SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark one)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended June 30, 2004
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File No. 0-23911

 

 

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 ý  No o.

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No ý.

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

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

 

 

 

FOG CUTTER CAPITAL GROUP INC.

 

FORM 10-Q

 

I N D E X

 

PART I—FINANCIAL INFORMATION
Item 1.	Interim Financial Statements (Unaudited):
	Consolidated Statements of Financial Condition
	Consolidated Statements of Operations
	Consolidated Statement of Changes in Stockholders’ Equity
	Consolidated Statements of Cash Flows
	Notes to Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures about Market Risk
Item 4.	Controls and Procedures
PART II—OTHER INFORMATION
Item 1.	Legal Proceedings
Item 2.	Changes in Securities and Use of Proceeds
Item 3.	Defaults Upon Senior Securities
Item 4.	Submission of Matters to a Vote of Security Holders
Item 5.	Other Information
Item 6.	Exhibits and Reports on Form 8-K
Signatures

 

Available information

 

Our website is www.fccgi.com.  We make our annual report on Form 10-K, as well as other reports filed with the Securities and Exchange Commission, available free of charge through our website as soon as reasonably practicable after they are filed.  A copy of these reports may also be obtained by writing to us at 1410 SW Jefferson Street, Portland, Oregon 97201, Attn:  Investor Reporting.

 

 

PART I — FINANCIAL INFORMATION

 

ITEM 1.  INTERIM FINANCIAL STATEMENTS

 

FOG CUTTER CAPITAL GROUP INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands, except share data)

 

		June 30 2004			December 31 2003
		(Unaudited)
Assets
Cash and cash equivalents		$	8,237		$	19,607
Securities available for sale, pledged under repurchase agreements, at estimated fair value		15			35,010
Securities available for sale, at estimated fair value		25			500
Loans held for investment		9,360			3,744
Investments in real estate, net		25,014			22,577
Loans to senior executives		2,966			2,964
Investment in Bourne End		3,728			2,141
Restaurant property, plant and equipment, net		6,069			5,897
Intangible assets, net		5,510			5,640
Goodwill		7,449			7,300
Other assets		5,516			3,596
Total assets		$	73,889		$	108,976
Liabilities and Stockholders’ Equity
Liabilities:
Repurchase agreements		$	25		$	25,318
Borrowings and notes payable		7,974			7,804
Obligations under capital leases		12,681			12,942
Obligation under leave of absence agreement		2,750			—
Dividend payable		32			1,216
Deferred income		4,009			3,700
Deferred income taxes		5,962			6,980
Accrued expenses and other liabilities		5,916			5,635
Total liabilities		39,349			63,595
Commitments and contingencies
Stockholders’ Equity:
Preferred stock, $.0001 par value; 25,000,000 shares authorized; no shares issued and outstanding		—			—
Common stock, $.0001 par value; 200,000,000 shares authorized; 11,754,073 shares issued as of June 30, 2004 and 11,716,600 shares issued as of December 31, 2003; 8,377,673 shares outstanding as of June 30, 2004 and 8,670,700 shares outstanding as of December 31, 2003		168,182			168,018
Accumulated deficit		(123,578		)	(115,588		)
Option to purchase common stock		(592		)	—
Accumulated other comprehensive income		330			968
Treasury stock; 3,376,400 common shares as of June 30, 2004, and 3,045,900 common shares as of December 31, 2003, at cost		(9,802		)	(8,017		)
Total stockholders’ equity		34,540			45,381
Total liabilities and stockholders’ equity		$	73,889		$	108,976

 

The accompanying notes are an integral part of these consolidated financial statements.

 

3

 

FOG CUTTER CAPITAL GROUP INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(dollars in thousands, except share data)

 

		Quarter Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
Net Interest Income:
Loans		$	585		$	179		$	975		$	315
Loans to senior executives		51			55			87			109
Securities		292			699			605			1,474
Other investments		24			36			71			91
Total interest income		952			969			1,738			1,989
Interest expense		41			210			112			418
Net interest income		911			759			1,626			1,571
Real Estate Operations:
Operating income		1,022			959			1,976			1,931
Gain on sale of real estate		5			281			5			281
Operating expense		(420		)	(528		)	(876		)	(1,066		)
Interest expense		(281		)	(360		)	(562		)	(720		)
Depreciation		(163		)	(153		)	(322		)	(306		)
Total real estate operations		163			199			221			120
Restaurant Operations:
Operating revenue		5,467			—			10,751			—
Cost of goods sold		(3,461		)	—			(6,538		)	—
Franchise and royalty fee		377			—			649			—
General and administrative cost		(2,702		)	—			(5,417		)	—
Interest expense		(181		)	—			(346		)	—
Depreciation and amortization		(391		)	—			(743		)	—
Total restaurant operations		(891		)	—			(1,644		)	—
Other Operating Income:
Gain on sale of loans and securities		1,013			4,595			2,099			9,383
Gain on sale of prepaid servicing credit		1,530			—			1,530			—
Equity in income of equity investees		1,490			1,878			1,512			870
Loan origination fees		1,248			1,453			2,374			2,253
Other revenue		662			400			873			591
Total other operating income		5,943			8,326			8,388			13,097
Operating Expenses:
Compensation and employee benefits		2,762			3,615			5,523			5,818
Leave of absence expense		4,750			—			4,750			—
Professional fees		928			596			1,169			1,095
Fees paid to related parties		95			156			224			270
Other		1,729			862			2,698			1,648
Total operating expenses		10,264			5,229			14,364			8,831
Net income before provision for income taxes		(4,138		)	4,055			(5,773		)	5,957
Provision for income taxes		—			1,469			—			1,711
Net Income		$	(4,138	)	$	2,586		$	(5,773	)	$	4,246

