McCormick & Schmicks Seafood Restaurants Inc. - 10-Q Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 26, 2005

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 000-50845

McCormick & Schmick’s Seafood Restaurants, Inc.

(Exact name of registrant as specified in its charter)

Delaware		20-1193199
(State or other jurisdiction of		(IRS Employer Identification Number)
incorporation or organization)

720 SW Washington Street, Suite 550 Portland, Oregon		97205
(Address of principal executive offices)		(Zip Code)

(503) 226-3440

(Registrant’s telephone number, including area code)

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 Act). Yes o No ý

There were 13,782,350 shares of common stock outstanding as of May 10, 2005.

PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

McCormick & Schmick’s Seafood Restaurants, Inc. and Subsidiaries

Consolidated Balance Sheets—Unaudited

(In thousands, except per share data)

	December 25,			March 26,
	2004			2005
Assets
Current assets
Cash and cash equivalents	$	451		$	607
Trade accounts receivable, net	4,641			4,069
Tenant improvement allowance receivables	347			2,840
Inventories	3,384			3,532
Prepaid expenses and other current assets	2,846			2,942
Deferred income taxes	830			844
Total current assets	12,499			14,834
Equipment and leasehold improvements, net	92,744			95,971
Other assets	53,821			53,745
Goodwill	19,996			19,996
Total assets	$	179,060		$	184,546
Liabilities and Stockholders’ Equity
Current liabilities
Book overdraft	$	429		$	—
Accounts payable	12,875			12,048
Accrued expenses	15,197			15,732
Capital lease obligations, current portion	433			413
Total current liabilities	28,934			28,193
Revolving credit facility	12,000			14,500
Other long-term liabilities	11,791			13,258
Capital lease obligations, noncurrent portion	707			619
Deferred income taxes	1,558			2,259
Total liabilities	54,990			58,829

Stockholders’ equity
Common stock, $0.001 par value, 120,000 shares authorized, 13,782 shares issued and outstanding	14			14
Additional paid in capital	127,917			127,917
Accumulated deficit	(3,861		)	(2,214		)
Total stockholders’ equity	124,070			125,717
Total liabilities and stockholders’ equity	$	179,060		$	184,546

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

McCormick & Schmick’s Seafood Restaurants, Inc. and Subsidiaries

Consolidated Statements of Operations—Unaudited

(In thousands, except per share data)

	Quarter Ended
	March 27,			March 26,
	2004			2005
	Restated
Revenues	$	54,513		$	60,385

Restaurant operating costs
Food and beverage	16,286			17,760
Labor	17,810			19,356
Operating	7,874			9,017
Occupancy	4,848			5,605
Total restaurant operating costs	46,818			51,738
General and administrative expenses	2,549			3,342
Restaurant pre-opening costs	994			529
Depreciation and amortization	2,683			2,232
Management fees and covenants not to compete	638			—
Total costs and expenses	53,682			57,841
Operating income	831			2,544
Interest expense	857			156
Accrued dividends and accretion on mandatorily redeemable preferred stock	1,012			—
Income (loss) before income taxes	(1,038		)	2,388
Income tax expense (benefit)	(15		)	741
Net income (loss)	$	(1,023	)	$	1,647
Net income (loss) per share(1)
Basic and diluted	$	(0.13	)	$	0.12
Shares used in computing net income (loss) per share(1)
Basic	7,782			13,782
Diluted	7,782			13,959

(1) For the quarter ended March 27, 2004, which was prior to the Company’s initial public offering, the presentation gives retroactive effect to the completion of the Company’s corporate reorganization in calculating common shares outstanding.

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

McCormick & Schmick’s Seafood Restaurants, Inc. and Subsidiaries

Consolidated Statements of Cash Flows—Unaudited

(In thousands)

	Quarter Ended
	March 27,			March 26,
	2004			2005
	Restated
Operating activities
Net income (loss)	$	(1,023	)	$	1,647
Adjustments to reconcile net income (loss) to net cash provided by operating activities
Depreciation and amortization	2,683			2,232
Amortization of unearned compensation	3			—
Deferred income taxes	(15		)	741
Accrued dividends and accretion on mandatorily redeemable preferred stock	1,012			—
Changes in operating assets and liabilities
Trade accounts receivable	(707		)	572
Tenant improvement allowance receivables	(1,209		)	(2,493		)
Inventories	(234		)	(148		)
Prepaid expenses and other current assets	(700		)	(96		)
Accounts payable	(846		)	(827		)
Accrued expenses	1,628			481
Other long-term liabilities	1,315			1,467
Net cash provided by operating activities	1,907			3,576
Investing activities
Acquisition of equipment and leasehold improvements	(11,482		)	(5,394		)
Other assets	(53		)	11
Net cash used in investing activities	(11,535		)	(5,383		)
Financing activities
Decrease in book overdraft	(2,319		)	(429		)
Borrowings made on revolving credit facility	25,500			5,500
Payments made on revolving credit facility	(13,500		)	(3,000		)
Payments on capital lease obligations	(102		)	(108		)
Net cash provided by financing activities	9,579			1,963
Net increase (decrease) in cash and cash equivalents	(49		)	156
Cash and cash equivalents, beginning of period	2,453			451
Cash and cash equivalents, end of period	$	2,404		$	607

Supplemental disclosure of cash flow information
Cash paid during the period
Interest	$	646		$	229
Income taxes	16			54

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

McCormick & Schmick’s Seafood Restaurants, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—Unaudited

1. The Business and Organization

McCormick & Schmick’s Seafood Restaurants, Inc. is a leading national seafood restaurant operator in the affordable upscale dining segment. McCormick & Schmick’s Seafood Restaurants, Inc. is the survivor of a merger with McCormick & Schmick Holdings LLC (the “LLC”) that occurred on July 20, 2004, prior to the Company’s initial public offering.

The financial statements for the period covered by this report are those of McCormick & Schmick’s Seafood Restaurants, Inc. for periods beginning after July 19, 2004 and those of the LLC for periods ended on or before July 19, 2004. Except with respect to information regarding the membership units in the LLC and the common stock issued upon the reorganization, there was no impact to the financial statements as a result of converting from a limited liability company to a corporation. Before July 20, 2004, the Company’s operations were conducted by subsidiaries of the LLC, which were taxable corporations. Accordingly, the financial statements of the Company have historically included a provision for income taxes and related deferred income taxes. Throughout this report, McCormick & Schmick’s Seafood Restaurants, Inc. and the LLC are referred to collectively as “the Company.”

2. Basis of Presentation

As of March 26, 2005 the Company owned and operated 51 restaurants in 23 states throughout the United States of America. The Company also provides management services to two additional restaurants.

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the quarter ended March 26, 2005 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2005.

The consolidated balance sheet at December 25, 2004 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 25, 2004.

Certain prior period amounts have been reclassified to conform to current period presentation.

3. Restatement of Financial Information

Like many other restaurant companies and retailers, the Company conducted a review of its accounting policies applicable to leases, leasehold improvements, rent commencement, deferred rent, and other related items. This review was prompted in part by a February 7, 2005 letter from the Office of the Chief Accountant of the Securities and Exchange Commission to the American Institute of Certified Public Accountants regarding proper accounting for certain operating lease matters under generally accepted accounting principles. Based on our review, we determined that we incorrectly accounted for certain operating lease transactions under generally accepted accounting principles. Accordingly, the Company has adjusted its consolidated financial statements for fiscal years and quarters ended prior to December 25, 2004. These restatement adjustments increased net loss by

$274,000 and increased basic and diluted net loss per share by ($0.03) for the quarter ended March 27, 2004. The restatement adjustments are non-cash and had no impact on revenues or cash and cash equivalents.

Lease Term

Historically, the Company amortized its leasehold improvements on leased properties over the shorter of the combined initial term and all option periods of the lease (generally ranging from 20 to 30 years) or the useful life of the asset. In addition, the Company recognized rent expense on the straight-line basis from the opening date of the restaurant through the initial term of the lease. The Company concluded that its calculation of straight line rent expense should be based on the lease term as defined in Statement of Financial Accounting Standards (“SFAS”) No. 13, Accounting for Leases, as amended, which in most cases exceeds the initial term of the lease. As a result, it restated its financial statements to recognize rent expense on the straight-line basis over the lease term, including option periods which are reasonably assured of renewal primarily due to the presence of certain economic penalties. For purposes of calculating straight-line rents, the lease term commences on the date the lessee obtains control over the property, which is generally when the lessor’s property is substantially complete and is ready for tenant improvements. In addition, the Company amortizes leasehold improvements over the shorter of the lease term or the useful life of the assets. As a result of these changes, the Company’s deferred rent credit liability included in other long-term liabilities, pre-opening costs and rent expense in the accompanying financial statements have increased on a restated basis.

