10-Q 1 frd2q200110-q.txt FRD ACQUISITION CO. SECOND QUARTER 2001 10-Q UNITED STATES 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 June 27, 2001, 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 333-07601 FRD ACQUISITION CO. -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 57-1040952 ------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 3355 Michelson Dr., Suite 350 Irvine, California 92612 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (864) 597-8000 -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) -------------------------------------------------------------------------------- (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 [ ] As of August 10, 2001, 1,000 shares of the registrant's Common Stock, $0.10 par value per share, were outstanding, all of which were owned by the registrant's parent, Advantica Restaurant Group, Inc. 1 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS FRD Acquisition Co. Debtor-In-Possession Consolidated Statements of Operations (Unaudited)

See accompanying notes 2 FRD Acquisition Co. Debtor-In-Possession Consolidated Statements of Operations (Unaudited)

See accompanying notes 3 FRD Acquisition Co. Debtor-In-Possession Condensed Consolidated Balance Sheets (Unaudited)

See accompanying notes 4 FRD Acquisition Co. Debtor-In-Possession Consolidated Statements of Cash Flows (Unaudited)

See accompanying notes 5 FRD ACQUISITION CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 27, 2001 (Unaudited) Note 1. BASIS OF PRESENTATION FRD Acquisition Co. ("FRD" or, together with its subsidiaries, the "Company"), a wholly owned subsidiary of Advantica Restaurant Group, Inc. ("Advantica"), owns and operates the Coco's and Carrows restaurant brands. The consolidated financial statements of the Company included herein are unaudited and include all adjustments management believes are necessary for a fair presentation of the results of operations for such interim periods. Excluding reorganization items recorded in the quarter and two quarters ended June 27, 2001, all such adjustments are of a normal and recurring nature. The interim consolidated financial statements should be read in conjunction with the Consolidated Financial Statements and notes thereto for the year ended December 27, 2000 and the related Management's Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in the FRD Acquisition Co. 2000 Annual Report on Form 10-K. The results of operations for the quarter and two quarters ended June 27, 2001 are not necessarily indicative of the results for the entire fiscal year ending December 26, 2001. On February 14, 2001 (the "Petition Date"), FRD filed a voluntary petition for relief under Chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code") in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court"), Case No. 01-0436 PJW, to facilitate the divestiture of its Coco's and Carrows brands and to preserve their going concern value. None of the Company's operating subsidiaries are a party to or are included in these Chapter 11 proceedings. FRD is currently operating its business as a debtor-in-possession pursuant to Sections 1107(a) and 1108 of the Bankruptcy Code and subject to the jurisdiction of the Bankruptcy Court. The financial statements of the Company have been prepared on a going concern basis, which contemplates the continuity of operations, the realization of assets and the satisfaction of liabilities and commitments in the ordinary course of business. The Company's Consolidated Financial Statements for the year ended December 27, 2000 and the quarter and two quarters ended June 27, 2001 have been presented in conformity with the American Institute of Certified Public Accountants' Statement of Position 90-7, "Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" ("SOP 90-7"). In accordance with SOP 90-7, all prepetition liabilities of FRD that are subject to compromise through this bankruptcy proceeding are segregated in the Company's Consolidated Balance Sheets as liabilities subject to compromise (see Note 3). These liabilities are recorded at the amounts expected to be allowed as claims by the Bankruptcy Court rather than estimates of the amounts for which those allowed claims may be settled as a result of any plan of reorganization approved by the Bankruptcy Court. In addition, SOP 90-7 requires the Company to report interest expense during the bankruptcy proceeding only to the extent that it will be paid during the proceedings or that it is probable to be an allowed priority, secured or unsecured claim. Accordingly, the Company has ceased recording interest on its 12.5% Senior Notes due 2004 (the "Senior Notes"). The contractual interest expense for the quarter and two quarters ended June 27, 2001 is disclosed in the accompanying Consolidated Statements of Operations. The accompanying Consolidated Financial Statements include the accounts of the operating subsidiaries of the Company which are not a party to the previously described Chapter 11 proceedings. The following condensed financial statements of FRD have been prepared using the equity method of accounting for reporting the results of all wholly owned subsidiaries of FRD that are not a party to such Chapter 11 proceedings. 6 FRD Acquisition Co. (Debtor-In-Possession) Condensed Statements of Operations