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4

 

		Quarter Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
Basic net  (loss) income per share		$	(0.49	)	$	0.30		$	(0.68	)	$	0.50
Basic weighted average shares outstanding		8,417,005			8,603,450			8,507,260			8,549,057
Diluted net income per share		$	(0.49	)	$	0.28		$	(0.68	)	$	0.46
Diluted weighted average shares outstanding		8,417,005			9,261,450			8,507,260			9,207,057
Dividends declared per share		$	0.13		$	0.13		$	0.26		$	0.26

 

The accompanying notes are an integral part of these consolidated financial statements.

 

5

 

FOG CUTTER CAPITAL GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Unaudited)
(dollars in thousands)

 

		Common Stock					Treasury Stock					Common Stock Subject to Options			Accumulated			Accumulated Other Comprehensive
		Shares (1)		Amount			Shares		Amount			Amount			Deficit			Income			Total
Balance at January 1, 2004		8,670,700		$	168,018		3,045,900		$	(8,017	)	—			$	(115,588	)	$	968		$	45,381
Comprehensive income (loss):
Net income (loss)		—		—			—		—			—			(5,773		)	—			(5,773		)
Other comprehensive income:
Foreign currency translation		—		—			—		—			—			—			105			105
Unrealized holding gains on securities available for sale		—		—			—		—			—			—			1,378			1,378
Reclassification adjustment for gains on securities and foreign currency translation included in net income		—		—			—		—			—			—			(2,121		)	(2,121		)
Total comprehensive income (loss)		—		—			—		—			—			—			—			(6,411		)
Purchase of treasury stock		(330,500	)	—			330,500		(1,785		)	—			—			—			(1,785		)
Common stock issued pursuant to exercise of stock options		37,473		164			—		—			—			—			—			164
Dividends declared		—		—			—		—			—			(2,217		)	—			(2,217		)
Purchase of call options		—		—			—		—			(592		)	—			—			(592		)
Balance at June 30, 2004		8,377,673		$	168,182		3,376,400		$	(9,802	)	$	(592	)	$	(123,578	)	$	330		$	34,540

 

(1)                                  Issued and outstanding

 

The accompanying notes are an integral part of these consolidated financial statements.

 

6

 

FOG CUTTER CAPITAL GROUP INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(dollars in thousands)

 

		Quarter Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	(4,138	)	$	2,586		$	(5,773	)	$	4,246
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization		575			180			1,102			372
(Gain) on foreign currency translation		(5		)	(239		)	(20		)	(237		)
Gain on sale of securities and loans		(1,013		)	(4,595		)	(2,099		)	(9,383		)
Gain on sale of real estate		(5		)	(281		)	(5		)	(281		)
Gain on sale of prepaid servicing credit		(1,530		)	—			(1,530		)	—
Equity in income of equity investees		(1,490		)	(1,878		)	(1,512		)	(870		)
Other		(282		)	(23		)	(645		)	(23		)
Change in:
Deferred income		149			—			309			—
Accrued interest receivable		55			89			48			76
Other assets		(1,345		)	156			(1,201		)	658
Accounts payable and accrued liabilities		3,073			2,655			3,053			1,212
Net cash used in operating activities		(5,956		)	(1,350		)	(8,273		)	(4,230		)
CASH FLOWS FROM INVESTING ACTIVITIES:
Repayments of securities available for sale		4,571			5,169			6,818			7,308
Investment in real estate		(573		)	—			(1,634		)	—
Investment in variable interest entity		(628		)	—			(628		)	—
Proceeds from sale of securities available for sale		27,790			6,431			29,090			11,991
Purchase of loans and discounted loans		(2,850		)	(1,422		)	(7,073		)	(1,486		)
Principal repayments on loans and discounted loans		984			366			1,054			493
Proceeds from sale of real estate		2			281			174			281
Proceeds from sale of prepaid servicing credit		1,530			—			1,530			—
Investment in and loans to equity investees		—			—			—			(3,000		)
Proceeds from investments in and loans to equity investees		—			2,900			—			2,900
Purchase of restaurant property plant and equipment		(227		)	—			(784		)	—
Other		21			(487		)	27			(510		)
Net cash provided by investing activities		30,620			13,238			28,574			17,977
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments under capital leases		(118		)	—			(261		)	—
Repayments on borrowings		(24,551		)	(7,400		)	(25,812		)	(8,220		)
Payment of obligation to purchase treasury stock		—			—			—			(1,399		)
Proceeds from issuance of common stock		140			840			164			875
Investment in option to purchase stock		(593		)	—			(593		)	—
Investment in treasury stock		(1,785		)	—			(1,785		)	—
Dividend payments on common stock		(1,153		)	(1,127		)	(3,400		)	(3,483		)
Other		—			(293		)	—			(293		)
Net cash used in financing activities		(28,060		)	(7,980		)	(31,687		)	(12,520		)
EFFECT OF EXCHANGE RATE CHANGES ON CASH		(5		)	12			16			(5		)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		(3,401		)	3,920			(11,370		)	1,222
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		11,638			11,807			19,607			14,505
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	8,237		$	15,727		$	8,237		$	15,727
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest		$	467		$	633		$	975		$	1,199
Notes payable issued to settle obligation to purchase treasury stock		$	—		$	—		$	—		$	2,800
Cash paid for income taxes		$	—		$	—		$	4		$	—

 

The accompanying notes are an integral part of these consolidated financial statements.

