **                                                                       | ** ** | **For the Three Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                       | ** ** | **April 1,**                                  | ** ** | **April 2,** | ** ** |
| ** **                                                                       | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                           |       |                                               |       |   |   |
| Net loss                                                                         |       | $                                                  | (5,952     | ) | $ | (1,820 | ) |
| Adjustments to  reconcile net loss to net cash provided by operating activities: |       |                                               |       |   |   |
| Stock  compensation expense                                                      |       | 214                                                |       | 79 |   |
| Depreciation and  amortization                                                   |       | 6,160                                              |       | 5,780 |   |
| Non-cash income  from discontinued operations                                    |       | —                                             |       | (2,864 | ) |
| Write-downs of  property and equipment                                           |       | 206                                                |       | 215 |   |
| Loss (gain) on  disposals of property and equipment, net                         |       | 35                                                 |       | (772 | ) |
| Changes in  operating assets and liabilities:                                    |       |                                               |       |   |   |
| Accounts  receivable                                                             |       | (829                                               | )          | (1,031 | ) |
| Inventories                                                                      |       | 1,092                                              |       | (199 | ) |
| Other assets                                                                     |       | (80                                                | )          | 1,471 |   |
| Accounts payable                                                                 |       | (1,715                                             | )          | (2,797 | ) |
| Accrued expenses  and other long-term liabilities                                |       | 910                                                |       | 4,637 |   |
| NET CASH PROVIDED BY  OPERATING ACTIVITIES                                       |       | 41                                                 |       | 2,699 |   |
|                                                                             |       |                                               |       |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                           |       |                                               |       |   |   |
| Purchases of property  and equipment                                             |       | (2,530                                             | )          | (2,404 | ) |
| Proceeds from sales of  property and equipment                                   |       | —                                             |       | 5,794 |   |
| NET CASH (USED IN)  PROVIDED BY INVESTING ACTIVITIES                             |       | (2,530                                             | )          | 3,390 |   |
|                                                                             |       |                                               |       |   |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                           |       |                                               |       |   |   |
| Proceeds from  borrowings under revolving credit facility                        |       | —                                             |       | 8,000 |   |
| Repayments of debt                                                               |       | (385                                               | )          | (8,338 | ) |
| Payments of deferred  financing costs                                            |       | (9                                                 | )          | (205 | ) |
| Repayments of capital  lease and finance obligations                             |       | (370                                               | )          | (391 | ) |
| Stock options exercised                                                          |       | 36                                                 |       | 19 |   |
| NET CASH USED IN  FINANCING ACTIVITIES                                           |       | (728                                               | )          | (915 | ) |
|                                                                             |       |                                               |       |   |   |
| NET (DECREASE) INCREASE  IN CASH AND CASH EQUIVALENTS                            |       | (3,217                                             | )          | 5,174 |   |
|                                                                             |       |                                               |       |   |   |
| CASH AND CASH  EQUIVALENTS, BEGINNING OF PERIOD                                  |       | 25,077                                             |       | 14,597 |   |
|                                                                             |       |                                               |       |   |   |
| CASH AND CASH  EQUIVALENTS, END OF PERIOD                                        |       | $                                                  | 21,860     |   | $ | 19,771 |   |
|                                                                             |       |                                               |       |   |   |
| SUPPLEMENTAL  DISCLOSURES:                                                       |       |                                               |       |   |   |
| Cash paid (refunded)  during the period for:                                     |       |                                               |       |   |   |
| Interest                                                                         |       | $                                                  | 1,269      |   | $ | 1,528 |   |
| Income taxes                                                                     |       | 232                                                |       | (503 | ) |

 

The accompanyingnotes are an integral part of these condensed consolidated financialstatements.

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**FRIENDLY ICE CREAMCORPORATION AND SUBSIDIARIES**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

**1. NATURE OFOPERATIONS**

As of April 1, 2007, Friendly’s operated 317 full-servicerestaurants and franchised 198 full-service restaurants and sevennon-traditional units. The Company manufactures and distributes a full line ofpremium ice cream dessert products. These products are distributed to Friendly’srestaurants, supermarkets and other retail locations in 12 states. Therestaurants offer a wide variety of breakfast, lunch and dinner menu items aswell as premium ice cream dessert products.

References herein to “Friendly’s” or the “Company”refer to Friendly Ice Cream Corporation, its predecessor and its consolidatedsubsidiaries; references herein to “FICC” refer to Friendly Ice CreamCorporation and not its subsidiaries; and as used herein, “Northeast” refers tothe Company’s core markets, which include Connecticut, Maine, Massachusetts,New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island and Vermont.

Following is a summary of Company-operated andfranchised units:

|                            | ** ** | **For the Three Months Ended** | ** ** |
|----------------------------|------------|----------------------------------------------------|------------|
| ** **                 | ** ** | **April 1,**                                  | ** ** | **April 2,** | ** ** |
| ** **                 | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
|                       |       |                                               |       |   |   |
| Company Units:             |       |                                               |       |   |   |
| Beginning of period        |       | 316                                                |       | 314 |   |
| Openings                   |       | 1                                                  |       | 1 |   |
| Acquired from  franchisees |       | 1                                                  |       | — |   |
| Acquired by franchisees    |       | —                                             |       | (1 | ) |
| Closings                   |       | (1                                                 | )          | (2 | ) |
| End of period              |       | 317                                                |       | 312 |   |
|                       |       |                                               |       |   |   |
| Franchised Units:          |       |                                               |       |   |   |
| Beginning of period        |       | 205                                                |       | 213 |   |
| Openings                   |       | 1                                                  |       | — |   |
| Acquired by franchisees    |       | —                                             |       | 1 |   |
| Acquired from franchisees  |       | (1                                                 | )          | — |   |
| Closings                   |       | —                                             |       | — |   |
| End of period              |       | 205                                                |       | 214 |   |

 

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**2. BASIS OFPRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES**

*InterimFinancial Information —*

The accompanying condensed consolidated financialstatements as of April 1, 2007 and for the three months ended April 1, 2007 andApril 2, 2006 are unaudited, but have been prepared in accordance with U.S.generally accepted accounting principles (“GAAP”) for interim financialinformation and with the instructions to Form 10-Q and Article 10 of RegulationS-X.  Accordingly, they do not includeall of the information and footnotes required by GAAP for complete financialstatements.  In the opinion ofmanagement, all adjustments which are necessary for a fair presentation of theconsolidated financial position, results of operations, cash flows andcomprehensive loss of the Company have been included. Such adjustments consistsolely of normal recurring accruals. Operating results for the three monthperiods ended April 1, 2007 and April 2, 2006 are not necessarily indicative ofthe results that may be expected for the entire year due, in part, to theseasonality of the Company’s business. Historically, higher revenues andoperating income have been experienced during the second and third fiscalquarters. The Company’s consolidated financial statements, including the notesthereto, which are contained in the 2006 Annual Report on Form 10-K for thefiscal year ended December 31, 2006 as amended (“2006 Annual Report on Form10-K/A”) should be read in conjunction with these condensed, consolidatedfinancial statements. Capitalized terms not otherwise defined herein should bereferenced to the 2006 Annual Report on Form 10-K/A.

*Use ofEstimates in the Preparation of Financial Statements —*

The preparation of financial statements in conformitywith GAAP requires management to make estimates and assumptions that affect thereported amounts of assets and liabilities and the disclosure of contingentassets and liabilities at the dates of the financial statements and the reportedamounts of revenues and expenses during the reporting periods. The criticalaccounting policies and most significant estimates and assumptions relate torevenue recognition, insurance reserves, recoverability of accounts receivableand notes receivable, pension and post-retirement medical and life insurancebenefits expense, asset impairment analysis, income tax valuation allowancesand tax contingency reserves. Actual amounts could differ significantly fromthe estimates.

*Inventories —*

Inventories are stated atthe lower of first-in, first-out cost or market and consisted ofthe following at April 1, 2007 and December 31, 2006 (in thousands):

|                  | ** ** | **April 1,** | ** ** | **December 31,** | ** ** |
|------------------|------------|-------------------|------------|-----------------------|------------|
| ** **       | ** ** | **2007**          | ** ** | **2006**              | ** ** |
|             |       |              |       |                  |       |
| Raw materials    |       | $                 | 1,654      |                  | $          | 1,640 |   |
| Goods in process |       | 100               |       | 158                   |       |
| Finished goods   |       | 14,213            |       | 15,261                |       |
| Total            |       | $                 | 15,967     |                  | $          | 17,059 |   |

 

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*Other Accrued Expenses —*

Other accrued expensesconsisted of the following at April 1, 2007 and December 31, 2006 (inthousands):

|                                    | ** ** | **April 1,** | ** ** | **December 31,** | ** ** |
|------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **2007**          | ** ** | **2006**              | ** ** |
|                               |       |              |       |                  |       |
| Accrued rent                       |       | $                 | 4,992      |                  | $          | 5,178 |   |
| Gift cards outstanding             |       | 2,915             |       | 4,317                 |       |
| Accrued meals and other  taxes     |       | 2,443             |       | 2,241                 |       |
| Unearned revenues                  |       | 1,147             |       | 1,153                 |       |
| Accrued advertising                |       | 916               |       | 1,150                 |       |
| Accrued construction  costs        |       | 780               |       | 918                   |       |
| Accrued bonus                      |       | 752               |       | 3,635                 |       |
| Current portion of  deferred gains |       | 638               |       | 638                   |       |
| Income taxes payable               |       | 467               |       | 1,962                 |       |
| All other                          |       | 1,246             |       | 1,283                 |       |
| Total                              |       | $                 | 16,296     |                  | $          | 22,475 |   |

 

*Income Taxes —*

The Company accounts forincome taxes in accordance with SFAS No. 109, “Accounting for Income Taxes,”which requires recognition of deferred tax assets and liabilities for theexpected future tax consequences of events that have been included in thefinancial statements or tax returns. The Company records deferred tax assets tothe extent it believes there will be sufficient future taxable income toutilize those assets prior to their expiration. To the extent deferred taxassets may be unable to be utilized, the Company records a valuation allowanceagainst the potentially unrealizable amount and records a charge againstearnings.   The calculation of theCompany’s tax liabilities involves dealing with uncertainties in theapplication of complex tax regulations in several different tax jurisdictions.The Company is periodically reviewed by tax authorities regarding the amount oftaxes due. These reviews include questions regarding the timing and amount ofdeductions. In evaluating the exposure associated with various filingpositions, the Company records estimated reserves for probable exposures.

As of December 31, 2006the Company remained in a three-year cumulative loss position and expected torecord valuation allowances on future tax benefits until it can sustain anappropriate level of profitability. However, the Company incurred approximately$1,093,000 of federal tax liabilities for 2005 and 2006 combined. Approximately$928,000 of the $1,093,000 would be available for refund if 2007 results in aloss for income tax purposes. As a result, the valuation allowances as ofDecember 31, 2006 of $27,429,000 reduced the carrying value of net deferred taxassets to $928,000. Should the Company’s future profitability providesufficient evidence, in accordance with SFAS No. 109, to support the ultimaterealization of income tax benefits attributable to net operating loss (“NOL”)and credit carryforwards and other deductible temporary differences, areduction in the valuation allowance may be recorded and the carrying value ofdeferred tax assets may be restored, resulting in a non-cash credit toearnings.

6

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*Lease Guarantees and Contingencies —*

Primarilyas a result of the Company’s strategy to sell Company-operated restaurants tofranchisees, the Company remains liable for certain lease assignments andguarantees. These leases have varying terms, the latest of which expires in2020. As of April 1, 2007, the potential amount of undiscounted payments theCompany could be required to make in the event of non-payment by the primarylessees was $6,203,000. The present value of these potential paymentsdiscounted at the Company’s pre-tax cost of debt at April 1, 2007 was$4,699,000. The Company generally has cross-default provisions with franchiseesthat would put them in default of their franchise agreement in the event ofnon-payment under the lease. The Company believes these cross-default provisionssignificantly reduce the risk that the Company will be required to makepayments under these leases and, historically, the Company has not beenrequired to make such payments. Accordingly, no liability has been recorded forexposure under such leases at April 1, 2007 and December 31, 2006.

*Net Loss Per Share —*

Basic net loss per share is calculated by dividing netloss by the weighted average number of common shares outstanding during theperiod. Diluted net loss per share is calculated by dividing net loss by theweighted average number of shares of common stock and common stock equivalentsoutstanding during the period. Common stock equivalents are dilutive stockoptions and warrants that are assumed exercised for calculation purposes. Therewere no common stock equivalents included in diluted net loss per share for thethree months ended April 1, 2007 and April 2, 2006.  The number of common stock options whichcould dilute basic earnings per share in the future, that were not included inthe computation of diluted earnings per share because to do so would have beenantidilutive, was 240,000 and 316,000 for the three months ended April 1, 2007and April 2, 2006, respectively.

