**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

 

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

| **x**      | ** **                                                                                                                                                                                                                                                                                  | **QUARTERLY REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**  |
|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------|
| ** ** |
|       | **For the quarterly period ended  September 30, 2007**                                                                                                                                                                                                                                 |
|       |
| **Or**     |
|       |
| **o**      | ** **                                                                                                                                                                                                                                                                                  | **TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
| ** ** |
|       | **For the transition period from                        to                      .** |

 

**Commission file number 333-116310**

 

**REAL MEXRESTAURANTS, INC.**

(Exact name ofRegistrant as specified in its charter)

 

| **Delaware**                                                     | ** ** | **13-4012902**                         |
|------------------------------------------------------------------|------------|----------------------------------------|
| (State  or other jurisdiction of  incorporation or organization) |       | (I.R.S.  Employer  Identification No.) |

 

**5660 Katella Avenue, Suite 100Cypress, CA 90630**

(Address ofprincipal executive offices)

 

Registrant’stelephone number, including area code:

**(562)-346-1200**

 

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed by Section 13or 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 suchreports) and (2) has been subject to such filing requirements for the past90 days. Yes x No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer or anon-accelerated filer.

 

(See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act).(Check one):

 
| Large Accelerated  Filer o |   | Accelerated Filer o |   | Non-Accelerated Filer x |
|---------------------------------|--------|--------------------------|--------|------------------------------|

 

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

 

As of November 13,2007, the registrant had outstanding 1,000 shares of Common Stock, par value$0.001 per share.

 

 

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**Real Mex Restaurants, Inc.and SubsidiariesIndex**

 
| PART I FINANCIAL  INFORMATION |
|------------------------------------|
|                               |
| Item 1.                            |   | Financial Statements |
|                               |   | Consolidated Balance Sheets |
|                               |   | Consolidated Statements of  Operations |
|                               |   | 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 1A.                           |   | Risk Factors |
| Item 2.                            |   | Unregistered  Sales of Equity 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 |
| SIGNATURE                          |

 

2

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**FORWARD-LOOKING STATEMENTS**

 

*Thisreport includes “forward looking statements” within the meaning of Section 27Aof the Securities Act of 1933 and Section 21E of the Securities ExchangeAct of 1934 (the “Exchange Act”). Forward looking statements are those that donot relate solely to historical fact. They include, but are not limited to, anystatement that may predict, forecast, indicate or imply future results,performance, achievements or events. They may contain words such as “believe,”“anticipate,” “expect,” “estimate,” “intend,” “project,” “plan,” “will,” “should,”“may,” or “could” or words or phrases of similar meaning. They may relateto, among other things: our liquidity and capital resources; legal proceedingsand regulatory matters involving our Company; food-borne illness incidents;increases in the cost of ingredients; our dependence upon frequent deliveriesof food and other supplies; our vulnerability to changes in consumerpreferences and economic conditions; our ability to compete successfully withother casual dining restaurants; our ability to expand; and anticipated growthin the restaurant industry and our markets.*

 

*Theseforward looking statements reflect our current views with respect to futureevents and are based on assumptions and subject to ri**s**ks and uncertainties, including, but not limited to, economic,competitive, governmental and technological factors outside of our control,that may cause actual results to differ materially from trends, plans orexpectations set forth in the forward looking statements. These risks anduncertainties may include these factors and the risks and uncertaintiesdescribed elsewhere in this report and in Item 1A “Risk Factors” of our annualreport on Form 10-K filed with the SEC on March 20, 2007. Given theserisks and uncertainties, we urge you to read this report completely and withthe understanding that actual future results may be materially differentfrom what we plan or expect. All of the forward-looking statements made in thisForm 10-Q are qualified by these cautionary statements and we cannotassure you that the actual results or developments anticipated by our Companywill be realized or, even if substantially realized, that they will have theexpected consequences to or effects on our Company or our business oroperations. In addition, these forward-looking statements present our estimatesand assumptions only as of the date of this report. Except for our ongoingobligation to disclose material information as required by federal securitieslaws, we do not intend to update you concerning any future revisions to anyforward looking statements to reflect events or circumstances occurring afterthe date of this report.*

 

*Unlessotherwise provided in this report, references to “we”, “us”, “our” and “Company”refer to Real Mex Restaurants, Inc. and its consolidated subsidiaries.*

 

3

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**PART IFINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

**Real Mex Restaurants, Inc.**

**ConsolidatedBalance Sheets**

**(in thousands, except for share data)**

 
| ** **                                                                                                                             | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                             | ** ** | **(unaudited)**              | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                             | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                        |       |                         |       |                        |       |
| Cash and cash equivalents                                                                                                              |       | $                            | 2,089      |                        | $          | 2,710 |   |
| Trade receivables, net                                                                                                                 |       | 10,406                       |       | 8,604                       |       |
| Other receivables                                                                                                                      |       | 3,011                        |       | 1,572                       |       |
| Related party receivables                                                                                                              |       | 3,488                        |       | 3,591                       |       |
| Inventories                                                                                                                            |       | 12,367                       |       | 10,565                      |       |
| Prepaid expenses and other current assets                                                                                              |       | 10,961                       |       | 6,037                       |       |
| Current portion of favorable lease asset,  net                                                                                         |       | 3,566                        |       | 4,910                       |       |
| Deferred tax asset                                                                                                                     |       | 6,653                        |       | 8,265                       |       |
| Total current assets                                                                                                                   |       | 52,541                       |       | 46,254                      |       |
|                                                                                                                                   |       |                         |       |                        |       |
| Property and equipment, net                                                                                                            |       | 97,161                       |       | 90,802                      |       |
| Goodwill                                                                                                                               |       | 286,938                      |       | 277,461                     |       |
| Deferred charges, net                                                                                                                  |       | 3,441                        |       | 3,939                       |       |
| Deferred tax asset                                                                                                                     |       | 865                          |       | 1,149                       |       |
| Favorable lease asset, less current  portion, net                                                                                      |       | 12,103                       |       | 17,753                      |       |
| Other assets                                                                                                                           |       | 9,363                        |       | 9,777                       |       |
| Total assets                                                                                                                           |       | $                            | 462,412    |                        | $          | 447,135 |   |
|                                                                                                                                   |       |                         |       |                        |       |
| **Liabilities and stockholders’ equity**                                                                                          | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Current liabilities:                                                                                                                   |       |                         |       |                        |       |
| Accounts payable                                                                                                                       |       | $                            | 30,663     |                        | $          | 23,354 |   |
| Accrued self-insurance reserves                                                                                                        |       | 15,247                       |       | 15,877                      |       |
| Accrued compensation and benefits                                                                                                      |       | 11,597                       |       | 15,576                      |       |
| Other accrued liabilities                                                                                                              |       | 19,905                       |       | 18,469                      |       |
| Current portion of long-term debt                                                                                                      |       | 11,842                       |       | 9,573                       |       |
| Current portion of capital lease  obligations                                                                                          |       | 241                          |       | 224                         |       |
| Total current liabilities                                                                                                              |       | 89,495                       |       | 83,073                      |       |
|                                                                                                                                   |       |                         |       |                        |       |
| Long-term debt, less current portion                                                                                                   |       | 172,365                      |       | 173,345                     |       |
| Capital lease obligations, less current  portion                                                                                       |       | 581                          |       | 763                         |       |
| Unfavorable lease asset, less current  portion, net                                                                                    |       | 4,806                        |       | 2,514                       |       |
| Other liabilities                                                                                                                      |       | 5,955                        |       | 3,363                       |       |
| Total liabilities                                                                                                                      |       | 273,202                      |       | 263,058                     |       |
|                                                                                                                                   |       |                         |       |                        |       |
| Commitments and contingencies                                                                                                          |       |                         |       |                        |       |
|                                                                                                                                   |       |                         |       |                        |       |
| Stockholders’ equity:                                                                                                             |       |                         |       |                        |       |
| Common stock, $.001 par value, 1,000 shares  authorized, issued and outstanding at September 30, 2007 and  December 31, 2006 |       | —                       |       | —                      |       |
| Additional paid-in capital                                                                                                             |       | 201,495                      |       | 199,124                     |       |
| Accumulated deficit                                                                                                                    |       | (12,285                      | )          | (15,047                     | )          |
| Total stockholders’ equity                                                                                                        |       | 189,210                      |       | 184,077                     |       |
| Total liabilities and stockholders’ equity                                                                                        |       | $                            | 462,412    |                        | $          | 447,135 |   |

 

See notes to consolidated financialstatements.

