SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 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 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

 

FRIENDLY ICE CREAM CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

 

(413) 731-4000

(Registrant’s Telephone Number, Including Area Code)

 

Not Applicable

(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 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 o

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

 

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

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

 

 

PART I — FINANCIAL INFORMATION

Item 1.  Financial Statements

FRIENDLY ICE 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 accompanying notes are an integral part of these condensed consolidated financial statements.

 

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FRIENDLY ICE CREAM CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED 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 accompanying notes are an integral part of these condensed consolidated financial statements.

 

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FRIENDLY ICE CREAM CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED 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 accompanying notes are an integral part of these condensed consolidated financial statements.

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FRIENDLY ICE CREAM CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. NATURE OF OPERATIONS

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

References herein to “Friendly’s” or the “Company” refer to Friendly Ice Cream Corporation, its predecessor and its consolidated subsidiaries; references herein to “FICC” refer to Friendly Ice Cream Corporation and not its subsidiaries; and as used herein, “Northeast” refers to the 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 and franchised units:

 

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2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

Interim Financial Information —

The accompanying condensed consolidated financial statements as of April 1, 2007 and for the three months ended April 1, 2007 and April 2, 2006 are unaudited, but have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.  In the opinion of management, all adjustments which are necessary for a fair presentation of the consolidated financial position, results of operations, cash flows and comprehensive loss of the Company have been included. Such adjustments consist solely of normal recurring accruals. Operating results for the three month periods ended April 1, 2007 and April 2, 2006 are not necessarily indicative of the results that may be expected for the entire year due, in part, to the seasonality of the Company’s business. Historically, higher revenues and operating income have been experienced during the second and third fiscal quarters. The Company’s consolidated financial statements, including the notes thereto, which are contained in the 2006 Annual Report on Form 10-K for the fiscal year ended December 31, 2006 as amended (“2006 Annual Report on Form 10-K/A”) should be read in conjunction with these condensed, consolidated financial statements. Capitalized terms not otherwise defined herein should be referenced to the 2006 Annual Report on Form 10-K/A.

Use of Estimates in the Preparation of Financial Statements —

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. The critical accounting policies and most significant estimates and assumptions relate to revenue recognition, insurance reserves, recoverability of accounts receivable and notes receivable, pension and post-retirement medical and life insurance benefits expense, asset impairment analysis, income tax valuation allowances and tax contingency reserves. Actual amounts could differ significantly from the estimates.

Inventories —

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

 

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Other Accrued Expenses —

Other accrued expenses consisted of the following at April 1, 2007 and December 31, 2006 (in thousands):

 

Income Taxes —

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

As of December 31, 2006 the Company remained in a three-year cumulative loss position and expected to record valuation allowances on future tax benefits until it can sustain an appropriate 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 a loss for income tax purposes. As a result, the valuation allowances as of December 31, 2006 of $27,429,000 reduced the carrying value of net deferred tax assets to $928,000. Should the Company’s future profitability provide sufficient evidence, in accordance with SFAS No. 109, to support the ultimate realization of income tax benefits attributable to net operating loss (“NOL”) and credit carryforwards and other deductible temporary differences, a reduction in the valuation allowance may be recorded and the carrying value of deferred tax assets may be restored, resulting in a non-cash credit to earnings.

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Lease Guarantees and Contingencies —

Primarily as a result of the Company’s strategy to sell Company-operated restaurants to franchisees, the Company remains liable for certain lease assignments and guarantees. These leases have varying terms, the latest of which expires in 2020. As of April 1, 2007, the potential amount of undiscounted payments the Company could be required to make in the event of non-payment by the primary lessees was $6,203,000. The present value of these potential payments discounted 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 franchisees that would put them in default of their franchise agreement in the event of non-payment under the lease. The Company believes these cross-default provisions significantly reduce the risk that the Company will be required to make payments under these leases and, historically, the Company has not been required to make such payments. Accordingly, no liability has been recorded for exposure under such leases at April 1, 2007 and December 31, 2006.

Net Loss Per Share —

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

Stock-Based Compensation —

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

On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“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 income statement based on their fair values at the date of grant. Pro forma disclosure is no longer an alternative.

