<PAGE>
 
================================================================================

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, DC  20549


                                   FORM 10-Q


(Mark One)
    X        QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
---------    EXCHANGE ACT OF 1934
                                                                  
             
                  FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998

                                       OR

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


               For the transition period from _______________  to

                         Commission file number 0-19548

                               KOO KOO ROO, INC.
             (Exact name of registrant as specified in its charter)

                DELAWARE                            22-3132583
     (State or Other Jurisdiction of             (I.R.S. Employer
     Incorporation or Organization)             Identification No.)

        11075 SANTA MONICA BOULEVARD, SUITE 225, LOS ANGELES, CA 90025
              (Address of principal executive offices) (Zip Code)

      Registrant's telephone number, including area code: (310) 479-2080


     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

                    Yes    X     No 
                        -------     -------

     As of  August 10, 1998, the registrant had issued and outstanding
54,488,063 shares of common stock, $.01 par value per share.


================================================================================
<PAGE>
 
                               KOO KOO ROO, INC.

                               INDEX TO FORM 10-Q
                                        
<TABLE>
<CAPTION>
 
                                                                                          PAGE NO.
<S>                                                                                       <C>
PART I.  FINANCIAL INFORMATION
 
ITEM 1.  FINANCIAL STATEMENTS:

     Condensed Consolidated Balance Sheets as of
        December 31, 1997 and June 30, 1998                                                   1
                                                                                             
     Condensed Consolidated Statements of Operations for the                                 
        Three and Six Months Ended June 30, 1997 and 1998                                     2
                                                                                             
     Condensed Consolidated Statements of Cash Flows for the                                 
        Six Months Ended June 30, 1997 and 1998                                               3
                                                                                             
     Notes to Condensed Consolidated Financial Statements                                     4

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF                                             
         FINANCIAL CONDITION AND RESULTS OF OPERATIONS                                        7

                                                                                             
PART II.  OTHER INFORMATION                                                                  
                                                                                             
ITEM 1.  LEGAL PROCEEDINGS                                                                   12
                                                                                             
ITEM 2.  CHANGES IN SECURITIES                                                               12
                                                                                             
ITEM 3.  DEFAULTS UPON SENIOR SECURITIES                                                     12
                                                                                             
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                 12
                                                                                             
ITEM 5.  OTHER INFORMATION                                                                   12
                                                                                             
ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K                                                    12
                                                                                             
SIGNATURES                                                                                   13
</TABLE>
<PAGE>
 
                        PART 1 - FINANCIAL INFORMATION
                        ------------------------------

Item 1. - Financial Statements

                      KOO KOO ROO, INC. AND SUBSIDIARIES
                     CONDENSED CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                       December 31,         June 30,
                            ASSETS                                        1997 *              1998
                                                                       ------------       ------------
                                                                                          (Unaudited)
<S>                                                                    <C>                <C>
CURRENT ASSETS:
   Cash and cash equivalents                                           $  6,754,601       $  5,175,055
   Marketable securities                                                  5,712,454          2,340,221
   Receivables - trade                                                      627,174             82,525
   Notes receivable                                                         760,988            433,334
   Inventories                                                              691,939            581,822
   Prepaid expenses                                                       1,000,077          1,172,229
                                                                       ------------       ------------
     Total current assets                                                15,547,233          9,785,186
PROPERTY AND EQUIPMENT, net                                              41,856,321         37,943,104
INVESTMENTS IN AND ADVANCES TO RELATED ENTITIES                             653,494               -
INTANGIBLES AND OTHER ASSETS, net                                        10,713,955          9,936,949
                                                                       ------------       ------------
                                                                       $ 68,771,003       $ 57,665,239
                                                                       ============       ============

LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
   Accounts payable                                                    $  4,983,296       $  3,344,932
   Other accrued liabilities                                              3,751,552          2,890,603
   Accrued payroll                                                          731,800            862,400
   Reserves for store closings and disposal costs                         1,450,000          5,399,639
   Net liabilities and reserves of discontinued operations                1,699,953            407,893
   Current portion of long-term debt                                        316,760          2,764,051
                                                                       ------------       ------------
     Total current liabilities                                           12,933,361         15,669,518
                                                                       ------------       ------------
NOTES AND LOANS PAYABLE, LONG-TERM                                       12,848,310         13,292,862
                                                                       ------------       ------------
MINORITY INTEREST                                                           240,440            415,162
                                                                       ------------       ------------
STOCKHOLDERS' EQUITY:
  Preferred stock, $.01 par value, 5,000,000 shares
    authorized; 175,342 and 0 shares of Series A and
    215,839 and 16,925 shares of Series B, Adjustable
    Convertible Preferred Stock issued and outstanding
    (aggregate liquidation preference $25,173,850 and $1,692,500)             3,912                169
  Common stock, $.01 par value, 75,000,000 shares authorized;
    26,770,170 and 52,485,075 shares issued and outstanding                 267,702            524,850
  Additional paid-in capital                                            106,631,872        107,573,165
  Accumulated deficit                                                   (63,413,964)       (79,564,164)
  Treasury stock, 147,012 and 151,012 shares at cost                       (238,493)          (246,323)
  Common stock issued for unearned compensation                            (502,137)              -
                                                                       ------------       ------------
     Total stockholders' equity                                          42,748,892         28,287,697
                                                                       ------------       ------------
                                                                       $ 68,771,003       $ 57,665,239
                                                                       ============       ============
</TABLE> 

*  Derived from restated audited financial statements.