*Stock-Based Compensation —*

Prior to January 2, 2006, the Company accounted forstock-based compensation for employees under Accounting Principles Board(“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and relatedinterpretations.  The Company had adoptedthe disclosure-only provisions of SFAS No. 123, “Accounting for Stock-BasedCompensation” and the disclosures required by SFAS No. 148, “Accounting forStock-Based Compensation—Transition and Disclosure.”  In accordance with APB Opinion No. 25, theCompany generally recognized no stock-based compensation cost, as all optionsgranted during that period had an exercise price equal to the market value ofthe stock on the date of grant.

OnDecember 16, 2004, the Financial Accounting Standards Board (“FASB”) issuedSFAS No. 123 (revised 2004), “Share-BasedPayment”**(“SFAS No. 123R”).SFAS No. 123R supersedes APB Opinion No. 25 and amends SFAS No. 95, “Statement of Cash Flows.” Generally,the approach in SFAS No. 123R is similar to the approach described in SFAS No.123. However, SFAS No. 123R requires all share-based payments to employees,including grants of employee stock options, to be recognized in the incomestatement based on their fair values at the date of grant. Pro forma disclosureis no longer an alternative.

OnJanuary 2, 2006 (the first day of its 2006 fiscal year), the Company adoptedSFAS No. 123R using the modified prospective method as permitted under SFAS No.123R. Under this transition method, compensation cost recognized in the threemonths ended April 1, 2007 and April 2, 2006 included: (a) compensationcost for all share-based payments granted prior to but not yet vested as ofJanuary 1, 2006, based on the grant-date fair value estimated in accordancewith the provisions of SFAS No. 123, and (b) compensation cost for allshare-based payments granted subsequent to January 1, 2006, based on thegrant-date fair value estimated in accordance with the provisions of SFAS No.123R.

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**3. STOCK BASEDCOMPENSATION**

*Equity Compensation Plans**—*

TheCompany currently grants stock awards under the following equity compensationplans:

*1997Stock Option Plan (“1997 Plan”)*- The 1997 Plan was adoptedby the Company’s Board of Directors and stockholders in November 1997 and wassubsequently amended on March 27, 2000 and October 24, 2001. Under the 1997Plan, the Company’s Board of Directors may grant options to purchase up to1,034,970 shares of common stock to employees, executive officers anddirectors. The 1997 Plan provides for the issuance of nonqualified stockoptions and incentive stock options (which are intended to satisfy therequirements of Section 422 of the Internal Revenue Code) and stockappreciation rights (“SARs”). The Compensation Committee of the Board ofDirectors determines the employees who will receive awards under the 1997 Planand the terms of such awards. The exercise price of a stock option or SARgranted or awarded under the 1997 Plan may not be less than the fair marketvalue of one share of common stock on the date the stock option or SAR isgranted.

*The2003 Equity Incentive Plan (the “2003 Incentive Plan”)*- OnApril 9, 2003, the Board of Directors adopted an equity incentive plan, whichwas approved by shareholders on May 14, 2003. On May 10, 2006, the shareholdersapproved an amendment to the 2003 Incentive Plan to increase the number ofshares of common stock reserved for issuance under the 2003 Incentive Plan from307,000 to 607,000 shares. The 2003 Incentive Plan provides for the issuance ofnonqualified stock options and incentive stock options (which are intended tosatisfy the requirements of Section 422 of the Internal Revenue Code), SARs,bonus stock, stock units, performance shares, performance units, restrictedstock and restricted stock units. The Compensation Committee of the Board ofDirectors determines the employees who will receive awards under the 2003Incentive Plan and the terms of such awards. The exercise price of a stock option or SAR granted or awarded under the2003 Incentive Plan may not be less than the fair market value of one share ofcommon stock on the date the stock option or SAR is granted.

*Key Executive Stock Option -*On January 8, 2007, as a material inducement to the employment of George M.Condos, the Company’s President and Chief Executive Officer, the Companygranted Mr. Condos stock options to purchase an aggregate of 75,000 shares ofthe Company’s common stock, at an exercise price of $11.80 per share (equal tothe closing price of the Company’s common stock on the American Stock Exchangeon the date of grant).  These stockoptions were granted outside of any of the Company’s equity incentive and stockoption plans, pursuant to an exemption from stockholder approval set forth inSection 711 of the American Stock Exchange Company Guide.  The stock options vest in three equal annualinstallments and expire five years after the date of grant.

Options issuedpursuant to the 1997 Plan and the 2003 Incentive Plan generally vest over threeyears, and have a five year expiration date.

8

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Grant-Date Fair Value *—*

TheCompany uses the Black-Scholes option pricing model to calculate the grant-datefair value of an award. The fair value of options granted during the threemonths ended April 1, 2007 and April 2, 2006 were calculated using thefollowing estimated weighted average assumptions:

|                                         | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|
| ** **                              | ** ** | **April 1, 2007**      | ** ** | **April 2, 2006** | ** ** |
| Options granted                         |       | 136,720                          |       | 145,409 |   |
| Weighted-average  exercise price        |       | $                                | 13.02      |   | $ | 8.10 |   |
| Weighted-average grant  date fair value |       | $                                | 4.90       |   | $ | 3.82 |   |
| Assumptions:                            |       |                             |       |   |   |
| Risk free interest rate                 |       | 4.45%-4.6                        | 6%         | 4.68 | % |
| Expected life (in  years)               |       | 4                                |       | 4 |   |
| Expected volatility                     |       | 40.13                            | %          | 54.86 | % |
| Expected dividend yield                 |       | 0.00                             | %          | 0.00 | % |

 

Risk-freeinterest rate — the yield on zero-coupon U.S. Treasury securities for a periodthat is commensurate with the expected term assumption is used as the risk-freeinterest rate.

Expectedlife — the Company uses historical employee exercise and option expiration datato estimate the expected life assumption for the Black-Scholes grant-datevaluation. The Company believes that this historical data is currently the bestestimate of the expected life of a new option.

Expectedvolatility — the Company is responsible for estimating volatility and has usedhistorical volatility to estimate the grant-date fair value of stock options.Management considered the guidance in SFAS No. 123R and believes that thehistorical estimated volatility is materially indicative of expectations aboutfuture volatility.

Expected dividend yield — the Companyhas not paid any dividends in the last five years and currently intends toretain any earnings to finance future growth and, therefore, does notanticipate paying any cash dividends on its common stock in the foreseeablefuture.

9

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*Expense* —

TheCompany used the straight-line attribution method to recognize expense for alloptions granted. Stock-based compensation is included in general andadministrative expenses in the accompanying condensed consolidated statementsof operations.

Theamount of stock-based compensation recognized during a period is based on thevalue of the portion of the awards that are ultimately expected to vest. SFASNo. 123R requires forfeitures to be estimated at the time of grant and revised,if necessary, in subsequent periods if actual forfeitures differ from thoseestimates. The term “forfeitures” is distinct from “cancellations” or “expirations”and represents only the unvested portion of the surrendered option. In September 2006, John Cutter, the Company’sformer President and Chief Executive Officer, resigned.  As of December 31, 2006, the Company adjustedits stock compensation expense to reflect his forfeitures.  The Company currently expects, basedon an analysis of its historical forfeitures, that approximately 95% of itsoptions will actually vest and therefore has applied an annual forfeiture rateof 5% to options granted as of April 1, 2007. This analysis will bere-evaluated quarterly and the forfeiture rate will be adjusted as necessary.Ultimately, the actual expense recognized over the vesting period will only befor those shares that vest.

*OptionActivity* —

Asummary of the stock option activity under the Company’s equity compensationplans as of April 1, 2007 and changes during the three-month period then endedis presented below:
| ** **                                             | ** ** | ** **      | ** ** | **Weighted-**               | ** ** | ** **              | ** ** | ** **    | ** ** |
|--------------------------------------------------------|------------|-----------------|------------|-----------------------------|------------|-------------------------|------------|---------------|------------|
| ** **                                             | ** ** | ** **      | ** ** | **Average**                 | ** ** | ** **              | ** ** | ** **    | ** ** |
| ** **                                             | ** ** | ** **      | ** ** | **Remaining**               | ** ** | **Weighted-**           | ** ** | **Aggregate** | ** ** |
| ** **                                             | ** ** | **Options**     | ** ** | **Contractual**             | ** ** | **Average**             | ** ** | **Intrinsic** | ** ** |
| ** **                                             | ** ** | **Outstanding** | ** ** | **Life in Years** | ** ** | **Exercise Price** | ** ** | **Value**     | ** ** |
|                                                   |       |            |       |                        |       |                    |       |          |       |
| Options outstanding at December  31, 2006              |       | 452,280         |       |                        |       | $                       | 8.83       |          |       |   |
| Granted                                                |       | 136,720         |       |                        |       | $                       | 13.02      |          |       |   |
| Cancelled                                              |       | (800            | )          |                        |       | $                       | 17.37      |          |       |   |
| Forfeited                                              |       | (7,776          | )          |                        |       | $                       | 8.31       |          |       |   |
| Exercised                                              |       | (3,250          | )          |                        |       | $                       | 11.26      |          |       |   |
| Options outstanding at  April 1, 2007                  |       | 577,174         |       | 3.55                        |       | $                       | 9.80       |          | $          | 4,509,485 |   |
|                                                   |       |            |       |                        |       |                    |       |          |       |
| Options fully vested  and exercisable at April 1, 2007 |       | 321,331         |       | 2.80                        |       | $                       | 8.75       |          | $          | 2,048,561 |   |

 

Duringthe three months ended April 1, 2007 and April 2, 2006, the total intrinsicvalue of options exercised (i.e., the difference between the market price atexercise and the price paid by the employee to exercise the options) was $9,518and $14,648, respectively, and the total amount of cash received from exerciseof stock options was $36,607 and $19,090, respectively.

Asof April 1, 2007, there was $1,094,000 of unrecognized compensation costrelated to unvested stock options. That cost is expected to be recognized overa weighted-average period of 2.44 years.

10

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*RestrictedStock and Restricted Stock Unit Activity* —

On December 2, 2005, 30,000 restricted stock unitswere issued to directors with a weighted average fair value of $8.90 at grantdate.  On November 1, 2006, 30,000restricted stock units were issued to directors with a weighted average fairvalue of $10.61 at grant date.  Therestricted stock units were issued pursuant to and subject to the terms of theCompany’s 2003 Incentive Plan.  Subjectto the terms of the 2003 Incentive Plan, each restricted stock unit providesthe holder with the right to receive one share of Common Stock of the Companywhen the restrictions lapse or vest. The restricted stock units granted to thedirectors vest three years after the date of grant if the recipient is a memberof the Company’s Board of Directors on such date, subject to acceleratedvesting in the event of a change in control or the director’s death, disabilityor retirement.

Pursuantto a long-term incentive plan for fiscal 2006 approved by the CompensationCommittee of the Board of Directors under the Company’s 2003 Incentive Plan,the Compensation Committee established target EBITDA levels for the Company forfiscal 2006 and target awards for each officer named below based on apercentage (ranging from 50% to 100%) of each such officer’s base salary.

OnFebruary 28, 2007 the Compensation Committee determined that the Companyexceeded the threshold EBITDA for fiscal 2006, and awarded shares of restrictedCommon Stock under the Company’s 2003 Incentive Plan to each of the officersnamed below.  The number of shares ofrestricted Common Stock issued to each officer listed below was determined bydividing the officer’s 2006 Award Value (set forth below) by 90% of the closingprice of the Company’s Common Stock on the date of grant as reported on theAmerican Stock Exchange.  25% of theshares of restricted Common Stock issued to each officer were fully vested uponissuance.  The remaining 75% of the sharesof restricted Common Stock will vest in three equal annual installmentsfollowing issuance if the officer remains employed by the Company.  The unvested shares will also fully vest upona change in control, as provided in the 2003 Incentive Plan.

The following table sets forth for each officer listedbelow the 2006 Award Value and the number of shares of restricted Common Stocksuch officer received under the long-term incentive plan for fiscal 2006.

| Name            | ** ** | **Award Value** | ** ** | **Number of Shares** | ** ** |
|-----------------|------------|----------------------|------------|--------------------------------|------------|
| Paul Hoagland   |       | $                    | 188,664    |                           | 17,469     |   |
| Gregory Pastore |       | $                    | 79,207     |                           | 7,334      |   |
| Kenneth Green   |       | $                    | 91,304     |                           | 8,454      |   |
| Garrett Ulrich  |       | $                    | 91,690     |                           | 8,490      |   |

 

During the three months ended April 1, 2007 and April2, 2006, stock-based compensation cost of $81,560 and $21,894, respectively,was recorded related to the restricted stock units and shares of restrictedCommon Stock issued pursuant to the long-term incentive plan for fiscal2006.  As of April 1, 2007, there was$788,560 of total unrecognized compensation cost related to unvested restrictedstock units and shares of restricted Common Stock.  That cost is expected to be recognized over aweighted-average period of 2.45 years.