Tenant Improvement Allowances

The Company historically netted all tenant improvement allowances against the capitalized cost of leasehold improvements. It determined that certain tenant improvement allowances should be considered lease incentives and recorded as a deferred rent credit and amortized as a reduction to rent expense over the lease term. This change increases capitalized leasehold improvements and the deferred rent credit liability included in other long-term liabilities which results in increases in amortization expense and decreases in rent expense.

4. Summary of Selected Accounting Policies

Principles of Consolidation

The consolidated financial statements include the assets, liabilities and results of operations of McCormick & Schmick’s Seafood Restaurants, Inc. and its subsidiaries: McCormick & Schmick Acquisition Corp II, McCormick & Schmick Acquisition Corp., McCormick & Schmick Restaurant Corp., McCormick & Schmick Maryland Liquor, Inc., McCormick & Schmick Acquisition I Texas, Inc., McCormick & Schmick Acquisition II Texas, Inc., McCormick & Schmick Acquisition III Texas, Inc., McCormick & Schmick Acquisition Texas, LP, McCormick & Schmick’s Atlanta II, LLC, McCormick & Schmick’s Hackensack, LLC, McCormick & Schmick Orlando, LLC, McCormick & Schmick Dallas LP, McCormick & Schmick Dallas Liquor, Inc., McCormick & Schmick Austin LP, and McCormick & Schmick Austin Liquor, Inc. All intercompany balances and transactions have been eliminated upon consolidation.

Management Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. The Company bases its estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances at the time. Actual results could differ from those estimates under different assumptions or conditions.

Revenue Recognition

Revenues are recognized at the point of delivery of products and services. A deferred liability is recognized for gift certificates that have been sold but not yet redeemed at their anticipated redemption value. The anticipated redemption value includes the cash value of gift certificates outstanding for approximately eighteen months from the date of sale. The anticipated redemption value is adjusted thereafter based on the Company’s historical redemption rates. The Company recognizes revenue and reduces the related deferred liability when the gift certificates are redeemed.

Equity-Based Compensation Plan

The Company accounts for its equity-based compensation plan using the intrinsic-value method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, as amended, (“APB 25”). Accordingly, the Company computed compensation cost for employee equity units granted as the amount by which the estimated fair value of the Company’s equity units on the date of grant exceeds the amount the employee must pay to acquire the related equity units. The amount of compensation cost is charged to income over the vesting period.

Under SFAS No. 123, Accounting for Stock-Based Compensation, (“SFAS 123”), as amended by SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, as amended, (“SFAS 148”), companies who choose to account for equity-based compensation plans using the intrinsic-value method are required to determine the fair value of employee equity grants using the fair value method and to disclose the impact of fair value accounting in a note to the financial statements. Prior to the Company’s initial public offering, there was no difference between the accounting for the equity-based compensation plan described under APB 25 and SFAS 123. Accordingly, prior to the initial public offering, there was no difference between reported net income and pro forma net income determined under SFAS 123.

In December 2004, the Financial Accounting Standards Board (‘‘FASB’’) issued SFAS No. 123(R), ‘‘Share-Based Payment’’(“SFAS 123(R)”), which is a revision of SFAS 123 and supercedes APB 25. SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be valued at fair value on the date of grant, and to be expensed over the applicable vesting period. On April 14, 2005, the Securities and Exchange Commission adopted a new rule that amends the compliance dates for SFAS 123(R). SFAS 123(R) is effective for public companies for fiscal years beginning after June 15, 2005. Under the new rule, the Company is required to adopt SFAS 123(R) beginning January 1, 2006. Pro forma disclosure of share-based payments effect to the statement of operations is not permissible under SFAS 123(R). SFAS 123(R) is effective for all stock-based awards granted on or after January 1, 2006. In addition, companies must also recognize compensation expense related to any awards that are not fully vested as of January 1, 2006. Compensation expense for the unvested awards will be measured based on the fair value of the awards previously calculated in developing the pro forma disclosures in accordance with the provisions of SFAS 123. The Company is currently evaluating the effect that the adoption of SFAS 123(R) will have on its financial position and results of operations. The adoption of SFAS 123(R) is expected to increase compensation expense.

The table below shows the effects on net income and net income per share had compensation cost been measured with the fair value method pursuant to SFAS 123:

	Quarter Ended
	March 26, 2005
	(in thousands, except per share data)
Net income, as reported	$	1,647
Compensation cost based on the fair value method	(216		)
Pro forma net income	$	1,431

Basic and fully diluted net income per share
As reported	$	0.12
Pro forma	$	0.10
Shares used in computing net income per common share
Basic	13,782
Fully diluted	13,959

The preceding proforma results were calculated with the use of the Black-Scholes option pricing model. The following assumptions were used:

(1) risk-free interest rate of 3.9%;

(2) dividend yield of 0%;

(3) expected life of 5.5 years;

(4) and volatility of 24.3%.

Results may vary depending on the assumptions applied within the model.

There is no difference between reported net loss and net loss per share and proforma net loss and net loss per share determined under SFAS 123 for the quarter ended March 27, 2004.

Basic and Diluted Net Income (Loss) per Share

Basic income (loss) per share is computed based on the weighted-average number of common shares outstanding during the period since the Company’s initial public offering. For periods prior to the initial public offering the 7,179,357 shares of common stock of the Company issued to the former unit holders of the LLC and the 602,292 shares issuable upon the exercise of certain warrants (because the warrants have a nominal exercise price) are assumed to be outstanding for all periods presented. Diluted earnings per share are computed using the weighted average number of shares of common stock and potentially dilutive securities assumed to be outstanding during the year. Potentially dilutive shares from stock options and other common stock equivalents are excluded from the computation when their effect is antidilutive.

Options to purchase 865,300 shares of common stock were outstanding at March 26, 2005. The diluted weighted-average shares for the quarter ended March 26, 2005 include 176,695 shares subject to stock options. There were no stock options prior to the initial public offering.

Operating Leases

The Company has entered into operating leases, which have accelerating minimum base rent terms and contingent rent terms if individual restaurant sales exceed certain levels. The Company records the minimum base rents on a straight-line basis over the life of the lease term, including option periods which are reasonably assured of renewal due to the presence of certain economic penalties. For purposes of calculating straight-line rents, the lease term commences on the date the lessee obtains control of the property, which is normally when the property is ready for normal tenant improvements (build-out-period), when no rent payments are typically due

under the terms of the lease. For certain leases the Company only has the right to exercise its option for renewal if certain sales targets are achieved at or near the renewal date. These renewal option periods have been included in the lease term when the Company determines at lease inception or at the acquisition date of the restaurant, if later, that the sales targets are nonsubstantive and achievement of such sales targets is virtually certain. The difference between rent expense calculated on a straight line basis and rent paid is recorded as deferred rent liability. The Company receives certain tenant improvement allowances which are considered lease incentives and are amortized as reduction of rent expense over the lease term. Accordingly, the Company has recorded a deferred rent liability for the straightlining of rents and lease incentives, which is included in other long-term liabilities of $10.8 million and $12.3 million as of December 25, 2004 and March 26, 2005, respectively. Non-cash rents were $0.5 million in both the first quarter of 2005 and the first quarter of 2004.

5. Long-Term Debt

On July 23, 2004, the Company repaid the outstanding balance on its revolving credit facility in the amount of $51.5 million with net proceeds from its initial public offering and $18.1 million in loans under a new revolving credit facility agreement, which provides among other things for $50.0 million in revolving credit loans. Loans under the facility are collateralized by a first priority security interest in all of the Company’s assets and mature on July 23, 2009.

The outstanding balance on the Company’s revolving credit facility was $14.5 million and $12.0 million as of March 26, 2005 and December 25, 2004, respectively. The interest rate on the credit facility is based on the financial institution’s prime rate plus a margin of 0.25% to 0.75% or the Eurodollar rate plus a margin of 1.75% to 2.25%, with margins determined by certain financial ratios. Under the revolving credit facility, the Company is subject to certain financial and non-financial covenants, including an adjusted leverage ratio, a consolidated cash flow ratio, and a growth capital expenditures limitation. The Company was in compliance with these covenants as of March 26, 2005.