 

4

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**Real MexRestaurants, Inc. and Subsidiaries**

**ConsolidatedStatements of Operations (unaudited)**

**(inthousands)**

 
| ** **                                                     | ** ** | **Quarter**            | ** ** | **Year-to-date**       | ** ** |
|----------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                     | ** ** | **Successor**          | ** ** | **Predecessor**        | ** ** | **Successor** | ** ** | **Predecessor** | ** ** |
| ** **                                                     | ** ** | **July 2,**       | ** ** | **August 21,**    | ** ** | **June 26** | ** ** | **January 1,** | ** ** | **August 21,** | ** ** | **December 26** | ** ** |
| ** **                                                     | ** ** | **2007 to**       | ** ** | **2006 to**       | ** ** | **2006 to** | ** ** | **2007 to** | ** ** | **2006 to** | ** ** | **2005 to** | ** ** |
| ** **                                                     | ** ** | **September 30,** | ** ** | **September 24,** | ** ** | **August 20,** | ** ** | **September 30,** | ** ** | **September 24,** | ** ** | **August 20,** | ** ** |
| ** **                                                     | ** ** | **2007**               | ** ** | **2006**               | ** ** | **2006** | ** ** | **2007** | ** ** | **2006** | ** ** | **2006** | ** ** |
| Revenues:                                                      |       |                   |       |                   |       |   |   |   |   |   |   |   |   |
| Restaurant revenues                                            |       | $                      | 130,859    |                   | $          | 48,207 |   | $ | 83,232 |   | $ | 401,036 |   | $ | 48,207 |   | $ | 351,591 |   |
| Other revenues                                                 |       | 10,799                 |       | 2,804                  |       | 4,451 |   | 26,675 |   | 2,804 |   | 18,358 |   |
| Royalty and franchise fees                                     |       | 852                    |       | 304                    |       | 595 |   | 2,885 |   | 304 |   | 2,603 |   |
| Total revenues                                                 |       | 142,510                |       | 51,315                 |       | 88,278 |   | 430,596 |   | 51,315 |   | 372,552 |   |
|                                                           |       |                   |       |                   |       |   |   |   |   |   |   |   |   |
| Costs and expenses:                                            |       |                   |       |                   |       |   |   |   |   |   |   |   |   |
| Cost of sales                                                  |       | 36,588                 |       | 12,441                 |       | 20,694 |   | 105,710 |   | 12,441 |   | 87,388 |   |
| Labor                                                          |       | 49,423                 |       | 18,031                 |       | 28,730 |   | 151,329 |   | 18,031 |   | 125,748 |   |
| Direct operating and occupancy expense                         |       | 38,179                 |       | 13,135                 |       | 23,300 |   | 112,541 |   | 13,135 |   | 94,422 |   |
| General and administrative expense                             |       | 7,571                  |       | 2,911                  |       | 4,635 |   | 23,708 |   | 2,911 |   | 18,893 |   |
| Depreciation and amortization                                  |       | 6,150                  |       | 1,899                  |       | 2,875 |   | 18,068 |   | 1,899 |   | 12,230 |   |
| Legal settlement costs                                         |       | 62                     |       | 8                      |       | 1,422 |   | 384 |   | 8 |   | 4,180 |   |
| Merger costs                                                   |       | —                 |       | 157                    |       | 9,433 |   | — |   | 157 |   | 9,434 |   |
| Pre-opening costs                                              |       | 524                    |       | 116                    |       | 467 |   | 1,380 |   | 116 |   | 910 |   |
| Impairment of property and equipment                           |       | —                 |       | —                 |       | 1,197 |   | — |   | — |   | 1,197 |   |
|                                                           |       |                   |       |                   |       |   |   |   |   |   |   |   |   |
| Operating income (loss)                                        |       | 4,013                  |       | 2,617                  |       | (4,475 | ) | 17,476 |   | 2,617 |   | 18,150 |   |
|                                                           |       |                   |       |                   |       |   |   |   |   |   |   |   |   |
| Other income (expense):                                        |       |                   |       |                   |       |   |   |   |   |   |   |   |   |
| Interest expense                                               |       | (4,788                 | )          | (2,918                 | )          | (3,910 | ) | (14,476 | ) | (2,918 | ) | (16,005 | ) |
| Other income (expense), net                                    |       | (178                   | )          | 245                    |       | 288 |   | 1,680 |   | 245 |   | 642 |   |
|                                                           |       |                   |       |                   |       |   |   |   |   |   |   |   |   |
| Total other expense, net                                       |       | (4,966                 | )          | (2,673                 | )          | (3,622 | ) | (12,796 | ) | (2,673 | ) | (15,363 | ) |
|                                                           |       |                   |       |                   |       |   |   |   |   |   |   |   |   |
| (Loss) income before income tax provision  (benefit)           |       | (953                   | )          | (56                    | )          | (8,097 | ) | 4,680 |   | (56 | ) | 2,787 |   |
|                                                           |       |                   |       |                   |       |   |   |   |   |   |   |   |   |
| Income tax provision (benefit)                                 |       | (345                   | )          | 21                     |       | (3,175 | ) | 1,918 |   | 21 |   | 1,307 |   |
|                                                           |       |                   |       |                   |       |   |   |   |   |   |   |   |   |
| Net (loss) income before redeemable  preferred stock accretion |       | (608                   | )          | (77                    | )          | (4,922 | ) | 2,762 |   | (77 | ) | 1,480 |   |
|                                                           |       |                   |       |                   |       |   |   |   |   |   |   |   |   |
| Redeemable preferred stock accretion                           |       | —                 |       | —                 |       | (2,330 | ) | — |   | — |   | (10,126 | ) |
|                                                           |       |                   |       |                   |       |   |   |   |   |   |   |   |   |
| Net (loss) income attributable to common  stockholders         |       | $                      | (608       | )                      | $          | (77 | ) | $ | (7,252 | ) | $ | 2,762 |   | $ | (77 | ) | $ | (8,646 | ) |

 

See notes to consolidated financialstatements.

 

5

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**Real MexRestaurants, Inc.**

**ConsolidatedStatements of Cash Flows (unaudited)**

**(inthousands)**

 
| ** **                                                                                          | ** ** | **Successor**                         | ** ** | **Predecessor**                       | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                          | ** ** | **January 1, 2007 to** | ** ** | **August 21, 2006 to** | ** ** | **December 26, 2005 to** | ** ** |
| ** **                                                                                          | ** ** | **September 30, 2007**      | ** ** | **September 24, 2006**      | ** ** | **August 20, 2006** | ** ** |
| **Operating activities**                                                                            | ** ** | ** **                            | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Net income (loss)                                                                                   |       | $                                     | 2,762      |                                  | $          | (77 | ) | $ | 1,480 |   |
| Adjustments to reconcile net income (loss)  to net cash (used in) provided by operating activities: |       |                                  |       |                                  |       |   |   |
| Depreciation                                                                                        |       | 16,940                                |       | 1,899                                 |       | 12,230 |   |
| Amortization of:                                                                                    |       |                                  |       |                                  |       |   |   |
| Favorable lease asset and unfavorable lease  liability, net                                         |       | 1,128                                 |       | —                                |       | — |   |
| Debt premium                                                                                        |       | (1,270                                | )          | —                                |       | — |   |
| Deferred financing costs                                                                            |       | 1,190                                 |       | 147                                   |       | 1,179 |   |
| Gain on disposal of property and equipment                                                          |       | (755                                  | )          | (14                                   | )          | (18 | ) |
| Impairment of property and equipment                                                                |       | —                                |       | —                                |       | 1,197 |   |
| Tax benefit from employee stock option  exercise                                                    |       | —                                |       | —                                |       | 1,799 |   |
| Stock-based compensation expense                                                                    |       | 628                                   |       | —                                |       | — |   |
| Deferred tax asset                                                                                  |       | 1,896                                 |       | —                                |       | (1,108 | ) |
| Other                                                                                               |       | 232                                   |       | —                                |       | — |   |
| Changes in operating assets and liabilities:                                                        |       |                                  |       |                                  |       |   |   |
| Trade and other receivables                                                                         |       | (3,138                                | )          | 153                                   |       | (1,071 | ) |
| Inventories                                                                                         |       | (1,802                                | )          | (154                                  | )          | (35 | ) |
| Prepaid expenses and supplies                                                                       |       | (4,710                                | )          | (753                                  | )          | (1,525 | ) |
| Deferred charges, net                                                                               |       | (158                                  | )          | —                                |       | (301 | ) |
| Other assets                                                                                        |       | 168                                   |       | (202                                  | )          | 912 |   |
| Accounts payable and accrued liabilities                                                            |       | 3,327                                 |       | (9,493                                | )          | 14,235 |   |
| Other liabilities                                                                                   |       | 2,600                                 |       | 329                                   |       | 1,484 |   |
| Net cash provided by (used in) operating  activities                                                |       | 19,038                                |       | (8,165                                | )          | 30,458 |   |
|                                                                                                |       |                                  |       |                                  |       |   |   |
| **Investing activities**                                                                            | ** ** | ** **                            | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Purchases of property and equipment                                                                 |       | (26,990                               | )          | (2,224                                | )          | (15,885 | ) |
| Sale of Fuzio trademark                                                                             |       | 1,200                                 |       | —                                |       | — |   |
| Net proceeds from disposal of property and  equipment                                               |       | 4,662                                 |       | —                                |       | — |   |
| Net cash used in investing activities                                                               |       | (21,128                               | )          | (2,224                                | )          | (15,885 | ) |
|                                                                                                |       |                                  |       |                                  |       |   |   |
| **Financing activities**                                                                            | ** ** | ** **                            | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Net borrowings under revolving credit  facility                                                     |       | 1,900                                 |       | —                                |       | — |   |
| Borrowings under long-term debt agreements                                                          |       | 981                                   |       | —                                |       | — |   |
| Payments on long-term debt agreements and  capital lease obligations                                |       | (878                                  | )          | (23                                   | )          | (174 | ) |
| Payment of financing costs                                                                          |       | (534                                  | )          | (110                                  | )          | — |   |
| Dividend paid                                                                                       |       | —                                |       | (10,000                               | )          | — |   |
| Net cash provided by (used in) financing  activities                                                |       | 1,469                                 |       | (10,133                               | )          | (174 | ) |
| Net (decrease) increase in cash and cash  equivalents                                               |       | (621                                  | )          | (20,522                               | )          | 14,399 |   |
|                                                                                                |       |                                  |       |                                  |       |   |   |
| Cash and cash equivalents at beginning of  period                                                   |       | 2,710                                 |       | 29,270                                |       | 14,871 |   |
| Cash and cash equivalents at end of period                                                          |       | $                                     | 2,089      |                                  | 8,748      |   | $ | 29,270 |   |
|                                                                                                |       |                                  |       |                                  |       |   |   |
| **Supplemental disclosure of cash flow  information**                                               | ** ** | ** **                            | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Interest paid                                                                                       |       | $                                     | 12,197     |                                  | $          | 3,409 |   | $ | 11,405 |   |
| Income taxes paid                                                                                   |       | $                                     | 69         |                                  | $          | 21 |   | $ | 44 |   |
|                                                                                                |       |                                  |       |                                  |       |   |   |
| **Supplemental disclosure of noncash  investing and financing activities**                          | ** ** | ** **                            | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Preferred and common stock issued as  additional consideration for an acquisition made in 2005      |       | $                                     | —     |                                  | $          | — |   | $ | 5,682 |   |