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

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3. STOCK BASED COMPENSATION

Equity Compensation Plans —

The Company currently grants stock awards under the following equity compensation plans:

1997 Stock Option Plan (“1997 Plan”) - The 1997 Plan was adopted by the Company’s Board of Directors and stockholders in November 1997 and was subsequently amended on March 27, 2000 and October 24, 2001. Under the 1997 Plan, the Company’s Board of Directors may grant options to purchase up to 1,034,970 shares of common stock to employees, executive officers and directors. The 1997 Plan provides for the issuance of nonqualified stock options and incentive stock options (which are intended to satisfy the requirements of Section 422 of the Internal Revenue Code) and stock appreciation rights (“SARs”). The Compensation Committee of the Board of Directors determines the employees who will receive awards under the 1997 Plan and the terms of such awards. The exercise price of a stock option or SAR granted or awarded under the 1997 Plan may not be less than the fair market value of one share of common stock on the date the stock option or SAR is granted.

The 2003 Equity Incentive Plan (the “2003 Incentive Plan”) - On April 9, 2003, the Board of Directors adopted an equity incentive plan, which was approved by shareholders on May 14, 2003. On May 10, 2006, the shareholders approved an amendment to the 2003 Incentive Plan to increase the number of shares of common stock reserved for issuance under the 2003 Incentive Plan from 307,000 to 607,000 shares. The 2003 Incentive Plan provides for the issuance of nonqualified stock options and incentive stock options (which are intended to satisfy the requirements of Section 422 of the Internal Revenue Code), SARs, bonus stock, stock units, performance shares, performance units, restricted stock and restricted stock units. The Compensation Committee of the Board of Directors determines the employees who will receive awards under the 2003 Incentive Plan and the terms of such awards.  The exercise price of a stock option or SAR granted or awarded under the 2003 Incentive Plan may not be less than the fair market value of one share of common 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 Company granted Mr. Condos stock options to purchase an aggregate of 75,000 shares of the Company’s common stock, at an exercise price of $11.80 per share (equal to the closing price of the Company’s common stock on the American Stock Exchange on the date of grant).  These stock options were granted outside of any of the Company’s equity incentive and stock option plans, pursuant to an exemption from stockholder approval set forth in Section 711 of the American Stock Exchange Company Guide.  The stock options vest in three equal annual installments and expire five years after the date of grant.

Options issued pursuant to the 1997 Plan and the 2003 Incentive Plan generally vest over three years, and have a five year expiration date.

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Grant-Date Fair Value —

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

 

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

Expected life — the Company uses historical employee exercise and option expiration data to estimate the expected life assumption for the Black-Scholes grant-date valuation. The Company believes that this historical data is currently the best estimate of the expected life of a new option.

Expected volatility — the Company is responsible for estimating volatility and has used historical volatility to estimate the grant-date fair value of stock options. Management considered the guidance in SFAS No. 123R and believes that the historical estimated volatility is materially indicative of expectations about future volatility.

Expected dividend yield — the Company has not paid any dividends in the last five years and currently intends to retain any earnings to finance future growth and, therefore, does not anticipate paying any cash dividends on its common stock in the foreseeable future.

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Expense —

The Company used the straight-line attribution method to recognize expense for all options granted. Stock-based compensation is included in general and administrative expenses in the accompanying condensed consolidated statements of operations.

The amount of stock-based compensation recognized during a period is based on the value of the portion of the awards that are ultimately expected to vest. SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. 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’s former President and Chief Executive Officer, resigned.  As of December 31, 2006, the Company adjusted its stock compensation expense to reflect his forfeitures.  The Company currently expects, based on an analysis of its historical forfeitures, that approximately 95% of its options will actually vest and therefore has applied an annual forfeiture rate of 5% to options granted as of April 1, 2007. This analysis will be re-evaluated quarterly and the forfeiture rate will be adjusted as necessary. Ultimately, the actual expense recognized over the vesting period will only be for those shares that vest.