6. Related Party Transactions

Prior to the Company’s initial public offering, it paid annual management fees of $1.1 million to each of Bruckman, Rosser, Sherrill & Co., L.L.C. (“BRS”) and Castle Harlan, Inc. (“Castle Harlan”), affiliates of which had significant ownership interests in the Company. These management agreements were terminated in conjunction with the Company’s initial public offering in July 2004, at which time, affiliates of each of BRS and Castle Harlan had significant ownership interests in the Company. Management fees recognized as expenses totaled $550,000 in the first quarter of 2004. Pursuant to covenants not to compete agreements with the Company’s co-founders, William P. McCormick and Douglas L. Schmick, the Company expensed $87,500 in the first quarter of 2004. These covenants not to compete agreements were terminated in connection with the Company’s initial public offering.

The Company leases properties from landlords controlled by certain stockholders of the Company. Total rent paid to these landlords was $202,000 and $127,000 for the first quarter of 2005 and the first quarter of 2004, respectively.

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

FORWARD LOOKING STATEMENTS

This Quarterly Report, including Items 1 and 2 of Part I, contains forward-looking statements that are subject to substantial risks and uncertainties. These statements relate to future events or our future financial performance. We have attempted to identify forward-looking statements by terminology including “anticipate,” “believe,” “can,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “should” or “will” or the negative of these terms or other comparable terminology. The expectations reflected in these forward-looking statements may prove to be incorrect.

Important factors that could cause actual results to differ materially from our expectations include those discussed below under “Factors That May Affect Our Business and the Price of Our Stock.” We do not

undertake any duty to update forward-looking statements after the date they are made or to conform them to actual results or to changes in circumstances or expectations.

Restatement of Financial Information

Like many other restaurant companies and retailers, we have conducted a review of our accounting policies applicable to leases, leasehold improvements, rent commencement, deferred rent, and other related items. This review was prompted in part by a February 7, 2005 letter from the Office of the Chief Accountant of the Securities and Exchange Commission to the American Institute of Certified Public Accountants regarding proper accounting for certain operating lease matters under generally accepted accounting principles. Accordingly, we have adjusted our consolidated financial statements for fiscal years and quarters ended prior to December 25, 2004. These restatement adjustments increased net loss by $274,000 and increased basic and diluted net loss per share by ($0.03) for the quarter ended March 27, 2004. The restatement adjustments are non-cash and had no impact on revenues or cash and cash equivalents.

Lease term

Historically, we amortized our leasehold improvements on leased properties over the shorter of the combined initial term and all option periods of the lease (generally ranging from 20 to 30 years) or the useful life of the asset. In addition, we recognized rent expense on the straight-line basis from the opening date of the restaurant through the initial term of the lease. We have concluded that our calculation of straight-line rent expense should be based on the lease term as defined in Statement of Financial Accounting Standards (“SFAS”) No. 13, Accounting for Leases, as amended, (“SFAS 13”), which in most cases exceeds the initial term of the lease. As a result, we have restated our financial statements to recognize rent expense on the straight-line basis over the lease term, including option periods which are reasonably assured of renewal due to the presence of certain economic penalties. For purposes of calculating straight-line rents, the lease term commences on the date the lessee obtains control over the property, which is generally when the lessor’s property is substantially complete and ready for tenant improvements. In addition, we now amortize leasehold improvements over the shorter of the lease term or the useful life of the assets. As a result of these changes, deferred rent credit liability included in other long-term liabilities, pre-opening costs and rent expense in the accompanying financial statements have increased on a restated basis.

Tenant improvement allowances

We historically netted all tenant improvement allowances against the capitalized cost of leasehold improvements. We have determined that certain tenant improvement allowances should be considered lease incentives and recorded as a deferred rent credit and amortized as a reduction to rent expense over the lease term. This change increases capitalized leasehold improvements and the deferred rent credit liability, which results in increases in amortization expense and decreases in rent expense.

Reorganization in Connection with Initial Public Offering

In connection with our initial public offering in July 2004, we converted McCormick & Schmick Holdings LLC, a Delaware limited liability company, into McCormick & Schmick’s Seafood Restaurants, Inc., a Delaware corporation. Because our operations are conducted by wholly owned subsidiaries, the conversion did not affect our financial statements, except with respect to information regarding the membership units in McCormick & Schmick Holdings LLC. Except where specifically noted, references in this Quarterly Report on Form 10 Q to “we” or to “the Company” means McCormick & Schmick Holdings LLC for periods before July 20, 2004 and McCormick & Schmick’s Seafood Restaurants, Inc. for periods on and after July 20, 2004.

Overview

Our company was founded in 1972 with William P. McCormick’s acquisition of Jake’s Famous Crawfish in Portland, Oregon. We grew our family of restaurants slowly through the next two decades and in 1994, when we owned 14 restaurants, a majority interest in our company was purchased by Castle Harlan Partners II, L.P., a private investment firm. Avado Brands purchased us in 1997. We operated as a division of Avado Brands and added 18 new restaurants in just under four and a half years. In August 2001, Avado Brands sold our company to Castle Harlan Partners III, L.P. and Bruckmann, Rosser, Sherrill & Co. II, L.P. , private equity investment firms that actively invest in restaurant companies. We have expanded our restaurant base to 53 restaurants, including two restaurants operated under management contracts.

We have grown our business by offering our customers a daily-printed menu with a broad selection of affordable, quality fresh seafood in an upscale environment, serviced by knowledgeable and professional management and staff. Our revenues are generated by sales at our restaurants, including banquets.

We measure performance using key operating indicators such as comparable restaurant sales, food and beverage costs, labor costs, restaurant operating expenses, and total occupancy costs, with a focus on those costs and expenses as a percentage of revenues. We also track trends in average weekly revenues at both the restaurant level and on a consolidated basis as an indicator of our performance. The key operating measure used by management in evaluating our operating results is operating income. Operating income is calculated by deducting restaurant operating costs, general and administrative expenses, restaurant pre-opening costs, depreciation and amortization and other corporate costs from revenues. We monitor general and administrative expenses as a percentage of revenues, which we target to be approximately 5% of revenues. Restaurant pre-opening costs are analyzed based on the number and timing of restaurant openings and by comparison to budgeted amounts, with an overall target of approximately $0.3 to $0.4 million per restaurant opening, which may include up to $0.1 million in non-cash rent expense during the construction period.

The most significant restaurant operating costs are food and beverage costs and labor and related employee benefits. We believe our national and regional presence allows us to achieve better quality and pricing on key products than most of our competitors. We closely monitor food and beverage costs and regularly review our selection of preferred vendors on the basis of several key metrics, including pricing. In addition, because we print our menu daily, we are able to adapt the seafood items we offer to changes in vendor pricing to optimize our revenue mix and mitigate the impact of cost increases in any particular seafood item by substituting a lower-cost alternative on our menu or by adjusting the price. With respect to labor costs, we believe the combination of future growth in revenues and the resulting greater leverage of our vice presidents of operations and regional managers will allow us to better leverage payroll expenses over time. Our employee benefits include health insurance, the cost of which continues to increase faster than the general rate of inflation. We continually monitor this cost and review strategies to effectively control increases but we are subject to the overall trend of increases in healthcare costs.

General and administrative expenses are controlled in absolute amounts and monitored as a percentage of revenues. As we have continued our growth, we have incurred substantial training costs and made significant investments in infrastructure, including our information systems. As we continue to grow and are able to leverage investments made in our people and systems, we expect these expenses to decrease as a percentage of revenues over time.

Identification of appropriate new restaurant sites is essential to our growth strategy. We evaluate and invest in new restaurants based on site-specific projected returns on investment. We believe our store model and flexible real estate strategy provide us with continued opportunities to find attractive real estate locations on favorable terms.

Strategic Focus and Operating Outlook

Our primary business focus for over 33 years has been to consistently offer a broad selection of high quality, fresh seafood, which we believe commands strong loyalty from our customers. We have successfully expanded our McCormick & Schmick’s seafood restaurant concept throughout the United States and have competed

effectively with both national and regional restaurant chains as well as with local operators. We opened three, three and nine new company-owned restaurants in 2002, 2003 and 2004, respectively, and entered into management contracts for one restaurant in 2002 and one restaurant in 2004, growing from 35 to 52 restaurants during this three year period.

Our objective is to continue to prudently grow McCormick & Schmick’s seafood restaurants in existing and new markets. Our 2005 plan includes the opening of seven new restaurants. In addition to new unit growth, we are committed to improving comparable restaurant sales over the levels achieved in 2004 by driving increased customer counts as well as restaurant level operating margins.

