| FRIENDLY ICE CREAM CORP Item 1A RISK FACTORS This report contains forward-looking statements that involve risks and uncertainties, such as statements of our objectives, expectations and intentions |
| The cautionary statements made in this report are applicable to all forward-looking statements wherever they appear in this report |
| Our actual results could differ materially from those discussed herein |
| Risk factors that could cause or contribute to such differences include those discussed below, as well as those discussed elsewhere in this report |
| We operate in a highly competitive business environment |
| The restaurant business is highly competitive and is affected by changes in the public’s eating habits and preferences, population trends and traffic patterns, as well as by local and national economic conditions affecting consumer spending habits, many of which are beyond our control |
| Key competitive factors in the industry are the quality and value of the food products offered, quality and speed of service, attractiveness of facilities, advertising, name brand awareness and image and restaurant location |
| Each of our restaurants competes directly or indirectly with locally owned restaurants as well as restaurants with national or regional images, and to a limited extent, restaurants operated by our franchisees |
| A number of our significant competitors are larger or more diversified and have substantially greater resources than we have |
| Our retail operations compete with national and regional manufacturers of premium ice cream desserts, many of which have greater financial resources and more established channels of distribution than ours |
| Key competitive factors in the retail food business include brand awareness, access to retail locations, price and quality |
| Increases in the prices of, or interruptions in the supply of, raw materials and other essential food supplies may increase the costs of our products, create shortages in the manufacturing of products or cause interruptions in the supply of products to our customers |
| The cost, availability and quality of the ingredients that we use to prepare our food are subject to a range of factors, including fluctuations in supply and demand and political and economic conditions, which are beyond our control |
| Our ability to maintain consistent quality throughout our restaurants depends in part upon our ability to acquire fresh food products and related items from reliable sources in accordance with our specifications |
| If these suppliers do not perform adequately or otherwise fail to distribute products or supplies to our restaurants, we may be unable to replace the suppliers in a short period of time on acceptable terms |
| The basic raw materials for the manufacture of our premium ice cream desserts are dairy products and sugar |
| Our purchasing department purchases other food products, such as coffee, in large quantities |
| We rarely hedge our positions in these commodities other than with respect to cream as a matter of policy, but may opportunistically purchase some of these items in advance of a specific need |
| As a result, we are subject to the risk of substantial and sudden price increases, shortages or interruptions in supply of such items, which could have a material adverse effect on our business |
| Increases in the price of cream have adversely affected our financial results in the past and may do so in the future because we may be unable to pass along all price increases |
| Increases in the prices of, or interruptions in the supply of, fuel may increase the costs of our products, or cause interruptions in the supply of products to our customers |
| Our private truck fleet delivers most of the product lines required to our Company-operated and franchised restaurants |
| We also distribute our packaged ice cream desserts to our retail customers |
| As a result, we are subject to the risk of substantial and sudden price increases, shortages or interruptions in the supply of fuel, which could have a material adverse effect on our business |
| 11 ______________________________________________________________________ Changes in consumer preferences and economic conditions could adversely affect our financial performance |
| Food service businesses are often affected by changes in consumer tastes, national, regional and local economic conditions, demographic trends, traffic patterns, the cost and availability of labor, purchasing power, availability of products and the type, number and location of competing restaurants |
| In addition, factors such as increased food, labor and benefits costs, regional weather conditions and the potential scarcity of experienced management and hourly employees may also adversely affect the food service industry in general and the results of our operations and financial condition in particular |
| In addition, purchases at our restaurants are discretionary for consumers and, therefore, we are susceptible to economic slowdowns |
| Consumers are generally more willing to make discretionary purchases during periods in which favorable conditions prevail |
| A general slowdown in the United States economy could adversely affect consumer confidence and spending habits, which could negatively impact our sales |
| Our business may be harmed by highly publicized incidents at one or more of our restaurants |
| Multi-unit food service businesses can be materially and adversely harmed by publicity resulting from poor food quality, illness, injury or other health concerns or employee relations or other operating issues stemming from one location or a limited number of locations, whether or not the company is liable, or from consumer concerns with respect to the nutritional value of certain food |