11

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*2007 Long-Term Incentive Plan*

OnFebruary 28, 2007 the Compensation Committee approved a long-term incentiveplan for fiscal 2007 under the Company’s 2003 Incentive Plan, pursuant to whichthe Compensation Committee established target EBITDA levels for the Company forfiscal 2007 and target awards for each officer named below based on apercentage (ranging from 50% to 100%) of each officer’s base salary.  The actual awards for each officer arepayable in shares of restricted stock (representing approximately two-thirds ofthe value of the target award) and stock options to purchase shares of CommonStock (representing approximately one-third of the value of the target award).

Withrespect to the potential restricted stock awards, the Compensation Committee approvedthe issuance of restricted stock unit award agreements (the “Restricted StockUnits Award Agreements”) for each of the officers named below, pursuant towhich each officer is eligible to receive a certain number of shares ofrestricted Common Stock of the Company calculated in accordance with the termsof the officer’s individual Restricted Stock Unit Award Agreement. If theCompany meets or exceeds a certain threshold EBITDA for fiscal 2007 (the “2007Threshold EBITDA”), then the officer will receive an award payable in shares ofrestricted Common Stock having a value determined based on the Company’s actualEBITDA for fiscal 2007 compared to projected EBITDA for fiscal 2007 and thepercentage (ranging from 50% to 150%) of the officer’s target award applicableto those results (the “2007 Award Value”). In the event of a Change in Control, as provided under the 2003Incentive Plan, prior to the Compensation Committee’s determination of the 2007Award Value, the 2007 Threshold EBITDA shall be deemed to have been achievedand the 2007 Award Value shall be deemed to be equal to the target EBITDA forfiscal 2007.  The number of shares ofCommon Stock to be issued to the officer, if any, will be calculated by dividingthe 2007 Award Value by 90% of the closing price of the Company’s Common Stockon the date of grant as reported by the American Stock Exchange (or such otherexchange on which the Company’s Common Stock is traded) (the “Award Shares”).

The following table sets forth the range of 2007 AwardValues each officer may receive under the long-term incentive plan for fiscal2007:
| **Name**         | ** ** | **Value of Award** | ** ** |
|------------------|------------|------------------------------|------------|
| George M. Condos |       | $                            | 159,125    |   | To |   | $ | 477,375 |   |
| Paul Hoagland    |       | $                            | 83,670     |   | To |   | $ | 251,009 |   |
| Gregory Pastore  |       | $                            | 35,477     |   | To |   | $ | 106,430 |   |
| Kenneth Green    |       | $                            | 44,053     |   | To |   | $ | 132,158 |   |
| Garrett Ulrich   |       | $                            | 41,071     |   | To |   | $ | 123,213 |   |

 

The2007 Award Value will be determined, and the date of grant of any Award Shareswill occur, upon the earlier of (i) the date of the Compensation Committee’sfirst regularly scheduled meeting held after the completion of the Company’sindependent audit for fiscal 2007 and the Company’s Audit Committee’srecommendation to include the Company’s audited financial statements in theCompany’s Annual Report on Form 10-K or (ii) immediately prior to theconsummation of a Change in Control of the Company (the “Issue Date”).  If the officer’s employment with the Companyor one of its affiliates is terminated due to death, disability, retirement,involuntary (with or without cause) or voluntary termination prior to the IssueDate, then the officer’s Restricted Stock Unit Award Agreement shall terminateand the officer shall have no right to receive any Award Shares.

IfAward Shares are issued to the officer, 25% of the shares of restricted CommonStock issued to each officer will be fully vested upon issuance. The remaining75% of the shares of restricted Common Stock will vest in three equal annualinstallments following issuance if the officer remains employed by the Company.  The unvested shares will also fully vest upona change in control, as provided in the 2003 Incentive Plan.

Duringthe three months ended April 1, 2007, stock-based compensation of $45,000 wasrecorded related to the foregoing awards.

12

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**4.EMPLOYEE BENEFIT PLANS**

The components of net periodicpension cost for the three months ended April 1, 2007 and April 2, 2006 were(in thousands):

|                                                      | ** ** | **For the Three Months Ended** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                           | ** ** | **April 1,**                                  | ** ** | **April 2,** | ** ** |
| ** **                                           | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
|                                                 |       |                                               |       |   |   |
| Interest cost                                        |       | $                                                  | 1,702      |   | $ | 1,720 |   |
| Expected return  on assets                           |       | (1,975                                             | )          | (1,969 | ) |
| Net amortization  of unrecognized net actuarial loss |       | 610                                                |       | 719 |   |
|                                                 |       |                                               |       |   |   |
| Net periodic pension  cost                           |       | $                                                  | 337        |   | $ | 470 |   |

 

The components of the netpostretirement medical and life insurance benefit cost for the three monthsended April 1, 2007 and April 2, 2006 were (in thousands):

|                                                         | ** ** | **For the Three Months Ended** | ** ** |
|---------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                              | ** ** | **April 1,**                                  | ** ** | **April 2,** | ** ** |
| ** **                                              | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
|                                                    |       |                                               |       |   |   |
| Service cost                                            |       | $                                                  | 36         |   | $ | 41 |   |
| Interest cost                                           |       | 105                                                |       | 95 |   |
| Recognized  actuarial loss                              |       | 10                                                 |       | 4 |   |
| Net amortization  of unrecognized prior service benefit |       | (36                                                | )          | (36 | ) |
|                                                    |       |                                               |       |   |   |
| Net postretirement  benefit cost                        |       | $                                                  | 115        |   | $ | 104 |   |

 

13

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**5. ASSETIMPAIRMENT AND DISCONTINUED OPERATIONS**

SFAS No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets,” requires the results ofoperations of a component of an entity that is classified as held for sale orthat has been disposed of to be reported as discontinued operations in thestatement of operations if certain conditions are met. These conditions includecommitment to a plan of disposal after the effective date of this statement,elimination of the operations and cash flows of the entity component from theongoing operations of the Company and no significant continuing involvement inthe operations of the entity component after the disposal transaction.

In accordance withSFAS No. 144, the results of operations of the eight properties that weredisposed of during 2006 and any related net gain on the disposals, as well asthe results of operations of three properties held for sale at April 1, 2007were reported separately as discontinued operations in the accompanyingcondensed consolidated statements of operations for the three months endedApril 1, 2007 and April 2, 2006.

During 2006, the Company closed one restaurant and committedto a plan to sell that restaurant.  AtApril 1, 2007, this property met the criteria for “held for sale” as defined inSFAS No. 144.  The results ofoperations associated with this restaurant were not material and therefore werereported within continuing operations in the accompanying condensedconsolidated statements of operations for all periods presented.

For the threemonths ended April 1, 2007 and April 2, 2006, these discontinued resultsconsisted of the following (in thousands):

|                                              | ** ** | **For the Three Months Ended** | ** ** |
|----------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                   | ** ** | **April 1,**                                  | ** ** | **April 2,** | ** ** |
| ** **                                   | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
| ** **                                   | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Net sales                                    |       | $                                                  | —     |   | $ | — |   |
|                                         |       |                                               |       |   |   |
| Operating loss                               |       | $                                                  | (14        | ) | $ | (248 | ) |
| Gain on  disposals of property and equipment |       | —                                             |       | 2,864 |   |
| Income tax  benefit                          |       | —                                             |       | — |   |
| (Loss) income from discontinued  operations  |       | $                                                  | (14        | ) | $ | 2,616 |   |

 

The table belowidentifies the components of the “Loss on disposals of other property andequipment, net” as shown in the accompanying condensed consolidated statementsof operations (in thousands):

|                                                         | ** ** | **For the Three Months Ended** | ** ** |
|---------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                              | ** ** | **April 1,**                                  | ** ** | **April 2,** | ** ** |
| ** **                                              | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
| ** **                                              | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Restaurant  equipment assets retired due to replacement |       | $                                                  | 35         |   | $ | 75 |   |
| Loss due to  restaurant fire                            |       | —                                             |       | 30 |   |
| All other                                               |       | —                                             |       | 4 |   |
| Loss on disposals of  other property and equipment, net |       | $                                                  | 35         |   | $ | 109 |   |

 

During each of the three month periods ended April 1,2007 and April 2, 2006, the Company determined that the carrying value of oneoperating restaurant property exceeded its estimated fair value less costs tosell and the carrying values were reduced by $206,000 and $215,000,respectively.

14

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**6. INCOMETAXES**

InJuly 2006, the FASB issued FASB Interpretation No. 48, “Accounting forUncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (“FIN48”), which clarifies the accounting for uncertainty in tax positions. FIN 48requires that the Company recognize in its financial statements the impact of atax position, if that position is more likely than not of being sustained onaudit based on the technical merits of the position. The provisions of FIN 48are effective as of the beginning of the Company’s 2007 fiscal year, with thecumulative effect of the change in accounting principle recorded as anadjustment to opening retained earnings.

  The Company adopted the provisions of FIN 48on January 1, 2007. As a result of the implementation of FIN 48 onJanuary 1, 2007, the Company recognized an additional $221,000 as adecrease to retained earnings. As of the date of adoption, the Company’sunrecognized tax benefits totaled $1,579,000, which would affect the Company’stax rate if recognized. During the three months ended April 1, 2007, theCompany recognized $94,000 in potential tax and interest associated withuncertain tax positions and settled one previously uncertain tax position whichresulted in the payment of $72,065 of tax and $7,324 of interest.

The Company files numerous consolidated and separateincome tax returns in the United States Federal jurisdiction and in many statejurisdictions. With few exceptions, the Company is no longer subject to USFederal and state and local income tax examinations for years before 2003.

The Company recognizespotential accrued interest and penalties related to unrecognized tax benefitswithin its operations as income tax expenses. As of the date of implementationof FIN 48, the Company had approximately $580,000 accrued for interest andpenalties. To the extent interest and penalties are not assessed with respectto uncertain tax positions, amounts accrued will be reduced and reflected as areduction of the overall income tax provision.

The Company anticipates that the total unrecognizedtax benefits will decrease by approximately $500,000 due to the settlement ofongoing state voluntary disclosure processes prior to March 30, 2008.

**7. SEGMENT REPORTING**

Operating segmentsare components of an enterprise about which separate financial information isavailable that is evaluated regularly by the chief operating decision-maker, ordecision-making group, in deciding how to allocate resources and in assessingperformance. The Company’s operating segments include restaurant, foodserviceand franchise. The revenues from these segments include both sales tounaffiliated customers and intersegment sales, which generally are accountedfor on a basis consistent with sales to unaffiliated customers. Intersegmentsales and other intersegment transactions have been eliminated in theaccompanying consolidated financial statements.

The Company’srestaurants target families with children and adults who desire areasonably-priced meal in a full-service setting. The Company’s menuoffers a broad selection of freshly-prepared foods which appeal tocustomers throughout all dayparts. The menu currently features over 100 itemscomprised of a broad selection of breakfast, lunch, dinner and afternoon andevening snack items. The Company’s foodservice operations manufactures premiumice cream dessert products and distributes such manufactured products andpurchased finished goods to Company-operated and franchised restaurants.Additionally, it sells premium ice cream dessert products to distributors andretail locations. The Company’s franchise segment includes a royalty based onfranchise restaurant revenue. In addition, the Company receives rental incomefrom various franchised restaurants. The Company does not allocate general andadministrative expenses associated with its headquarters operations to anybusiness segment. These costs include expenses of the following functions:legal, accounting, personnel not directly related to a segment, informationsystems and other headquarter activities.

15

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The accountingpolicies of the operating segments are the same as those described in thesummary of significant accounting policies except that the financial resultsfor the foodservice operating segment, prior to intersegment eliminations, havebeen prepared using a management approach, which is consistent with the basisand manner in which the Company’s management internally reviews financialinformation. Using this approach, the Company evaluates performance based onstand-alone operating segment income (loss) before income taxes and generallyaccounts for intersegment sales and transfers as if the sales or transfers wereto third parties, that is, at current market prices.