 

See notes to consolidated financialstatements.

 

6

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**Real Mex Restaurants, Inc.and Subsidiaries**

**Notes to ConsolidatedFinancial Statements (unaudited)**

**September 30, 2007****(in thousands, except for share data)**

 

**1.****                                     ****Basis of Presentation**

 

Real MexRestaurants, Inc. (the surviving corporation resulting from a merger on August 21,2006 with RM Integrated, Inc. (the “Merger”)), a Delaware corporation, wasformed on May 15, 1998.

 

After the Mergerthe Company is referred to as the “Successor” and before the Merger the Companyis referred to as the “Predecessor”.

 

Real MexRestaurants, Inc. (the “Company”), primarily through its majorsubsidiaries El Torito Restaurants, Inc. (“El Torito”), ChevysRestaurants, LLC (“Chevys”) and Acapulco Restaurants, Inc. (“Acapulco”),operated 188 restaurants as of September 30, 2007, of which 156 werelocated in California and the remainder were located in 12 other states,primarily under the trade names El Torito Restaurant®, Chevys Fresh Mex® andAcapulco Mexican Restaurant Y Cantina®. Real Mex Restaurants, Inc.’s othermajor subsidiary, Real Mex Foods, Inc., provides internal production,purchasing and distribution services for the restaurant operations and alsomanufactures specialty products for sale to outside customers.

 

The accompanying unaudited consolidated financialstatements include the accounts of Real Mex Restaurants, Inc. and itswholly owned subsidiaries. Our consolidated financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States for interim financial information and with the instructions to Form 10-Qand Rule 10-01 of Regulation S-X.

 

Certain information and footnote disclosures normallyincluded in consolidated financial statements in accordance with U.S. generallyaccepted accounting principles have been omitted pursuant to requirements ofthe Securities and Exchange Commission (“SEC”). A description of our accountingpolicies and other financial information is included in our audited consolidatedfinancial statements as filed with the SEC in our annual report on Form 10-Kfor the year ended December 31, 2006. We believe that the disclosuresincluded in our accompanying interim consolidated financial statements andfootnotes are adequate to make the information not misleading, but should beread in conjunction with our consolidated financial statements and notesthereto included in the our annual report on Form 10-K. The accompanyingconsolidated balance sheet as of December 31, 2006 has been derived fromour audited financial statements.

 

Certain prior year amounts have been reclassified toconform to the current year presentation.

 

**2.****                                     ****Merger Agreement**

 

On August 17, 2006, the Company entered into anAgreement and Plan of Merger (“Merger Agreement”) with RM Restaurant HoldingCorp. (“RM Restaurant Holding”) and its subsidiary, RM Integrated, Inc. (“RMIntegrated”, and together with RM Restaurant Holding, “Buyer”). The majority ofthe stock of RM Restaurant Holding is owned by Sun Cantinas LLC (“Sun LLC”), anaffiliate of Sun Capital Partners, Inc. (“Sun Capital”). On August 18,2006, the stockholders of the Company entitled to vote thereon (including theholders of a majority of the Company’s Series C Preferred Stock, par value$0.001 per share) approved the Merger Agreement. On August 21, 2006 (the “EffectiveTime”), the closing of the transactions contemplated by the Merger Agreementoccurred, and RM Integrated merged with and into Real Mex Restaurants, Inc.,with Real Mex Restaurants, Inc. continuing as the surviving corporationand the 100% owned subsidiary of RM Restaurant Holding. The net purchase priceof Real Mex Restaurants, Inc. was $200.9 million, consisting of $359.0million in cash, plus net cash acquired of $35.2 million, plus $4.6 million inworking capital and other adjustments plus direct acquisition costs of $3.9million, less indebtedness assumed of $188.2 million and seller costs of $9.3million. Pursuant to the Merger Agreement, $6.0 million of the MergerConsideration is being held in escrow. Indebtedness assumed included accruedinterest and the purchase price is subject to adjustment based on certain otheradjustments. As a result of the Merger and in accordance with the terms of theMerger Agreement, (i) all of the outstanding capital stock of Real MexRestaurants, Inc. was converted into the right to receive a portion of thepurchase price, and all Real Mex Restaurants, Inc. stock options, warrantsand shares of restricted stock were cancelled and converted into the right toreceive a portion of the purchase price, less the exercise prices or unpaidpurchase prices therefore, as applicable, and (ii) the Company became awholly-owned subsidiary of RM Restaurant Holding. Prior to the Merger,Bruckmann, Rosser, Sherrill & Co., Inc. (“BRS”), together withits affiliates, was a controlling stockholder of Real Mex Restaurants, Inc.As described in the Merger Agreement, the Amended and Restated ManagementAgreement dated June 28, 2000 by and among the Company, certain of itssubsidiaries, BRS, and FS Private Investments, L.L.C. was terminated inconnection with the Merger.

 

7

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The foregoing description of the Merger Agreement isqualified in its entirety by reference to the Merger Agreement filed with theSecurities and Exchange Commission as Exhibit 10.1 to Form 8-K (File No. 333-116310)on August 23, 2006 and incorporated by reference herein.

 

The Merger was accounted for under the purchasemethod of accounting and, accordingly, the purchase price has been allocated tothe assets acquired and the liabilities assumed based on their estimated fairmarket values at the date of the Merger. The Companyattributes the goodwill associated with the Merger to the historical financialperformance and the anticipated future performance of the Company’s operations.