FRD Acquisition Co. (Debtor-In-Possession) Condensed Balance Sheets

Note 2. BANKRUPTCY PROCEEDINGS FRD's Chapter 11 filing is intended to preserve and maximize the going concern value of FRD's operating subsidiaries by allowing them to continue to operate in the ordinary course of business, without the need to commence Chapter 11 cases of their own. The events leading to FRD's Chapter 11 filing include the continued deterioration of the performance of FRD's operating subsidiaries due to increased competition, outdated facilities and unfavorable industry trends. In addition, FRD failed to make the scheduled January 16, 2001 interest payment due (and all subsequent interest payments to date) on its prepetition Senior Notes. The 30-day grace period provided by the indenture governing the Senior Notes' interest payments expired on February 15, 2001, the day after FRD filed its voluntary Chapter 11 petition. These matters raise substantial doubt about FRD's ability to continue as a going concern. FRD's continued existence is dependent upon several factors including its ability to sell its operating subsidiaries or restructure its liabilities through the bankruptcy process. In connection with this process, FRD is consulting with the official committee of unsecured creditors that has 7 been formed and Denny's, Inc. (another wholly owned subsidiary of Advantica) as the senior secured lender under the Coco's/Carrows Credit Facility (see Note 5). Shortly before the filing date, FRD received preliminary proposals from several interested parties related to a sale of the stock of FRD's subsidiaries. FRD has actively continued the sale process post-petition with the goal of maximizing value to creditors. The process has taken longer than expected, due in part to procedural and legal constraints inherent in the bankruptcy filing. FRD and its subsidiaries intend to consummate a sale transaction or restructuring without the need for the operating subsidiaries to also commence Chapter 11 cases. No assurance can be given, however, that FRD's subsidiaries will not be required to commence Chapter 11 cases in the future. FRD's subsidiaries have entered into an agreement pursuant to which they will fund the expenses incurred by FRD in connection with the Chapter 11 case including, but not limited to, fees and expenses of counsel and advisors for FRD and any official committee appointed in the Chapter 11 case. Pursuant to Section 362 of the Bankruptcy Code, the commencement of FRD's Chapter 11 case operates as an automatic stay of the following: (1) commencement or continuation of a judicial, administrative or other proceeding against FRD that was or could have been commenced prior to commencement of the Chapter 11 case; (2) enforcement of any judgments against FRD that arose before the commencement of the Chapter 11 case; (3) the taking of any action to obtain possession of or to exercise control over FRD's property; (4) the creation, perfection or enforcement of any lien against FRD's property; (5) the taking of any action to collect, assess or recover a claim against FRD that arose prior to the commencement of the Chapter 11 case; or (6) the setoff of any debt owing to FRD that arose prior to commencement of the Chapter 11 case against a claim held by such creditor of or party-in-interest against FRD that rose before the commencement of the Chapter 11 case. Any entity may apply to the Bankruptcy Court for relief from the automatic stay to allow enforcement of any of the aforesaid remedies that are automatically stayed by operation of law at the commencement of the Chapter 11 case. Although FRD is authorized to operate its business as a debtor-in-possession, it may not engage in transactions outside the ordinary course of business without first complying with the notice and hearing provisions of the Bankruptcy Code and obtaining Bankruptcy Court approval. Other parties-in-interest in the Chapter 11 case are also entitled to be heard on motions made in the Chapter 11 case, including motions for approval of transactions outside the ordinary course of business. Note 3. LIABILITIES SUBJECT TO COMPROMISE Liabilities subject to compromise are obligations which were outstanding on the Petition Date and include the following:

8 Note 4. REORGANIZATION ITEMS Reorganization items included in the accompanying Consolidated Statements of Operations consist of the following items: Quarter Two Quarters Ended Ended JUNE 27, 2001 JUNE 27, 2001 ------------- ------------- (In thousands) Professional fees $ 3 $ 736 Financing expenses for the debtor-in-possession -- 208 Interest income (99) (207) ----- ----- $ (96) $ 737 ===== ===== Note 5. DEBT As discussed in Note 2, on January 16, 2001, FRD elected not to make the interest payment due and payable with respect to the Senior Notes. As a result of this nonpayment, and as a result of FRD's Chapter 11 filing on February 14, 2001, FRD is in default under the indenture governing the Senior Notes. The Senior Notes are included in liabilities subject to compromise in the Consolidated Balance Sheets. As described in more detail in Note 2, the bankruptcy filing operates as an automatic stay of all collection and enforcement actions by the holders of the Senior Notes with respect to FRD's failure to make the interest payments when due. Certain of FRD's operating subsidiaries have a $70 million senior secured credit facility (the "Coco's/Carrows Credit Facility") owed to Denny's, Inc., consisting of a $30 million term loan and a $40 million revolving credit facility. On February 14, 2001, to facilitate the divestiture of its Coco's and Carrows brands and to preserve their going concern value, FRD filed for protection under Chapter 11 of the Bankruptcy Code. At June 27, 2001, FRD's operating subsidiaries had $30 million outstanding term loan borrowings, working capital borrowings of $24.7 million and letters of credit outstanding of $11.4 million. FRD's operating subsidiaries were not in compliance with certain financial covenants under the Coco's/Carrows Credit Facility for the quarter ended June 27, 2001, and therefore, the debt to Denny's, Inc. is classified as a current liability. Note 6. RELATED PARTY TRANSACTIONS Certain administrative functions are provided for the Company by Advantica. The Company is allocated a portion of Advantica's administrative expenses based upon services received. These allocations, which are in addition to management fees equal to one percent of revenues payable to Advantica under the management services agreement, are included in operating expenses and totaled $0.6 million and $1.2 million for the quarter and two quarters ended June 27, 2001 and $0.6 million and $1.3 million for the quarter and two quarters ended June 28, 2000, respectively. Payment of the fees to Advantica cannot occur unless certain financial targets are met as described in FRD's Senior Notes indenture and in the Coco's/Carrows Credit Facility. Advantica's method of allocating these expenses is not the only reasonable method and other reasonable methods of allocation might produce different results. For other related party transactions between FRD and Advantica or Advantica's wholly owned subsidiaries, see Notes 3 and 5. Note 7. EARNINGS (LOSS) PER COMMON SHARE As described in Note 1, FRD is a wholly owned subsidiary of Advantica. Accordingly, per share data is not meaningful and has been omitted for all periods. 9 Note 8. SEGMENT INFORMATION The Company operates two restaurant concepts -- Coco's and Carrows -- and each concept is considered a reportable segment. Administrative costs of the corporate headquarters have been allocated to the reportable segments primarily on the basis of percentage of sales. The Company evaluates performance based on several factors, of which the primary financial measure is business segment operating income before interest, taxes, depreciation, amortization, management fees to Advantica and restructuring and impairment charges ("EBITDA as defined"). EBITDA as defined is a key internal measure used to evaluate the amount of cash flow available for debt repayment and funding of additional investments. EBITDA as defined is not a measure defined by generally accepted accounting principles and should not be considered as an alternative to net income or cash flow data prepared in accordance with generally accepted accounting principles. The Company's measure of EBITDA as defined may not be comparable to similarly titled measures reported by other companies.