                                 Page 1 of 13
<PAGE>
 
                      KOO KOO ROO, INC. AND SUBSIDIARIES
                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                  (Unaudited)

<TABLE>
<CAPTION>
                                                              Three Months Ended June 30,        Six Months Ended June 30,
                                                             ----------------------------      -----------------------------
                                                                1997             1998             1997              1998
                                                             -----------      -----------      -----------      ------------
<S>                                                          <C>              <C>              <C>              <C>
RESTAURANT SALES                                             $15,949,468      $22,730,426      $27,172,728      $ 45,066,386
                                                             -----------      -----------      -----------      ------------
COSTS AND EXPENSES:
 Food, labor and related costs                                11,078,732       15,218,902       19,199,077        30,562,076
 Occupancy expenses                                            1,350,020        1,767,716        2,293,271         3,639,259
 Other operating expenses                                      5,009,719        5,234,596        8,618,692        11,029,556
 Depreciation and amortization                                 1,250,402        1,229,549        2,453,304         2,447,975
 Restructuring and other charges                                (193,866)            -            (193,866)       11,757,118
                                                             -----------      -----------      -----------      ------------
      Total                                                   18,495,007       23,450,763       32,370,478        59,435,984
                                                             -----------      -----------      -----------      ------------
LOSS FROM OPERATIONS                                          (2,545,539)        (720,337)      (5,197,750)      (14,369,598)
OTHER INCOME (EXPENSE):
 Interest and other income (expense)                             350,436         (383,250)         528,145          (706,218)
 Equity in net loss of joint ventures                           (203,303)            -            (338,303)             -
 Minority interest in net loss of joint venture                   97,975          142,106          157,160           234,877
                                                             -----------      -----------      -----------      ------------
LOSS FROM CONTINUING OPERATIONS                               (2,300,431)        (961,481)      (4,850,748)      (14,840,939)
LOSS FROM DISCONTINUED OPERATIONS                               (596,679)            -          (1,541,009)             -
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING                           -                -                -           (1,276,952)
                                                             -----------      -----------      -----------      ------------
NET LOSS                                                      (2,897,110)        (961,481)      (6,391,757)      (16,117,891)
DIVIDENDS ON PREFERRED STOCK                                  (1,372,895)            -          (2,095,756)          (32,309)
                                                             -----------      -----------      -----------      ------------
NET LOSS APPLICABLE TO
   COMMON STOCKHOLDERS                                       $(4,270,005)     $  (961,481)     $(8,487,513)     $(16,150,200)
                                                             ===========      ===========      ===========      ============
                                                                                                          
BASIC AND DILUTED LOSS PER SHARE:
 Loss from continuing operations                             $     (0.19)     $     (0.02)     $     (0.39)     $      (0.33)
 Loss from discontinued operations                                 (0.03)            -               (0.09)             -
 Cumulative effect of change in accounting                          -                -                                 (0.03)
                                                             -----------      -----------      -----------      ------------
 Net Loss                                                    $     (0.22)     $     (0.02)     $     (0.48)     $      (0.36)
                                                             ===========      ===========      ===========      ============

WEIGHTED AVERAGE NUMBER OF
   COMMON SHARES OUTSTANDING                                  19,046,463       50,683,529       17,601,149        44,429,435
                                                             ===========      ===========      ===========      ============
</TABLE>

                                 Page 2 of 13
<PAGE>
 
                      KOO KOO ROO, INC. AND SUBSIDIARIES
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (Unaudited)