Adjusted EBITDA represents net income (loss) fromcontinuing operations before (i) (provision for) benefit from income taxes, (ii)interest expense, net, (iii) depreciation and amortization, (iv) write-downsof property and equipment, (v) net periodic pension cost and (vi) other non-cashitems. Adjusted EBITDA is a non-GAAP financial measure.  The Company has included informationconcerning adjusted EBITDA in this Form 10-Q because the Company’s managementincentive plan pays bonuses based on achieving operating segment adjustedEBITDA targets and the Company believes that such information is used bycertain investors as one measure of a company’s historical ability to servicedebt. Adjusted EBITDA should not be considered as an alternative to, or moremeaningful than, earnings (loss) from continuing operations or othertraditional indications of the Company’s operating performance.

Due to a reorganization of the finance group,positions within the foodservice accounting department were absorbed by variouscorporate finance departments.  The costsrelated to those positions are now included in general and administrativecorporate expenses.  Results for thethree months ended April 2, 2006 have been restated accordingly.  Adjusted EBITDA and loss from continuingoperations before benefit from income taxes have been restated to remove thecosts associated with this department of $120,000 during the three month periodended April 2, 2006.

|                         | ** ** | **For the Three Months Ended** | ** ** |
|-------------------------|------------|----------------------------------------------------|------------|
| ** **              | ** ** | **April 1,**                                  | ** ** | **April 2,** | ** ** |
| ** **              | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
| ** **              | ** ** | **(in thousands)**                                 | ** ** |
| Revenues:               |       |                                               |       |   |   |
| Restaurant              |       | $                                                  | 93,187     |   | $ | 95,276 |   |
| Foodservice             |       | 53,588                                             |       | 54,958 |   |
| Franchise               |       | 3,495                                              |       | 3,545 |   |
| Total                   |       | $                                                  | 150,270    |   | $ | 153,779 |   |
|                    |       |                                               |       |   |   |
| Intersegment  revenues: |       |                                               |       |   |   |
| Restaurant              |       | $                                                  | —     |   | $ | — |   |
| Foodservice             |       | (27,644                                            | )          | (28,064 | ) |
| Franchise               |       | —                                             |       | — |   |
| Total                   |       | $                                                  | (27,644    | ) | $ | (28,064 | ) |
|                    |       |                                               |       |   |   |
| External  revenues:     |       |                                               |       |   |   |
| Restaurant              |       | $                                                  | 93,187     |   | $ | 95,276 |   |
| Foodservice             |       | 25,944                                             |       | 26,894 |   |
| Franchise               |       | 3,495                                              |       | 3,545 |   |
| Total                   |       | $                                                  | 122,626    |   | $ | 125,715 |   |

 

16

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| ** **                                                                   | ** ** | **For the Three Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                   | ** ** | **April 1,**                                  | ** ** | **April 2,** | ** ** |
| ** **                                                                   | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
| ** **                                                                   | ** ** | **(in thousands)**                                 | ** ** |
|                                                                         |       |                                               |       |   |   |
| Adjusted EBITDA:                                                             |       |                                               |       |   |   |
| Restaurant                                                                   |       | $                                                  | 5,728      |   | $ | 6,834 |   |
| Foodservice                                                                  |       | 3,175                                              |       | 2,668 |   |
| Franchise                                                                    |       | 2,116                                              |       | 2,418 |   |
| Corporate                                                                    |       | (5,539                                             | )          | (5,699 | ) |
| (Loss) gain on property and equipment, net                                   |       | (34                                                | )          | 758 |   |
| Pension cost included in reporting segments                                  |       | 337                                                |       | 470 |   |
| Total                                                                        |       | $                                                  | 5,783      |   | $ | 7,449 |   |
|                                                                         |       |                                               |       |   |   |
| Interest  expense, net-Corporate                                             |       | $                                                  | 4,924      |   | $ | 5,420 |   |
|                                                                         |       |                                               |       |   |   |
| Depreciation and  amortization:                                              |       |                                               |       |   |   |
| Restaurant                                                                   |       | $                                                  | 3,897      |   | $ | 4,143 |   |
| Foodservice                                                                  |       | 1,274                                              |       | 736 |   |
| Franchise                                                                    |       | 137                                                |       | 68 |   |
| Corporate                                                                    |       | 852                                                |       | 833 |   |
| Total                                                                        |       | $                                                  | 6,160      |   | $ | 5,780 |   |
|                                                                         |       |                                               |       |   |   |
| Other non-cash  expenses:                                                    |       |                                               |       |   |   |
| Net periodic pension cost                                                    |       | $                                                  | 337        |   | $ | 470 |   |
| Write-downs of property and equipment                                        |       | 206                                                |       | 215 |   |
| Total                                                                        |       | $                                                  | 543        |   | $ | 685 |   |
|                                                                         |       |                                               |       |   |   |
| Income (loss)  from continuing operations before provision for income taxes: |       |                                               |       |   |   |
| Restaurant                                                                   |       | $                                                  | 1,831      |   | $ | 2,691 |   |
| Foodservice                                                                  |       | 1,901                                              |       | 1,932 |   |
| Franchise                                                                    |       | 1,979                                              |       | 2,350 |   |
| Corporate                                                                    |       | (11,315                                            | )          | (11,952 | ) |
| Gain on property and equipment, net                                          |       | (240                                               | )          | 543 |   |
| Total                                                                        |       | $                                                  | (5,844     | ) | $ | (4,436 | ) |

 

17

----

** **
| ** **                                                             | ** ** | **For the Three** | ** ** | **For the**                | ** ** |
|------------------------------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| ** **                                                             | ** ** | **Months Ended**       | ** ** | **Year Ended**             | ** ** |
| ** **                                                             | ** ** | **April 1, 2007** | ** ** | **December 31, 2006** | ** ** |
| ** **                                                             | ** ** | **(in thousands)**     | ** ** |
| Capital  expenditures, including assets acquired under capital leases: |       |                        |       |                            |       |
| Restaurant                                                             |       | $                           | 1,757      |                            | $          | 16,068 |   |
| Foodservice                                                            |       | 692                         |       | 4,306                           |       |
| Corporate                                                              |       | 81                          |       | 1,350                           |       |
| Total                                                                  |       | $                           | 2,530      |                            | $          | 21,724 |   |

 
| ** **    | ** ** | **April 1,**       | ** ** | **December 31,** | ** ** |
|---------------|------------|-------------------------|------------|-----------------------|------------|
| ** **    | ** ** | **2007**                | ** ** | **2006**              | ** ** |
| ** **    | ** ** | **(in thousands)** | ** ** |
| Total assets: |       |                    |       |                  |       |
| Restaurant    |       | $                       | 117,968    |                  | $          | 119,787 |   |
| Foodservice   |       | 40,464                  |       | 40,875                |       |
| Franchise     |       | 11,472                  |       | 11,827                |       |
| Corporate     |       | 43,002                  |       | 47,678                |       |
| Total         |       | $                       | 212,906    |                  | $          | 220,167 |   |

 

**8. SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION**

FICC’s obligationrelated to its $175 million of 8.375% senior notes (the “Senior Notes”) isguaranteed fully and unconditionally by one of FICC’s wholly ownedsubsidiaries. There are no restrictions on FICC’s ability to obtain dividendsor other distributions of funds from this subsidiary, except those imposed byapplicable law. The following supplemental financial information sets forth, ona condensed consolidating basis, balance sheets, statements of operations andstatements of cash flows for FICC (the “Parent Company”), Friendly’sRestaurants Franchise, LLC (the “Guarantor Subsidiary”) and Friendly’sInternational, Inc., Restaurant Insurance Corporation, Friendly’s Realty I,LLC, Friendly’s Realty II, LLC and Friendly’s Realty III, LLC (collectively,the “Non-guarantor Subsidiaries”). All of the limited liability companies’(the “LLCs”) assets were owned by the LLCs, which are separate entities withseparate creditors which will be entitled to be satisfied out of the LLCs’assets. Separate complete financial statements and other disclosures of theGuarantor Subsidiary as of April 1, 2007 and December 31, 2006 and for thethree months ended April 1, 2007 and April 2, 2006 were not presented becausemanagement has determined that such information is not material to investors.

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

18

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**Supplemental Condensed Consolidating Balance Sheet****As of April 1, 2007**(In thousands)
| ** **                                                 | ** ** | ** **  | ** ** | ** **     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                 | ** ** | **Parent**  | ** ** | **Guarantor**  | ** ** | **guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                 | ** ** | **Company** | ** ** | **Subsidiary** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Assets                                                     |       |        |       |           |       |             |       |             |       |             |       |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Current assets:                                            |       |        |       |           |       |             |       |             |       |             |       |
| Cash and cash  equivalents                                 |       | $           | 18,546     |           | $          | 1,113            |       | $                | 2,201      |             | $          | — |   | $ | 21,860 |   |
| Restricted cash                                            |       | —      |       | —         |       | 380              |       | —           |       | 380              |       |
| Accounts  receivable, net                                  |       | 10,529      |       | 1,735          |       | —           |       | —           |       | 12,264           |       |
| Inventories                                                |       | 15,967      |       | —         |       | —           |       | —           |       | 15,967           |       |
| Assets held for  sale                                      |       | 896         |       | —         |       | —           |       | —           |       | 896              |       |
| Deferred income  taxes                                     |       | —      |       | 156            |       | —           |       | (156             | )          | —           |       |
| Prepaid expenses  and other current assets                 |       | 3,899       |       | 49             |       | 7,785            |       | (8,358           | )          | 3,375            |       |
| Total current assets                                       |       | 49,837      |       | 3,053          |       | 10,366           |       | (8,514           | )          | 54,742           |       |
| Deferred income taxes                                      |       | 928         |       | 288            |       | —           |       | (288             | )          | 928              |       |
| Property and equipment,  net                               |       | 93,902      |       | —         |       | 40,095           |       | —           |       | 133,997          |       |
| Intangibles and  deferred costs, net                       |       | 15,381      |       | —         |       | 1,969            |       | —           |       | 17,350           |       |
| Investments in  subsidiaries                               |       | (287        | )          | —         |       | —           |       | 287              |       | —           |       |
| Other assets                                               |       | 4,974       |       | 974            |       | 915              |       | (974             | )          | 5,889            |       |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Total assets                                               |       | $           | 164,735    |           | $          | 4,315            |       | $                | 53,345     |             | $          | (9,489 | ) | $ | 212,906 |   |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Liabilities and  Stockholders’ (Deficit) Equity       |       |        |       |           |       |             |       |             |       |             |       |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Current liabilities:                                       |       |        |       |           |       |             |       |             |       |             |       |
| Current  maturities of long-term obligations               |       | $           | 9,427      |           | $          | —           |       | $                | 1,524      |             | $          | (7,776 | ) | $ | 3,175 |   |
| Accounts payable                                           |       | 20,532      |       | —         |       | —           |       | —           |       | 20,532           |       |
| Deferred income  taxes                                     |       | 156         |       | —         |       | —           |       | (156             | )          | —           |       |
| Accrued expenses                                           |       | 39,349      |       | 2,739          |       | 1,523            |       | (582             | )          | 43,029           |       |
| Total current  liabilities                                 |       | 69,464      |       | 2,739          |       | 3,047            |       | (8,514           | )          | 66,736           |       |
| Deferred income taxes                                      |       | 288         |       | —         |       | —           |       | (288             | )          | —           |       |
| Long-term obligations,  less current maturities            |       | 180,240     |       | —         |       | 46,266           |       | —           |       | 226,506          |       |
| Other long-term  liabilities                               |       | 47,563      |       | 683            |       | 5,212            |       | (974             | )          | 52,484           |       |
| Stockholders’ (deficit)  equity                       |       | (132,820    | )          | 893            |       | (1,180           | )          | 287              |       | (132,820         | )          |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Total liabilities and  stockholders’ (deficit) equity |       | $           | 164,735    |           | $          | 4,315            |       | $                | 53,345     |             | $          | (9,489 | ) | $ | 212,906 |   |

 