Note 9. NEW ACCOUNTING STANDARDS In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations." SFAS 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method. The Company does not believe that the adoption of SFAS 141 will have a significant impact on its financial statements. Also in July 2001, the FASB issued Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets," which will be effective for the Company beginning December 27, 2001, the first day of its 2002 fiscal year. SFAS 142 requires the Company, among other things, to discontinue goodwill amortization, including reorganization value in excess of amounts allocable to identifiable assets. In addition, the standard provides for reclassifying certain existing recognized intangibles as goodwill, reassessing the useful lives of existing recognized intangibles, reclassifying certain intangibles out of previously reported goodwill and identifying reporting units for purposes of assessing potential future impairments of goodwill. SFAS 142 also requires the Company to complete a transitional goodwill impairment test six months from the date of adoption. The Company is currently assessing but has not yet determined the impact of SFAS 142 on its financial position and results of operations. 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion is intended to highlight significant changes in financial position as of June 27, 2001 compared to December 27, 2000 and the results of operations for the quarter and two quarters ended June 27, 2001 compared to the quarter and two quarters ended June 28, 2000. The forward-looking statements included in Management's Discussion and Analysis of Financial Condition and Results of Operations, which reflect management's best judgment based on factors currently known, involve risks, uncertainties, and other factors which may cause the actual performance of FRD and its subsidiaries and underlying concepts to be materially different from the performance indicated or implied by such statements. Such factors include, among others: the outcome of FRD's pending Chapter 11 proceeding, divestiture efforts and related matters described herein; competitive pressures from within the restaurant industry; the level of success of the Company's operating initiatives and advertising and promotional efforts, including the initiatives and efforts specifically mentioned herein; adverse publicity; changes in business strategy or development plans; terms and availability of capital; regional weather conditions; overall changes in the general economy, particularly at the retail level; and other factors included in the discussion below, in Management's Discussion and Analysis of Financial Condition and Results of Operations contained in the Company's Annual Report on Form 10-K for the year ended December 27, 2000 and in Exhibit 99 thereto. RESULTS OF OPERATIONS QUARTER ENDED JUNE 27, 2001 COMPARED TO QUARTER ENDED JUNE 28, 2000 ------------------------------------------------------------------- The table below summarizes restaurant unit activity for the quarter ended June 27, 2001:

11 COCO'S

Coco's NET COMPANY SALES for the second quarter of 2001 decreased $4.1 million (7.8%) compared to the prior year quarter, primarily resulting from a 6.5% decrease in same-store sales. Lower same-store sales resulted from a decrease in customer traffic partially offset by a higher guest check average. FRANCHISE AND LICENSING REVENUE remained relatively flat compared to the prior year quarter. Coco's OPERATING EXPENSES decreased $3.3 million (6.0%) compared to the prior year quarter. Excluding the impact of a $2.5 million decrease in amortization of excess reorganization value, operating expenses decreased $0.8 million over the prior year quarter. This decrease resulted primarily from lower same-store sales. As a percentage of sales, operating expenses increased primarily due to higher payroll costs resulting from staffing requirements and wage rate pressures and to increased utility costs. In addition, the prior year quarter also benefited from $1.5 million of reductions in workers' compensation and general liability accruals resulting from improved actuarial trends. The decrease in amortization of excess reorganization value from the prior year quarter resulted from an impairment charge to excess reorganization value recorded in the fourth quarter of 2000. EBITDA AS DEFINED decreased $3.3 million (52.4%) compared to the prior year quarter as a result of the factors noted in the preceding paragraphs, excluding the decrease in amortization expense. Coco's OPERATING LOSS increased $0.9 million compared to the prior year quarter as a result of the factors noted above. 12 CARROWS