<TABLE>
<CAPTION>
                                                                                 Six Months Ended June 30,
                                                                      ---------------------------------------------
                                                                          1997                             1998
                                                                      ------------                     ------------
<S>                                                                   <C>                              <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
 Net loss                                                             $ (6,391,757)                    $(16,117,891)
 Adjustments to reconcile net loss to
   net cash used in operating activities:
     Depreciation and amortization                                       2,730,440                        2,447,975
     Cumulative effect of change in accounting                                -                           1,276,952
     Minority interest                                                    (308,583)                         234,877
     Gain on sale of assets                                               (200,588)                            -
     Restructuring and other charges, including store closings                -                          11,757,118
    Changes in operating assets and liabilities:
       Receivables                                                            -                             172,215
       Inventories                                                        (221,083)                         110,117
       Prepaid expenses and other assets                                  (113,223)                        (530,348)
       Accounts payable                                                    926,022                          132,114
       Accrued expenses and other liabilities                              545,986                         (510,254)
       Accrued expenses for store closings and other charges                  -                          (2,900,106)
                                                                      ------------                     ------------
       Net cash used in operating activities                            (3,032,786)                      (3,927,231)
                                                                      ------------                     ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
   Purchase of property and equipment                                   (7,423,477)                      (4,214,167)
   Acquisition of Hamburger Hamlet                                     (10,476,955)                            -
   Purchase of marketable securities                                    (9,350,130)                        (399,938)
   Sale of marketable securities                                         9,886,455                        3,772,171
   Pre-opening costs                                                      (761,363)                            -
   Proceeds from sale/leaseback of store assets                          1,418,039                             -
   Payments on notes receivable                                            100,000                             -
   Notes and loans to employees and others                                (658,613)                         (62,144)
   Lease acquisition and other                                             (74,871)                        (717,369)
   Investments in and advances to related entities                      (1,164,450)                         (20,526)
                                                                      ------------                     ------------
       Net cash used in investing activities                           (18,505,365)                      (1,641,973)
                                                                      ------------                     ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
   Proceeds from debt financing and private placements                  26,685,435                        3,000,000
   Debt repayments                                                        (201,927)                        (108,157)
   Minority capital contributions                                           75,622                          160,439
   Preferred stock cash dividends                                         (292,861)                         (54,794)
   Repurchase of common stock                                             (109,970)                          (7,830)
   Exercise of common stock options and warrants                               204                        1,000,000
                                                                      ------------                     ------------
       Net cash provided by financing activities                        26,156,503                        3,989,658
                                                                      ------------                     ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                     4,618,352                       (1,579,546)
CASH AND CASH EQUIVALENTS, beginning of period                           4,591,318                        6,754,601
                                                                      ------------                     ------------
CASH AND CASH EQUIVALENTS, end of period                              $  9,209,670                     $  5,175,055
                                                                      ============                     ============
</TABLE>

                                 Page 3 of 13
<PAGE>
 
                       KOO KOO ROO, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1 - GENERAL

     The consolidated financial statements include the accounts of Koo Koo Roo,
Inc. (the "Company"), its majority-owned subsidiaries and limited partnerships
in which the Company has a controlling interest.  All significant inter-company
transactions and balances have been eliminated.

     The accompanying unaudited condensed consolidated financial statements were
prepared on the accrual basis of accounting.  In the opinion of management, all
adjustments (consisting only of normal, recurring accruals) which are necessary
for a fair presentation of the financial results for the periods presented have
been made.  The interim period results of operations are not necessarily
indicative of the results of operations for the full year.  The financial
statements presented herein should be read in conjunction with the audited
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K for the year ended December 31, 1997.

NOTE 2 - NET LOSS PER SHARE
 
     Basic earnings per share includes no dilution and is computed by dividing
net loss applicable to common stockholders by the weighted average number of
common shares outstanding during the periods presented.  Dilutive earnings per
share reflects the potential dilution of securities that could share in the
earnings, such as shares issuable upon the exercise of options and warrants to
purchase common stock or the conversion of convertible securities.  Shares
issuable upon the exercise of options and warrants to purchase common stock or
the conversion of convertible  securities outstanding during the periods
presented were not included in diluted earnings per share since their effect
would be anti-dilutive.  The net loss attributable to common stockholders has
been adjusted for deemed dividends and dividends paid on preferred stock.

NOTE 3 - NEW ACCOUNTING STANDARD

     In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-5 ("SOP 98-5") "Reporting on the Costs of Start-
Up Activities."  SOP 98-5 requires that costs of start-up activities should be
expensed as incurred.  SOP 98-5 is effective for years beginning after December
15, 1998 and earlier application is permitted and encouraged.  Accordingly, the
Company has elected to expense such costs commencing January 1, 1998 and has
recorded, as of January 1, 1998, the cumulative effect of the change in
accounting method, or $1,276,952, related to the adoption of SOP 98-5 in the
accompanying condensed statement of operations for the six months ended June 30,
1998.

NOTE 4 - EMPLOYEE STOCK OPTIONS

          The Company has two stock award plans for selected eligible employees
and consultants. The two plans cover an aggregate of 5,000,000 shares of Common
Stock.  On March 24, 1998 the Company's Board of Directors agreed to reset the
exercise price of employee options covering approximately 2,700,000 shares from
an average of $3.75 per option to $1.56 per option.