Financial Performance Overview

The following are highlights of our financial performance for the first quarter ended March 26, 2005:

• Comparable restaurant sales in the first quarter of 2005 increased 1.2% compared to an increase of 5.8% over the comparable restaurant sales in the first quarter of 2004.

• Revenues increased 10.8% in the first quarter of 2005 compared to the first quarter of 2004, to $60.4 million. The increase was primarily due to revenues generated by the five company-owned restaurants opened in the last three quarters of 2004 and the first quarter of 2005 coupled with our 1.2% positive comparable restaurant sales.

• Net income increased $2.7 million in the first quarter of 2005 compared to the first quarter of 2004, to $1.6 million due to the following:

• Operating income increased $1.7 million in the first quarter of 2005 compared to the first quarter of 2004, to $2.5 million primarily due to the higher revenues.

• General and administrative expenses increased $0.8 million primarily due to additional expenses related to being a public company.

• Restaurant pre-opening costs decreased $0.5 million due to the decreased number of restaurant openings or restaurants under construction in the first quarter of 2005.

• In connection with the initial public offering, we eliminated certain stockholder management agreements and covenants not to compete agreements resulting in the elimination of management fees and covenants not to compete expense. The impact of these items resulted in a $0.6 million increase to operating income.

• With the proceeds from our initial public offering, we redeemed all of our preferred stock, and substantially decreased our average outstanding debt balance, resulting in the elimination of accrued dividends and accretion on our mandatorily redeemable preferred stock coupled with a reduction in interest expense. The impact of these two items resulted in a $1.5 million increase to net income.

The following table sets forth our operating results and our operating results expressed as a percentage of revenues for the quarterly periods ended March 27, 2004 and March 26, 2005.

	Quarter Ended
	March 27, 2004					March 26, 2005
	Restated
	(in thousands)

Revenues	$	54,513		100	%	$	60,385	100	%

Restaurant operating costs
Food and beverage	16,286			29.9	%	17,760		29.4	%
Labor	17,810			32.7	%	19,356		32.1	%
Operating	7,874			14.4	%	9,017		14.9	%
Occupancy	4,848			8.9	%	5,605		9.3	%
Total restaurant operating costs	46,818			85.9	%	51,738		85.7	%
General and administrative expenses	2,549			4.7	%	3,342		5.5	%
Restaurant pre-opening costs	994			1.8	%	529		0.9	%
Depreciation and amortization	2,683			4.9	%	2,232		3.7	%
Management fees and covenants not to compete	638			1.2	%	—		—
Total costs and expenses	53,682			98.5	%	57,841		95.8	%
Operating income	831			1.5	%	2,544		4.2	%
Interest expense	857			1.6	%	156		0.3	%
Accrued dividends and accretion on mandatorily redeemable preferred stock	1,012			1.9	%	—		—
Income (loss) before income taxes	(1,038		)	(1.9	)%	2,388		4.0	%
Income tax expense (benefit)	(15		)	—		741		1.2	%
Net income (loss)	$	(1,023	)	(1.9	)%	$	1,647	2.7	%

Revenues and Restaurant Operating Costs

The following table sets forth revenues and restaurant operating costs, including food and beverage, labor, operating and occupancy costs from our unaudited consolidated statements of operations:

	Quarter Ended				Change
	March 27,		March 26,
	2004		2005		$		%
	Restated
	(in thousands)

Revenues	$	54,513	$	60,385	$	5,872	10.8	%

Restaurant operating costs
Food and beverage	$	16,286	$	17,760	$	1,474	9.1	%
Labor	17,810		19,356		1,546		8.7	%
Operating	7,874		9,017		1,143		14.5	%
Occupancy	4,848		5,605		757		15.6	%
Total restaurant operating costs	$	46,818	$	51,738	$	4,920	10.5	%

Revenues. Revenues increased by $5.9 million, or 10.8%, to $60.4 million in the first quarter of 2005 from $54.5 million in the first quarter of 2004. This increase was primarily attributable to revenues of $4.0 million generated by five company-owned restaurants opened in the last three quarters of 2004 and the first quarter of 2005 and an increase in comparable restaurant sales of $0.6 million, or 1.2%. Comparable restaurant sales were positive

1.2%, primarily as a result of higher pricing.

Food and Beverage Costs. Food and beverage costs increased by $1.5 million, or 9.1%, to $17.8 million in the first quarter of 2005 from $16.3 million in the first quarter of 2004. This increase was primarily due to the five company-owned restaurants opened in the last three quarters of 2004 and the first quarter of 2005. Food and beverage costs as a percentage of revenues decreased to 29.4% in the first quarter of 2005 compared to 29.9% in the first quarter of 2004, primarily related to pricing increases and increased product handling efficiency for the restaurants opened in 2004.

Labor Costs. Labor costs increased by $1.5 million, or 8.7%, to $19.4 million in the first quarter of 2005 from $17.8 million in the first quarter of 2004. This increase was primarily due to the five company-owned restaurants opened in the last three quarters of 2004 and the first quarter of 2005. Labor costs as a percentage of revenue decreased to 32.1 % in the first quarter of 2005 compared to 32.7% in the first quarter of 2004 because of lower management costs as a percentage of revenues.

Operating Costs. Operating costs increased by $1.1 million, or 14.5%, to $9.0 million in the first quarter of 2005 from $7.9 million in the first quarter of 2004. This increase was primarily due to the five company-owned restaurants opened in the last three quarters of 2004 and the first quarter of 2005. Operating costs as a percentage of revenues increased to 14.9% in the first quarter of 2005 from 14.4% in the first quarter of 2004. The percentage increase in operating costs was primarily due to higher marketing and utility costs.

Occupancy Costs. Occupancy costs increased by $0.8 million, or 15.6%, to $5.6 million in the first quarter of 2005 from $4.8 million in the first quarter of 2004, primarily due to the occupancy costs of the five company-owned restaurants opened in the last three quarters of 2004 and the first quarter of 2005. Occupancy costs as a percentage of revenues increased to 9.3% in the first quarter of 2005 from 8.9% in the first quarter of 2004, primarily due to occupancy costs as a percentage of revenues for the restaurants opened in the last three quarters of 2004 and the first quarter of 2005 being higher than occupancy costs as a percentage of revenues for the comparable restaurants. Non-cash rents were $0.5 million in both the first quarter of 2005 and the first quarter of 2004.

General and Administrative, Restaurant Pre-Opening, Depreciation and Amortization and Management Fees and Covenants Not to Compete

The following table sets forth general and administrative, restaurant pre-opening, depreciation and amortization and management fees and covenants not to compete costs from our unaudited consolidated statements of operations:

	Quarter Ended				Change
	March 27,		March 26,
	2004		2005		$			%
	Restated
	(in thousands)

General and administrative expenses	$	2,549	$	3,342	$	793		31.1	%
Restaurant pre-opening costs	994		529		(465		)	(46.8%	)
Depreciation and amortization	2,683		2,232		(451		)	(16.8%	)
Management fees and covenants not to compete	638		—		(638		)	(100.0%	)

General and Administrative Expenses. General and administrative expenses increased by $0.8 million, or 31.1%, to $3.3 million in the first quarter of 2005 from $2.5 million in the first quarter of 2004. General and administrative expenses as a percentage of revenues were 5.5% in the first quarter of 2005 and 4.7% in the first quarter of 2004. The increase in general and administrative expenses as a percentage of revenues was primarily due to costs associated with being a public company.

Restaurant Pre-Opening Costs. Restaurant pre-opening costs decreased by $0.5 million, or 47.0%, to $0.5 million in the first quarter of 2005 from $1.0 million in the first quarter of 2004, primarily due to the decreased number of restaurant openings or restaurants under construction in the first quarter of 2005 compared to the first quarter of 2004.

Depreciation and Amortization. Depreciation and amortization decreased by $0.5 million, or 16.8%, to $2.2 million in the first quarter of 2005 from $2.7 million in the first quarter of 2004. The decrease was primarily due to three-year lived assets acquired in August of 2001 which became fully depreciated in 2004.

Management Fees and Covenants Not to Compete. Prior to our initial public offering, we paid annual management fees of $1.1 million to each of BRS and Castle Harlan. These management agreements were terminated in conjunction with our initial public offering at which time affiliates of each of BRS and Castle Harlan had significant ownership interests in the Company. Management fees recognized as expenses totaled $550,000 in the first quarter of 2004. Pursuant to covenants not to compete agreements with our co-founders, William P. McCormick and Douglas L. Schmick, we expensed $87,500 in the first quarter of 2004. These covenants not to compete agreements were terminated in connection with our initial public offering.