Carrows' NET COMPANY SALES for the second quarter of 2001 decreased $1.7 million (4.3%) compared to the prior year quarter. The decrease is primarily the result of a decrease in same-store sales. Lower same-store sales resulted from a decrease in customer traffic partially offset by a higher guest check average. FRANCHISE REVENUE remained flat compared to the prior year quarter. Carrows' OPERATING EXPENSES decreased $3.1 million (7.5%) compared to the prior year quarter. Excluding the impact of a $2.2 million decrease in amortization of excess reorganization value, operating expenses decreased $0.9 million over the prior year quarter. This decrease resulted primarily from lower same-store sales. As a percentage of sales, operating expenses increased primarily due to higher payroll costs resulting from staffing requirements and wage rate pressures and to increased utility costs. In addition, the prior year quarter benefited from $1.3 million of reductions in workers' compensation and general liability accruals and from a reduction of lease liabilities, offset by higher legal expense. The decrease in amortization of excess reorganization value from the prior year quarter resulted from an impairment charge to excess reorganization value recorded in the fourth quarter of 2000. EBITDA AS DEFINED decreased $1.7 million (37.8%) compared to the prior year quarter as a result of the factors noted in the proceeding paragraphs, excluding the decrease in amortization expense. Carrows' OPERATING LOSS decreased $1.4 million compared to the prior year quarter as a result of the factors noted above. FRD CONSOLIDATED The Company's CONSOLIDATED EBITDA AS DEFINED decreased $5.0 million (46.1%) for the second quarter of 2001 compared to the second quarter of 2000. This decrease is a result of the factors discussed in the preceding paragraphs. 13 CONSOLIDATED INTEREST EXPENSE, NET, decreased $4.5 million (68.8%) compared to the prior year quarter due primarily to the automatic stay of interest payments related to the bankruptcy proceedings. The PROVISION FOR (BENEFIT FROM) INCOME TAXES from continuing operations for the quarter ended June 27, 2001 has been computed based on management's estimate of the annual effective income tax rate applied to loss before taxes. The Company recorded an income tax provision reflecting an approximate rate of 2.2% for the quarter ended June 27, 2001 compared to a provision reflecting an approximate rate of 1.2% for the quarter ended June 28, 2000. The decrease in CONSOLIDATED NET LOSS of $5.0 million in comparison to the prior year quarter is a result of the items previously discussed. TWO QUARTERS ENDED JUNE 27, 2001 COMPARED TO TWO QUARTERS ENDED JUNE 28, 2000 ----------------------------------------------------------------------------- COCO'S

Coco's NET COMPANY SALES for the two quarters ended June 27, 2001 decreased $8.3 million (7.8%) compared to the prior year period, primarily resulting from a 6.5% decrease in same-store sales. Lower same-store sales resulted from a decrease in customer traffic partially offset by a higher guest check average. FRANCHISE AND LICENSING REVENUE decreased $0.2 million compared to the prior year period, primarily resulting from a weaker yen versus the dollar in the current year. Coco's OPERATING EXPENSES decreased $8.2 million (7.3%) compared to the prior year comparable period. Excluding the impact of a $5.0 million decrease in amortization of excess reorganization value, operating expenses decreased $3.2 million over the prior year period. The decrease resulted primarily from lower same-store sales. As a percentage of sales, operating expenses increased primarily due to higher payroll costs resulting from staffing requirements and wage rate pressures and to increased utility costs. In addition, the prior year period also benefited from $1.5 million of reductions in workers' compensation and general liability accruals resulting from improved actuarial trends. The 14 decrease in amortization of excess reorganization value from the prior year period resulted from an impairment charge to reorganization value recorded in the fourth quarter of 2000. EBITDA AS DEFINED decreased $5.2 million (44.1%) compared to the prior year period as a result of the factors noted in the preceding paragraphs, excluding the decrease in amortization expense. Coco's OPERATING LOSS increased $0.3 million compared to the prior year period as a result of the factors noted above. CARROWS