                                 Page 4 of 13
<PAGE>
 
                       KOO KOO ROO, INC. AND SUBSIDIARIES
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

NOTE 5 - FIRST QUARTER RESTRUCTURING

     During March 1998, the Company developed and approved a plan to restructure
the Company.  The restructuring plan provides for, among other things, a
reduction in the number of store openings planned for 1998,  a reduction in the
number of employees at the corporate office and the Company's decision to divest
non-core businesses.  In addition, the Company decided to exit the Washington D.
C. market and closed three Koo Koo Roo California Kitchen restaurants and
abandoned a lease for a fourth location.  In connection with this restructuring
plan, the Company recognized charges during the three months ended March 31,
1998 as follows:

<TABLE>
          <S>                                   <C>
          Severance costs                       $ 2,800,000
          Joint venture impairment reserve          674,000
          Write-off of Arrosto assets               990,000
          Other miscellaneous items                 453,460
                                                -----------
                                                  4,917,460
          Store closings and other charges        6,839,658
                                                -----------
            Total                               $11,757,118
                                                ===========
</TABLE>

     During June 1998, the Company completed the sale of its Arrosto Coffee
assets, including the roasting plant and its only stand-alone retail store. The
Company received net cash proceeds of approximately $285,000.  In addition, the
buyer assumed the lease obligations relating to the roasting plant and stand-
alone retail store.  In connection with this transaction the Company entered
into a twenty-six month agreement to purchase coffee from Arrosto's new owner.
The purchase agreement may be terminated by the Company if the quality of the
coffee is not maintained and under certain other conditions.

     In connection with the restructuring plan and related charges, during the
six months ended June 30, 1998, the Company expended cash totaling $1,387,452
relating to the restructuring efforts, net of proceeds received from the sale of
assets.

NOTE 6 - DISCONTINUED OPERATIONS

     In March 1996, the Company acquired 90% of the common stock of Color Me
Mine, Inc., a small chain of paint-your-own ceramics studios located in Southern
California. The acquisition was accounted for using the pooling of interest
method of accounting.  In November 1997, the Company initiated a plan to divest
Color Me Mine.  Accordingly, the Company has reclassified the operations of
Color Me Mine as discontinued operations in the accompanying financial
statements.   The Company recorded an estimated loss of $7.0 million related to
the anticipated divestiture of the assets of Color Me Mine, including
approximately $1,200,000 for estimated losses during the phase out period.  The
accompanying condensed consolidated balance sheet as of December 31, 1997 has
been restated to reflect the net assets and the estimated loss as a single
amount as follows:

<TABLE>
<CAPTION>
                                                     December 31,      June 30,
                                                         1997            1998
                                                     -------------   ------------
     <S>                                             <C>             <C>
     Current assets                                   $ 1,971,761    $ 1,107,885
     Non-current assets                                 4,719,843      4,455,361
     Liabilities                                       (1,391,557)    (1,255,427)
                                                      -----------    -----------
       Net assets                                       5,300,047      4,307,819

     Reserve for loss on disposition                   (7,000,000)    (4,715,712)
                                                      -----------    -----------

     Net liabilities of discontinued operations       $(1,699,953)   $  (407,893)
                                                      ===========    ===========
</TABLE>


                                 Page 5 of 13
<PAGE>
 
                       KOO KOO ROO, INC. AND SUBSIDIARIES
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED



     During the six months ended June 30, 1998, the Company recorded Color Me
Mine's net losses of approximately $2,172,340 (including write-offs of certain
assets by the subsidiary) as adjustments against the related reserve for
discontinued operations. The Company is in negotiations with a prospective
purchaser for the assets of Color Me Mine, although definitive agreements have
not been signed and there can be no assurance that such transaction will be
completed or as to the terms thereof.

NOTE 7 - PREFERRED STOCK CONVERSIONS AND WARRANTS

     During the six months ended June 30, 1998, 175,342 shares of the Company's
5% Series A Adjustable Convertible Preferred Stock were converted into 4,474,210
shares of the Company's Common Stock. In addition, 200,861 shares of the
Company's 6% Series B Adjustable Convertible Preferred Stock were converted into
20,120,281 shares of the Company's Common Stock. Since June 30, 1998 the Company
issued 2,002,988 shares of common stock relating to the conversion of 16,225
shares of the Company's 6% Series B Adjustable, Convertible Preferred Stock. As
of August 13, 1998, 700 shares of 6% Series B Adjustable Convertible Preferred
shares remain outstanding. The Company also issued 1,120,414 shares of common
stock in connection with the exercise of previously issued options and warrants
to purchase common stock.

NOTE 8 - LICENSING AGREEMENTS

     During the quarter ended June 30, 1998, the Company entered into licensing
agreements with two separate groups to license its Koo Koo California Kitchen
concept in England and in the State of Israel. Each agreement provides for a
development schedule for the licensees to open a minimum number of restaurants
during the next five years. The Company received up front fees of $450,000 upon
execution of the agreements. The Company will receive additional licensing fees
at the time the restaurants are opened and continuing royalty payments based on
the revenues of such restaurants. The Company will not be required to supply any
of the required capital. Pursuant to the licensing agreements, the Company is
required to provide the licensees with various services and assistance,
including training and store openings.

NOTE 9 - PROPOSED MERGER

     In June 1998, the Company entered into a definitive agreement to merge with
Family Restaurants, Inc. ("FRI"), an operator of approximately 275 full service
Mexican restaurants, primarily located in the United States. Both companies'
Board of Directors have unanimously approved the merger agreement. The Company
is preparing proxy materials to be mailed to the stockholders related to a
special meeting of stockholders.  No date for the meeting has yet been
established.