Other Expenses

The following table sets forth interest expense, minority interest, write off of deferred loan costs, and income tax expense (benefit) from our unaudited consolidated statements of operations.

	Quarter Ended					Change
	March 27,			March 26,
	2004			2005		$			%
	Restated
	(in thousands)

Interest expense	$	857		$	156	$	(701	)	(81.8	)%
Accrued dividends and accretion on mandatorily redeemable preferred stock	$	1,012		$	—	$	(1,012	)	(100.0	)%
Income (loss) before income taxes	$	(1,038	)	$	2,388	$	3,426		*
Income tax expense (benefit)	(15		)	741		756			*
Net income (loss)	$	(1,023	)	$	1,647	$	2,671		*

* Percentage change is not meaningful.

Interest Expense. Interest expense decreased by $0.7 million, or 81.8%, to $0.2 million in the first quarter of 2005, from $0.9 million in the first quarter of 2004. This was primarily due to a decrease of approximately $40.0 million in the average outstanding debt balance as a result of the payoff of our prior credit facility.

Accrued Dividends and Accretion on Mandatorily Redeemable Preferred Stock. Dividends and accretive rights of a subsidiary’s redeemable preferred stock are reflected as accrued dividends and accretion on mandatorily redeemable preferred stock in the consolidated financial statements. Proceeds from our initial public offering were used to redeem all of the preferred stock.

Income Tax (Benefit) Expense. Income tax expense was $0.7 million in the first quarter of 2005, which reflects an effective tax rate of approximately 31% and the benefit of FICA tip credits. In the first quarter of 2004 income tax benefit was $15,000.

Net Income (Loss). Net income increased $2.7 million in the first quarter of 2005 compared to the first quarter of 2004, to $1.6 million due to the following:

• Operating income increased $1.7 million in the first quarter of 2005 compared to the first quarter of 2004, to $2.5 million primarily due to the higher revenues.

• General and administrative expenses increased $0.8 million primarily due to additional expenses related to being a public company.

• Restaurant pre-opening costs decreased $0.5 million due to the decreased number of restaurant openings or restaurants under construction in the first quarter of 2005.

• In connection with the initial public offering, we terminated certain management agreements and covenants not to compete agreements resulting in the elimination of management fees and covenants not to compete expense. The impact of these items resulted in a $0.6 million increase to operating income.

Liquidity and Capital Resources

Our primary cash needs have been for new restaurant construction, working capital and general corporate purposes, including payments under credit facilities. Our main sources of cash have been issuance of common stock, net cash provided by operating activities and borrowings under credit facilities.

On July 20, 2004, we completed our initial public offering. In connection with the initial public offering we:

• Issued 7,179,357 shares of common stock in the merger to the holders of McCormick & Schmick Holdings LLC’s units, not including 602,992 shares issuable upon the exercise of warrants at a nominal price to The Bell Atlantic Master Trust.

• Sold 6,000,000 shares at $12.00 per share, raising approximately $65.1 million after underwriting discounts and transaction costs.

• Repaid $51.5 million of indebtedness on our then existing credit facility with the proceeds raised in the initial public offering and from $18.1 million in loans under a new revolving credit facility, which provides, among other things, for $50.0 million in revolving credit loans.

• Paid $28.9 million to The Bell Atlantic Master Trust to redeem all of the 13% senior exchangeable preferred stock of a wholly owned subsidiary.

• Paid $2.8 million in connection with the termination of the management agreements and covenants not to compete agreements.

The following table summarizes our sources and uses of cash and cash equivalents from our unaudited consolidated statements of cash flows:

	Quarter Ended
	March 27,			March 26,
	2004			2005
	Restated
	(in thousands)

Net cash provided by operating activities	$	1,907		$	3,576
Net cash used in investing activities	(11,535		)	(5,383		)
Net cash provided by financing activities	9,579			1,963
Net increase (decrease) in cash and cash equivalents	$	(49	)	$	156

Net cash provided by operating activities was $3.6 million in the first quarter of 2005, compared to $1.9 million in the first quarter of 2004. The increase in net cash provided by operating activities was primarily due to

generating net income in the first quarter of 2005, an increase in net income (loss) of $2.7 million, partially offset by a decrease in accrued expenses of $1.1 million.

Net cash used in investing activities was $5.4 million in the first quarter of 2005, compared to $11.5 million in the first quarter of 2004. We use cash for tenant improvements and equipment to open new restaurants, and to upgrade and add capacity to existing restaurants. Net cash used in investing activities varied in the periods presented based on the number of new restaurants opened and the expansion of existing restaurant capacity during the period. Purchases of property and equipment also include purchases of information technology systems and expenditures relating to our corporate headquarters.

Net cash provided by financing activities was $2.0 million in the first quarter of 2005 compared to $9.6 million in the first quarter of 2004. The decrease in net cash provided by financing activities was primarily due to a decrease in borrowings under our revolving credit facilities of $20.0 million partially offset by a decrease in payments made on our revolving credit facilities of $10.5 million.

As of March 26, 2005, the outstanding balance on our revolving credit facility was $14.5 million. The interest rate on the credit facility is based on the financial institution’s prime rate plus a margin of 0.25% to 0.75% or the Eurodollar rate plus a margin of 1.75% to 2.25%, with margins determined by certain financial ratios. Under our revolving credit facility, we are subject to certain financial and non-financial covenants, including an adjusted leverage ratio, a consolidated cash flow ratio and growth capital expenditures limitation. We were in compliance with these covenants as of March 26, 2005.

We believe the net cash provided by operating activities and funds available from our revolving credit facility will be sufficient to satisfy our working capital and capital expenditure requirements, including restaurant construction, pre-opening costs and potential initial operating losses related to new restaurant openings for at least the next 12 months.

Critical Accounting Policies and Estimates

Our significant accounting policies are those that we believe are both important to the portrayal of our financial condition and results and require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. We believe our critical accounting policies and estimates used in the preparation of our consolidated financial statements are the following:

Equipment and Leasehold Improvements

Equipment and leasehold improvements are stated at cost less accumulated depreciation and amortization. Equipment consists primarily of restaurant equipment, furniture, fixtures and small wares. Depreciation is generally calculated using the straight-line method over the estimated useful lives of the related assets. Leasehold improvements are amortized using the straight-line method over the shorter of the lease term as defined in SFAS 13 or the estimated useful life of the asset. As discussed in SFAS 13, the lease term includes any period covered by a renewal option where the renewal is reasonably assured because failure to renew the lease would impose an economic penalty to the lessee. Repairs and maintenance are expensed as incurred; renewals and betterments are capitalized. Estimated useful lives are generally as follows: equipment—5 to 10 years; furniture and fixtures—5 to 10 years and leasehold improvements—7 to 30 years. Judgments and estimates made by us related to the expected useful lives of these assets are affected by factors such as changes in economic conditions and changes in operating performance. If these assumptions change in the future, we may be required to record impairment charges for these assets.

Impairment of Long-Lived Assets

We review property and equipment (which includes leasehold improvements) for impairment when events or circumstances indicate these assets might be impaired. We test impairment using historical cash flow and other relevant facts and circumstances as the primary basis for our estimates of future cash flows. The analysis is performed at the restaurant level for indicators of permanent impairment. In determining future cash flows,

significant estimates are made by us with respect to future operating results of each restaurant over its remaining lease term. If assets are determined to be impaired, the impairment charge is measured by calculating the amount by which the asset-carrying amount exceeds its fair value. The determination of asset fair value is also subject to significant judgment. This process requires the use of estimates and assumptions, which are subject to a high degree of judgment. If these assumptions change in the future, we may be required to record impairment charges for these assets. In our most recent impairment evaluation for long-lived assets, no additional impairment charge would have resulted even if there were a permanent 5% reduction in revenues in our restaurants.

Goodwill and Other Indefinite Lived Assets

Goodwill and other indefinite lived assets resulted from our acquisition in 2001. Goodwill and other intangible assets with indefinite lives are not subject to amortization. However, such assets must be tested for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable and at least annually. We completed our most recent impairment test on balances as of December 25, 2004, and determined that there were no impairment losses related to goodwill and other indefinite lived assets. In assessing the recoverability of goodwill and other indefinite lived assets, market values and projections regarding estimated future cash flows and other factors are used to determine the fair value of the respective assets. The estimated future cash flows were projected using significant assumptions, including future revenues and expenses. If these estimates or related projections change in the future, we may be required to record impairment charges for these assets. In our most recent impairment evaluation for goodwill and other indefinite lived assets, no impairment charge would have resulted even if a permanent 5% reduction in revenues were to occur.