 

7

 

FOG CUTTER CAPITAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 1 - BASIS OF PRESENTATION

 

The accompanying interim consolidated financial statements of Fog Cutter Capital Group Inc. and Subsidiaries (“FCCG” or the “Company”) are unaudited and have been prepared in conformity with the requirements of Regulation S-X promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), particularly Rule 10-01 thereof, which governs the presentation of interim financial statements.  Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.  The accompanying interim consolidated financial statements should be read in conjunction with the Company’s 2003 Annual Report on Form 10-K/A.  A summary of the Company’s significant accounting policies is set forth in Note 2 to the consolidated financial statements in the 2003 Annual Report on Form 10-K/A.

 

In the Company’s opinion, all adjustments, comprised of normal recurring accruals necessary for the fair presentation of the interim financial statements, have been included in the accompanying consolidated financial statements.  Operating results for the six months ended June 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  Certain items in the previously reported consolidated financial statements were reclassified to conform to the June 30, 2004 presentation, none of which affected previously reported results of operations.

 

At June 30, 2004, certain Company officers and directors had, directly or indirectly, majority voting control of the Company.

 

NOTE 2 - SIGNIFICANT TRANSACTIONS

 

Fatburger Holdings, Inc.

 

On August 15, 2003, the Company acquired a controlling interest in Fatburger Holdings, Inc. (“Fatburger”), and began reporting the operations of Fatburger on a consolidated basis as of that date.  Fatburger operates or franchises 58 hamburger restaurants located in California, Nevada, Arizona, Colorado, Florida and Washington.  Franchisees currently own and operate about half of the Fatburger locations and Fatburger has agreements for approximately 220 new franchise restaurants.  The terms of the original acquisition by the Company were amended on January 12, 2004 and May 12, 2004.  Initially, the Company made a $5.4 million investment and acquired approximately 83% of the voting control of Fatburger.  However, all but 15% of the ownership investment was redeemable by Fatburger.  On May 12, 2004, the Company contributed an additional $3.0 million, bringing its total investment to $8.4 million.  As a result of this transaction, the Company’s voting control of Fatburger was reduced to approximately 71%, but the Company retained a non-redeemable, fully diluted 47% ownership interest in Fatburger.  The Company’s investment consists of the purchase of convertible preferred stock (the “Series A Preferred”) and redeemable preferred stock (the “Series D Preferred”).

 

The Series A Preferred is convertible into a 50% ownership interest of the common stock of Fatburger on a fully diluted basis.  The Company owns approximately 93% of the issued and outstanding Series A Preferred, and currently holds voting rights equal to 71% of the voting control of Fatburger.  The Series A Preferred is not redeemable and does not pay dividends.

 

8

 

The Series D Preferred has a liquidation preference and is redeemable by Fatburger for $10.1 million plus accrued but unpaid dividends.  Dividends accrue at a rate of 20% of the redemption value, compounded annually.  The Series D Preferred does not have any voting rights.  The Company owns all of the issued and outstanding Series D Preferred.

 

Mortgage-Backed Securities

 

During the six months ended June 30, 2004, the Company sold four mortgage-backed securities for $29.1 million in cash.  As a result of these transactions, the Company recognized gains on the sale of securities of $2.1 million in the accompanying consolidated statement of operations.  As of June 30, 2004, the Company’s investment in mortgage-backed securities had decreased to less than $0.1 million.

 

Loans

 

During the six months ended June 30, 2004, the Company purchased or funded three loans secured by real estate for a total of $6.6 million.  The current yield to the Company on these loans is approximately 16.8%.

 

Dividends

 

The Company has declared and paid a $0.13 per share dividend for each quarter of 2004 to date.  The first quarter dividend was paid on March 1, 2004 to stockholders of record on February 20, 2004.  The second quarter dividend was paid on June 1, 2004 to stockholders of record on May 21, 2004.  On July 27, 2004, the Company announced the declaration of the $0.13 per share third quarter dividend, payable on September 1, 2004 to stockholders of record on August 18, 2004.

 

Call Option

 

On April 26, 2004, the Company purchased a three year call option (the “Call Option”) from Andrew A. Wiederhorn, the Company’s Chairman and former Chief Executive Officer and current Chief Strategic Officer.  The Call Option gives the Company the right, but not the obligation, to purchase 423,245 of the Company’s outstanding common stock (the “Option Shares”) from Mr. Wiederhorn for a purchase price of $3.99 per share.  The option may be exercised at any time during the three year option period.  The Company paid $750,000 ($1.77 per option share) for the Call Option.  The premium paid for the Call Option, together with the strike price, represented a small premium to the Company’s book value per share and market price per share at the time the option was purchased.  In purchasing the Call Option, the Company and its directors considered the following factors:  (1) the potentially negative impact on the Company’s share price if the Option Shares were disposed of publicly; (2) the Company’s favorable liquidity position; (3) the potential reduction in the risk that shares are transferred in a transaction which would have an adverse impact on its NOL position; and (4) the reduction in the future expenditure of cash dividends by the Company once the Company exercises the Call Option.  The Board of Directors reviewed and approved the transaction to confirm that the transaction was in the best interest of the Company and its other stockholders.  As a result of the purchase of the Call Option, the Company recorded a direct reduction to stockholders’ equity of $593,000 and compensation expense of $157,000.