 

The following table presents the allocation of theacquisition costs, including professional fees and other related transactioncosts, to the assets acquired and liabilities assumed based on their estimatedfair values (in thousands):

 
| Cash and cash equivalents                |   | $       | 29,270  |   |
|------------------------------------------|--------|---------|---------|--------|
| Trade and other accounts receivable      |   | 11,625  |    |
| Inventories                              |   | 10,012  |    |
| Other current assets                     |   | 5,615   |    |
| Property and equipment                   |   | 88,997  |    |
| Deferred tax asset                       |   | 6,196   |    |
| Other assets                             |   | 35,281  |    |
| Goodwill                                 |   | 288,138 |    |
| Total assets acquired                    |   | 475,134 |    |
|                                     |   |    |    |
| Accounts payable and accrued liabilities |   | 20,881  |    |
| Long-term debt                           |   | 186,057 |    |
| Other liabilities                        |   | 67,329  |    |
| Total liabilities assumed                |   | 274,267 |    |
| Net assets acquired                      |   | $       | 200,867 |   |

 

**3.****                                     ****Long-Term Debt**

 

Long-term debtconsists of the following (in thousands):

 
| ** **                                     | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Senior Secured Notes due 2010                  |       | $                            | 105,000    |                        | $          | 105,000 |   |
| Senior Secured Notes unamortized debt  premium |       | 2,930                        |       | 3,809                       |       |
| Senior Secured Revolving Credit Facility       |       | 9,850                        |       | 7,950                       |       |
| Senior Unsecured Credit Facility               |       | 65,000                       |       | 65,000                      |       |
| Mortgage                                       |       | 672                          |       | 711                         |       |
| Other                                          |       | 755                          |       | 448                         |       |
|                                           |       | 184,207                      |       | 182,918                     |       |
|                                           |       |                         |       |                        |       |
| Less current portion                           |       | (11,842                      | )          | (9,573                      | )          |
|                                           |       |                         |       |                        |       |
|                                           |       | $                            | 172,365    |                        | $          | 173,345 |   |

 

*Senior Secured Notes due 2010*.Interest on our senior secured registered notes (“senior secured notes”)accrues at a contract rate of 10% per annum. (The interest rate was 10.25%through March 31, 2007 as, in fiscal year 2005, we exceeded the capitalexpenditure limit under the indenture governing the senior secured notes and asa result were required to pay a 0.25% increase in the stated rate. Exceedingthe capital expenditure limit did not constitute a default with respect to thesenior secured notes or indenture.) Interest is payable semiannually on April 1and October 1 of each year. Our senior secured notes are fully andunconditionally guaranteed on a senior secured basis by all of our present andfuture domestic subsidiaries which are restricted subsidiaries under theindenture governing our senior secured notes. Our senior secured notes andrelated guarantees are secured by substantially all of our and our domesticrestricted subsidiaries’ tangible and intangible assets, subject to the priorranking claims on such assets by the lenders under our New Senior SecuredRevolving Credit Facilities. The indenture governing our senior secured notescontains various affirmative and negative covenants, subject to a number ofimportant limitations and exceptions, including but not limited to our abilityto incur additional indebtedness, make capital expenditures, pay dividends,redeem stock or make other distributions, issue stock of our subsidiaries, makecertain

 

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investments or acquisitions, grant liens onassets, enter into transactions with affiliates, merge, consolidate or transfersubstantially all of our assets, and transfer and sell assets. The covenantthat limits our incurrence of indebtedness requires that, after giving effectto any such incurrence of indebtedness and the application of the proceedsthereof, our fixed charge coverage ratio as of the date of such incurrence willbe at least 2.50 to 1.00 in the case of any incurrence after September 30,2006. The indenture defines consolidated fixed charge coverage ratio as theratio of Consolidated Cash Flow (as defined therein) to Fixed Charges (asdefined therein). The Company was in compliance with all specified financialand other covenants under the senior secured notes indenture at September 30,2007.

 

Wecan redeem our senior secured notes at any time after April 1, 2007. Weare required to offer to redeem our senior secured notes under certaincircumstances involving a change of control. Additionally, if we or any of ourdomestic restricted subsidiaries engage in assets sales, we generally musteither invest the net cash proceeds from such sales in our business within 360days, prepay the indebtedness obligations under our New Senior Secured RevolvingCredit Facility or certain other secured indebtedness or make an offer topurchase a portion of our senior secured notes.

 

On September 19, 2006, the Company commenced achange of control offer (the “Offer”) to purchase any or all of its notes thatremained outstanding under the indenture dated March 31, 2004 by and amongthe Company, the guarantors thereto and Wells Fargo Bank, National Association,as trustee. The Offer was made pursuant to Section 4.15 of the indentureas the Merger constituted a “change of control” under the indenture. Inaccordance with the terms of the indenture, the Company offered to repurchasethe notes at a purchase price in cash equal to 101% of the aggregate principalamount of the notes or portion of notes validly tendered for payment thereof,plus accrued and unpaid interest up to, but not including, the date of payment,upon the terms and subject to the conditions of the Offer. The Offer expired onOctober 19, 2006. No notes were tendered pursuant to the Offer and as ofthe expiration date of the Offer, $105.0 million aggregate principal amount ofnotes remained outstanding.

 

As a result of the Merger and under purchaseaccounting rules we recorded $4.2 million of unamortized debt premium asadditional debt related to our senior secured notes as the fair market value ofthe debt on the Merger date was greater than its carrying value. The premium isamortized to interest expense over the remaining life of the debt.

 

*Senior Secured Revolving Credit Facilities*. In 2004, the Company entered into anamended and restated revolving credit agreement providing for $30.0 million ofsenior secured credit facilities. The revolving credit agreement included a$15.0 million letter of credit facility and a $15.0 million revolving creditfacility that could be used for letters of credit.

 

OnOctober 5, 2006, the Company entered into a new amended and restatedrevolving credit facility, pursuant to which the existing $15.0 millionrevolving credit facility and $15.0 million letter of credit facility, wasincreased to a $15.0 million revolving credit facility (the “Old Senior SecuredRevolving Credit Facility”) and a $25.0 million letter of credit facility (the “OldSenior Secured Letter of Credit Facility”, together with the Old Senior SecuredRevolving Credit Facility, the “Old Senior Secured Revolving Credit Facilities”)maturing on October 5, 2008, pursuant to which the Lenders agreed to makeloans to the Company and its subsidiaries (all of the proceeds of which were tobe used for working capital purposes) and issue letters of credit on behalf ofthe Company and its subsidiaries.

 

OnJanuary 29, 2007, the Company entered into a Second Amended and RestatedCredit Agreement pursuant to which the Old Senior Secured Revolving CreditFacilities were refinanced with a new agent and administrative agent, GeneralElectric Capital Corporation, and a new $15.0 million revolving credit facility(the “New Senior Secured Revolving Credit Facility”) and $25.0 million letterof credit facility (the “New Senior Secured Letter of Credit Facility”,together with the New Senior Secured Revolving Credit Facility, the “New SeniorSecured Revolving Credit Facilities”), maturing on January 29, 2009, wereput into place, pursuant to which the lenders agree to make loans and issueletters of credit to and on behalf of the Company and its subsidiaries.

 

Obligations under the New Senior Secured Revolving Credit Facilitiesare guaranteed by all of the Company’s subsidiaries as well as by RM RestaurantHolding, which wholly owns the Company and has made a first priority pledge ofall of its equity interests in the Company as security for the obligations. Intereston the New Senior Secured Revolving Credit Facility accrues pursuant to anApplicable Margin as set forth in the Second Amended and Restated CreditAgreement. The New Senior Secured Revolving Credit Facilities are secured by,among other things, first priority pledges of all of the equity interests ofthe Company’s direct and indirect subsidiaries, and first priority securityinterests (subject to customary exceptions) in substantially all of the currentand future property and assets of the Company and its direct and indirectsubsidiaries, with certain limited exceptions. In connection with the Company’sentrance into the New Senior Secured Revolving Credit Facilities on January 29,2007, the Company borrowed $7.4 million under the New Senior Secured RevolvingCredit Facility, the proceeds of which were used to pay the outstandingrevolving borrowings under the Old Senior Secured Revolving Credit Facility. Asof September 30, 2007, there was $9.9 million outstanding under the New

 

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Senior Secured Revolving Credit Facility.

 

TheSecond Amended and Restated Credit Agreement contains various affirmative andnegative covenants and restrictions, which among other things, require us tomeet certain financial tests (including certain leverage and cash flow ratios),and limits our and our subsidiaries’ ability to incur or guarantee additionalindebtedness, make certain capital expenditures, pay dividends or make otherequity distributions, purchase or redeem capital stock, make certaininvestments, enter into arrangements that restrict dividends from subsidiaries,sell assets, engage in transactions with affiliates and effect a consolidationor merger. Under the terms of the Second Amended and Restated Credit Agreementwe are required to maintain a cash flow ratio determined on an annual basisequal to 1.70 to 1.00 until maturity, except for the fiscal quarters endedSeptember 30, 2007 and December 30, 2007, when compliance with theCash Flow Ratio is not to be tested. Pursuant to the terms of the SecondAmended and Restated Credit Agreement, the Cash Flow Ratio is defined as theratio of (a) Consolidated Cash Flow (as defined therein) to (b) ConsolidatedFinancial Obligations (as defined therein).

 

TheCompany was in compliance with all specified financial and other covenantsunder the New Senior Secured Revolving Credit Facilities at September 30,2007.