| In addition, we cannot guarantee that our internal controls and training will be fully effective in preventing all food-borne illnesses |
| Some food-borne illness incidents could be caused by third party food suppliers and transporters outside of our control |
| Any outbreak of such illness attributed to one or more of our restaurants or to a similar multi-unit restaurant chain, or the perception of such an outbreak, could harm our business |
| We may not be able to successfully continue the development and implementation of our franchising program |
| The success of our business strategy depends, in part, on the continued development and implementation of our franchising program |
| We can provide no assurance that we will be able to continue to successfully locate and attract suitable franchisees or that these franchisees will have the business abilities or sufficient access to capital to open restaurants or will operate restaurants in a manner consistent with the Friendly’s concept and standards or in compliance with franchise agreements |
| The success of our franchising program will also be dependent upon factors not within our control or the control of our franchisees, including the availability of suitable sites on acceptable lease or purchase terms, permitting and regulatory compliance and general economic and business conditions |
| In addition, even if our franchising program is successful, we can provide no assurance that it will prove advantageous to us from an operational standpoint |
| The interests of franchisees may conflict with our interests |
| For example, whereas franchisees are concerned with individual business strategies and objectives, we are responsible for ensuring the success of the entire range of our products and services |
| Finally, although we evaluate and screen potential franchisees, we can provide no assurance that franchisees will have the business acumen or financial resources necessary to operate successful franchises in their franchise areas |
| The failure of franchisees to operate successfully could have an adverse effect on our business, reputation and brand and our ability to attract prospective franchisees |
| Our operations are highly concentrated in the Northeast region |
| Approximately 97prca of Company-operated restaurants are located, and substantially all of our retail sales are generated, in the Northeast |
| As a result, a severe or prolonged economic recession or changes in demographic mix, employment levels, population density, weather, real estate market conditions or other factors specific to the Northeast may adversely affect our business more than certain of our competitors which are more geographically diverse |
| 12 ______________________________________________________________________ Our cash flows may fluctuate due to seasonality |
| Due to the seasonality of premium ice cream dessert consumption, and the effect from time to time of weather on patronage of our restaurants, our revenues and operating income are typically higher in the second and third quarters |
| This seasonality may adversely affect our cash flows |
| The locations where we have restaurants may cease to be attractive which could negatively affect our sales at these locations |
| The success of Company-operated and franchised restaurants is significantly influenced by location |
| Current locations may not continue to be as attractive as demographic patterns change |
| Likewise, we may face difficulties in acquiring new locations at reasonable costs |
| It is possible that the neighborhood or economic conditions where our restaurants are located could decline in the future, potentially resulting in reduced sales in those locations |
| Our franchisees and we may experience delays in restaurant openings, which could adversely affect our ability to increase revenues and profitability |
| Our franchisees and we have experienced delays in restaurant openings from time to time and may experience delays in the future |
| Delays in opening new restaurants in accordance with our current plans and the current plans of our franchisees could materially adversely affect our expected revenues and profitability |
| Our ability or the ability of our franchisees to open new restaurants will depend on a number of factors, some of which are beyond our control, including: · the availability of funding; · the identification and availability of suitable restaurant sites; · negotiation of favorable leases; · the timely development in certain cases of commercial, residential, street or highway construction near restaurants; · dependence on contractors to construct new restaurants in a timely manner; · management of construction and development costs of new restaurants; · securing required local, state and federal governmental approvals and permits; and · recruitment of qualified operating personnel |
| If our manufacturing and distribution operation is damaged or otherwise interrupted for any prolonged period of time, our operations would be harmed |
| Our business depends on our ability to reliably produce ice cream dessert products and deliver them to retailers, distributors and restaurants on a regular schedule |
| We currently produce most of our ice cream dessert products in a single manufacturing facility in Wilbraham, Massachusetts |
| As a result, our business is vulnerable to damage or interruption from fire, severe drought, flood, power loss, telecommunications failure, break-ins, snow and ice storms, work stoppages and similar events |