 

Treasury Stock Purchase

 

On April 28, 2004, the Company purchased 330,500 shares of its common stock from Clarence B. Coleman, who at the time was a greater than 10% shareholder.  The purchase price was $5.40 per share ($1.8 million) and the shares were added to treasury stock.  At the time, the purchase price represented a small premium to the Company’s book value per share and market price per share.  The Company and its directors considered the following factors:  (1) the potentially negative impact on the Company’s share price if the shares were disposed of publicly; (2) the Company’s favorable liquidity position; (3) the potential reduction in the risk that shares are transferred in a transaction which would have an adverse impact on its NOL position; and (4) the reduction in the future expenditure of cash dividends by the Company.  The Board of Directors reviewed and approved the transaction to confirm that the transaction was in the best interest of the Company and its other stockholders.

 

9

 

Leave of Absence Agreement

 

As the Company has previously disclosed, the Company’s former Chief Executive Officer and current Chief Strategic Officer, Andrew Wiederhorn, and former President, Lawrence Mendelsohn, received letters from the United States Attorney’s Office for the District of Oregon (“USAODO”) in March 2001 advising them that they were targets of a grand jury investigation (the “CCL Investigation”) into the failure of Capital Consultants, L.L.C (“CCL”).

 

In August 2002, Mr. Mendelsohn resigned as President and Director of the Company. In November 2003, Mr. Mendelsohn entered into an agreement with the USAODO pursuant to which he plead guilty to filing a false 1998 personal tax return and agreed to cooperate in the CCL Investigation.

 

On June 3, 2004 the Company announced that Chief Executive Officer and Chairman of the Board Andrew Wiederhorn had entered into a settlement with the USAODO regarding its investigation into CCL (the “Settlement”) and would take a leave of absence from his corporate positions at Fog Cutter Capital.  Under the Settlement’s terms, Mr. Wiederhorn pled guilty on June 2, 2004 to two federal counts and was sentenced to 18 months incarceration and fined $2.0 million.  The charges to which Mr. Wiederhorn has pled guilty pursuant to the Settlement are not based upon any acts or omission of the Company or of Mr. Wiederhorn in his capacity as an officer or director of the Company.

 

In entering into Mr. Wiederhorn’s leave of absence agreement, the Board of Directors considered the nature of the statutes to which Mr. Wiederhorn pled and the fact that he relied entirely on the advice of expert legal counsel and a national accounting firm.  The Board also believed it was important to assure Mr. Wiederhorn’s return to active involvement with the Company because of his expertise and knowledge and to preserve a significant business relationship and the value of the Company’s investments.

 

Under the terms of the leave of absence agreement, Mr. Wiederhorn will continue to receive his regular salary and bonus pursuant to and as set forth in his employment agreement.  In addition, for the reasons stated in the agreement, the Company made a leave of absence payment to Mr. Wiederhorn in the amount of $2.0 million on June 2, 2004.

 

Mr. Wiederhorn began his leave of absence on August 2, 2004 and is expected to remain in that status for a period of 14 to 18 months.  The accompanying consolidated financial statements reflect a charge to earnings of $4.8 million for the three month and six month periods ending June 30, 2004.  This is comprised of the $2.0 million payment made on June 2, 2004 and the accrual of the expected salary and bonus relating to the leave of absence period.  (See Part II, Item 1. “Legal Proceedings”.)

 

NOTE 3 – COMMITMENTS, CONTINGENCIES & OFF-BALANCE SHEET RISK

 

CCL Investigation

 

The Company’s former Chief Executive Officer and current Chief Strategic Officer, Andrew Wiederhorn, and former President, Lawrence Mendelsohn, pursuant to the terms of their respective employment agreements, may have been entitled to indemnity from the Company for litigation expenses and personal losses in connection with the CCL investigations and any related litigation.  Messrs. Wiederhorn and Mendelsohn had notified the Company that, although they believed they were entitled to primary indemnification from other sources, they were reserving their rights to seek indemnity from the Company.  The Company did not agree to any indemnity requests.  Mr. Wiederhorn released the Company from any and all claims he may have had relating to the CCL matter as partial consideration for the leave of absence agreement in June 2004.  The USAODO has settled the CCL matter as it relates to both Mr. Wiederhorn and Mr. Mendelsohn.  As a result, the Company believes that the contingencies relating to the potential indemnification of these officers or former officers have now been resolved.

 

10

 

Strouds Acquisition Corporation

 

On October 6, 2003, the Official Committee of Unsecured Creditors of Strouds Acquisition Corporation (“Strouds”) filed a lawsuit in the United States Bankruptcy Court (LA 03-23620-ER) which named the Company, among others, as a defendant.  The lawsuit was amended on November 10, 2003 and limits the complaint against the Company solely in its capacity as collateral agent for certain secured creditors of Strouds Acquisition Corporation.  The lawsuit, as it pertains to the Company, sought reimbursement of the proceeds from approximately $3.0 million in funds received in October 2003, which the Company was holding as collateral agent for other secured creditors.  These funds were not included in the assets of the Company, but were being held in trust.  On July 1, 2004, the lawsuit was settled and the Company distributed the trust funds, net of legal reimbursements of $0.3 million, in accordance with the settlement agreement.  The Company received a general release from the parties and considers the matter closed.