 

*Senior Unsecured Credit Facility*. In 2005 we entered into a $75.0 millionsenior unsecured credit facility (the “Old Senior Unsecured Credit Facility”)consisting of a single term loan maturing on December 31, 2008, all of theproceeds of which were used to finance a portion of the cash consideration ofan acquisition and pay related fees and expenses. On October 5, 2006, theCompany entered into an Amended and Restated Senior Unsecured Credit Facility,pursuant to which the Old Senior Unsecured Credit Facility was decreased to a$65.0 million senior unsecured credit facility (the “ New Senior UnsecuredCredit Facility”), consisting of a single term loan maturing on October 5,2010. All of the proceeds of the New Senior Unsecured Credit Facility were usedto repay in full any term loans outstanding under the Old Senior UnsecuredCredit Facility and not continued on the restatement date. The total amount ofterm loans repaid was $10.0 million. Obligations under the New Senior UnsecuredCredit Facility are guaranteed by all of the Company’s subsidiaries. Intereston the term loan outstanding under the New Senior Unsecured Credit Facilityaccrues, at the Company’s option, at either (i) the greater of the primerate or the rate which is 0.5% in excess of the federal funds rate, plus 4.0%or (ii) a reserve adjusted Eurodollar rate, plus 5.0%. As of September 30,2007, the interest rate on the New Senior Unsecured Credit Facility term loanwas 10.41%.

 

OurNew Senior Unsecured Credit Facility contains various affirmative and negativecovenants which, among other things, require us to meet certain financial tests(including certain leverage and interest coverage ratios) and limits our andour subsidiaries’ ability to incur or guarantee additional indebtedness, grantcertain liens, make certain restricted payments, make capital expenditures,engage in transactions with affiliates, make certain investments, sell ourassets, make acquisitions, effect a consolidation or merger and amend or modifyinstruments governing certain indebtedness (including relating to our seniorsecured notes and the New Senior Secured Revolving Credit Facilities). We arerequired to maintain certain minimum interest coverage ratios ranging from (i) 2.15to 1.00 for the fiscal quarters ending on or after March 31, 2007 through December 31,2007 and (ii) 2.30 to 1.00 thereafter until maturity. Pursuant to theterms of the New Senior Unsecured Credit Facility, the Interest Coverage Ratiois defined as the ratio as of the last day of any fiscal quarter of (a) ConsolidatedEBITDA (as defined therein) for the four-fiscal quarter period then ending to (b) ConsolidatedInterest Expense (as defined therein) for such four-fiscal quarter period. TheCompany was in compliance with all specified financial and other covenantsunder the New Senior Unsecured Credit Facility at September 30, 2007.

 

*Mortgage.* In 2005, concurrent with an acquisition, we assumed a $0.8 millionmortgage secured by the building and improvements of one of the restaurantsacquired in the transaction. The mortgage carries a fixed annual interest rateof 9.28% and requires equal monthly payments of principal and interest through April 2015.As of September 30, 2007, the principal amount outstanding on the mortgagewas $0.7 million.

 

Interestrates for the Company’s long-term debt are shown in the following table:

 
| ** **                               | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Senior Secured Notes due 2010            |       | 10.00                        | %          | 10.25                       | %          |
| Senior Secured Revolving Credit Facility |       | 7.40 to 8.50                 | %          | 8.25                        | %          |
| Senior Unsecured Credit Facility         |       | 10.41                        | %          | 10.35                       | %          |
| Mortgage                                 |       | 9.28                         | %          | 9.28                        | %          |
| Other                                    |       | 6.45 to 7.75                 | %          | 7.75                        | %          |

 

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**4.****            ****Capitalization**

 

**Common Stock**

 

TheCompany is authorized to issue 1,000 shares of common stock. At September 30,2007 and December 31, 2006, there were 1,000 shares of common stockauthorized, issued and outstanding.

 

**RedeemablePreferred Stock-Predecessor**

 

Priorto the Merger, the Company was authorized to issue 100,000 shares of PreferredStock. Shares were issued upon approval of the board of directors and alloutstanding shares of Preferred Stock were redeemable at any time at the optionof the Company, subject to restrictions under certain debt covenants.

 

Series A12.5% Cumulative Compounding Redeemable Preferred Stock (Series A) and Series B13.5% Cumulative Compounding Redeemable Preferred Stock (Series B) had aliquidation preference equal to $1 per share plus accreted dividends. Withrespect to dividend rights and rights of liquidation, Series A rankedsenior to all classes of Common Stock and Series B. Series B rankedsenior to all classes of Common Stock.

 

Series C15% Cumulative Compounding Participating Preferred stock (Series C) rankedsenior with respect to payment of dividends, liquidation, and redemption to allother series of preferred stock and common stock of the Company. The Series Chad a liquidation preference equal to two times the original issue price of $1per share, plus accreted dividends. As a result of the liquidation preference, Series Cwas recorded at liquidation value at the date of issuance. Holders of Series Cwere entitled to receive, in addition to the liquidation preference, an amountequal to 40% of any amounts that would otherwise be available to the holders ofCommon Stock in the event of a liquidation or sale of the Company.

 

Theliquidation preference on the Series A, Series B and Series Caccreted at the stated rates on the liquidation preference value thereof;dividends (representing accreted liquidation preference) were to be paid fromlegally available funds, when and if declared by the board of directors.Dividends were payable only when and if declared, or upon a sale or liquidationof the Company or upon redemption of the applicable series of preferredstock. Accretion of the liquidation preference on the redeemable preferredstock was reflected as an increase in the preferred stock values and anincrease in the accumulated deficit. Accretion of the liquidation preference onthe Redeemable Preferred Stock during the two month and eight month Predecessorperiods ended August 20, 2006 was $2.3 million and $10.1 million,respectively. In the Predecessor periods, net loss attributable to commonstockholders includes the effect of the accretion of the liquidation preferenceon the redeemable preferred stock which reduced net income attributable tocommon stockholders for the period.

 

OnAugust 21, 2006, as a result of the Merger and in accordance with theterms of the Merger Agreement, all issued and outstanding preferred stock wasconverted into the right to receive a portion of the Merger consideration.

 

**StockOption Plans**

 

Asa result of the Merger and in accordance with the terms of the Merger Agreementall of the Company’s then outstanding vested and unvested stock options werecancelled and converted into the right to receive a portion of the purchaseprice, less the exercise prices thereon, as applicable. Concurrently with theMerger, the Company’s 1998 and 2000 Stock Option Plans were terminated.

 

In December 2006, the Board of Directors of RMRestaurant Holding (the “Board”), the Company’s parent, adopted a Non-QualifiedStock Option Plan (the “2006 Plan”). The 2006 Plan reserved 100,000 shares ofthe Company’s non-voting common stock for issuance upon exercise of stockoptions granted under the 2006 Plan. In January 2007, the Board issuedstock options to certain members of management. These options vest 20% per yearbeginning August 16, 2007, with full vesting on August 16, 2011.Accelerated vesting of all outstanding options is triggered upon a change ofcontrol of the Company. The options have a life of 10 years, and can only beexercised upon the earliest of the following dates: (i) the 10 yearanniversary of the effective date; (ii) the date of a change in control,as defined in the 2006 Plan; or (iii) date of employment termination,subject to certain exclusions.

 

The Company accounts for stock-based compensation inaccordance with Statement of Financial Accounting Standards (“SFAS”) No. 123(Revised), “Share-Based Payment” (“SFAS 123R”), which requires the Company tomeasure the cost of employee services received in exchange for an award ofequity instruments based on the grant-date fair value of the award. That costis recognized in the consolidated statement of operations over the periodduring which an employee is required to provide service in exchange for theaward – the requisite service period. No compensation cost is recognized for

 

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equity instruments for which employees do notrender the requisite service. The grant-date fair value of employee stockoptions is estimated using the Black-Scholes option pricing model.

 

The valuation of the stock-based compensation wascompleted during the third quarter of 2007. At such time, the Company determined that $0.6 million of stock-basedcompensation expense should be recorded in the nine months ended September 30,2007 as the amounts had not been previously recorded.  Of the $0.6 million, $0.2 million relates tothe quarter ended September 30, 2007 and $0.4 million relates to the prior 2007quarters. The following table presents the major subtotals for the Company’sunaudited Consolidated Statements of Operations and the related impact of therestatement adjustments discussed above for the first and second quarter of2007 (in thousands):

 
| ** **                         | ** ** | **Three months ended April 1, 2007** | ** ** | **Three months ended July 1, 2007** | ** ** |
|------------------------------------|------------|----------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                         | ** ** | **Previously  Reported**                                 | ** ** | **Effect of  Restatement**                              | ** ** | **Restated** | ** ** | **Previously  Reported** | ** ** | **Effect of  Restatement** | ** ** | **Restated** | ** ** |
| General and administrative expense |       | 7,681                                                    |       | 228                                                          |       | 7,909 |   | 8,057 |   | 228 |   | 8,285 |   |
| Operating income                   |       | 5,821                                                    |       | (228                                                         | )          | 5,593 |   | 8,041 |   | (228 | ) | 7,813 |   |
| Income before income tax provision |       | 881                                                      |       | (228                                                         | )          | 653 |   | 5,151 |   | (228 | ) | 4,923 |   |
| Income tax provision               |       | 368                                                      |       | (95                                                          | )          | 273 |   | 2,040 |   | (90 | ) | 1,950 |   |
| Net income                         |       | 513                                                      |       | (133                                                         | )          | 380 |   | 3,111 |   | (138 | ) | 2,973 |   |