     Under the terms of the merger agreement, Koo Koo Roo stockholders will
receive one share of FRI common stock in exchange for each share they currently
own, representing approximately 31% of the outstanding common shares of the new
company which will be renamed Koo Koo Roo Enterprises, Inc. The merger agreement
provides for certain fees to be paid to FRI in the event the Company terminates
the merger agreement. The merger will be accounted for as a purchase.

     Concurrent with the signing of the merger agreement, FRI provided a
$3,000,000 loan to The Hamlet Group, Inc., a wholly-owned subsidiary of the
Company.  The note provides for quarterly interest payments at the prime rate
and is collateralized by certain assets of The Hamlet Group, Inc.  Assuming the
proposed merger with FRI is approved, the note will be due on June 9, 2000.  In
the event the merger is terminated, depending on the reasons therefor, the note
is due on either June 9, 1999, or no later than sixty days after the termination
of the merger agreement.


                                 Page 6 of 13
<PAGE>
 
ITEM 2.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
          AND RESULTS OF OPERATIONS

INTRODUCTION

     The discussion below and elsewhere in this Report on Form 10-Q include
forward looking statements about the future business results and activities of
the Company which, by their very nature, involve a number of risks and
uncertainties.  For an explanation of certain of these risks and uncertainties,
see the matters discussed in the last paragraph of this Introduction section and
the materials referred to therein.

     The Company adopted a plan to restructure its operations and concentrate
its efforts on its core business of operating restaurants during the quarter
ended March 31, 1998.  In connection with this plan, the Company closed the
three remaining Koo Koo Roo California Kitchen stores located in the Washington
D.C. area.  The Company intends to focus it efforts on operating restaurants in
California and Nevada and the Company will continue to operate three restaurants
with its joint venture partner in Florida and has plans to open one additional
restaurant in Florida.  The Company also has a 28% ownership interest in three
restaurants operated in Toronto, Ontario, Canada.  In addition, the Company will
continue to operate 14 Hamburger Hamlet restaurants acquired during 1997.  As
part of the restructuring efforts, the Company recognized restructuring and
other charges of $11,757,118 related to store closings, reductions in corporate
staffing levels, closing its Arrosto coffee plant and various other charges,
which includes the write down of Koo Koo Roo's investment in its Canadian joint
venture.  The Company believes that these steps, along with continued 
improvement in operating efficiencies at the stores, will help improve 
operating results during 1998 and in future periods.

     In June 1998, the Company entered into a definitive agreement to merge with
FRI, an operator of approximately 275 full service Mexican restaurants,
primarily located in the United States. Both companies' Board of Directors have
unanimously approved the merger agreement. The Company is preparing proxy
materials to be mailed to stockholders related to a special meeting of
stockholders.  No date for the meeting has yet been established.

     Under the terms of the merger agreement, Koo Koo Roo stockholders will
receive one share of FRI common stock in exchange for each share they currently
own, representing approximately 31% of the outstanding common shares of the new
company which will be renamed Koo Koo Roo Enterprises, Inc.  The merger 
agreement provides for certain fees to be paid to FRI in the event the Company 
terminates the merger agreement.  The merger will be accounted for as a 
purchase.

     Concurrent with the signing of the merger agreement, FRI provided a
$3,000,000 loan to The Hamlet Group, Inc., a wholly-owned subsidiary of the
Company.  The note provides for quarterly interest payments at the prime rate
and is collateralized by certain assets of The Hamlet Group, Inc.  Assuming the
proposed merger with FRI is approved, the note will be due June 9, 2000.  In the
event the merger is terminated, depending on the reasons therefor, the note is
due on either June 9, 1999, or no later than sixty days after the termination of
the merger agreement.

     During the quarter ended June 30, 1998, the Company entered into licensing
agreements with two separate groups to license its Koo Koo California Kitchen
concept in England and in the State of Israel. Each agreement provides for a
development schedule for the licensees to open a minimum number of restaurants
during the next five years. The Company received up front fees of $450,000 upon
execution of the agreements. The Company will receive additional licensing fees
at the time the restaurants are opened and continuing royalty payments based on
the revenues of such restaurants. The Company will not be required to supply any
of the required capital. Pursuant to the licensing agreements, the Company is
required to provide the licensees with various services and assistance,
including training and store openings.

     In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-5 ("SOP 98-5") "Reporting on the Costs of Start-
Up Activities."  SOP 98-5 requires that costs of start-up activities should be
expensed as incurred.  SOP 98-5 is effective for years beginning after December
15, 1998 and earlier application is permitted and encouraged.  Accordingly, the
Company has elected to expense such costs commencing January 1, 1998 and has
recorded, as of January 1, 1998, the cumulative effect of the change in
accounting method, or $1,276,952, related to the adoption of SOP 98-5 in the
accompanying condensed statement of operations for the six months ended June 30,
1998.

     As of August 10, 1998, the Company operated 52 restaurants, including 14
Hamburger Hamlet restaurants and the Company's Canadian joint venture partner
operated three Koo Koo Roo restaurants in Toronto, Ontario.