 

Shareholder Derivative Complaint

 

On July 6, 2004, Jeff Allen McCoon, derivatively on behalf of the Company, filed a lawsuit in the Circuit Court for the State of Oregon (Multnomah County Case No. 0407-06900) which named all of the directors of the Company as defendants.  The lawsuit alleges that members of the Company’s Board of Directors breached their duties to the Company by entering into the leave of absence agreement with Andrew Wiederhorn.  The lawsuit generally seeks restitution of payments made under the leave of absence agreement plus attorney fees and costs.  The Board of Directors and the Company believe that the allegations of the lawsuit are without merit and intend to put forth a vigorous defense.  At the present time, it is not possible to determine the amount of damages, if any, that the Company may ultimately incur or recover as a result of the derivative lawsuit.

 

Other

 

The Company is involved in various other legal proceedings occurring in the ordinary course of business which the Company believes will not have a material adverse effect on the consolidated financial condition or operations of the Company.

 

The Company may utilize a wide variety of off-balance sheet financial techniques to manage its interest rate risk.  In hedging the interest rate and/or exchange rate exposure of a foreign currency denominated asset or liability, the Company may enter into hedge transactions to counter movements in the different currencies, as well as interest rates in those currencies.  These hedges may be in the form of currency and interest rate swaps, options, and forwards, or combinations thereof.

 

At June 30, 2004, the Company had no outstanding derivative instruments held for trading or hedging purposes.

 

11

 

The Company has operating leases for office and retail space which expire through 2012.  The leases provide for varying minimum annual rental payments including rent increases and free rent periods.

 

Future minimum rental payments, by year and in the aggregate, under noncancelable operating leases with initial or remaining terms of one year or more, consisted approximately of the following at June 30, 2004 (dollars in thousands):

 

2004		$	1,464
2005		2,764
2006		2,324
2007		1,751
2008		1,191
Thereafter		3,076
Total minimum lease payments		$	12,570

 

In order to facilitate the development of franchise locations, as of June 30, 2004, Fatburger had guaranteed the annual minimum lease payments of two restaurant sites owned and operated by franchisees.  The amount of the guarantees approximate $0.4 million plus certain contingent rental payments as defined in the respective leases.  These leases expire at various times through 2008.

 

The Company did not have any other off balance sheet arrangements in place as of June 30, 2004.

 

NOTE 4 - GOODWILL AND OTHER INTANGIBLE ASSETS

 

Primarily due to the acquisition of Fatburger, the Company has goodwill in the amount of $7.4 million and other intangible assets in the amount of $5.5 million. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”, goodwill is not amortized, but is subject to an annual impairment test, which will be performed as of August 15, 2004.  Since the acquisition of Fatburger by the Company, Fatburger has experienced operating losses and has funded its operations and expansion with limited liquidity.  The Company believes that these conditions are temporary in nature, however, should these conditions not be corrected, the Company may be required to recognize impairment losses on its recorded goodwill.  As of June 30, 2004, the Company was not aware of any events or changes in circumstances that would require the impairment of the recorded goodwill.

 

Summarized information for the Company’s acquired intangible assets as of June 30, 2004 is as follows (dollars in thousands):

 

Amortized intangible assets:
Franchise Agreements		$	1,017
Other		522
Total amortized intangible assets		$	1,539
Unamortized intangible assets:
Trademarks		$	3,971

 

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Trademarks, which have indefinite lives, are not subject to amortization.  All other intangible assets are amortized using the straight-line method over five to fifteen years, the estimated useful lives of the assets.  Estimated amortization expense for the remainder of 2004 and the five succeeding years is as follows (dollars in thousands):

 

2004		$	121
2005		242
2006		242
2007		242
2008		242
2009		242

 

The recorded values of goodwill and other intangible assets may become impaired in the future. The determination of the value of such intangible assets requires management to make estimates and assumptions that affect the consolidated financial statements.  Potential impairments to intangible assets are assessed when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset may not be recovered.  This assessment is based on the operational performance of acquired businesses, market conditions and other factors including future events.  Any resulting impairment loss could have an adverse impact on the results of operations of the Company.

 

NOTE 5 – RECENTLY ISSUED ACCOUNTING STANDARDS

 

In December 2003, the Accounting Standards Executive Committee (“AcSEC”) issued Statement of Position 03-3 (“SOP 03-3”), “Accounting for Certain Loans or Debt Securities Acquired in a Transfer.” SOP 03-3 requires that the excess of contractual cash flows over cash flows expected to be collected not be recognized as an adjustment of yield, loss accrual, or valuation allowance. Subsequent increases in cash flows expected to be collected generally should be recognized prospectively through adjustment of the loan’s yield over its remaining life and decreases in cash flows expected to be collected should be recognized as impairment. SOP 03-3 is effective for loans acquired in fiscal years beginning after December 15, 2004 and is not expected to have a material effect on the Company’s consolidated financial position or results of operations

 

In March 2004, the Financial Accounting Standards Board issued an exposure draft, “Share-Based Payment - An Amendment to FASB Statements No. 123 and 95”, which changes the requirements of stock option accounting. The exposure draft requires expense recognition of stock options and certain employee stock purchase plans in the statement of operations. A final standard is expected to be effective to the Company during the year ending December 31, 2005. Such stock option expensing would require the Company to value its employee stock option grants pursuant to an option valuation formula and then amortize that value against its earnings over the vesting period in effect for those options. The Company currently account for stock-based awards to employees in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and have adopted the disclosure-only alternative of FASB Statement No. 123, “Accounting for Stock-Based Compensation.” If the Company is required to expense employee stock options in the future, this change in accounting treatment may adversely affect the Company’s future reported results of operations.