19

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**Supplemental Condensed Consolidating Statement ofOperations****For the Three Months EndedApril 1, 2007**(In thousands)
| ** **                                                                                                             | ** ** | ** **  | ** ** | ** **     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                                             | ** ** | **Parent**  | ** ** | **Guarantor**  | ** ** | **guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                                                                             | ** ** | **Company** | ** ** | **Subsidiary** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Revenues                                                                                                               |       | $           | 120,183    |           | $          | 2,443            |       | $                | —     |             | $          | — |   | $ | 122,626 |   |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Costs and  expenses:                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Cost of sales                                                                                                          |       | 47,103      |       | —         |       | —           |       | —           |       | 47,103           |       |
| Labor and benefits                                                                                                     |       | 34,397      |       | —         |       | —           |       | —           |       | 34,397           |       |
| Operating expenses and write-                                                                                          |       |        |       |           |       |             |       |             |       |             |       |
| downs of property and equipment                                                                                        |       | 26,824      |       | —         |       | (1,606           | )          | —           |       | 25,218           |       |
| General and administrative expenses                                                                                    |       | 9,478       |       | 1,155          |       | —           |       | —           |       | 10,633           |       |
| Depreciation and amortization                                                                                          |       | 5,626       |       | —         |       | 534              |       | —           |       | 6,160            |       |
| Gain on  franchise sales of restaurant operations and properties                                                       |       | —      |       | —         |       | —           |       | —           |       | —           |       |
| Loss on  disposals of other property and equipment, net                                                                |       | 35          |       | —         |       | —           |       | —           |       | 35               |       |
| Interest  expense, net                                                                                                 |       | 3,877       |       | —         |       | 1,047            |       | —           |       | 4,924            |       |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| (Loss) income  before benefit from (provision for) income taxes and equity in net income of  consolidated subsidiaries |       | (7,157      | )          | 1,288          |       | 25               |       | —           |       | (5,844           | )          |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Benefit from  (provision for) income taxes                                                                             |       | 488         |       | (528           | )          | (54              | )          | —           |       | (94              | )          |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| (Loss) income  from continuing operations                                                                              |       | (6,669      | )          | 760            |       | (29              | )          | —           |       | (5,938           | )          |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Loss from  discontinued operations                                                                                     |       | (14         | )          | —         |       | —           |       | —           |       | (14              | )          |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| (Loss) income  before equity in net income of consolidated subsidiaries                                                |       | (6,683      | )          | 760            |       | (29              | )          | —           |       | (5,952           | )          |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Equity in net  income of consolidated subsidiaries                                                                     |       | 731         |       | —         |       | —           |       | (731             | )          | —           |       |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Net (loss) income                                                                                                      |       | $           | (5,952     | )              | $          | 760              |       | $                | (29        | )                | $          | (731 | ) | $ | (5,952 | ) |

 

20

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**SupplementalCondensed Consolidating Statement of Cash FlowsFor the Three Months Ended April 1, 2007**(Inthousands)
| ** **                                                | ** ** | ** **  | ** ** | ** **     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
|-----------------------------------------------------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                | ** ** | **Parent**  | ** ** | **Guarantor**  | ** ** | **guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                | ** ** | **Company** | ** ** | **Subsidiary** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                      |       |        |       |           |       |             |       |             |       |             |       |
| Net cash (used in) provided  by operating activities      |       | $           | (749       | )              | $          | 315              |       | $                | 633        |             | $          | (158 | ) | $ | 41 |   |
|                                                      |       |        |       |           |       |             |       |             |       |             |       |
| Cash flows from  investing activities:                    |       |        |       |           |       |             |       |             |       |             |       |
| Purchases of  property and equipment                      |       | (2,530      | )          | —         |       | —           |       | —           |       | (2,530           | )          |
| Proceeds from  sales of property and equipment            |       | —      |       | —         |       | —           |       | —           |       | —           |       |
| Return of  investment in subsidiary                       |       | 125         |       | —         |       | —           |       | (125             | )          | —           |       |
| Net cash used in  investing activities                    |       | (2,405      | )          | —         |       | —           |       | (125             | )          | (2,530           | )          |
|                                                      |       |        |       |           |       |             |       |             |       |             |       |
| Cash flows from  financing activities:                    |       |        |       |           |       |             |       |             |       |             |       |
| Proceeds from  borrowings under revolving credit facility |       | —      |       | —         |       | —           |       | —           |       | —           |       |
| Repayments of  obligations                                |       | (385        | )          | —         |       | (370             | )          | —           |       | (755             | )          |
| Payments of  deferred financing costs                     |       | (9          | )          | —         |       | —           |       | —           |       | (9               | )          |
| Stock options  exercised                                  |       | 36          |       | —         |       | —           |       | —           |       | 36               |       |
| Reinsurance  payments made from deposits                  |       | —      |       | —         |       | (158             | )          | 158              |       | —           |       |
| Dividends paid                                            |       | —      |       | —         |       | (125             | )          | 125              |       | —           |       |
| Net cash used in  financing activities                    |       | (358        | )          | —         |       | (653             | )          | 283              |       | (728             | )          |
|                                                      |       |        |       |           |       |             |       |             |       |             |       |
| Net (decrease) increase  in cash and cash equivalents     |       | (3,512      | )          | 315            |       | (20              | )          | —           |       | (3,217           | )          |
|                                                      |       |        |       |           |       |             |       |             |       |             |       |
| Cash and cash  equivalents, beginning of period           |       | 22,058      |       | 798            |       | 2,221            |       | —           |       | 25,077           |       |
|                                                      |       |        |       |           |       |             |       |             |       |             |       |
| Cash and cash  equivalents, end of period                 |       | $           | 18,546     |           | $          | 1,113            |       | $                | 2,201      |             | $          | — |   | $ | 21,860 |   |
|                                                      |       |        |       |           |       |             |       |             |       |             |       |
| Supplemental  disclosures:                                |       |        |       |           |       |             |       |             |       |             |       |
| Interest paid                                             |       | $           | 219        |           | $          | —           |       | $                | 1,050      |             | $          | — |   | $ | 1,269 |   |
| Income taxes paid                                         |       | 41          |       | 130            |       | 61               |       | —           |       | 232              |       |

 

21

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**SupplementalCondensed Consolidating Balance SheetAs of December 31, 2006**(Inthousands)
| ** **                                                 | ** ** | ** **  | ** ** | ** **     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                 | ** ** | **Parent**  | ** ** | **Guarantor**  | ** ** | **guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                 | ** ** | **Company** | ** ** | **Subsidiary** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Assets                                                     |       |        |       |           |       |             |       |             |       |             |       |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Current assets:                                            |       |        |       |           |       |             |       |             |       |             |       |
| Cash and cash equivalents                                  |       | $           | 22,057     |           | $          | 798              |       | $                | 2,222      |             | $          | — |   | $ | 25,077 |   |
| Restricted cash                                            |       | —      |       | —         |       | 517              |       | —           |       | 517              |       |
| Accounts receivable, net                                   |       | 9,593       |       | 1,842          |       | 7,776            |       | (7,776           | )          | 11,435           |       |
| Inventories                                                |       | 17,059      |       | —         |       | —           |       | —           |       | 17,059           |       |
| Assets held for sale                                       |       | 896         |       | —         |       | —           |       | —           |       | 896              |       |
| Deferred income taxes                                      |       | —      |       | 156            |       | —           |       | (156             | )          | —           |       |
| Prepaid expenses and other current assets                  |       | 3,181       |       | (2             | )          | 9                |       | (61              | )          | 3,127            |       |
| Total current  assets                                      |       | 52,786      |       | 2,794          |       | 10,524           |       | (7,993           | )          | 58,111           |       |
| Deferred income  taxes                                     |       | 928         |       | 288            |       | —           |       | (288             | )          | 928              |       |
| Property and  equipment, net                               |       | 96,850      |       | —         |       | 40,575           |       | —           |       | 137,425          |       |
| Intangibles and  deferred costs, net                       |       | 15,759      |       | —         |       | 2,024            |       | —           |       | 17,783           |       |
| Investments in  subsidiaries                               |       | 107         |       | —         |       | —           |       | (107             | )          | —           |       |
| Other assets                                               |       | 5,005       |       | 851            |       | 915              |       | (851             | )          | 5,920            |       |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Total assets                                               |       | $           | 171,435    |           | $          | 3,933            |       | $                | 54,038     |             | $          | (9,239 | ) | $ | 220,167 |   |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Liabilities and Stockholders’ (Deficit) Equity        |       |        |       |           |       |             |       |             |       |             |       |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Current  liabilities:                                      |       |        |       |           |       |             |       |             |       |             |       |
| Current maturities of long-term obligations                |       | $           | 9,387      |           | $          | —           |       | $                | 1,493      |             | $          | (7,776 | ) | $ | 3,104 |   |
| Accounts payable                                           |       | 22,247      |       | —         |       | —           |       | —           |       | 22,247           |       |
| Accrued expenses                                           |       | 39,926      |       | 2,098          |       | 1,533            |       | (217             | )          | 43,340           |       |
| Total current  liabilities                                 |       | 71,560      |       | 2,098          |       | 3,026            |       | (7,993           | )          | 68,691           |       |
| Long-term  obligations, less current maturities            |       | 180,665     |       | —         |       | 46,667           |       | —           |       | 227,332          |       |
| Other long-term  liabilities                               |       | 46,106      |       | 702            |       | 5,371            |       | (1,139           | )          | 51,040           |       |
| Stockholders’  (deficit) equity                       |       | (126,896    | )          | 1,133          |       | (1,026           | )          | (107             | )          | (126,896         | )          |
|                                                       |       |        |       |           |       |             |       |             |       |             |       |
| Total liabilities and  stockholders’ (deficit) equity |       | $           | 171,435    |           | $          | 3,933            |       | $                | 54,038     |             | $          | (9,239 | ) | $ | 220,167 |   |

 

22

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**Supplemental Condensed Consolidating Statement ofOperations****For the Three Months EndedApril 2, 2006**(In thousands)
| ** **                                                                                                             | ** ** | ** **  | ** ** | ** **     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                                             | ** ** | **Parent**  | ** ** | **Guarantor**  | ** ** | **guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                                                                             | ** ** | **Company** | ** ** | **Subsidiary** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Revenues                                                                                                               |       | $           | 123,097    |           | $          | 2,618            |       | $                | —     |             | $          | — |   | $ | 125,715 |   |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Costs and expenses:                                                                                                    |       |        |       |           |       |             |       |             |       |             |       |
| Cost of sales                                                                                                          |       | 48,385      |       | —         |       | —           |       | —           |       | 48,385           |       |
| Labor and  benefits                                                                                                    |       | 36,012      |       | —         |       | —           |       | —           |       | 36,012           |       |
| Operating  expenses and write-                                                                                         |       |        |       |           |       |             |       |             |       |             |       |
| downs of  property and equipment                                                                                       |       | 25,920      |       | —         |       | (1,706           | )          | —           |       | 24,214           |       |
| General and  administrative expenses                                                                                   |       | 9,942       |       | 1,155          |       | —           |       | —           |       | 11,097           |       |
| Depreciation and  amortization                                                                                         |       | 5,237       |       | —         |       | 543              |       | —           |       | 5,780            |       |
| Gain on franchise sales  of restaurant operations and properties                                                       |       | (866        | )          | —         |       | —           |       | —           |       | (866             | )          |
| Loss on disposals of  other property and equipment, net                                                                |       | 109         |       | —         |       | —           |       | —           |       | 109              |       |
| Interest expense, net                                                                                                  |       | 4,337       |       | —         |       | 1,083            |       | —           |       | 5,420            |       |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| (Loss) income before  benefit from (provision for) income taxes and equity in net income of  consolidated subsidiaries |       | (5,979      | )          | 1,463          |       | 80               |       | —           |       | (4,436           | )          |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Benefit from (provision  for) income taxes                                                                             |       | 654         |       | (600           | )          | (54              | )          | —           |       | —           |       |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| (Loss) income from  continuing operations                                                                              |       | (5,325      | )          | 863            |       | 26               |       | —           |       | (4,436           | )          |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Income from  discontinued operations                                                                                   |       | 2,616       |       | —         |       | —           |       | —           |       | 2,616            |       |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| (Loss) income before  equity in net income of consolidated subsidiaries                                                |       | (2,709      | )          | 863            |       | 26               |       | —           |       | (1,820           | )          |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Equity in net income of  consolidated subsidiaries                                                                     |       | 889         |       | —         |       | —           |       | (889             | )          | —           |       |
|                                                                                                                   |       |        |       |           |       |             |       |             |       |             |       |
| Net (loss) income                                                                                                      |       | $           | (1,820     | )              | $          | 863              |       | $                | 26         |             | $          | (889 | ) | $ | (1,820 | ) |

 