 

The Company utilizes comparator companies toestimate its price volatility and the simplified method to calculate optionexpected time to exercise, under SAB 107. The fair value of stock-based paymentawards was estimated using the Black-Scholes option pricing model with thefollowing assumptions and weighted average fair values for the three and ninemonths ended September 30, 2007:

 
| Weighted average fair value of grants |   | $     | 39.43  |   |
|---------------------------------------|--------|-------|--------|--------|
| Risk-free interest rate               |   | 4.52  | %      |
| Expected volatility                   |   | 42.28 | %      |
| Expected life in years                |   | 6.15  |   |

 

The following table summarizes the stock optionactivity as of September 30, 2007 and changes during the nine months endedSeptember 30, 2007:

 
| ** **                                              | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|---------------------------------------------------------|------------|------------|------------|--------------------------------------------|------------|
| Outstanding at December 31, 2006                   |       | 0          |       |                                       |       |
| Granted                                                 |       | 78,250     |       | $                                          | 81.50      |   |
| Exercised                                               |       | 0          |       |                                       |       |
| Forfeited/expired                                       |       | (500       | )          | 81.50                                      |       |
| Outstanding at September 30, 2007                  |       | 77,750     |       | $                                          | 81.50      |   |
| Vested and expected to vest at  September 30, 2007 |       | 68,799     |       | $                                          | 81.50      |   |
| Exercisable at September 30, 2007                  |       | 15,550     |       | $                                          | 81.50      |   |

 

The Company recorded $0.2million and $0.6 million of stock-based compensation expense for the three andnine months ended September 30, 2007, respectively, and is included ingeneral and administrative expense on the consolidated statements ofoperations. The income taxbenefit associated with stock-based compensation was $0.1 million and $0.3million for the three and nine months ended September 30, 2007, respectively.

 

As of September 30, 2007, $2.0 million of totalunrecognized compensation costs related to non-vested stock-based awards isexpected to be recognized through fiscal year 2011, and the weighted averageremaining vesting period of those awards is approximately 3.9 years.

 

At September 30, 2007, the aggregate intrinsicvalue of exercisable options was $0, based on a market value per share of $81.50.

 

**5.****            ****Related Party Transactions**

 

**SuccessorTransactions**

 

The Company has aManagement Services Agreement (the Management Agreement”) dated August 21,2006, by and between the Company and Sun Capital Partners Management IV, LLC(the “Manager”), an affiliate of Sun Cantinas LLC, the indirect holder of themajority of the capital stock of the Company. The Manager is paid annual feesequal to the greater of (i) $0.5 million or (ii) 1% of the Company’sEBITDA for such period. EBITDA is defined as (A) net income (or loss)after taxes of the Company and its direct and indirect subsidiaries on aconsolidated basis (“Net Income”), plus (B) interest expense whichhas been deducted in the determination of Net Income, plus (C) federal,state and local taxes which have been deducted

 

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in determining Net Income, plus (D) depreciationand amortization expenses which have been deducted in determining Net Income,including without limitation amortization of capitalized transaction expensesincurred in connection with the transactions contemplated by the Merger, plus (E) extraordinarylosses which have been deducted in the determination of Net Income, plus (F) un-capitalizedtransaction expenses incurred in connection with the Merger, plus (G) allother non-cash charges, minus (H) extraordinary gains which have beenincluded in the determination of Net Income. EBITDA is computed without takinginto consideration the fees payable under the Management Agreement. The Companypays the fees in quarterly installments in advance equal to the greater of (i) $0.1million or (ii) 1% of EBITDA for the immediately preceding fiscal quarter.Expenses relating to the Management Agreement of $0.1 million in the threemonth period ended September 30, 2007 and $0.5 million in the nine monthperiod ended September 30, 2007, were recorded as general andadministrative expense. Additionally, the Company prepaid $0.1 million in feesunder the agreement for the fourth quarter of 2007. Expenses relating to theManagement Agreement for the one month period ended September 24, 2006were immaterial.

 

In September 2006,the Company made a dividend distribution of $10.0 million to RM RestaurantHolding, its parent, which was recorded as a reduction to retained earnings.The Company has also made subsequent additional payments to and on behalf of RMRestaurant Holding related to the Merger and has recorded the payments as arelated party receivable, with a balance of $3.4 million at September 30,2007.

 

**PredecessorTransactions**

 

The Company had anAmended and Restated Management Agreement dated June 28, 2000 with two ofits former stockholders Bruckman, Rosser, Sherrill & Co., L.P. and FSPrivate Investments, LLC. The stockholders were paid annual fees equating to..667% and .333%, respectively, of consolidated earnings before interest, incometaxes, depreciation and amortization of the Company. As described in the MergerAgreement, the Amended and Restated Management Agreement dated June 28,2000 was terminated in connection with the Merger. Expenses relating to theagreement of $0.1 million were recorded as general and administrative expensein the two months ended August 20, 2006 and $0.4 million for the eightmonths ended August 20, 2006. Additionally, the Company recorded atermination fee of $1.8 million in the two months and eight months ended August 20,2006 related to the termination of the Amended and Restated ManagementAgreement. The termination fee was recorded in merger costs.

 

**6.****            ****Impact of Recently IssuedAccounting Principles**

 

In July 2006, the Financial Accounting StandardsBoard (“FASB”) issued Interpretation No. 48 (“FIN No. 48”) *Accounting for Uncertainty in Income Taxes: aninterpretation of FASB Statement No. 109.*This interpretationclarifies the accounting for uncertainty in income taxes recognized in anentity’s financial statements in accordance with SFAS No. 109, *Accounting*far *Income Taxes.*FIN No. 48 prescribes a recognitionthreshold and measurement principles for financial statement disclosure of taxpositions taken or expected to be taken on a tax return. The Company adoptedthe provision of this interpretation effective January 1, 2007. Theadoption of FIN No. 48 did not have a material impact on the Company’sconsolidated financial position and results of operations.

 

In September 2006, the FASB issued SFAS No. 157,*Fair Value Measurements.*ThisStandard defines fair value, establishes a framework for measuring fair valuein generally accepted accounting principles and expands disclosures about fairvalue measurements. SFAS No. 157 is effective for financial statementsissued for fiscal years beginning after November 15, 2007, which is theyear beginning December 31, 2007 for the Company. The adoption of SFAS No. 157is not expected to have a material impact on the Company’s financial position,results of operations or cash flows.

 

In February 2007, the FASB issued SFAS No. 159,*The Fair Value Option for Financial Assetsand Financial liabilities - Including an Amendment of FASB Statement No. 115.*SFAS No. 159 permits entities to choose to measure manyfinancial instruments and certain other items at fair value. Unrealized gainsand losses on items for which the fair value option has been elected will berecognized in earnings at each subsequent reporting date. SFAS No. 159 iseffective for financial statements issued for fiscal years beginning after November 15,2007, which is the year beginning December 31, 2007 for the Company. TheCompany is evaluating the impact that the adoption of SFAS No. 159 willhave on its consolidated results of operations and financial condition.

 

**7.****            ****Other Events**

 

In May 2007, the Company sold four Company-ownedFuzio restaurants to a franchisee, entered into a management agreement with thefranchisee on a fifth Company-owned Fuzio restaurant and sold the Fuziotrademark, trade name and Fuzio franchise rights to the franchisee (the “FuzioTransaction”). The selling price of $4.9 million in cash included $0.7

 

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million in prepaid management fees associated with themanagement agreement. The management fees will be amortized over seven yearsbeginning in May 2007. Concurrent with the sale, the Company purchasedthree franchised Chevys restaurants from the franchisee for $3.1 million incash.

 

The Company recorded a gain of $1.5 million on thedisposal of the assets of the Fuzio Transaction. The gain is included in otherincome on the consolidated statements of operations and has been recorded netof associated expenses and remaining net book value of the assets transferred.

 

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**Item 2.****   ****Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

*Thefollowing discussion and analysis of our financial condition and results ofoperations contains forward-looking statements within the meaning of thefederal securities laws. See the discussion under the heading “Forward-LookingStatements” elsewhere in this report.*

 

**Overview**

** **

We are one of thelargest full-service casual dining Mexican restaurant chain operators in theUnited States in terms of number of restaurants. As of September 30, 2007we operated 188 restaurants, of which 156 were located in California, withadditional restaurants in Arizona, Florida, Indiana, Illinois, Maryland,Missouri, Nevada, New Jersey, New York, Oregon, Virginia and Washington. Ourfour major subsidiaries are El Torito Restaurants, Inc., AcapulcoRestaurants, Inc., Chevys Restaurants, LLC and a purchasing, distribution,and manufacturing subsidiary, Real Mex Foods, Inc.