Insurance Liability

We maintain various insurance policies for workers’ compensation, employee health, general liability, and property damage. Pursuant to those policies, we are responsible for losses up to certain limits and are required to estimate a liability that represents our ultimate exposure for aggregate losses below those limits. This liability is based on management’s estimates of the ultimate costs to be incurred to settle known claims and claims not reported as of the balance sheet date. Our estimated liability is not discounted and is based on a number of assumptions and factors, including historical trends, actuarial assumptions, and economic conditions. If actual trends differ from our estimates, our financial results could be impacted.

Income Taxes

We have accounted for, and currently account for, income taxes in accordance with SFAS No. 109, Accounting for Income Taxes. This Statement establishes financial accounting and reporting standards for the effects of income taxes that result from an enterprise’s activities during the current and preceding years. It requires an asset and liability approach for financial accounting and reporting of income taxes. We recognize deferred tax liabilities and assets for the future consequences of events that have been recognized in our consolidated financial statements or tax returns. In the event the future consequences of differences between financial reporting bases and tax bases of our assets and liabilities result in a net deferred tax asset, an evaluation is made of the probability of being able to realize the future benefits indicated by such asset. A valuation allowance related to a deferred tax asset is recorded when it is more likely than not that some portion or all of the deferred tax asset will not be realized. The realization of such net deferred tax asset will generally depend on whether we will have sufficient taxable income of an appropriate character within the carry forward period permitted by the tax law. Without sufficient taxable income to offset the deductible amounts and carry forwards, the related tax benefits will expire unused. We have evaluated both positive and negative evidence in making a determination as to whether it is more likely than not that all or some portion of the deferred tax asset will not be realized. Measurement of deferred items is based on enacted tax laws. No deferred tax asset valuation allowance has been recorded as of March 26, 2005.

Operating Leases

Rent expense for our operating leases, which generally have escalating rentals over the term of the lease, is recorded on the straight-line basis over the lease term as defined in SFAS 13. The lease term commences on the date which is normally when the property is ready for normal tenant improvements (build-out period), when no rent payments are typically due under the terms of the lease. The difference between rent expense and rent paid is recorded as deferred rent liability and is included in the consolidated balance sheets.

Factors That May Affect Our Business and the Price of Our Stock

Our ability to expand our restaurant base is influenced by factors beyond our control and therefore we may not be able to achieve our planned growth.

Our growth strategy depends in large part on our ability to open new restaurants and to operate these restaurants profitably. Delays or failures in opening new restaurants could impair our ability to meet our growth objectives. We have in the past experienced delays in restaurant openings and may experience similar delays in the future. Our ability to expand our business successfully will depend upon numerous factors, including:

• hiring, training and retaining skilled management, chefs and other qualified personnel to open, manage and operate new restaurants;

• locating and securing a sufficient number of suitable new restaurant sites in new and existing markets on acceptable lease terms;

• managing the amount of time and construction and development costs associated with the opening of new restaurants;

• obtaining adequate financing for the construction of new restaurants;

• securing governmental approvals and permits required to open new restaurants in a timely manner, if at all;

• successfully promoting our new restaurants and competing in the markets in which our new restaurants are located; and

• general economic conditions.

Some of these factors are beyond our control. We may not be able to achieve our expansion goals and our new restaurants may not be able to achieve operating results similar to those of our existing restaurants.

Unexpected expenses and low market acceptance could adversely affect the profitability of restaurants that we open in new markets.

Our growth strategy includes opening restaurants in markets where we have little or no meaningful operating experience and in which potential customers may not be familiar with our restaurants. The success of these new restaurants may be affected by different competitive conditions, consumer tastes and discretionary spending patterns, and our ability to generate market awareness and acceptance of the McCormick & Schmick’s brand. As a result, we may incur costs related to the opening, operation and promotion of these new restaurants that are greater than those incurred in other areas. Even though we may incur substantial additional costs with these new restaurants, they may attract fewer customers than our more established restaurants in existing markets. Sales at restaurants that we open in new markets may take longer to reach our average annual sales, if at all. As a result, the results of operations at our new restaurants may be inferior to those of our existing restaurants. We may not be successful in profitably opening restaurants in new markets.

Our growth may strain our infrastructure and resources, which could slow our development of new restaurants and adversely affect our ability to manage our existing restaurants.

We opened nine company-owned restaurants and began operating an additional restaurant under a management contract in 2004. We plan to open seven company-owned restaurants in 2005. Our 2004 expansion and our future growth may strain our restaurant management systems and resources, financial controls and information systems. Those demands on our infrastructure and resources may also adversely affect our ability to manage our existing restaurants. If we fail to continue to improve our infrastructure or to manage other factors necessary for us to meet our expansion objectives, our operating results could be materially and adversely affected.

Our ability to raise capital in the future may be limited, which could adversely impact our growth.

Changes in our operating plans, acceleration of our expansion plans, lower than anticipated sales, increased expenses or other events described in this section may require us to seek additional debt or equity financing. Financing may not be available on acceptable terms, or at all, and our failure to raise capital when needed could negatively impact our growth and our financial condition and results of operations. Additional equity financing may be dilutive to the holders of our common stock, and debt financing, if available, may involve significant cash payment obligations and covenants that restrict our ability to operate our business. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

Our operations are susceptible to changes in food availability and costs, which could adversely affect our operating results.

Our profitability depends significantly on our ability to anticipate and react to changes in seafood costs. We rely on local, regional and national suppliers to provide our seafood. Increases in distribution costs or sale prices or failure to perform by these suppliers could cause our food costs to increase. We could also experience significant short-term disruptions in our supply if a significant supplier failed to meet its obligations. The supply of seafood is more volatile than other types of food. The type, variety, quality and price of seafood is subject to factors beyond our control, including weather, governmental regulation, availability and seasonality, each of which may affect our food costs or cause a disruption in our supply. Changes in the price or availability of certain types of seafood could affect our ability to offer a broad menu and price offering to customers and could materially adversely affect our profitability.

Our operating results may fluctuate significantly and could fall below the expectations of securities analysts and investors due to seasonality and other factors, resulting in a decline in our stock price.

Our operating results may fluctuate significantly because of several factors, including:

• our ability to achieve and manage our planned expansion;

• our ability to achieve market acceptance, particularly in new markets;

• our ability to raise capital in the future;

• changes in the availability and costs of food;

• the loss of key management personnel;

• the concentration of our restaurants in specific geographic areas;

• our ability to protect our name and logo and other proprietary information;

• changes in consumer preferences or discretionary spending;

• fluctuations in the number of visitors or business travelers to downtown locations;

• health concerns about seafood or other food products;

• our ability to attract, motivate and retain qualified employees;

• increases in labor costs;

• the impact of federal, state or local government regulations relating to our employees or the sale or preparation of food and the sale of alcoholic beverages;

• the impact of litigation;

• the effect of competition in the restaurant industry; and

• economic trends generally.

Our business also is subject to seasonal fluctuations. Historically, sales in most of our restaurants have been higher during the second and fourth quarter of each year. As a result, our quarterly and annual operating results and restaurant sales may fluctuate significantly as a result of seasonality and the factors discussed above. Accordingly, results for any one fiscal quarter are not necessarily indicative of results to be expected for any other quarter or for any year and comparable restaurant sales for any particular future period may decrease. Our operating results may also fall below the expectations of securities analysts and investors. In that event, the price of our common stock would likely decrease.

A decline in visitors or business travelers to downtown areas where our restaurants are located could negatively affect our restaurant sales.

Many of our restaurants are located in downtown areas. We depend on both local residents and business travelers to frequent these locations. We experienced a decline in revenues in our downtown locations in 2001 and 2002, caused in part by decreases in business travel and the general decline in economic conditions. We may experience a similar decline in our revenues in the future. If the number of visitors to downtown areas declines due to economic or other conditions, changes in consumer preferences, changes in discretionary consumer spending or for other reasons, our revenues could decline significantly and our results of operations could be adversely affected.

If we lose the services of any of our key management personnel or our co-founders, our business could suffer.