23

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**Supplemental Condensed Consolidating Statement ofCash Flows****For the Three Months EndedApril 2, 2006**(In thousands)
| ** **                                    | ** ** | ** **  | ** ** | ** **     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
|-----------------------------------------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                    | ** ** | **Parent**  | ** ** | **Guarantor**  | ** ** | **guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                    | ** ** | **Company** | ** ** | **Subsidiary** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|                                          |       |        |       |           |       |             |       |             |       |             |       |
| Net cash  provided by operating activities    |       | $           | 1,998      |           | $          | 10               |       | $                | 926        |             | $          | (235 | ) | $ | 2,699 |   |
|                                          |       |        |       |           |       |             |       |             |       |             |       |
| Cash flows from  investing activities:        |       |        |       |           |       |             |       |             |       |             |       |
| Purchases of property and equipment           |       | (2,404      | )          | —         |       | —           |       | —           |       | (2,404           | )          |
| Proceeds from sales of property and equipment |       | 5,794       |       | —         |       | —           |       | —           |       | 5,794            |       |
| Return of investment in subsidiary            |       | 282         |       | —         |       | —           |       | (282             | )          | —           |       |
| Net cash  provided by investing activities    |       | 3,672       |       | —         |       | —           |       | (282             | )          | 3,390            |       |
|                                          |       |        |       |           |       |             |       |             |       |             |       |
| Cash flows from  financing activities:        |       |        |       |           |       |             |       |             |       |             |       |
| Proceeds from revolving credit facility       |       | 8,000       |       | —         |       | —           |       | —           |       | 8,000            |       |
| Repayments of obligations                     |       | (8,405      | )          | —         |       | (324             | )          | —           |       | (8,729           | )          |
| Payments of deferred financing costs          |       | (205        | )          | —         |       | —           |       | —           |       | (205             | )          |
| Stock options exercised                       |       | 19          |       | —         |       | —           |       | —           |       | 19               |       |
| Reinsurance payments made from deposits       |       | —      |       | —         |       | (235             | )          | 235              |       | —           |       |
| Dividends paid                                |       | —      |       | —         |       | (282             | )          | 282              |       | —           |       |
| Net cash used in  financing activities        |       | (591        | )          | —         |       | (841             | )          | 517              |       | (915             | )          |
|                                          |       |        |       |           |       |             |       |             |       |             |       |
| Net increase in  cash and cash equivalents    |       | 5,079       |       | 10             |       | 85               |       | —           |       | 5,174            |       |
|                                          |       |        |       |           |       |             |       |             |       |             |       |
| Cash and cash  equivalents, beginning of year |       | 11,546      |       | 780            |       | 2,271            |       | —           |       | 14,597           |       |
|                                          |       |        |       |           |       |             |       |             |       |             |       |
| Cash and cash  equivalents, end of year       |       | $           | 16,625     |           | $          | 790              |       | $                | 2,356      |             | $          | — |   | $ | 19,771 |   |
|                                          |       |        |       |           |       |             |       |             |       |             |       |
| Supplemental  disclosures:                    |       |        |       |           |       |             |       |             |       |             |       |
| Interest paid                                 |       | $           | 505        |           | $          | —           |       | $                | 1,023      |             | $          | — |   | $ | 1,528 |   |
| Income taxes  (refunded) paid                 |       | (3,094      | )          | 2,534          |       | 57               |       | —           |       | (503             | )          |

 

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

*The following discussion should be read inconjunction with the Condensed Consolidated Financial Statements of the Companyand the notes thereto included elsewhere herein.*

**ForwardLooking Statements**

Statementscontained herein that are not historical facts constitute “forward lookingstatements” as that term is defined in the Private Securities Litigation ReformAct of 1995. Words such as “believes,” “plans,” “anticipates,” “expects,” “will”and similar expressions are intended to identify forward lookingstatements.  Forward looking statements include, but are not limited to,statements relating to the sufficiency of our capital resources, trendsrelating to our results of operations, changes in commodity prices, anticipatedcapital expenditures, and estimates and assumptions used in the preparation ofour financial statements.

Allforward looking statements are subject to known and unknown risks,uncertainties and other factors which could cause our or the foodserviceindustry’s actual results, performance or achievements to be materiallydifferent from any future results, performance or achievements expressed orimplied by the forward-looking statements. These factors include: our highlycompetitive business environment; exposure to fluctuating commodity prices;risks associated with the foodservice industry, such as changes in consumertastes and adverse publicity resulting from food quality, illness, injury or otherhealth concerns; the ability to retain and attract new and qualified employees;government regulations; high geographic concentration in the Northeast and itsattendant weather patterns; conditions needed to meet restaurant re-imaging andnew opening targets; risks and uncertainties arising out of accountingestimates and adjustments; our ability to service our debt and otherobligations; our ability to meet ongoing financial covenants contained in ourdebt instruments, loan agreements, leases and other long-term commitments;unforeseen or increased costs associated with litigation and similar matters;and costs associated with improved service and other initiatives.  On March 7, 2007, we announced that our Boardof Directors is exploring strategic alternatives for enhancing shareholdervalue, including a possible sale of the Company.  There is no assurance that the process willresult in any specific transaction. However, the implementation of certainstrategic alternatives could affect our current plans and strategies, and anyforward-looking statements in this report are qualified by reference to ourongoing analysis.  Other factors thatcould adversely affect our business and prospects are described in our filingswith the Securities and Exchange Commission, including our 2006 Annual Reporton Form 10-K/A.

Giventhese uncertainties, you should not place undue reliance on theseforward-looking statements. Also, these forward-looking statements representour estimates and assumptions only as of the date of this report.  Exceptas otherwise required by law, we expressly disclaim any obligation orundertaking to release publicly any updates or revisions to any forward-lookingstatement contained in this report to reflect any change in expectations or anychange in events, conditions or circumstances on which any of ourforward-looking statements are based.

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**Overview**

We are a leading full-service, casual diningrestaurant company and provider of premium ice cream products with locationsprimarily in the Northeast.  As of April1, 2007, we operated 317 full-service restaurants and franchised 198 full-servicerestaurants and seven non-traditional units, located in 16 states.

Our revenues are derived from three primary sources:

·                  Restaurantrevenue, which consists of sales from Company-operated full-servicerestaurants;

·                  Foodservicerevenue, which consists of sales of food and premium ice cream products that wedistribute and sell to our franchisees and to more than 4,000 supermarkets andother retail locations in 12 states; and

·                  Franchiserevenue, which consists of franchise fees, royalty income we receive from ourfranchisees, and other franchise income. Initial franchise fees typically rangefrom $30,000 to $35,000 for each restaurant opened.  Franchise royalties are generally 4% of eachfranchise restaurant’s monthly net sales. Other franchise income includes rental income on any properties we ownand lease or sublease to franchisees.

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

|                            | ** ** | **For the Three Months Ended** | ** ** |
|----------------------------|------------|----------------------------------------------------|------------|
| ** **                 | ** ** | **April 1,**                                  | ** ** | **April 2,** | ** ** |
| ** **                 | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
|                       |       |                                               |       |   |   |
| Company Units:             |       |                                               |       |   |   |
| Beginning of  period       |       | 316                                                |       | 314 |   |
| Openings                   |       | 1                                                  |       | 1 |   |
| Acquired from  franchisees |       | 1                                                  |       | — |   |
| Acquired by  franchisees   |       | —                                             |       | (1 | ) |
| Closings                   |       | (1                                                 | )          | (2 | ) |
| End of period              |       | 317                                                |       | 312 |   |
|                       |       |                                               |       |   |   |
| Franchised  Units:         |       |                                               |       |   |   |
| Beginning of  period       |       | 205                                                |       | 213 |   |
| Openings                   |       | 1                                                  |       | — |   |
| Acquired by  franchisees   |       | —                                             |       | 1 |   |
| Acquired from  franchisees |       | (1                                                 | )          | — |   |
| Closings                   |       | —                                             |       | — |   |
| End of period              |       | 205                                                |       | 214 |   |

 

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*** ***

***Discontinued Operations***

SFAS No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets,” requires the results ofoperations of a component of an entity that is classified as held for sale orthat has been disposed of to be reported as discontinued operations in thestatement of operations if certain conditions are met. These conditions includecommitment to a plan of disposal after the effective date of this statement,elimination of the operations and cash flows of the entity component from ourongoing operations and no significant continuing involvement in the operationsof the entity component after the disposal transaction.

In accordance withSFAS No. 144, the results of operations of the eight properties that weredisposed of during 2006 and any related net gain on the disposals, as well asthe results of operations of three properties held for sale at April 1, 2007were reported separately as discontinued operations in the accompanyingcondensed consolidated statements of operations for the three months endedApril 1, 2007 and April 2, 2006.

During 2006, we closed one restaurant and committed to aplan to sell that restaurant.  At April1, 2007, this property met the criteria for “held for sale” as defined in SFASNo. 144.  The results ofoperations associated with this restaurant were not material and therefore werereported within continuing operations in the accompanying condensedconsolidated statements of operations for all periods presented.

***Three Months Ended April 1, 2007 Compared With Three MonthsEnded April 2, 2006***

*Revenues:*

*Totalrevenues —* Total revenues decreased $3.1 million, or 2.5%, to$122.6 million for the three months ended April 1, 2007 from $125.7 million forthe same quarter in 2006.

*Restaurantrevenues —* Restaurant revenues decreased $2.1 million, or2.2%, to $93.2 million for the three months ended April 1, 2007 from $95.3million for the same period in 2006. Comparable Company-operated restaurantrevenues during this period decreased by $3.6 million, or 4.1%, compared to anincrease of 4.8% experienced during the same period in 2006. Colder weather in2007, especially at night, combined with a greater number of operating dayswith significant snow and rain events, had a negative impact on sales. Theclosing of six locations and the acquisition of six Company-operated locationsby franchisees over the past 15 months resulted in declines of $0.8 million and$1.7 million, respectively, in restaurant revenues in the three months endedApril 1, 2007 as compared to the same period in 2006. These decreases were partiallyoffset by our opening three new restaurants and taking over operation of twelveformerly franchised restaurants over the past 15 months, which resulted inincreased revenues of $4.0 million.  Webegan operating the twelve restaurants in December 2006 following a default andpeaceful surrender by a former franchisee under its leases and franchiseagreements with us. We are currently operating these restaurants while wesearch for a new franchisee to take over their operation.  If the properties are not re-franchised, wemay acquire or close the restaurants, at our option.

There was one newrestaurant opened during each of the first quarters of 2007 and 2006.

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*Foodservicerevenues —* Foodservice revenues (product sales to franchiseesand retail customers) decreased $1.0 million, or 3.5%, to $25.9 million for thethree months ended April 1, 2007 from $26.9 million for the three months endedApril 2, 2006. Sales to foodservice retail supermarket customers decreased $0.7million in the three months ended April 1, 2007 compared to the same period in2006 primarily due to lower case volume of 5.8% and higher promotional tradespending and sales allowances of 0.7% of sales during the period.  Franchised restaurant product revenuedecreased $0.3 million. Revenues from product sales to franchisees decreaseddue primarily to a lower average number of operating franchised restaurantsthroughout the quarter, 205 for the 2007 quarter compared to 214 for the 2006quarter.  The lower average number ofoperating franchised restaurants was primarily due to the default by a formerfranchisee under its leases and franchise agreements with us with respect totwelve franchised restaurants.  We arecurrently operating these restaurants while we seek a substitutefranchisee.  Additionally, a 4.6%reduction in comparable franchised restaurant revenues was experienced duringthe three months ended April 1, 2007, compared to the 0.6% increase incomparable franchised restaurant revenues experienced in the three months endedApril 2, 2006.

*Franchiserevenues —* Franchise revenues were $3.5 million for boththree month periods in 2007 and 2006.

Royalties of $2.4 million decreased $0.1 million forthe three months ended April 1, 2007 as compared to the same period in 2006 dueprimarily to a lower average number of operating franchised restaurantsthroughout the quarter, 205 for the 2007 quarter compared to 214 for the 2006quarter.  Additionally, a 4.6% reductionin comparable franchised restaurant revenues was experienced during the threemonths ended April 1, 2007, compared to the 0.6% increase in comparablefranchised restaurant revenues experienced in the three months ended April 2,2006.

Initial franchise fees were minimal during the threemonths ended April 1, 2007 and April 2, 2006.

Rental income for leased and subleased franchiselocations increased $0.1 million, to a total of $1.1 million, for the threemonths ended April 1, 2007 primarily due to increases in miscellaneousoccupancy revenues, which were partially offset by a decrease in the number ofoperating franchised locations.

*Cost of sales:*

Cost of sales decreased $1.3 million, or 2.6%, to$47.1 million for the three months ended April 1, 2007 from $48.4 million forthe same period in 2006. Cost of sales as a percentage of total revenues was38.4% and 38.5% for the three months ended April 1, 2007 and April 2, 2006,respectively. This improvement resulted primarily from a 0.8% improvement incost of sales experienced within the foodservice segment, as the overall salesmix between restaurants and foodservice remained essentially the same year overyear. The improvement in foodservice cost of sales more than offset the 0.3%increase experienced in restaurant cost of sales.