 

Our primaryrestaurant concepts, El Torito, El Torito Grill, Acapulco and Chevys, offerhigh quality Mexican food, a wide selection of alcoholic beverages andexcellent guest service. In addition to the El Torito, El Torito Grill,Acapulco and Chevys concepts, we operate nine additional restaurant locations,all of which are also full service Mexican formats, under the following brands:Las Brisas; Casa Gallardo; El Paso Cantina; GuadalaHarry’s; and Who Song &Larry’s.

 

In 2007 we have opened four restaurants: an El Torito Grillrestaurant in Anaheim, CA a Chevys restaurant in Rocklin, CA and El Toritorestaurants in Rancho Cucamonga, CA and Santa Ana, CA. In 2006 we opened six restaurants: three El Toritorestaurants, an El Torito Grill restaurant and a Chevys restaurant, all inCalifornia and a Chevys restaurant in New York.We also have in the past, and may in the future, convert selectrestaurants to the El Torito or Chevys brand and divest underperformingrestaurants.

 

Our restaurantrevenues include sales of food and alcoholic and other beverages. Otherrevenues consist primarily of sales by Real Mex Foods, Inc. to outsidecustomers of processed and packaged prepared foods and other merchandise items.

 

Cost of sales iscomprised primarily of food and alcoholic beverage expenses. The components ofcost of sales are variable and increase with sales volume. In addition, thecomponents of cost of sales are subject to increase or decrease based onfluctuations in commodity costs and depend in part on the success ofcontrols we have in place to manage cost of sales in our restaurants. The cost,availability and quality of the ingredients we use to prepare our food andbeverages are subject to a range of factors including, but not limited to,seasonality, political conditions, weather conditions, and ingredientshortages.

 

Labor costincludes direct hourly and management wages, operations management bonusexpense, vacation pay, payroll taxes, workers’ compensation insurance andhealth insurance expenses.

 

Direct operatingand occupancy expense includes operating supplies, repairs and maintenance,advertising expenses, utilities, and other restaurant related operatingexpenses. This expense also includes all occupancy costs such as fixed rent,percentage rent, common area maintenance charges, real estate taxes and otherrelated occupancy costs.

 

General andadministrative expense includes all corporate and administrative functions thatsupport our operations. Expenses within this category include executivemanagement, supervisory and staff salaries, bonus and related employeebenefits, travel and relocation costs, information systems, training, corporaterent and professional and other consulting fees.

 

Depreciation andamortization principally includes depreciation of capital expenditures forrestaurants and also includes amortization of favorable lease asset andunfavorable lease liability, net. Amortization of favorable lease asset andunfavorable lease liability, net, represents the amortization of the asset inexcess of the approximate fair market value and the liability in excess of theapproximate fair market value of the leases assumed as of August 21, 2006,the date of the Merger of the Company. The amounts are being amortized over theremaining primary terms of the underlying leases.

 

Legal settlementcosts include amounts paid or accrued to settle various legal actions againstthe Company, excluding costs to defend the actions.

 

Merger costsinclude all direct costs related to the Merger that are not eligible forcapitalization including legal expenses, investment banker fees, other advisoryservices, restricted stock compensation and other costs.

 

Pre-opening costsare expensed as incurred and include costs associated with the opening of a newrestaurant or the

 

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conversion of an existing restaurant to a differentconcept.

 

Other incomeincludes gains on the disposal of assets and other miscellaneous income andexpense.

 

Goodwill is deemedto have an indefinite life and is subject to an annual impairment test, or morefrequently if facts and circumstances indicate that an impairment has occurred.Other intangible assets are amortized over their useful lives in accordancewith Statement of Financial Accounting Standards No. 142, “Goodwill andOther Intangible Assets.”

 

Our fiscal yearconsists of 52 or 53 weeks and ends on the last Sunday in December of eachyear. The three months ended September 30, 2007 and September 24,2006 consist of thirteen weeks. Each of the nine month periods ended September 30,2007 and September 24, 2006 contain 39 weeks. When calculating comparablestore sales, we include a restaurant that has been open for more than 18 monthsand for the entirety of each comparable period. As of September 30, 2007,we had 173 restaurants that met this criterion.

 

**Critical Accounting Policies**

** **

Thediscussion and analysis of our financial condition and results of operationsare based upon our consolidated financial statements, which have been preparedin accordance with accounting principles generally accepted in the UnitedStates. The preparation of these financial statements requires us to makeestimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses, and related disclosure of contingent assetsand liabilities. On an ongoing basis, we evaluate our estimates, includingthose related to property and equipment, impairment of long-lived assets,valuation of goodwill, self-insurance reserves, income taxes and revenuerecognition. We base our estimates on historical experience and on variousother assumptions and factors that are believed to be reasonable under thecircumstances, the results of which form the basis for making judgmentsabout the carrying values of assets and liabilities that are not readilyapparent from other sources. Based on our ongoing review, we plan to adjust ourjudgments and estimates where facts and circumstances dictate. Actual results coulddiffer from our estimates.

 

For furtherinformation regarding the accounting policies that we believe to be criticalaccounting policies that affect our more significant judgments and estimatesused in preparing our consolidated financial statements, see Note 4 of theConsolidated Financial Statements in our report on Form 10-K filed for thefiscal year ended December 31, 2006.

 

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**Results of Operations**

** **

The discussion ofand the results of operations for the 13 weeks (“third quarter” or “threemonths”) ended September 30, 2007 is based on the results for the 13 weekSuccessor period from July 2, 2007 to September 30, 2007. Thediscussion of and the results of operations for the 13 weeks (“third quarter”or “three months”) ended September 24, 2006 is based on the combinedresults of the eight week Predecessor period from June 26, 2006 to August 20,2006 and the five week Successor period from August 21, 2006 to September 24,2006. The discussion of and the results of operations for the 39 weeks (“ninemonths”) ended September 30, 2007 is based on the results for the 39 weekSuccessor period from January 1, 2007 to September 30, 2007. Thediscussion of and the results of operations for the 39 weeks (“nine months”)ended September 24, 2006 is based on the combined results of the 34 weekPredecessor period from December 26, 2005 to August 20, 2006 and thefive week Successor period from August 21, 2006 to September 24,2006. Because of purchase accounting adjustments to the fair market value oflong-term assets and long-term liabilities, certain amounts may not becomparable between the three and nine month periods ended September 30,2007 and September 24, 2006.

 

Our operatingresults for the three and nine months ended September 30, 2007 and September 24,2006 are expressed as a percentage of total revenues below:

 
| ** **                             | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **September  30, 2007**     | ** ** | **September  24, 2006**    | ** ** | **September  30, 2007** | ** ** | **September  24, 2006** | ** ** |
| Total revenues                         |       | 100.0                            | %          | 100.0                           | %          | 100.0 | % | 100.0 | % |
| Cost of sales                          |       | 25.7                             |       | 23.7                            |       | 24.5 |   | 23.6 |   |
| Labor                                  |       | 34.7                             |       | 33.5                            |       | 35.1 |   | 33.9 |   |
| Direct operating and occupancy expense |       | 26.8                             |       | 26.1                            |       | 26.1 |   | 25.4 |   |
| Total operating costs                  |       | 87.1                             |       | 83.3                            |       | 85.8 |   | 82.8 |   |
| General and administrative expense     |       | 5.3                              |       | 5.4                             |       | 5.4 |   | 5.1 |   |
| Depreciation and amortization          |       | 3.8                              |       | 3.4                             |       | 3.9 |   | 3.3 |   |
| Legal settlement costs                 |       | 0.0                              |       | 1.0                             |       | 0.1 |   | 1.0 |   |
| Merger transaction costs               |       | 0.0                              |       | 6.9                             |       | 0.0 |   | 2.3 |   |
| Pre-opening costs                      |       | 0.4                              |       | 0.4                             |       | 0.3 |   | 0.2 |   |
| Operating income (loss)                |       | 2.8                              |       | (1.3                            | )          | 4.1 |   | 4.9 |   |
| Interest expense                       |       | 3.4                              |       | 4.9                             |       | 3.4 |   | 4.5 |   |
| Total other expense, net               |       | 3.5                              |       | 4.5                             |       | 3.0 |   | 4.3 |   |
| Income (loss) before tax provision     |       | (0.7                             | )          | (5.8                            | )          | 1.1 |   | 0.6 |   |
| Net income (loss)                      |       | (0.4                             | )          | (3.6                            | )          | 0.6 |   | 0.3 |   |

 