We depend on the services of our key management personnel, including Saed Mohseni, our chief executive officer, and Douglas L. Schmick, our president. In addition, we have increasingly relied on personal appearances and interviews by our co-founders, William P. McCormick and Douglas L. Schmick, in our marketing and advertising efforts. If we lose the services of any members of our senior management, key personnel or co-founders for any reason, we may be unable to replace them with qualified personnel, which could have a material adverse effect on our business and growth. We do not carry key person life insurance on any of our executive officers.

Many of our restaurants are concentrated in local or regional areas and, as a result, we are sensitive to economic and other trends and developments in these areas.

We operate four restaurants in Seattle, Washington, six in the Portland, Oregon area and 10 in California; our East Coast restaurants are concentrated in and around Washington, D.C. As a result, adverse economic conditions, weather and labor markets in any of these areas could have a material adverse effect on our overall results of operations. For example, ice storms in northwestern Oregon in January 2004 affected sales at six, or 13%, of our then existing restaurants.

In addition, given our geographic concentrations, negative publicity regarding any of our restaurants in these areas could have a material adverse effect on our business and operations, as could other regional occurrences such as local strikes, oil spills, terrorist attacks, energy shortages or increases in energy prices, droughts or earthquakes or other natural disasters.

Our success depends on our ability to protect our proprietary information. Failure to protect our trademarks, service marks or trade secrets could adversely affect our business.

Our business prospects depend in part on our ability to develop favorable consumer recognition of the McCormick & Schmick’s name. Although McCormick & Schmick’s, M&S Grill and other of our service marks are federally registered trademarks with the United States Patent and Trademark Office, our trademarks could be imitated in ways that we cannot prevent. In addition, we rely on trade secrets, proprietary know-how, concepts and recipes. Our methods of protecting this information may not be adequate, however, and others could independently develop similar know-how or obtain access to our trade secrets, know-how, concepts and recipes. Moreover, we may face claims of misappropriation or infringement of third parties’ rights that could interfere with our use of our proprietary know-how, concepts, recipes or trade secrets. Defending these claims may be costly and, if unsuccessful, may prevent us from continuing to use this proprietary information in the future, and may result in a judgment or monetary damages.

We do not maintain confidentiality and non-competition agreements with all of our executives, key personnel or suppliers. If competitors independently develop or otherwise obtain access to our know-how, concepts, recipes or trade secrets, the appeal of our restaurants could be reduced and our business could be harmed.

Our current insurance policies may not provide adequate levels of coverage against all claims.

We believe we maintain insurance coverage that is customary for businesses of our size and type. However, there are types of losses we may incur that cannot be insured against or that we believe are not commercially reasonable to insure. These losses, if they occur, could have a material and adverse effect on our business and results of operations.

Expanding our restaurant base by opening new restaurants in existing markets could reduce the business of our existing restaurants.

Our growth strategy includes opening restaurants in markets in which we already have existing restaurants. We may be unable to attract enough customers to the new restaurants for them to operate at a profit. Even if we are able to attract enough customers to the new restaurants to operate them at a profit, those customers may be former customers of one of our existing restaurants in that market and the opening of new restaurants in the existing market could reduce the revenue of our existing restaurants in that market.

We may not be able to successfully integrate into our business the operations of restaurants that we acquire, which may adversely affect our business, financial condition and results of operations.

We may seek to selectively acquire existing restaurants and integrate them into our business operations. Achieving the expected benefits of any restaurants that we acquire will depend in large part on our ability to successfully integrate the operations of the acquired restaurants and personnel in a timely and efficient manner. The risks involved in such restaurant acquisitions and integration include:

• challenges and costs associated with the acquisition and integration of restaurant operations located in markets where we have limited or no experience;

• possible disruption to our business as a result of the diversion of management’s attention from its normal operational responsibilities and duties; and

• the consolidation of the corporate, information technology, accounting and administrative infrastructure and resources of the acquired restaurants into our business.

Future acquisitions of existing restaurants, which may be accomplished through a cash purchase transaction or the issuance of our equity securities, or a combination of both, could result in potentially dilutive issuances of our equity securities, the incurrence of debt and contingent liabilities and impairment charges related to goodwill and other intangible assets, any of which could harm our business and financial condition.

We may be unable to successfully integrate the operations, or realize the anticipated benefits, of any restaurant that we acquire. If we cannot overcome the challenges and risks that we face in integrating the operations of newly acquired restaurants, our business, financial condition and results of operations could be adversely affected.

Negative publicity concerning food quality, health and other issues and costs or liabilities resulting from litigation may have a material adverse effect on our results of operations.

We are sometimes the subject of complaints or litigation from customers alleging illness, injury or other food quality, health or operational concerns. Litigation or adverse publicity resulting from these allegations may materially and adversely affect us or our restaurants, regardless of whether the allegations are valid or whether we are liable. Further, these claims may divert our financial and management resources from revenue-generating activities and business operations.

Health concerns relating to the consumption of seafood or other food products could affect consumer preferences and could negatively impact our results of operations.

We may lose customers based on health concerns about the consumption of seafood or negative publicity concerning food quality, illness and injury generally, such as negative publicity concerning the accumulation of mercury or other carcinogens in seafood, e-coli, “mad cow” or “foot-and-mouth” disease, publication of government or industry findings about food products served by us or other health concerns or operating issues stemming from one of our restaurants. In addition, we cannot guarantee that our operational controls and training will be fully effective in preventing all food-borne illnesses. Some food-borne illness incidents could be caused by food suppliers and transporters and would be outside of our control. Any negative publicity, health concerns or specific outbreaks of food-borne illnesses attributed to one or more of our restaurants, or the perception of an outbreak, could result in a decrease in guest traffic to our restaurants and could have a material adverse effect on our business.

Changes in consumer preferences or discretionary consumer spending could negatively impact our results of operations.

The restaurant industry is characterized by the continual introduction of new concepts and is subject to rapidly changing consumer preferences, tastes and purchasing habits. Our continued success depends in part upon the popularity of seafood and the style of dining we offer. Shifts in consumer preferences away from this cuisine or dining style could materially and adversely affect our profitability and operating results. Our success will depend in part on our ability to anticipate and respond to changing consumer preferences, tastes and purchasing habits, as well as other factors affecting the restaurant industry, including new market entrants and demographic changes. If we change our concept and menu to respond to changes in consumer tastes or dining patterns, we may lose customers who do not prefer the new concept or menu, and may not be able to attract a sufficient new customer base to produce the revenue needed to make the restaurant profitable. Our success also depends to a significant extent on numerous factors affecting discretionary consumer spending, including economic conditions, disposable consumer income and consumer confidence. Adverse changes in these factors could reduce guest traffic or impose practical limits on pricing, either of which could harm our results of operations.

Labor shortages or increases in labor costs could slow our growth or harm our business.

Our success depends in part upon our ability to attract, motivate and retain a sufficient number of qualified employees, including regional operational managers and regional chefs, restaurant general managers and executive chefs, necessary to continue our operations and keep pace with our growth. Qualified individuals whom we need to fill these positions are in short supply and competition for these employees is intense. If we are unable to recruit and retain sufficient qualified individuals, our business and our growth could be adversely affected. Additionally, competition for qualified employees could require us to pay higher wages, which could result in higher labor costs. If our labor costs increase, our results of operations will be negatively affected.

We may incur costs or liabilities and lose revenue, and our growth strategy may be adversely impacted, as a result of government regulation.

Our restaurants are subject to various federal, state and local government regulations, including those relating to employees, the preparation and sale of food and the sale of alcoholic beverages. These regulations impact our current restaurant operations and our ability to open new restaurants.

Each of our restaurants must obtain licenses from regulatory authorities allowing it to sell liquor, beer and wine, and each restaurant must obtain a food service license from local health authorities. Each restaurant’s liquor license must be renewed annually and may be revoked at any time for cause, including violation by us or our employees of any laws and regulations relating to the minimum drinking age, advertising, wholesale purchasing and inventory control. In California, where we operate 10 restaurants, the number of alcoholic beverage licenses available is limited and licenses are traded at market prices.

The failure to maintain our food and liquor licenses and other required licenses, permits and approvals could adversely affect our operating results. Difficulties or failure in obtaining the required licenses and approvals could delay or result in our decision to cancel the opening of new restaurants.

We are subject to “dram shop” statutes in some states. These statutes generally allow a person injured by an intoxicated person to recover damages from an establishment that wrongfully served alcoholic beverages to the intoxicated person. A judgment substantially in excess of our insurance coverage could harm our financial condition.