Restaurant cost of sales as a percentage of restaurantrevenues increased to 27.1% for the three months ended April 1, 2007 from 26.8%for the same period in 2006. This increase was due primarily to normalincreases in prices for commodities, as menu pricing was only marginally up yearover year.

Foodservice cost of sales as a percentage offoodservice revenues decreased to 84.2% in the three months ended April 1, 2007from 85.0% in the three months ended April 2, 2006. This improvement wasprimarily a result of lower cream costs in the 2007 period compared to the sameperiod in 2006.

The cost of cream, the principal ingredient used inmaking ice cream, affects our costs of sales as a percentage of total revenues,especially in our foodservice retail business. The price of cream is directly affected by changes in the market pricefor AA butter traded on the Chicago Mercantile Exchange.  As an example, a $0.10 increase in the costof a pound of AA butter affects our annual costs of sales by approximately $0.9million.  This adverse impact may beoffset by price increases or other factors. However, no assurance can be given that we will be able to offset anycost increases in the future and future increases in cream prices could have amaterial adverse effect on our results of operations.  To minimize risk, alternative supply sourcescontinue to be pursued.

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The overall cost of cream was approximately $0.3million lower in the three month period ended April 1, 2007 (weighted averageprice of $1.24 per pound) when compared to the same period in 2006 (weighted averageprice of $1.35 per pound).  Additionally,market losses on cash-settled butter futures contracts were $0.4 million lowerthan the losses experienced on butter future contracts during the three monthsended April 2, 2006.  Approximately 70%of this $0.7 million net cost of sales benefit on a year to date basis, orapproximately $0.5 million, was reported within our foodservice segment.

When available, wepurchase butter option and/or futures contracts to minimize the impact ofincreases in the cost of cream. Our strategy related to hedging is never tohedge more than 50% of our needs using these instruments, so as not to put usin an uncompetitive position.  Optioncontracts are offered in the months of March, May, July, September, October andDecember; however, there is often not enough open interest in them to allow usto buy even very limited coverage without paying high premiums.  Our commodity option contracts andcash-settled butter futures contracts do not meet hedge accounting criteria asdefined by SFAS No. 133, “Accounting for Certain Derivative Instruments andCertain Hedging Activities,” and its related amendment, SFAS No. 138, “Accountingfor Certain Derivative Instruments and Certain Hedging Activities,” andaccordingly, are marked to market each period with the resulting gains orlosses recognized in cost of sales.

At April 1, 2007, we held55 contracts, spread over the remaining months of 2007.  These contracts correspond to approximately20% of our anticipated cream purchases for the periods represented.

For the remainder of2007, we expect that cream prices will be higher than the prices experiencedfor the same period in 2006 due to the spread in the futures market compared tothe actual prices of last year.

*Labor and benefits:*

Labor and benefits, which were only reported withinour restaurant segment, decreased $1.6 million, or 4.5%, to $34.4 million forthe three months ended April 1, 2007 from $36.0 million for the three monthsended April 2, 2006. As a percentage of total revenues, labor and benefitsdecreased to 28.1% for the three months ended April 1, 2007 from 28.6% for thethree months ended April 2, 2006. Labor and benefits, as a percentage ofCompany restaurant revenue only, decreased to 36.9% for the three months endedApril 1, 2007 from 37.8% for the same period in 2006. The decrease waspartially a result of lower general manager bonus of $0.4 million resultingfrom the negative comparable restaurant revenues generated during the quarter.In addition, fringe benefits decreased by 0.4% of Company restaurant revenues,due mostly to a slight reduction in non-group related insurance costs such asworkers compensation.

*Operating expenses:*

Operating expenses increased $1.0 million, or 4.2%, to$25.0 million for the three months ended April 1, 2007 from $24.0 million forthe three months ended April 2, 2006. Operating expenses as a percentage of total revenues were 20.4% and19.1% in the 2007 and 2006 periods, respectively. A significant portion ofthese expenses ($24.3 million in 2007 and $22.9 million in 2006) were reportedwithin our restaurant segment. In the three months ended April 1, 2007, thesecosts consisted of $3.7 million in supplies, $5.3 million in utilities, $2.7million in maintenance, $2.7 million in advertising, $5.6 million in occupancyand $4.3 million in other restaurant expenses. The increase is primarily due toincreases in advertising ($0.5 million) resulting from two additional weeks oftelevision advertising during the first quarter of 2007, occupancy ($0.4 million),utility costs ($0.3 million) and supplies ($0.2 million).  These increases were partially offset bylower selling expenses in the foodservice segment of $0.5 million.

29

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*General and administrative expenses:*

General and administrative expenses were $10.6 millionand $11.1 million for the three months ended April 1, 2007 and April 2, 2006,respectively. General and administrative expenses as a percentage of totalrevenues decreased to 8.7% in the 2007 period from 8.8% in the 2006 period. The$0.5 million decrease was primarily the result of lower salary, severance,fringe benefit, and bonus costs of $0.7 million partially offset by increasedlegal fees and stock compensation expense of $0.1 million and $0.1 million,respectively.

*Write-downs of property and equipment:*

Write-downs of property and equipment were $0.2million in each of the three month periods ended April 1, 2007 and April 2,2006. During each of the three month periods ended April 1, 2007 and April 2,2006, we determined that the carrying value of one restaurant property exceededits estimated fair value less costs to sell and each of the carrying valueswere reduced by $0.2 million accordingly.

*Depreciation and amortization:*

Depreciationand amortization was $6.2 million and $5.8 million for the three months endedApril 1, 2007 and April 2, 2006, respectively. Depreciation and amortization asa percentage of total revenues was 5.0% and 4.6% in the 2007 and 2006 periods,respectively.  The increase in depreciationand amortization was primarily related to accelerated depreciation on equipmentassociated with the conversion of our 56 oz packaging format from thetraditional “brick” container to the more contemporary and consumer-friendly “sqround”package.

*Gain on franchise sales of restaurant operationsand properties:*

Gainon franchise sales of restaurant operations and properties was $0.9 million inthe three months ended April 2, 2006 associated with the sale of certainequipment assets, lease and sublease rights and franchise rights in oneexisting Friendly’s restaurant.  Therewas no gain on sales of restaurant operations and properties during the threemonths ended April 1, 2007.

*Loss on disposals of other property and equipment, net:*

The loss on disposals of other property and equipment,net was $35 thousand and $0.1 million for the three months ended April 1, 2007and April 2, 2006, respectively.  Thetable below identifies the components of the loss on disposals of otherproperty and equipment, net as shown on the accompanying condensed consolidatedstatements of operations (in thousands):

|                                                         | ** ** | **For the Three Months Ended** | ** ** |
|---------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                              | ** ** | **April 1,**                                  | ** ** | **April 2,** | ** ** |
| ** **                                              | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
| ** **                                              | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Restaurant  equipment assets retired due to replacement |       | $                                                  | 35         |   | $ | 75 |   |
| Loss due to  restaurant fire                            |       | —                                             |       | 30 |   |
| All other                                               |       | —                                             |       | 4 |   |
| Loss on disposals of other  property and equipment, net |       | $                                                  | 35         |   | $ | 109 |   |

 

30

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* *

*Interest expense, net:*

Interest expense, net of capitalized interest andinterest income, was $4.9 million and $5.4 million for the three months endedApril 1, 2007 and April 2, 2006, respectively. The decrease in interest expensein the 2007 period compared to the same period in 2006 was primarily due toreduced amounts of interest on our revolving credit facility as there were noborrowings against the revolving credit facility during the 2007 period ascompared to borrowings of $8.0 million during the 2006 quarter. Totaloutstanding debt, including capital lease and finance obligations, decreasedfrom $233.2 million at April 2, 2006 to $229.7 million at April 1, 2007.

*Provisionfor income taxes:*

As a result of the lossfor each of the periods ended April 1, 2007 and April 2, 2006 and our intent torecord valuation allowances on tax benefits until we can sustain an appropriatelevel of profitability, the benefit from income taxes from continuingoperations was zero.  However, $0.1million of tax expense relating to the accounting for uncertain tax positionswas recognized in the three months ended April 1, 2007, resulting in aneffective tax rate of (1.6)% for the three month period ended April 1, 2007 and0% for the three months ended April 2, 2006.

*Loss from continuing operations:*

Loss from continuing operations was $5.9 million and$4.4 million for the three months ended April 1, 2007 and April 2, 2006, respectively,for the reasons discussed above.

*(Loss)income from discontinued operations:*

In accordance withSFAS No. 144, the results of operations of the eight properties that weredisposed of during 2006 and any related net gain on the disposals, as well as theresults of operations of three properties held for sale at April 1, 2007 werereported separately as discontinued operations in the accompanying condensedconsolidated statements of operations for the three months ended April 1, 2007and April 2, 2006.

During 2006, we closed one restaurant and committed to aplan to sell that restaurant.  At April1, 2007, this property met the criteria for “held for sale” as defined in SFASNo. 144.  The results ofoperations associated with this restaurant were not material and therefore werereported within continuing operations in the accompanying condensedconsolidated statements of operations for all periods presented.

For the three months endedApril 1, 2007 and April 2, 2006, this consisted of the following (in thousands):

|                                              | ** ** | **For the Three Months Ended** | ** ** |
|----------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                   | ** ** | **April 1,**                                  | ** ** | **April 2,** | ** ** |
| ** **                                   | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
| ** **                                   | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Net sales                                    |       | $                                                  | —     |   | $ | — |   |
|                                         |       |                                               |       |   |   |
| Operating loss                               |       | $                                                  | (14        | ) | $ | (248 | ) |
| Gain on  disposals of property and equipment |       | —                                             |       | 2,864 |   |
| Income tax  benefit                          |       | —                                             |       | — |   |
| (Loss) income from  discontinued operations  |       | $                                                  | (14        | ) | $ | 2,616 |   |

 

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**Liquidity and Capital Resources**

*General:*

Ourprimary sources of liquidity and capital resources are cash generated fromoperations and, if needed, borrowings under our $35 million revolving creditfacility (the “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. Othersources of cash are sales of under-performing existing restaurant propertiesand other assets and sales of Company-operated locations to franchisees (to theextent our debt instruments permit). The amount of debt financing that we areable to incur is limited by the terms of our Credit Facility and 8.375% seniornotes indenture. Below was the financing status of our operating restaurantsand properties that we lease to our franchisees as of April 1, 2007:

|                                         | ** ** | **Company  Operated** | ** ** | **Franchise  Operated** | ** ** |
|-----------------------------------------|------------|-----------------------|------------|-------------------------|------------|
| Owned land and  building, mortgaged     |       | 59                    |       | 12                      |       |
| Leased land, owned  building, mortgaged |       | 1                     |       | 0                       |       |
| Sold and leased back                    |       | 58                    |       | 4                       |       |
| Owned land and building                 |       | 18                    |       | 4                       |       |
| Leased land, owned  building            |       | 74                    |       | 18                      |       |
| Leased land and  building               |       | 107                   |       | 8                       |       |
| Total                                   |       | 317                   |       | 46                      |       |

 

TheCompany-operated restaurants above not identified as owned land and building,mortgaged or sold and leased back secure our obligations under the CreditFacility. Of the 18 restaurant properties identified as owned land andbuilding, five were available to be sold.

Inaddition to our 317 operating restaurants, we have four closed properties thatare classified as held for sale in accordance with SFAS No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets”.

*Operating Cash Flows:*

Netcash provided by operating activities was $41 thousand and $2.7 million for thethree months ended April 1, 2007 and April 2, 2006, respectively.  In 2007, cash provided by operatingactivities included a net loss of $6.0 million, offset by increases of $6.6 millionfor other non-cash expenses of depreciation and amortization, write-downs ofproperty and equipment and stock compensation expense.  The net cash provided by operating activitieswas reduced by unfavorable changes in operating assets and liabilities primarilyrelated to bonuses for fiscal 2006, which were paid in the first quarter of2007.

We had a working capital deficit of $12.0 million and$10.6 million as of April 1, 2007 and December 31, 2006, respectively. Ourworking capital deficit includes assets classified as held for sale inaccordance with SFAS No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets.” The workingcapital needs of companies engaged in the restaurant industry are generally lowand as a result, restaurants are frequently able to operate with a workingcapital deficit because: (i) restaurant operations are conducted primarily on acash (and cash equivalent) basis with a low level of accounts receivable; (ii)rapid turnover allows a limited investment in inventories; and (iii) cash fromsales is usually received before related expenses for food, supplies andpayroll are paid.

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*InvestingCash Flows:*

Net cash used in investing activities was $2.5 millionfor the three months ended April 1, 2007 as compared to net cash provided byinvesting activities of $3.4 million for the three months ended April 2, 2006.