Carrows' NET COMPANY SALES for the two quarters ended June 27, 2001 decreased $2.7 million (3.5%) compared to the prior year period. The decrease is primarily the result of a decrease in traffic partially offset by a higher guest check average. FRANCHISE REVENUE remained flat compared to the prior year period. Carrows' OPERATING EXPENSES decreased $5.5 million (6.7%) compared to the prior year period. Excluding the impact of a $4.4 million decrease in amortization of excess reorganization value, operating expenses decreased $1.1 million over the prior year period. This decrease resulted primarily from lower same-store sales. As a percentage of sales, operating expenses increased primarily due to higher payroll costs resulting from staffing requirements and wage rate pressures and to increased utility costs. In addition, the prior year period benefited from $1.3 million of reductions in workers' compensation and general liability accruals resulting from improved actuarial trends. The decrease in amortization of excess reorganization value from the prior year period resulted from an impairment charge to reorganization value recorded in the fourth quarter of 2000. EBITDA AS DEFINED decreased $2.6 million (32.9%) compared to the prior year period as a result of the factors noted in the proceeding paragraphs, excluding the decrease in amortization expense. 15 Carrows' OPERATING LOSS decreased $2.8 million compared to the prior year period as a result of the factors noted above. FRD CONSOLIDATED The Company's CONSOLIDATED EBITDA AS DEFINED decreased $7.7 million (39.4%) for the two quarters ended June 27, 2001 compared to the prior year period. This decrease is a result of the factors discussed in the preceding paragraphs. CONSOLIDATED INTEREST EXPENSE, NET, decreased $6.7 million (51.8%) compared to the prior year period due primarily to the automatic stay of interest payments related to the bankruptcy proceedings. The PROVISION FOR (BENEFIT FROM) INCOME TAXES from continuing operations for the two quarters ended June 27, 2001 has been computed based on management's estimate of the annual effective income tax rate applied to loss before taxes. The Company recorded an income tax provision reflecting an approximate rate of 1.7% for the two quarters ended June 27, 2001 compared to a provision reflecting an approximate rate of 1.0% for the two quarters ended June 28, 2000. The decrease in CONSOLIDATED NET LOSS of $8.2 million in comparison to the prior year period is a result of the items previously discussed. LIQUIDITY AND CAPITAL RESOURCES On January 16, 2001, FRD elected not to make the interest payment due and payable with respect to its Senior Notes. As a result of this nonpayment, and as a result of FRD's Chapter 11 filing on February 14, 2001, FRD is in default under the indenture governing the Senior Notes (see Notes 2, 3 and 5). As described in more detail in Note 2, the bankruptcy filing operates as an automatic stay of all collection and enforcement actions by the holders of the Senior Notes with respect to FRD's failure to make the interest payments when due. FRD's Chapter 11 filing is intended to preserve and maximize the going concern value of FRD's operating subsidiaries by allowing them to continue to operate in the ordinary course of business, without the need to commence Chapter 11 cases of their own. The events leading to FRD's Chapter 11 filing include the continued deterioration of the performance of FRD's operating subsidiaries due to increased competition, outdated facilities and unfavorable industry trends. In addition, FRD failed to make the scheduled January 16, 2001 interest payment (and all subsequent interest payments to date) due on its prepetition Senior Notes. The 30-day grace period provided by the indenture governing the Senior Notes' interest payments expired on February 15, 2001, the day after FRD filed its voluntary Chapter 11 petition. These matters raise substantial doubt about FRD's ability to continue as a going concern. FRD's continued existence is dependent upon several factors including its ability to sell its operating subsidiaries or restructure its liabilities through the bankruptcy process. In connection with this process, FRD is consulting with the official committee of unsecured creditors that has been formed and Denny's, Inc. (another wholly owned subsidiary of Advantica) as the senior secured lender under the Coco's/Carrows Credit Facility (see Note 5). Shortly before the filing date, FRD received preliminary proposals from several interested parties related to a sale of the stock of FRD's subsidiaries. FRD has actively continued the sale process post-petition with the goal of maximizing value to creditors. The process has taken longer than expected, due in part to procedural and legal constraints inherent in the bankruptcy filing. FRD and its subsidiaries intend to consummate a sale transaction or restructuring without the need for the operating subsidiaries to also commence Chapter 11 cases. No assurance can be given, however, that FRD's subsidiaries will not be required to commence Chapter 11 cases in the future. Certain of FRD's operating subsidiaries have a $70 million senior secured credit facility (i.e., the Coco's/Carrows Credit Facility) owed to Denny's, Inc., consisting of a $30 million term loan and a $40 million revolving credit facility. On February 14, 2001, to facilitate the divestiture of its Coco's and Carrows brands and to preserve their going concern value, FRD filed for protection under Chapter 11 of the Bankruptcy Code. FRD's operating subsidiaries were not in compliance with certain financial covenants under the Coco's/Carrows Credit Facility for the quarter ended June 27, 2001, and therefore, the debt to Denny's, Inc. is classified as a current liability. 