 

NOTE 6 – STOCK OPTIONS AND RIGHTS

 

The Company has adopted a non-qualified stock option plan (the “Option Plan”) which provides for options to purchase shares of the Company’s common stock.  The maximum number of shares of common stock that may be issued pursuant to options granted under the Option Plan is 3,500,000 shares.

 

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The Company applies Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting for the Option Plan. Accordingly, no compensation expense has been recognized in the Consolidated Statements of Operations for grants under the Option Plan.  Had compensation expense for the Company’s Option Plan been determined based on the fair value at the grant date consistent with the methods of SFAS No. 123 “Accounting for Stock Based Compensation”, the Company’s net income and income per share for the six months ended June 30, 2004 and 2002 would have been decreased to the pro forma amounts indicated below:

 

 

There were no options granted with exercise prices below the market value of the stock at the grant date. Fair values for 2004 were estimated using the Black-Scholes option-pricing model with the following weighted average assumptions used: 10% dividend yield, expected volatility of 46%, risk-free interest rate of 2.8% and expected lives of five years.

 

NOTE 7 – VARIABLE INTEREST ENTITIES

 

In May 2004, the Company funded a $0.6 million loan to Servitur Rent ABC, S.L., a Spanish entity formed to purchase, reposition and sell a 10 unit apartment building in Barcelona, Spain.  Under the terms of the loan, the Company receives a preferred 30% return on its investment plus an 80% share in additional profits generated by the investment.  The investment meets the definition of a Variable Interest Entity (“VIE”)  under FASB Interpretation 46 (“FIN 46”) and the Company is the primary beneficiary of the VIE.  As a result, the assets and liabilities of the VIE have been consolidated into the accompanying consolidated financial statements as of June 30, 2004.

 

The VIE purchased the 10 unit apartment building for $1.3 million in May 2004.  The purchase was funded with a bank loan of $0.7 million, the Company’s $0.6 million investment and a $0.1 million contribution from the project managers.  Neither the creditors nor the other beneficial interest holders have recourse to the Company with regard to this investment and, as a result, the maximum limit of the Company’s exposure to loss on this investment is $0.6 million.

 

As of June 30, 2004, the following assets and liabilities of the VIE were included in the accompanying consolidated statement of financial condition:

 

Investment in real estate, net		$	1,291,000
Other assets		111,000
Borrowings and notes payable		667,000
Accrued expense and other liabilities		107,000

 

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NOTE 8 – OPERATING SEGMENTS

 

As a result of the acquisition of Fatburger during August 2003, the Company began to report the results of operating segments.  The operating segments consist of (i) restaurant operations conducted through Fatburger Holdings, Inc. (“Fatburger”), (ii) commercial real estate mortgage brokerage activities conducted through George Elkins Mortgage Banking Company (“George Elkins”) and (iii) real estate, merchant banking and financing activities.  The following is a summary of each of the operating segments:

 

Restaurant Operations

 

Fatburger operates or franchises 58 hamburger restaurants located in California, Nevada, Arizona, Florida, Colorado and Washington.  The Company provided an investment and financing package for Fatburger which involved the acquisition of the 93% of the entire class of the Series A Preferred and the entire class of the Series D Preferred stock of Fatburger.  Currently, the Company owns approximately 71% of the voting control of Fatburger.  Fatburger has plans to open additional restaurants including expansion into Oregon, Louisiana, Georgia, New York, Ohio, New Jersey, Texas, Missouri, Kansas, Pennsylvania, West Virginia, Virginia, North Carolina, South Carolina, Washington D.C., British Columbia, Minnesota and Michigan.  Franchisees currently own and operate about half of the Fatburger locations.

 

Commercial Real Estate Mortgage Brokerage Operations

 

In May 2002, the Company purchased a 51% ownership interest in George Elkins, a California mortgage banking operation, which, in 2003, provided brokerage services related to the production of over $600 million in commercial real estate mortgages. George Elkins is headquartered in Los Angeles, with satellite offices located throughout the southern California area. As of June 30, 2004, the mortgage brokerage operation also manages a commercial loan servicing portfolio in excess of $700 million for various investors.  The Company earned mortgage servicing fees of $0.4 million during the six months ended June 30, 2004, which are included in other revenue in the accompanying consolidated statements of operations.

 

Real Estate, Merchant Banking and Financing Operations

 

The Company invests in or finances real estate, mortgage-backed securities and other real estate related or finance related assets.  The merchant banking and financing operations focus on the acquisition of controlling interests in businesses in the process of restructuring.  This can take the form of assisting in a management buy-out, refinancing corporate debt or acquiring the “non-core” assets of a business.