Various federal and state labor laws govern our relationship with our employees and affect operating costs. These laws include minimum wage requirements, overtime pay, unemployment tax rates, workers’ compensation rates, and citizenship requirements. Additional government-imposed increases in minimum wages, overtime pay, paid leaves of absence and mandated health benefits, increased tax reporting and tax payment requirements for employees who receive gratuities, or a reduction in the number of states that allow tips to be credited toward minimum wage requirements could harm our operating results.

The Federal Americans with Disabilities Act prohibits discrimination on the basis of disability in public accommodations and employment. Although our restaurants are designed to be accessible to the disabled, we could be required to make modifications to our restaurants to provide service to, or make reasonable accommodations for, disabled persons.

Restaurant companies have been the target of class-actions and other lawsuits alleging, among other things, violation of federal and state law.

We are subject to a variety of claims arising in the ordinary course of our business brought by or on behalf of our customers or employees, including personal injury claims, contract claims, and employment-related claims. In recent years, a number of restaurant companies have been subject to lawsuits, including class action lawsuits, alleging violations of federal and state law regarding workplace, employment and similar matters. A number of these lawsuits have resulted in the payment of substantial damages by the defendants. Similar lawsuits have been instituted against us from time to time. Regardless of whether any claims against us are valid or whether we are ultimately determined to be liable, claims may be expensive to defend and may divert time and money away from our operations and hurt our performance. A judgment significantly in excess of our insurance coverage for any claims could materially adversely affect our financial condition or results of operations, and adverse publicity resulting from these allegations may materially adversely affect our business. We offer no assurance that we will not incur substantial damages and expenses resulting from lawsuits, which could have a material adverse effect on our business.

Our operations and profitability are highly susceptible to the effects of violence, war and economic trends.

Terrorist attacks and other acts of violence or war and U.S. military reactions to such attacks may negatively affect our operations and your investment in our shares of common stock. The terrorist attacks in New York and Washington, D.C. on September 11, 2001 led to a temporary interruption in deliveries from some of our suppliers and, we believe, contributed to the decline in average annual comparable restaurant sales in 2001 and 2002.

Future acts of violence or war could cause a decrease in travel and in consumer confidence, decrease consumer spending, result in increased volatility in the United States and worldwide financial markets and economy, or result in an economic recession in the United States or abroad. They could also impact consumer leisure habits, for example, by increasing time spent watching television news programs at home, and may reduce the number of times consumers dine out, which could adversely impact our revenue. Any of these occurrences could harm our business, financial condition or results of operations, and may result in the volatility of the market price for our securities and on the future price of our securities.

Terrorist attacks could also directly impact our physical facilities or those of our suppliers, and attacks or armed conflicts may make travel and the transportation of our supplies and products more difficult and more expensive and ultimately affect our revenues.

We may not be able to compete successfully with other restaurants, which could adversely affect our results of operations.

The restaurant industry is intensely competitive with respect to price, service, location, food quality, ambiance and the overall dining experience. Our competitors include a large and diverse group of restaurant chains and individual restaurants that range from independent local operators to well-capitalized national restaurant companies. Some of our competitors have been in existence for a substantially longer period than we have and may be better established in the markets where our restaurants are or may be located. Some of our competitors may have substantially greater financial, marketing and other resources than we do. If our restaurants are unable to compete successfully with other restaurants in new and existing markets, our results of operations will be adversely affected. We also compete with other restaurants for experienced management personnel and hourly employees, and with other restaurants and retail establishments for quality restaurant sites.

Our stock price may be volatile, and you may not be able to resell your shares at or above the price you pay for them.

The stock market has experienced significant price and volume fluctuations. Our common stock has traded at a price lower than $12.00, the price at which our shares of common stock were sold in our initial public offering. The market price for our shares may continue to fluctuate significantly in response to a number of factors, some of which are beyond our control, including:

• quarterly variations in our operating results;

• changes in financial estimates by securities analysts;

• additions or departures of our key personnel; and

• sales of shares of our common stock in the public markets.

Fluctuations or decreases in the trading price of our common stock may adversely affect your ability to trade your shares. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted. A securities class action suit against us could result in substantial costs and divert management’s attention and resources that would otherwise be used to benefit the future performance of our operations.

Two significant shareholders each own approximately 20% of our outstanding common stock. Their interests may not coincide with yours and they may make decisions with which you may disagree.

Affiliates of Castle Harlan and BRS each own approximately 20% of our outstanding common stock. As a result, these stockholders, acting individually or together, could exert significant influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. In addition, this concentration of ownership may delay or prevent a change in control of our company and make some transactions more difficult or impossible without the support of these stockholders. The interests of these stockholders may not always coincide with our interests as a company or the interest of other stockholders.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our market risk exposures are related to our cash and cash equivalents. We invest any excess cash in highly liquid short-term investments with maturities of less than one year. These investments are not held for trading or other speculative purposes. Changes in interest rates affect the investment income we earn on our investments and, therefore, impact our cash flows and results of operations.

Under our revolving credit facility, we are exposed to market risk from changes in interest rates on borrowings, which bear interest at the financial institution’s prime rate plus a margin of 0.25% to 0.75% or the Eurodollar rate plus a margin of 1.75% to 2.25%, with margins determined by certain financial ratios. At our option, we may convert loans under our revolving credit facility from one type of rate to the other. At the end of the first quarter of 2005, we had $14.5 million of variable rate borrowings. Loans under our revolving credit facility mature on July 23, 2009.

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures. Our management has evaluated, under the supervision and with the participation of our chief executive officer and chief financial officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange Act”). Based on that evaluation, our chief executive officer and chief financial officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are effective in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting. In our annual report on Form 10-K for the fiscal year ended Decembert 25, 2004, we reported a material weakness in our internal control over financial reporting related to the way we have historically accounted for our real property leases. To remediate the weakness, we changed our accounting policies regarding the review, analysis and recording of new and current leases, including the selection and monitoring of appropriate assumptions and guidelines; there have been no other change in our internal control over financial reporting that occurred during our fiscal quarter ended March 26, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Occasionally, we are a defendant in litigation arising in the ordinary course of our business, including claims resulting from “slip and fall” accidents, employment related claims and claims from guests or employees alleging illness, injury or other food quality, health or operational concerns. None of these types of litigation, most of which are covered by insurance, has had a material effect on our business, results of operations, financial position or cash flows.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

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

None

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS

EXHIBITS.

Items identified with an asterisk (*) are management contracts or compensatory plans or arrangements.

3.1		Certificate of Incorporation of the Company, as amended. Incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1, File No. 333-114977.

3.2		Bylaws of the Company, as amended (incorporated by reference to Exhibits 3.2 and 3.2a to our Registration Statement on Form S-1, File No. 333-114977)

4.1		Registration Rights Agreement, dated as of August 22, 2001, by and among McCormick & Schmick Holdings LLC, Bruckmann, Rosser, Sherrill & Co. II, L.P., Castle Harlan Partners III, L.P. and certain other parties thereto (incorporated by reference to Exhibit 4.2 to our registration statement on Form S-1, file No. 333-114977)

10.1*		Summary of Director and Executive Officer Compensation for Fiscal 2005 (incorporated by reference to Exhibit 10.9 to our annual report on Form 10-K for the fiscal year ended December 25, 2004)

31.1		Certification of the Chief Executive Officer pursuant to Rule 13a 14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of the Chief Financial Officer pursuant to Rule 13a 14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

PART I. FINANCIAL INFORMATION

Item 1 - Financial Statements —(Unaudited)	2

Consolidated Balance Sheets as of December 25, 2004 and March 26, 2005	2

Consolidated Statements of Operations for the Quarter Ended March 27, 2004 and March 26, 2005	3

Consolidated Statements of Cash Flows for the Quarter Ended March 27, 2004 and March 26, 2005	4

Notes to Consolidated Financial Statements	5

Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations	9

Item 3 - Quantitative and Qualitative Disclosures About Market Risk	27

Item 4 - Controls and Procedures	27

PART II. OTHER INFORMATION

Item 1 - Legal Proceedings	27

Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds	28

Item 3 - Defaults Upon Senior Securities	28

Item 4 - Submissions of Matters to a Vote of Security Holders	28

Item 5 - Other Information	28

Item 6 - Exhibits	28

Signatures	29

	McCORMICK & SCHMICK’S SEAFOOD RESTAURANT, INC.

	By:	/s/ SAED MOHSENI
		Saed Mohseni
		*Cheif Executive Officer*
		*(principal executive officer)*

	By:	/s/ EMANUEL N. HILARIO
		Emanuel N. Hilario
		*Chief Financial Officer*
		*(principal financial and accounting officer)*