| Any such damage or failure could disrupt our operations and result in the loss of sales and current and potential customers if we are unable to quickly recover from such events |
| Our business interruption insurance may not be adequate to compensate for our losses if any of these events occur |
| In addition, business interruption insurance may not be available to us in the future on acceptable terms or at all |
| Even if we carry adequate insurance, such events could harm our business |
| 13 ______________________________________________________________________ The restaurant and food distribution industries are heavily regulated |
| We are subject to various federal, state and local laws affecting our business |
| Our restaurants and facilities are subject to licensing and regulation by a number of governmental authorities, which include health, safety, sanitation, environmental, building and fire agencies in the state or municipality in which the restaurant is located |
| Difficulties in obtaining or failures to obtain required licenses or approvals, or the losses of such licenses and approvals, can delay, prevent the opening of or close a restaurant in a particular area |
| Our relationship with our current and potential franchisees is governed by state laws, which regulate substantive aspects of the franchisor-franchisee relationship |
| Current and proposed franchise relationship laws limit, among other things, the rights of a franchisor to approve the transfer of a franchise, the ability of a franchisor to terminate or refuse to renew a franchise and the ability of a franchisor to designate sources of supply |
| We are also subject to the Americans with Disabilities Act of 1990, which, among other things, may require certain renovations to our restaurants to meet federally mandated requirements |
| Increasing labor costs could adversely affect our profitability |
| Our restaurant operations are subject to federal and state laws governing such matters as wages, hours, working conditions, civil rights and eligibility to work |
| Some states have set minimum wage requirements higher than the federal level |
| Significant numbers of hourly personnel at our restaurants are paid at rates related to the federal minimum wage and, accordingly, increases in the minimum wage at a federal and/or state level could increase labor costs at our restaurants |
| Other governmental initiatives such as mandated health insurance, if implemented, could adversely affect us as well as the restaurant industry in general |
| A failure to attract and retain qualified employees may adversely affect us |
| Our success and the success of our restaurants depend upon our ability to attract and retain a sufficient number of qualified employees, including skilled management, customer service personnel and wait and kitchen staff |
| We face significant competition in the recruitment of qualified employees |
| Our inability to recruit and retain qualified individuals may delay the planned openings of new restaurants, result in higher employee turnover, affect our ability to provide a high quality customer experience in restaurants or exert pressure on wages or other employee benefits to attract qualified personnel |
| Any of these consequences could have a material adverse effect on our business and results of operations |
| We may not be able to protect our trademarks and other proprietary rights |
| We believe that our trademarks and other proprietary rights are important to our success and competitive position |
| Accordingly, we devote substantial resources to the establishment and protection of our trademarks and proprietary rights |
| However, the actions we take to protect our intellectual property may be inadequate to prevent imitation of our products and concepts by others |
| Our substantial debt could harm our business, results of operations, financial position and cash flows |
| We have substantial debt and may incur additional debt in the future |
| The principal and interest payment obligations of such debt may restrict future operations and operating expenditures and impair our ability to meet our obligations under our debt instruments, loan agreements, letters of credit, leases and other long-term commitments, and may otherwise affect our profitability |
| In addition, our credit facility and our mortgage loans contain floating interest rates and any increase in the prevailing rates could have an adverse effect on our business |
| 14 ______________________________________________________________________ As of January 1, 2006, we had approximately dlra233dtta9 million of total indebtedness outstanding, including capital leases |
| In addition, the indenture governing our 8dtta375prca senior notes permits us to incur additional debt |
| Our substantial levels of debt may have important consequences |
| For instance, it could: · make it more difficult for us to satisfy our financial obligations; · require us to dedicate a substantial portion of any cash flow from operations to the payment of interest and principal due on our debt, which will reduce funds available for other business purposes; · increase our vulnerability to general adverse economic and industry conditions; · limit flexibility in planning for, or reacting to, changes in the business and in the industries in which we operate; · place us at a competitive disadvantage compared with some of our competitors that have less debt; and · limit our ability to obtain additional financing required to fund working capital and capital expenditures and for other general corporate purposes |