 

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Segment data for the six months ended June 30, 2004, and 2003 are as follows (dollars in thousands):

 

		Merchant Banking, Real Estate and Finance						Mortgage Brokerage						Restaurant						Total
		2004			2003			2004			2003			2004			2003			2004			2003
Net Interest Income:
Loans		$	975		$	315		$	—		$	—		$	—		$	—		$	975		$	315
Loans to senior executives		87			109			—			—			—			—			87			109
Securities		605			1,474			—			—			—			—			605			1,474
Other investments		70			90			1			1			—			—			71			91
Total interest income		1,737			1,988			1			1			—			—			1,738			1,989
Interest expense		112			418			—			—			—			—			112			418
Net interest income		1,625			1,570			1			1			—			—			1,626			1,571
Real estate operations:
Operating revenue		1,976			1,931			—			—			—			—			1,976			1,931
Operating expense		(876		)	(1,066		)	—			—			—			—			(876		)	(1,066		)
Gain on sale of real estate		5			281			—			—			—			—			5			281
Interest expense		(562		)	(720		)	—			—			—			—			(562		)	(720		)
Depreciation		(322		)	(306		)	—			—			—			—			(322		)	(306		)
Total real estate operations		221			120			—			—			—			—			221			120
Restaurant operations:
Operating income		—			—			—			—			10,751			—			10,751			—
Cost of goods sold		—			—			—			—			(6,538		)	—			(6,538		)	—
Franchise and advertising fees		—			—			—			—			649			—			649			—
General and administrative costs		—			—			—			—			(5,417		)	—			(5,417		)	—
Interest Expense		—			—			—			—			(346		)	—			(346		)	—
Depreciation and amortization		—			—			—			—			(743		)	—			(743		)	—
Total restaurant operations		—			—			—			—			(1,644		)	—			(1,644		)	—
Other operating income:
Market valuations loss / impairment		76			—			—			—			—			—			76			—
Gain on sale of prepaid servicing credit		1,530			—			—			—			—			—			1,530			—
Equity in losses of equity investees		1,512			870			—			—			—			—			1,512			870
Gain on sale of loans and securities		2,099			9,383			—			—			—			—			2,099			9,383
Loan origination fees		—			—			2,374			2,253			—			—			2,374			2,253
Other revenue (loss)		549			347			248			244			—			—			797			591
Total other operating income		5,766			10,600			2,622			2,497			—			—			8,388			13,097
Operating expenses:
Compensation and employee benefits		3,278			3,705			2,245			2,113			—			—			5,523			5,818
Leave of absence expense		4,750			—			—			—			—			—			4,750			—
Professional fees		1,154			1,050			15			45			—			—			1,169			1,095
Fees paid to related parties		224			270			—			—			—			—			224			270
Other		2,273			1,265			425			383			—			—			2,698			1,648
Total operating expenses		11,679			6,290			2,685			2,541			—			—			14,364			8,831
Net income (loss) before provisions		(4,067		)	6,000			(62		)	(43		)	(1,644		)	—			(5,773		)	5,957
Provision for income taxes		—			1,711			—			—			—			—			—			1,711
Net income (loss)		$	(4,067	)	$	4,289		$	(62	)	$	(43	)	$	(1,644	)	$	—		$	(5,773	)	$	4,246
Segment assets		$	60,065		$	101,215		$	1,944		$	2,960		$	11,880		$	—		$	73,889		$	104,175

 

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Segment data for the three months ended June 30, 2004, and 2003 are as follows (dollars in thousands):

 

		Merchant Banking, Real Estate and Finance						Mortgage Brokerage						Restaurant						Total
		2004			2003			2004			2003			2004			2003			2004			2003
Net Interest Income:
Loans		$	585		$	179		$	—		$	—		$	—		$	—		$	585		$	179
Loans to senior executives		51			55			—			—			—			—			51			55
Securities		292			699			—			—			—			—			292			699
Other investments		23			35			1			1			—			—			24			36
Total interest income		951			968			1			1			—			—			952			969
Interest expense		41			210			—			—			—			—			41			210
Net interest income		910			758			1			1			—			—			911			759
Real estate operations:
Operating revenue		1,022			959			—			—			—			—			1,022			959
Operating expense		(420		)	(528		)	—			—			—			—			(420		)	(528		)
Gain on sale of real estate		5			281			—			—			—			—			5			281
Interest expense		(281		)	(360		)	—			—			—			—			(281		)	(360		)
Depreciation		(163		)	(153		)	—			—			—			—			(163		)	(153		)
Total real estate operations		163			199			—			—			—			—			163			199
Restaurant operations:
Operating income		—			—			—			—			5,467			—			5,467			—
Cost of goods sold		—			—			—			—			(3,461		)	—			(3,461		)	—
Franchise and advertising fees		—			—			—			—			377			—			377			—
General and administrative costs		—			—			—			—			(2,702		)	—			(2,702		)	—
Interest Expense		—			—			—			—			(181		)	—			(181		)	—
Depreciation and amortization		—			—			—			—			(391		)	—			(391		)	—
Total restaurant operations		—			—			—			—			(891		)	—			(891		)	—
Other operating income:
Market valuations loss / impairment		34			—			—			—			—			—			34			—
Gain on sale of prepaid servicing credit		1,530			—			—			—			—			—			1,530			—
Equity in losses of equity investees		1,490			1,878			—			—			—			—			1,490			1,878
Gain on sale of loans and securities		1,013			4,595			—			—			—			—			1,013			4,595
Loan origination fees		—			—			1,248			1,453			—			—			1,248			1,453
Other revenue (loss)		533			351			95			49			—			—			628			400
Total other operating income		4,600			6,824			1,343			1,502			—			—			5,943			8,326
Operating expenses:
Compensation and employee benefits		1,628			2,266			1,134			1,349			—			—			2,762			3,615
Leave of absence expense		4,750			—			—			—			—			—			4,750			—
Professional fees		920			588			8			8			—			—			928			596
Fees paid to related parties		95			156			—			—			—			—			95			156
Other		1,530			650			199			212			—			—			1,729			862
Total operating expenses		8,923			3,660			1,341			1,569			—			—			10,264			5,229
Net income (loss) before provisions		(3,250		)	4,121			3			(66		)	(891		)	—			(4,138		)	4,055
Provision for income taxes		—			1,469			—			—			—			—			—			1,469
Net income (loss)		$	(3,250	)	$	2,652		$	3		$	(66	)	$	(891	)	$	—		$	(4,138	)	$	2,586
Segment assets		$	60,065		$	101,215		$	1,944		$	2,960		$	11,880		$	—		$	73,889		$	104,175