During the three months ended April 1, 2007 and April2, 2006, we spent $2.5 million and $2.4 million, respectively on capitalexpenditures, of which $1.8 million and $2.2 million, respectively, was spenton restaurant operations. Capital expenditures were offset by net proceeds fromthe sales of property and equipment of $5.8 million for the three months endedApril 2, 2006.  There were no proceedsreceived during the three months ended April 1, 2007.

As of January 1, 2006, we had 11 restaurants that werereported as “held for sale” in accordance with SFAS No. 144. During the threemonths ended April 2, 2006, we sold five of these restaurants.  In accordance with SFAS No. 144, the resultsof operations of the five properties that were disposed of during the threemonths ended April 2, 2006 and the related net gain on the disposals, as wellas the results of operations of the properties held for sale at April 2, 2006,were reported separately as discontinued operations in the accompanyingcondensed consolidated statements of operations for the three months endedApril 2, 2006.  Gross proceeds on thedisposals of the five properties sold during the 2006 quarter were $5.1million.  There were no properties sold during the 2007 quarter.

During the first quarterof 2006, we completed one transaction in which an existing franchisee purchasedone existing Company-operated restaurant and agreed to develop a total of twonew restaurants in future years.  Grossproceeds from this transaction were $1.2 million, of which $0.1 million was forfranchise fees and $1.1 million was for the sale of certain assets andleasehold rights.  There were no suchtransactions during 2007.

*Borrowingsand Credit Facility:*

*8.375% Senior Notes.*  In March 2004, we issued $175 million of8.375% senior notes (the “Senior Notes”) in a private offering to finance theredemption in full of our then outstanding 10.5% senior notes.  The Senior Notes are unsecured seniorobligations of FICC, guaranteed on an unsecured senior basis by FICC’s Friendly’sRestaurants Franchise, LLC subsidiary, but are effectively subordinated to allsecured indebtedness of FICC, including the indebtedness incurred under ourCredit Facility. The Senior Notes mature on June 15, 2012. Interest on theSenior Notes is payable at 8.375% per annum semi-annually on June 15 andDecember 15 of each year.  The SeniorNotes are redeemable, in whole or in part, at any time on or after June 15, 2008at FICC’s option at redemption prices from 104.188% to 100.00%, based on theredemption date.  In addition, at anytime prior to June 15, 2007, FICC may redeem, subject to certain conditions, upto 35% of the aggregate principal amount of the Senior Notes with the proceedsof one or more qualified equity offerings, as defined, at a redemption price of108.375% of the principal amount, plus accrued interest.

*Revolving Credit Facility.*  We have a $35 million Credit Facility whichis available for borrowings to provide working capital, for issuances ofletters of credit and for other corporate needs. As of April 1, 2007 andDecember 31, 2006, total letters of credit outstanding were $15.5 million and$15.5 million, respectively. During 2007 and 2006, there were no drawingsagainst the letters of credit.  Therevolving credit loans bear interest at our option at either (a) the baserate plus the applicable margin as in effect from time to time (the “Base Rate”)(10.25% at April 1, 2007) or (b) the Eurodollar rate plus the applicablemargin as in effect from time to time (the “Eurodollar Rate”) (9.32% at April1, 2007). As of April 1, 2007 and December 31, 2006, there were no revolvingcredit loans outstanding. As of April 1, 2007 and December 31, 2006, $19.5 millionand $19.5 million, respectively, was available for borrowing.

The Credit Facility includes certain restrictivecovenants including limitations on indebtedness, restricted payments such asdividends and stock repurchases, liens, mergers, investments and sales ofassets and of subsidiary stock. Additionally, the Credit Facility limits theamount which we may spend on capital expenditures, restricts the use ofproceeds from certain asset sales, obligates us to repay outstanding amountsduring certain periods of time during the year, and requires that we complywith certain financial covenants.  Wewere in compliance with the covenants in the Credit Facility as of April 1,2007.

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*Mortgage Financings*.

We have outstanding mortgage loans in connection withour $45 million fixed interest rate mortgage financing completed in December2001 (the “Fixed Rate Mortgages”), and our $8.5 million variable interest ratemortgage financing completed in December 2005 (the “Variable Rate Mortgages”,and together with the Fixed Rate Mortgages, the “Mortgage Financings”).  The Fixed Rate Mortgages bear interest at afixed annual rate of 10.16%, have a maturity date of January 1, 2022 and areamortized over 20 years.  The interestrate of the Variable Rate Mortgages is the sum of the 90-day LIBOR rate ineffect (5.35% at April 1, 2007) plus 4% on an annual basis. Changes in theinterest rate for the Variable Rate Mortgages are calculated monthly andrecognized annually when the monthly payment amount is adjusted. Changes in themonthly payment amounts owed due to interest rate changes for the Variable RateMortgages are reflected in the principal balances, which are re-amortized overthe remaining life of the mortgages. The Variable Rate Mortgages have amaturity date of January 1, 2020 and are amortized over 14 years.  All of the Mortgage Financings are subject toannual covenants, including various minimum fixed charge coverage ratios.  We were in compliance with the covenants forthe Variable Rate Mortgages and Fixed Rate Mortgages as of December 31, 2006.

*Capital Expenditures.*

We anticipate requiringcapital in the future principally to maintain existing restaurant and plantfacilities and to continue to renovate and re-image existing restaurants. Weanticipate that capital expenditures for 2007 will be between $20.0 million and$23.0 million in the aggregate, of which we expect to spend between $17.0million and $20.0 million on restaurants. Our actual 2007 capital expendituresmay vary from these estimated amounts. We believe that the combination of thefunds generated from operating activities and borrowing availability under ourCredit Facility will be sufficient to meet our anticipated operatingrequirements, debt service requirements, lease obligations and capital requirements.

*Contractual Obligations and Commitments.*

Therehave been no material changes to our contractual obligations and commitmentsfrom those disclosed in our 2006 Annual Report on Form 10-K/A.

**Seasonality**

Due to the seasonality of ice cream consumption, andthe effect from time to time of weather on patronage of the restaurants, ourrevenues and operating income are typically higher in our second and thirdquarters.

**Geographic Concentration**

Approximately 94% of our Company-operated restaurantsare located, and substantially all of our retail sales are generated, in theNortheast. As a result, a severe or prolonged economic recession or changes indemographic mix, employment levels, population density, weather, real estatemarket conditions or other factors specific to this geographic region mayadversely affect us more than certain of our competitors which are moregeographically diverse.

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**Critical Accounting Estimates**

Thediscussion and analysis of our consolidated financial condition and results ofoperations are based upon our interim condensed consolidated financialstatements, which have been prepared in accordance with U.S. generally acceptedaccounting principles. The preparation of these condensed consolidatedfinancial statements requires us to make estimates and judgments that affectthe reported amounts of assets, liabilities, revenues and expenses and relateddisclosure of contingent assets and liabilities. On an on-going basis, weevaluate our estimates, including those related to revenue recognition,insurance reserves, recoverability of accounts receivable and notes receivable,stock compensation expense, income tax valuation allowances and pension andother post-retirement benefits expense. We base our 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.

Thecritical accounting estimates that we believe affect the more significantjudgments and estimates used in the preparation of our condensed consolidatedfinancial statements presented in this report are described in our Management’sDiscussion and Analysis of Financial Condition and Results of Operations and inthe Notes to the consolidated financial statements included in our 2006 AnnualReport on Form 10-K/A. There has been no material change to our criticalaccounting estimates from those disclosed in our 2006 Annual Report on Form10-K/A.

Actualresults may differ from these estimates under different assumptions orconditions. Any differences may have a material impact on our financialcondition and results of operations. For a discussion of how these and otherfactors may affect our business, see the “Forward Looking Statements” above andother factors included in our other filings with the Securities and ExchangeCommission.

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**Recently Issued Accounting Pronouncements**

InJuly 2006, the FASB issued FASB Interpretation No. 48, “Accounting forUncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (“FIN48”), which clarifies the accounting for uncertainty in tax positions. FIN 48requires that we recognize in our financial statements the impact of a taxposition, if that position is more likely than not of being sustained on auditbased on the technical merits of the position. The provisions of FIN 48 areeffective as of the beginning of our 2007 fiscal year, with the cumulativeeffect of the change in accounting principle recorded as an adjustment toopening retained earnings.

  We adopted the provisions of FIN 48 onJanuary 1, 2007. As a result of the implementation of FIN 48 on January 1,2007, we recognized an additional $0.2 million as a decrease to retainedearnings. As of the date of adoption, our unrecognized tax benefits totaled$1.6 million, which would affect our tax rate if recognized.  During the three months ended April 1, 2007,we recognized approximately $0.1 million in potential tax and interestassociated with uncertain tax positions and settled one previously uncertaintax position which resulted in the payment of $72,065 of tax and $7,324 ofinterest.

We file numerous consolidated and separate income taxreturns in the United States Federal jurisdiction and in many statejurisdictions. With few exceptions, we are no longer subject to US Federal andstate and local income tax examinations for years before 2003.

We recognize potentialaccrued interest and penalties related to unrecognized tax benefits within ouroperations as income tax expenses. As of the date of implementation ofFIN 48, we had approximately $0.6 million accrued for interest andpenalties. To the extent interest and penalties are not assessed with respectto uncertain tax positions, amounts accrued will be reduced and reflected as areduction of the overall income tax provision.

We anticipate that the total unrecognized tax benefitswill decrease by approximately $0.5 million due to the settlement of ongoingstate voluntary disclosure processes prior to March 30, 2008.

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

There has been no material change in our market riskexposure since the filing of the 2006 Annual Report on Form 10-K/A.

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**Item 4. Controlsand Procedures**

As of April 1, 2007, our management, under thesupervision and with the participation of our Chief Executive Officer (“CEO”)and Chief Financial Officer (“CFO”), evaluated the effectiveness of the designand operation of our disclosure controls and procedures (as defined in Rule13a-15(e) and Rule 15d-15(e) under the Exchange Act).  Based on that evaluation, our CEO and CFO concludedthat our disclosure controls and procedures were effective as of April 1, 2007.

There were no significant changes in our internal controlover financial reporting that occurred during our last fiscal quarter that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

**PART II — OTHER INFORMATION**

**Item 1A.  Risk Factors**

Therehave been no material changes to our risk factors from those disclosed in our2006 Annual Report on Form 10-K/A.

**Item 5.  Other Information**

On May 9, 2007, we amended our change of controlagreements with Messrs. George M. Condos, Kenneth D. Green,Gregory A. Pastore and Garrett J. Ulrich. Mr. Condos’ change ofcontrol agreement was amended to extend the period of time that he will beentitled to receive his salary continuation payments, health benefits andoutplacement services, from one year to two years if, during the term of hisagreement, his employment is terminated by us within 60 days after achange of control. Messrs. Green, Pastore and Ulrich’s change of controlagreements were amended to provide for salary continuation payments in anamount equal to such employee’s base compensation (as defined in the agreement)for a period of two years, in lieu of a lump sum cash payment in an aggregateamount equal to the person’s base compensation for a one year period, and toprovide continued health benefits and outplacement services for the two yearperiod. These agreements were also amended to provide that we may delay oraccelerate the salary continuation payments to the extent we determine it isnecessary to comply with Section 409A of the Internal Revenue Code. Allother provisions of their agreements remain in full force and effect.

**Item 6.  Exhibits**

(a) Exhibits

The exhibit index is incorporated by reference herein.

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.
|        | Friendly Ice Cream Corporation |
|--------|--------------------------------|
|   |                           |
|   | By:                            | /s/ PAUL V. HOAGLAND |
|   |                           | Name: Paul V. Hoagland |
|   |                           | Title: Executive Vice President of Administration  and Chief Financial Officer |
|   |                           | (Principal Financial Officer) |
|   |                           |   |
|   | Date:                          | May 11, 2007 |

 

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**EXHIBIT INDEX**
| 3.2    |   | Amended and Restated Bylaws, as amended.                                                                                                                                  |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                      |
| 10.1   |   | Form of 2003 Incentive Plan Restricted Stock  Agreement for officers*.                                                                                                    |
|   |   |                                                                                                                                                                      |
| 10.2   |   | Form of 2003 Incentive Plan Restricted Stock Unit  Award Agreement for officers*.                                                                                         |
|   |   |                                                                                                                                                                      |
| 31.1   |   | Certification pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002 signed by George M. Condos.                                                                      |
|   |   |                                                                                                                                                                      |
| 31.2   |   | Certification pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002 signed by Paul V. Hoagland.                                                                      |
|   |   |                                                                                                                                                                      |
| 32.1   |   | Certification pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by  George M. Condos and Paul V. Hoagland. |

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*                    ManagementContract or Compensatory Plan or Arrangement

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