| Our ability to satisfy our obligations and to reduce our total debt depends on future operating performance and on economic, financial, competitive and other factors, many of which are beyond our control |
| Our business may not generate sufficient cash flow, and future financings may not be available to provide sufficient net proceeds, to meet these obligations or to successfully execute our business strategy |
| The instruments governing our 8dtta375prca senior notes and other debt impose restrictions |
| The indenture governing our 8dtta375prca senior notes and our other debt instruments, including without limitation our credit facility, contain, and other agreements we may enter into in the future may contain, covenants imposing significant restrictions on our business |
| These restrictions may affect our ability to operate our business and may limit our ability to take advantage of potential business opportunities as they arise |
| These covenants place restrictions on our ability to, among other things: · incur additional debt, · create liens, · make investments, · enter into transactions with affiliates, · sell assets, · declare or pay dividends, · redeem stock or make other distributions to shareholders, · enter into sale and leaseback transactions, and · consolidate or merge |
| Our ability to comply with these covenants may be affected by events beyond our control, including prevailing economic, financial and industry conditions |
| The breach of any of these restrictions could result in a default under the indenture |
| An event of default under our debt agreements would permit some of our lenders to declare all amounts borrowed from them to be due and payable, together with accrued and unpaid interest |
| If we were unable to repay debt to secured lenders, they could proceed against our assets securing that debt |
| On March 15, 2006, we amended and restated our credit facility to, among other things, (i) revise certain financial covenants beginning with the fourth quarter of 2005 and extending through the 15 ______________________________________________________________________ credit facility maturity date of June 30, 2007 (including leverage, interest coverage, minimum EBITDA and the deletion of the tangible net worth covenant) and (ii) permit certain transactions to be excluded from our annual capital expenditures limit |
| As a result of the amendments, we were in compliance with the covenants in our credit facility as of January 1, 2006 |
| We are exposed to potential risks as a result of the internal control testing and evaluation process mandated by Section 404 of the Sarbanes-Oxley Act of 2002 |
| We assessed the effectiveness of our internal control over financial reporting as of January 1, 2006 and assessed all deficiencies on both an individual basis and in combination to determine if, when aggregated, they constitute more than an inconsequential deficiency |
| As a result of this evaluation, no significant deficiencies or material weaknesses were identified |
| Although we have completed the documentation and testing of the effectiveness of our internal control over financial reporting for 2005 as required by Section 404 of the Sarbanes-Oxley Act of 2002, we expect to continue to incur costs, including accounting fees and staffing salaries, in order to maintain compliance with that section of the Sarbanes-Oxley Act |
| We continue to monitor controls for any additional weaknesses or deficiencies |
| However, no evaluation can provide complete assurance that our internal controls will detect or uncover all failures of persons within our company to disclose material information otherwise required to be reported |
| The effectiveness of our controls and procedures could also be limited by simple errors or faulty judgments |
| In the future, if we fail to complete the Sarbanes-Oxley Section 404 evaluation in a timely manner, or if our independent registered public accounting firm cannot attest in a timely manner to our evaluation, we could be subject to regulatory scrutiny and a loss of public confidence in our internal controls |
| In addition, any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations |
| Although we intend to devote substantial time and incur costs as necessary to ensure ongoing compliance, we cannot be certain that we will be successful in complying with Section 404 |
| We have incurred and may incur significant additional and unforeseen expenses and costs to defend or pursue litigation and related matters |
| From time to time we are named as a defendant in legal actions arising in the ordinary course of our business |
| We are currently a party to litigation brought by S Prestley Blake (“Blake”), holder of approximately 10prca of our common stock |
| On February 25, 2003, Mr |
| Blake sued us and our Chairman in a purported derivative action in Hampden Superior Court, Massachusetts |
| The suit alleges breach of fiduciary duty and misappropriation of corporate assets, and alleges that we paid certain expenses relating to a corporate jet and the Chairman’s use of that jet and use of an office in Illinois |
| The suit seeks to require the Chairman to reimburse us and for Friendly’s to pay Blake’s attorneys’ fees |
| Friendly’s and our Chairman have denied Blake’s allegations and are vigorously defending the lawsuit |
| We cannot guarantee that we will be successful in defending this or any other litigation |
| Defending the Blake litigation and other litigation may cause us to incur significant additional and unforeseen costs to defend or pursue litigation or other investigations relating to the matters subject to the litigation |