 

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NOTE 9– INCOME TAXES

 

As of June 30, 2004, the Company had, for U.S. Federal tax purposes, a net operating loss (“NOL”) carry forward of approximately $80.9 million, including $12.9 million relating to Fatburger. The Company’s NOL begins to expire in 2018. Fatburger’s NOL begins to expire in 2004 and is generally subject to an annual limitation under the Internal Revenue Code of 1986, Section 382, Limitation on Net Operating Loss Carryovers and Certain Built-In Losses Following Change in Control.  In addition, to the extent the Fatburger NOL is utilized, the recognition of the related tax benefits would first reduce goodwill related to Fatburger acquisition, then other non-current intangible assets related to that acquisition, and then income tax expense in accordance with Statement on Financial Accounting Standards No. 109, Accounting for Income Taxes.

 

United States tax regulations impose limitations on the use of NOL carry forwards following certain changes in ownership.  If such a change were to occur with respect to the Company, the limitation could significantly reduce the amount of benefits that would be available to offset future taxable income each year, starting with the year of ownership change.  To reduce the likelihood of such ownership changes, the Company established a Shareholder Rights Plan dated as of October 18, 2002, which discourages, under certain circumstances, ownership changes which would trigger the NOL limitations.

 

During the six months ended June 30, 2004, a provision for income taxes was not required.  During the six months ended June 30, 2003, the Company recognized a provision for income taxes of $ 1.7 million.

 

NOTE 10 – SUBSEQUENT EVENTS

 

Dividends

 

On July 27, 2004, the Board of Directors declared a $0.13 per share dividend for the third quarter of 2004.  The dividend is payable on September 1, 2004 to shareholders of record on August 18, 2004.

 

Auditor Resignation

 

On July 16, 2004, Ernst & Young LLP advised the Company that the firm will resign as the Company’s auditors upon completion of its review of the interim financial information for the second quarter of 2004 and filing of the Company’s quarterly report on Form 10-Q for the quarter ending June 30, 2004.  The resignation was not the result of disagreements with Ernst & Young LLP on any matter of accounting principles or practices, financial statements disclosure, or auditing scope or procedure. The Company’s audit committee did not recommend a change in accountants, however, as a result of the resignation; the Audit Committee has begun a search for a new independent auditing firm.

 

Nasdaq Notice

 

Shares of the Company’s stock are currently traded on the Nasdaq Stock Market.  On July 20, 2004, the Company was notified by Nasdaq of a staff determination to de-list the Company effective July 29, 2004.  The Company has challenged the staff determination and has requested an oral hearing by a Listing Qualifications Panel to review the staff’s conclusions.  A hearing has been scheduled for September 9, 2004.  The Company will continue to be listed on the Nasdaq Stock Market while the Listing Qualifications Panel’s decision is pending.  There can be no assurance that the Company’s appeal will be successful.  If the Company is de-listed by Nasdaq, the Company will seek arrangements to facilitate over-the-counter trading of its securities.

 

Bourne End

 

On August 6, 2004, Bourne End sold the Southend Shopping Center for approximately 28.0 million Great Britain pounds (“GBP”).  The Company’s share of the pre-tax gain on this transaction is $2.8 million.

 

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George Elkins Mortgage Banking Company

 

On August 11, 2004 the Company received a notice from the Class B Holders of Fog Cap GEMB Holdings LLC (“Holdings”), a 51% owned subsidiary of the Company which owns trade names and certain assets relating to the operation of George Elkins Mortgage Banking Company.  The notice was to inform the Company that the Class B Holders believe that a Change in Control Transaction (as defined in the Holdings Operating Agreement) has occurred as a result of the leave of absence of Mr. Wiederhorn.  The notice also indicates that unless the Change in Control Transaction is corrected within 120 days, the Class B Holders intend to exercise their rights to purchase the Class A Interests held by the Company in accordance with the formula outlined in the Operating Agreement.

 

The Company disputes the claim that a Change in Control Transaction has occurred as a result of the leave of absence agreement with Mr. Wiederhorn.  However, if the Company were unsuccessful in defending this position, an analysis of the economic effect of the buyback formula indicates that the Company would not incur a loss on the transaction.  As a result, no reserves are required due to the receipt of the notice.

 

Chief Strategic Officer

 

On August 13, 2004, the Board of Directors adopted a resolution changing the role of Andrew Wiederhorn from Co-Chief Executive Officer to Chief Strategic Officer during the leave of absence period.  The Board had discussed this alternative with Mr. Wiederhorn prior to the effective date of his leave of absence.  The Board determined that during the leave of absence period, Mr. Wiederhorn would be in a better position to develop strategies that would be of future benefit to the Company, while his current status would significantly limit his ability to perform the full functions of Co-Chief Executive Officer.  All other provisions of the Leave of Absence Agreement and employment agreement with Mr. Wiederhorn remain in force.  Donald J. Berchtold will continue as sole Chief Executive Officer and will serve as the principal executive of the Company.

 

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