     Many of the statements made herein are forward looking and, among other
things, relate to the prospects for the Company to expand and attain profitable
operations. The Company has historically incurred net losses and the Company
presently anticipates that it will continue to incur operating losses during
1998. However, the Company believes that the operating losses should begin to
decrease during the next calendar year both in the aggregate and as a percentage
of sales. Management presently cannot predict precisely when the Company may
achieve profitable operations. The opening of the additional stores, which would
contribute to Company profitability, is subject to factors


                                 Page 7 of 13
<PAGE>
 
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
         AND RESULTS OF OPERATIONS - CONTINUED


outside the control of management, including, among other things, locating
sites, negotiating and executing leases on acceptable terms, obtaining
governmental permits and the construction and completion of new restaurants by
contractors.


QUARTER TO QUARTER COMPARISON
 
     RESTAURANT OPERATIONS

     Restaurant sales for the three months ended June 30, 1998 amounted to
$22,730,426 compared to $15,949,468 for the three months ended June 30, 1997, an
increase of 43%.  The increase in revenues was primarily produced by 25 Koo Koo
Roo restaurants which operated during both the current quarter and the same
quarter of 1997 and 12 new restaurants opened during the remainder of 1997 and
the first quarter of 1998, plus $7,962,978 in restaurant sales from 14 Hamburger
Hamlet restaurants acquired in May 1997. Comparable same store sales for the Koo
Koo Roo restaurants in operation for a period of 18 months or more increased by
2.4% for the quarter ended June 30, 1998 compared to the same period in 1997.

     Gross profit (sales less food, labor and related costs) for the three
months ended June 30, 1998 increased to $7,511,524 from $4,870,736 for the same
quarter of 1997.  As a percentage of sales, gross profit increased to 33.0%
during the three months ended June 30, 1998 compared to 30.5% for the same
period of 1997. Gross profit generally increases in mature stores (those open
more than three months) and is lower in newly opened stores.  The Hamburger
Hamlet restaurants contributed to the overall improvement in the gross profit
percentage.  Cost of sales improvements were related to improvements in
operating efficiencies, waste reduction and increased sales volume, which
resulted in lower food, beverage and paper costs as a percentage of sales.
These improvements are a net of an increase in labor costs of 1.0%, as a
percentage of sales, during 1998 compared to 1997.

     Occupancy costs increased to $1,767,716 for the three months ended June 30,
1998, compared to $1,350,020 for the three months ended June 30, 1997.
Occupancy costs as a percentage of sales improved to 7.8% in the current
quarter, compared to 8.5% for the three months ended June 30, 1997.

     Depreciation and amortization expenses decreased to $1,229,549 from
$1,250,402 for 1998. Depreciation and amortization during the three months ended
June 30, 1997 included $269,280 of pre-opening cost amortization.  As discussed
above, effective January 1, 1998, the Company no longer amortizes pre-opening
costs.

     Other operating expenses, which include other store operating and corporate
overhead expenses, amounted to $5,234,596 for the three months ended June 30,
1998 compared to $5,009,719 for 1997. As a percentage of sales, operating
expenses decreased from 31.4% in 1997 to 23.0% for the quarter ended June 30,
1998.  The improvement resulted from higher sales volume, the addition of the
Hamburger Hamlet restaurants and reductions in general and administrative costs
implemented during the fourth quarter of 1997 and the first quarter of 1998.

     Minority interest represents the limited partners' interest in three
partnerships which are controlled by the Company.  Pursuant to the partnership
agreements, profits and losses and cash distributions are allocated based on
ownership percentage.  The financial results of the partnerships have been
consolidated with those of the Company.


                                 Page 8 of 13
<PAGE>
 
ITEM 2.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
          AND RESULTS OF OPERATIONS - CONTINUED

SIX MONTH COMPARISON

     Restaurant sales for the six months ended June 30, 1998 amounted to
$45,066,386 compared to $27,172,728 for the six months ended June 30, 1997, an
increase of 65.9%.  The increase in revenues was primarily produced by 23 Koo
Koo Roo restaurants which operated during the current year and the same period
of 1997 and 9 new restaurants opened during 1997 and five new restaurants opened
in 1998, net of store closings, plus $15,763,172 in restaurant sales from 14
Hamburger Hamlet restaurants acquired in May 1997. Comparable same store sales
for the Koo Koo Roo restaurants in operation for a period of 18 months or more
increased by 4.2% for the six months ended June 30, 1998 compared to the same
period in 1997.
 
     Gross profit (sales less food, labor and related costs) for the six months
ended June 30, 1998 increased to $14,504,310 from $7,973,651 for the same period
in 1997.  As a percentage of sales, gross profit increased to 32.2% during the
six months ended June 30, 1998 compared to 29.3% for the same period in 1997.
Gross profit generally increases in mature stores (those open more than three
months) and is lower in newly opened stores. Cost of sales improvements were
related to improvements in operating efficiencies, waste reduction and increased
sales volume, which resulted in lower food, beverage and paper costs as a
percentage of sales.  These improvements are net of an increase in labor costs
of 1.5%, as a percentage of sales, during 1998 compared to 1997.