Option Activity —

A summary of the stock option activity under the Company’s equity compensation plans as of April 1, 2007 and changes during the three-month period then ended is 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

 

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

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

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Restricted Stock and Restricted Stock Unit Activity —

On December 2, 2005, 30,000 restricted stock units were issued to directors with a weighted average fair value of $8.90 at grant date.  On November 1, 2006, 30,000 restricted stock units were issued to directors with a weighted average fair value of $10.61 at grant date.  The restricted stock units were issued pursuant to and subject to the terms of the Company’s 2003 Incentive Plan.  Subject to the terms of the 2003 Incentive Plan, each restricted stock unit provides the holder with the right to receive one share of Common Stock of the Company when the restrictions lapse or vest. The restricted stock units granted to the directors vest three years after the date of grant if the recipient is a member of the Company’s Board of Directors on such date, subject to accelerated vesting in the event of a change in control or the director’s death, disability or retirement.

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

On February 28, 2007 the Compensation Committee determined that the Company exceeded the threshold EBITDA for fiscal 2006, and awarded shares of restricted Common Stock under the Company’s 2003 Incentive Plan to each of the officers named below.  The number of shares of restricted Common Stock issued to each officer listed below was determined by dividing the officer’s 2006 Award Value (set forth below) by 90% of the closing price of the Company’s Common Stock on the date of grant as reported on the American Stock Exchange.  25% of the shares of restricted Common Stock issued to each officer were fully vested upon issuance.  The remaining 75% of the shares of restricted Common Stock will vest in three equal annual installments following issuance if the officer remains employed by the Company.  The unvested shares will also fully vest upon a change in control, as provided in the 2003 Incentive Plan.

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

 

During the three months ended April 1, 2007 and April 2, 2006, stock-based compensation cost of $81,560 and $21,894, respectively, was recorded related to the restricted stock units and shares of restricted Common Stock issued pursuant to the long-term incentive plan for fiscal 2006.  As of April 1, 2007, there was $788,560 of total unrecognized compensation cost related to unvested restricted stock units and shares of restricted Common Stock.  That cost is expected to be recognized over a weighted-average period of 2.45 years.

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2007 Long-Term Incentive Plan

On February 28, 2007 the Compensation Committee approved a long-term incentive plan for fiscal 2007 under the Company’s 2003 Incentive Plan, pursuant to which the Compensation Committee established target EBITDA levels for the Company for fiscal 2007 and target awards for each officer named below based on a percentage (ranging from 50% to 100%) of each officer’s base salary.  The actual awards for each officer are payable in shares of restricted stock (representing approximately two-thirds of the value of the target award) and stock options to purchase shares of Common Stock (representing approximately one-third of the value of the target award).

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

The following table sets forth the range of 2007 Award Values each officer may receive under the long-term incentive plan for fiscal 2007:

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

 

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

If Award Shares are issued to the officer, 25% of the shares of restricted Common Stock issued to each officer will be fully vested upon issuance. The remaining 75% of the shares of restricted Common Stock will vest in three equal annual installments following issuance if the officer remains employed by the Company.  The unvested shares will also fully vest upon a change in control, as provided in the 2003 Incentive Plan.

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

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4. EMPLOYEE BENEFIT PLANS

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

 

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

 

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5. ASSET IMPAIRMENT AND DISCONTINUED OPERATIONS

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

In accordance with SFAS No. 144, the results of operations of the eight properties that were disposed of during 2006 and any related net gain on the disposals, as well as the results of operations of three properties held for sale at April 1, 2007 were reported separately as discontinued operations in the accompanying condensed consolidated statements of operations for the three months ended April 1, 2007 and April 2, 2006.

During 2006, the Company closed one restaurant and committed to a plan to sell that restaurant.  At April 1, 2007, this property met the criteria for “held for sale” as defined in SFAS No. 144.  The results of operations associated with this restaurant were not material and therefore were reported within continuing operations in the accompanying condensed consolidated statements of operations for all periods presented.