16 At June 27, 2001 and December 27, 2000, the Company had working capital deficits of $67.9 million and $69.2 million, respectively. The Company is able to operate with a substantial working capital deficit because: (1) restaurant operations are conducted on a cash (and cash equivalent) basis with a low level of accounts receivable, (2) rapid turnover allows a limited investment in inventories; and (3) accounts payable for food, beverages, and supplies usually become due after the receipt of cash from related sales. The Company intends to continue to operate with working capital deficits. IMPACT OF BANKRUPTCY PETITION ON FRANCHISING The operation of the Company's franchise system is subject to regulations enacted by a number of states and to rules promulgated by the Federal Trade Commission. Among other things, such regulations and rules require that each franchising entity annually renew its Uniform Franchise Offering Circular (the "UFOC") which provides current information about the business. In addition, in the event that any information in the UFOC becomes misleading, inaccurate or incomplete during the year, the UFOC must be amended at that time to make appropriate disclosures. In some states, the updated UFOC must be reviewed and approved by a regulatory agency before the entity can resume franchise sales. Due to the filing of FRD's Chapter 11 petition on February 14, 2001, management decided that it would be appropriate for the Company's franchising subsidiary to cease sales of new franchises until an updated UFOC is prepared and approved by those states that regulate the sale of franchises. NEW ACCOUNTING STANDARDS In July 2001, the FASB issued Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations." SFAS 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method. The Company does not believe that the adoption of SFAS 141 will have a significant impact on its financial statements. Also in July 2001, the FASB issued Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets," which will be effective for the Company beginning December 27, 2001, the first day of its 2002 fiscal year. SFAS 142 requires the Company, among other things, to discontinue goodwill amortization, including reorganization value in excess of amounts allocable to identifiable assets. In addition, the standard provides for reclassifying certain existing recognized intangibles as goodwill, reassessing the useful lives of existing recognized intangibles, reclassifying certain intangibles out of previously reported goodwill and identifying reporting units for purposes of assessing potential future impairments of goodwill. SFAS 142 also requires the Company to complete a transitional goodwill impairment test six months from the date of adoption. The Company is currently assessing but has not yet determined the impact of SFAS 142 on its financial position and results of operations. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's market risk exposure at June 27, 2001 is consistent with the types of market risk and amount of exposure presented in its Annual Report on Form 10-K for the year ended December 27, 2000. PART II - OTHER INFORMATION ITEM 3. DEFAULTS UPON SENIOR SECURITIES On January 16, 2001, FRD elected not to make the interest payment due and payable with respect to the Senior Notes. As a result of this and subsequent nonpayments on the Senior Notes, and as a result of FRD's Chapter 11 filing on February 14, 2001, FRD is in default under the indenture governing the Senior Notes. Therefore, the Senior Notes are included in liabilities subject to compromise in the Consolidated Balance Sheets. As described in more detail in Note 2, the bankruptcy filing operates as an automatic stay of all collection and enforcement actions by the holders of the Senior Notes with respect to FRD's failure to make the interest payments when due. 17 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. b. No reports on Form 8-K were filed during the quarter ended June 27, 2001. 18 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. FRD ACQUISITION CO. Date: August 13, 2001 By: /s/David O. Devoy ------------------------------------- David O. Devoy President and Chief Financial Officer (Duly authorized officer of registrant/principal financial officer)

FRD ACQUISITION CO 10-Q