     Occupancy costs increased to $3,639,259 for the six months ended June 30,
1998, compared to $2,293,271 for the same period in 1997.  Occupancy costs as a
percentage of sales decreased to 8.1% for the six months ended June 30, 1998
compared to 8.4% for the same period in 1997.

     Depreciation and amortization expenses decreased to $2,447,975 from
$2,453,304 for 1998.  Depreciation and amortization during the six months ended
June 30, 1997 included $591,469 of pre-opening cost amortization. As discussed
above, effective January 1, 1998, the Company no longer amortizes pre-opening
costs.
 
     Other operating expenses, which include other store operating and corporate
overhead expenses, amounted to $11,029,556 for the six months ended June 30,
1998 compared to $8,618,692 for 1997.  The increase was due to several factors,
including, new Koo Koo Roo store openings and the acquisition of the 14
Hamburger Hamlet restaurants. As a percentage of sales, operating expenses
decreased from 31.7% in 1997 to 24.5% in 1998. The improvement resulted from
higher sales volume, the addition of the Hamburger Hamlet restaurants and
reductions in general and administrative costs implemented during the fourth
quarter of 1997 and the first quarter of 1998.

     Minority interest represents the limited partners' interest in three
partnerships which are controlled by the Company.  Pursuant to the partnership
agreements, profits and losses and cash distributions are allocated based on
ownership percentage.  The financial results of the partnerships have been
consolidated with those of the Company.
 
     DISCONTINUED OPERATIONS

     In November 1997, the Company decided to divest its 90%-owned subsidiary,
Color Me Mine.  Accordingly, the Company has reclassified the operations of
Color Me Mine as discontinued operations in the accompanying financial
statements.


                                 Page 9 of 13
<PAGE>
 
ITEM 2.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
          AND RESULTS OF OPERATIONS - CONTINUED



LIQUIDITY AND CAPITAL RESOURCES

     LIQUIDITY

     Total cash, cash equivalents and marketable securities at June 30, 1998
amounted to $7,515,276.  During the past two years the Company expended cash
resources principally to build new Koo Koo Roo California Kitchen stores,
acquire 14 Hamburger Hamlet restaurants, expand the operations of Color Me Mine
and finance consolidated operating losses.  During the first six months of 1998,
the Company completed the construction of and opened five new Koo Koo Roo
restaurants.  In addition, as of June 30, 1998, three Koo Koo Roo restaurants
were in various stages of construction and the Company had signed leases for two
other locations.

     Net cash used in operating activities amounted to $3,927,231 during the six
months ended June 30, 1998, compared to $3,032,786 for the same period in 1997.
The increase in net cash used in operating activities was primarily due to
reductions in accrual liabilities related to store closings and discontinued
operations.

     Net cash used in investing activities, including purchases of property and
equipment, together with costs for acquiring ground leases for certain
locations, amounted to $1,641,973 during the six months ended June 30, 1998.
Also included in investing activities were purchases and sales of marketable
securities which resulted in net funds provided of $3,372,233 during the six
months ended June 30, 1998

     Net cash, provided by financing activities amounted to $3,989,658 for the
six months ended June 30, 1998.  The Company received $1,000,000 from the
exercise of common stock options and warrants during the six months ended June
30, 1998 which were partially offset by cash dividends on preferred stock and
debt repayments.  In June 1998 the Company, through The Hamburger Hamlet Group,
Inc., received  $3,000,000 in loan proceeds from FRI in connection with the
proposed merger.

     At June 30 1998, management has provided a 100% valuation allowance against
the net deferred tax assets represented primarily by its net operating loss
carry forwards.  Such allowance was necessary because the Company was not able
to determine that it was more likely than not that the net deferred tax asset
would be realized.

     CAPITAL RESOURCES

     Concurrent with the signing of the merger agreement, FRI provided a
$3,000,000 loan to The Hamlet Group, Inc., a wholly-owned subsidiary of the
Company.  The note provides for quarterly interest payments at the prime rate
and is collateralized by certain assets of The Hamlet Group, Inc.  Assuming the
proposed merger with FRI is approved, the note is due June 9, 2000.  In the
event the merger is terminated, depending on the reasons therefor, the note is
due on either June 9, 1999, or no later than sixty days after the termination of
the merger agreement.

     In August 1997, the Company issued $12,000,000 aggregate principal amount
of Senior Notes due August 2000 (the "Senior Notes") to an institutional
investor in a private placement.  The Senior Notes provide for interest at the
rate of 13% per annum payable quarterly.  The Senior Notes also included five-
year warrants to purchase 330,000 shares of the Company's Common Stock at a
price of $5.375 per share.  The Company is required to redeem $2,500,000
principal amount of the Senior Notes on February 28, 1999.  Mandatory
redemptions of the balance, prior to the due date of the Senior Notes, are only
required if there is a change of control, sale of securities resulting in
proceeds in excess of $20,000,000 or certain dispositions of assets as outlined
in the Senior Notes. The Company presently expects to repay the Senior Notes
with the closing of the proposed merger with FRI.