For the three months ended April 1, 2007 and April 2, 2006, these discontinued results consisted of the following (in thousands):

 

The table below identifies the components of the “Loss on disposals of other property and equipment, net” as shown in the accompanying condensed consolidated statements of operations (in thousands):

 

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

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6. INCOME TAXES

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

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

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

The Company recognizes potential accrued interest and penalties related to unrecognized tax benefits within its operations as income tax expenses. As of the date of implementation of FIN 48, the Company had approximately $580,000 accrued for interest and penalties. To the extent interest and penalties are not assessed with respect to uncertain tax positions, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision.

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

7. SEGMENT REPORTING

Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision-maker, or decision-making group, in deciding how to allocate resources and in assessing performance. The Company’s operating segments include restaurant, foodservice and franchise. The revenues from these segments include both sales to unaffiliated customers and intersegment sales, which generally are accounted for on a basis consistent with sales to unaffiliated customers. Intersegment sales and other intersegment transactions have been eliminated in the accompanying consolidated financial statements.

The Company’s restaurants target families with children and adults who desire a reasonably-priced meal in a full-service setting. The Company’s menu offers a broad selection of freshly-prepared foods which appeal to customers throughout all dayparts. The menu currently features over 100 items comprised of a broad selection of breakfast, lunch, dinner and afternoon and evening snack items. The Company’s foodservice operations manufactures premium ice cream dessert products and distributes such manufactured products and purchased finished goods to Company-operated and franchised restaurants. Additionally, it sells premium ice cream dessert products to distributors and retail locations. The Company’s franchise segment includes a royalty based on franchise restaurant revenue. In addition, the Company receives rental income from various franchised restaurants. The Company does not allocate general and administrative expenses associated with its headquarters operations to any business segment. These costs include expenses of the following functions: legal, accounting, personnel not directly related to a segment, information systems and other headquarter activities.

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The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies except that the financial results for the foodservice operating segment, prior to intersegment eliminations, have been prepared using a management approach, which is consistent with the basis and manner in which the Company’s management internally reviews financial information. Using this approach, the Company evaluates performance based on stand-alone operating segment income (loss) before income taxes and generally accounts for intersegment sales and transfers as if the sales or transfers were to third parties, that is, at current market prices.

Adjusted EBITDA represents net income (loss) from continuing operations before (i) (provision for) benefit from income taxes, (ii) interest expense, net, (iii) depreciation and amortization, (iv) write-downs of property and equipment, (v) net periodic pension cost and (vi) other non-cash items. Adjusted EBITDA is a non-GAAP financial measure.  The Company has included information concerning adjusted EBITDA in this Form 10-Q because the Company’s management incentive plan pays bonuses based on achieving operating segment adjusted EBITDA targets and the Company believes that such information is used by certain investors as one measure of a company’s historical ability to service debt. Adjusted EBITDA should not be considered as an alternative to, or more meaningful than, earnings (loss) from continuing operations or other traditional indications of the Company’s operating performance.

Due to a reorganization of the finance group, positions within the foodservice accounting department were absorbed by various corporate finance departments.  The costs related to those positions are now included in general and administrative corporate expenses.  Results for the three months ended April 2, 2006 have been restated accordingly.  Adjusted EBITDA and loss from continuing operations before benefit from income taxes have been restated to remove the costs associated with this department of $120,000 during the three month period ended April 2, 2006.

 

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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	)

 

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		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 obligation related to its $175 million of 8.375% senior notes (the “Senior Notes”) is guaranteed fully and unconditionally by one of FICC’s wholly owned subsidiaries. There are no restrictions on FICC’s ability to obtain dividends or other distributions of funds from this subsidiary, except those imposed by applicable law. The following supplemental financial information sets forth, on a condensed consolidating basis, balance sheets, statements of operations and statements of cash flows for FICC (the “Parent Company”), Friendly’s Restaurants Franchise, LLC (the “Guarantor Subsidiary”) and Friendly’s International, 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 with separate creditors which will be entitled to be satisfied out of the LLCs’ assets. Separate complete financial statements and other disclosures of the Guarantor Subsidiary as of April 1, 2007 and December 31, 2006 and for the three months ended April 1, 2007 and April 2, 2006 were not presented because management has determined that such information is not material to investors.

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

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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

 

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Supplemental Condensed Consolidating Statement of Operations
For the Three Months Ended April 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	)

 

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