                                 Page 10 of 13
<PAGE>
 
ITEM 2.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
          AND RESULTS OF OPERATIONS - CONTINUED


    After giving effect to recent steps to slow the Company's development
program, management believes that the Company's existing capital resources will
be sufficient to fund its planned operations and growth for the next 12 months.
The Company's short and long-term debt as of June 30, 1998 amounts to
$16,056,913.  Management estimates that capital expenditures will approximate
$2,890,000 to $3,240,000 for stores under construction, plus new locations
planned for the remainder of 1998.

     The timing of future capital requirements will be affected by, among other
things, the number of stores opened, operational results, real estate
development, and other potential corporate opportunities. In the ordinary course
of its business, the Company regularly investigates and enters into negotiations
related to business opportunities. Subject to the consummation of the proposed
merger with FRI, the Company may seek additional funds from public or private
offerings of debt or equity, or may seek bank financing facilities or other
strategic alternatives.

     The Company is in the process of determining what, if any, steps have to be
taken to cure any potential computer software problems associated with the year 
2000. Based on preliminary discussions with the Company's software vendors, the 
Company has determined that it will not incur any material liability to upgrade 
computer programs to accommodate the year 2000.


                                 Page 11 of 13
<PAGE>
 
                           PART II. OTHER INFORMATION
                           --------------------------

ITEM 1.  LEGAL PROCEEDINGS.

     The Company has become subject to various lawsuits, claims and other legal
matters in the ordinary course of conducting its business.  As of the date of
this Report, management believes that there are no legal proceedings pending
which, if determined adversely to the Company, would be expected to have a
material adverse effect on the Company's consolidated financial position and
results of operations.

ITEM 2.  CHANGES IN SECURITIES.

     During the six months ended June 30, 1998, 175,342 shares of the Company's
5% Series A Adjustable Convertible Preferred Stock were converted into 4,474,210
shares of the Company's Common Stock for no additional consideration, pursuant
to the terms thereof.  In addition, 200,861 shares of the Company's 6% Series B
Adjustable Convertible Preferred Stock were converted into 20,120,281 shares of
the Company's Common Stock for no additional consideration, pursuant to the
terms thereof. Since June 30, 1998 the Company issued 2,002,988 shares of common
stock relating to the conversion of 16,225 shares of the Company's 6% Series B
Adjustable, Convertible Preferred Stock. As of August 13, 1998, 700 shares of 6%
Series B Adjustable Convertible Preferred shares remain outstanding. The Company
also issued 1,120,414 shares of common stock in connection with the exercise of
previously issued options and warrants to purchase common stock.
 
    Such securities referenced under this Item 2 were issued in reliance upon
the exemption from the registration provided in Section 4(2) of the Securities
Act of 1933, as amended, and Regulation D promulgated thereunder.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.

       None

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

       In May 1998, the stockholders approved an amendment to the Company's
Certificate of Incorporation increasing the authorized common stock from 50
million to 75 million share  The Company received 32,741,532 votes in favor of
the amendment, 1,029,674 opposed and 143,239 abstained. 33,914,445 shares voted
or 72.17%.

ITEM 5.   OTHER INFORMATION.

       None

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

   (a)   EXHIBITS -

          2.1 Agreement and Plan of Merger, dated June 9, 1998, by and among
              Family Restaurants, Inc., FRI-Sub, Inc. and Koo Koo Roo, Inc.
         10.1 Stock Purchase Agreement, dated June 9, 1998, by and between FRI-
              MRD Corporation and Koo Koo Roo, Inc.
         10.2 Bridge Loan Agreement, dated June 9, 1998, among The Hamburger
              Hamlet Group, Inc. as borrower, Koo Koo Roo, Inc., H.H.K. of
              Virginia, Inc. and H.H. of Maryland, Inc., as Guarantors and FRI-
              MRD Corporation as lender.
         27.1 Financial Data Schedule.

   (b)   REPORTS ON FORM 8-K - filed during the quarter ended June 30, 1998.

         -    Current report on Form 8-K, filed April 3, 1998, incorporating the
              Company's press release regarding the appointment of new officers
              and changes to the Company's Board of Directors.

         -    Current report on Form 8-K, filed June 11, 1998, incorporating the
              Company's press release regarding the definitive merger agreement
              entered into with Family Restaurants, Inc.


                                 Page 12 of 13
<PAGE>
 
                                   SIGNATURES
                                   ----------

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

                                    KOO KOO ROO, INC.



Date:  August 14, 1998              /s/ William M. McKay
                                    --------------------------
                                    William M. McKay
                                    Chief Financial Officer



Date:  August 14, 1998              /s/ Jeanne Giles
                                    --------------------------
                                    Jeanne Giles
                                    Principal Accounting Officer


                                 Page 13 of 13