The valuation of the stock-basedcompensation for the stock option grant in Q1 2007 was completed during thethird quarter of 2007.  At such time, theCompany determined that $0.6 million of stock-based compensation expense shouldbe recorded in the nine months ended September 30, 2007 as the amounts had notbeen previously recorded.  Of the $0.6million, $0.2 million relates to the quarter ended September 30, 2007 and $0.4million relates to the prior 2007 quarters. The following table presents themajor subtotals for the Company’s unaudited Consolidated Statements ofOperations and the related impact of the restatement adjustments discussedabove for the first and second quarter of 2007:

 
| ** **                         | ** ** | **Three months ended March 31, 2007** | ** ** | **Three months ended June 30, 2007** | ** ** |
|------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                         | ** ** | **Previously  Reported**              | ** ** | **Effect of  Restatement**           | ** ** | **Restated** | ** ** | **Previously  Reported** | ** ** | **Effect of  Restatement** | ** ** | **Restated** | ** ** |
| General and administrative expense |       | 7,681                                 |       | 228                                  |       | 7,909 |   | 8,057 |   | 228 |   | 8,285 |   |
| Operating income                   |       | 5,821                                 |       | (228                                 | )          | 5,593 |   | 8,041 |   | (228 | ) | 7,813 |   |
| Income before income tax provision |       | 881                                   |       | (228                                 | )          | 653 |   | 5,151 |   | (228 | ) | 4,923 |   |
| Income tax provision               |       | 368                                   |       | (95                                  | )          | 273 |   | 2,040 |   | (90 | ) | 1,950 |   |
| Net income                         |       | 513                                   |       | (133                                 | )          | 380 |   | 3,111 |   | (138 | ) | 2,973 |   |

 

 

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**Three months ended September 30, 2007 compared to the three monthsended September 24, 2006**

 

*TotalRevenues*. Totalrevenues increased by $2.9 million, or 2.1%, to $142.5 million in the thirdquarter of 2007 from $139.6 million in the third quarter of 2006 primarily dueto a $3.5 million increase in other revenues. The increase in other revenueswas primarily due to an increase in sales to existing outside customers and theaddition of new outside customers by Real Mex Foods, Inc., ourdistribution and manufacturing subsidiary. Comparable store sales remainedconsistent, with a slight increase of 0.6%.

 

*Cost ofSales*. Total costof sales of $36.6 million in the third quarter of 2007 increased $3.5 millionor 10.4% as compared to the third quarter of 2006. As a percentage of total revenues,cost of sales increased to 25.7% in the third quarter of 2007 from 23.7% in thethird quarter of 2006. This increase was primarily due to higher costsassociated with the increase in outside sales at Real Mex Foods, Inc.combined with higher commodity costs, specifically beef, chicken, dairy andproduce, in the third quarter of 2007.

 

*Labor*. Labor costs of $49.4 million in thethird quarter of 2007 increased by $2.7 million or 5.7% as compared to thethird quarter of 2006. As a percentage of total revenues, labor costs increasedto 34.7% in the third quarter of 2007 from 33.5% in the third quarter of 2006. Thisincrease was primarily due to minimum wage increases which took place in January inthe majority of the states in which we operate combined with annual managementsalary increases. Payroll and benefits remain subject to inflation andgovernment regulation, especially wage rates that are currently at or near theminimum wage, and expenses for health insurance.

 

*DirectOperating and Occupancy Expense*. Direct operating and occupancy expense of $38.2million in the third quarter of 2007 increased by $1.7 million or 4.8% ascompared to the third quarter of 2006. Direct operating and occupancy expenseas a percentage of sales increased to 26.8% in the third quarter of 2007 from26.1% in the third quarter of 2006 primarily due to an increase in expendituresfor advertising and promotion and an increase in rent expense resulting fromlease renewals and rent for new restaurants.

 

*Generaland Administrative Expense*. General and administrative expense of $7.6 millionin the third quarter of 2007 increased by $0.1 million or 0.3% as compared tothe third quarter of 2006 primarily due to stock-based compensation expenserelated to options issued during 2007, partially offset by lower corporatebonus expense in the current year combined with higher legal expense in theprior year. General and administrative expense as a percentage of salesdecreased to 5.3% in the third quarter of 2007 from 5.4% in the third quarterof 2006.

 

*Depreciationand Amortization*.Depreciation and amortization expense of $6.2 million in the third quarter of2007 increased $1.4 million or 28.8% as compared to the third quarter of 2006. Asa percentage of total revenues, depreciation and amortization increased to 4.3%in the third quarter of 2007 from 3.4% in the third quarter of 2006. Theincrease in expense as a percent of sales is due to the increase in thedepreciable basis of furniture, fixtures and equipment to fair market value andnet favorable lease asset and unfavorable lease liability amortization requiredunder purchase accounting rules due to the Merger on August 21, 2006,as well as depreciation on the assets of new restaurants.

 

*LegalSettlement Costs.*Legalsettlement costs of $0.1 million in the third quarter of 2007 decreased by $1.4million or 95.7% in the third quarter of 2007 as compared to the third quarterof 2006. The legal settlement expense in the third quarter of 2006 related tolawsuits filed against us in 2004 and 2006.

 

*MergerTransaction Costs.*Mergertransaction costs decreased by $9.6 million or 100% in the third quarter of2007 as compared to the third quarter of 2006. The merger transaction costs inthe third quarter of 2006 related to all direct costs associated with theMerger that were not eligible for capitalization including legal expenses,investment banker fees, other advisory services, restricted stock compensationand other costs.

 

*InterestExpense*. Interestexpense of $4.8 million in the third quarter of 2007 decreased $2.0 million or29.9% as compared to the third quarter of 2006 primarily due to a $10.0 millionreduction in our senior unsecured credit facility and a reduction in theweighted average interest rate on our senior unsecured credit facility from14.92% in the third quarter of 2006 to 10.41% in the third quarter of 2007. Asa percentage of total revenues, interest expense was 3.4% in the third quarterof 2007 as compared to 4.9% in the third quarter of 2006.

 

*Income tax provision.*The income tax provision for the third quarter of 2007 and 2006 was based onestimated annual effective tax rates. A rate of 36.2% was applied to the thirdquarter of 2007 versus a rate of 38.7% in the third quarter of 2006. The ratesare comprised of the combined federal and state statutory rates.

 

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**Nine months ended September 30,2007 compared to the nine months ended September 24, 2006**

** **

*TotalRevenues*. Totalrevenues increased by $6.7 million, or 1.6%, to $430.6 million in the firstnine months of 2007 from $423.9 million in the first nine months of 2006 due toa $1.2 million increase in restaurant revenues and a $5.5 million increase inother revenues. The increase in restaurant revenues was primarily due to comparablestore sales increases of 0.8% and sales from new restaurant openings which werepartially offset by restaurant closures. The increase in comparable store saleswas primarily driven by a 1.6% average menu price increase in all brands thatwas implemented in January 2007. The increase in other revenues wasprimarily due to an increase in sales to outside customers and the addition ofnew outside customers by Real Mex Foods, Inc., our distribution andmanufacturing subsidiary.

 

*Cost ofSales*. Total costof sales of $105.7 million in the first nine months of 2007 increased $5.9million or 5.9% as compared to the first nine months of 2006. As a percentageof total revenues, cost of sales increased to 24.5% in the first nine months of2007 from 23.6% in the first nine months of 2006. This increase was primarilydue to higher costs associated with the increase in outside sales at Real MexFoods, Inc. combined with higher commodity costs, specifically beef,chicken, dairy and produce, in the first nine months of 2007.

 

*Labor*. Labor costs of $151.3 million in thefirst nine months of 2007 increased by $7.6 million or 5.3% as compared to thefirst nine months of 2006. As a percentage of total revenues, labor costsincreased to 35.1% in the first nine months of 2007 from 33.9% in the firstnine months of 2006. This increase was primarily due to minimum wage increaseswhich took place in January in the majority of the states in which weoperate combined with annual management salary increases. Payroll and benefits remainsubject to inflation and government regulation, especially wage rates that arecurrently at or near the minimum wage, and expenses for health insurance.

 

*DirectOperating and Occupancy Expense*. Direct operating and occupancy expense of $112.5million in the first nine months of 2007 increased by $5.0 million or 4.6% ascompared to the first nine months of 2006. Direct operating and occupancyexpense as a percentage of sales increased to 26.1% in the first nine months of2007 from 25.4% in the first nine months of 2006 primarily due to an increasein expenditures for advertising and promotion and an increase in rent expenseresulting from lease renewals and rent for new restaurants.

 

*Generaland Administrative Expense*. General and administrative expense of $23.7 millionin the first nine months of 2007 increased by $1.9 million or 8.7% as comparedto the first nine months of 2006 primarily due to increased expenditures forlegal expenses related to employee class action litigation and an increasein salaries due to merit increases in the fourth quarter of 2006 andstock-based compensation expense related to options issued during 2007. Generaland administrative expense as a percentage of sales increased to 5.4% in thefirst nine months of 2007 from 5.1% in the first nine months of 2006.

 

*Depreciationand amortization*.Depreciation and amortization expense of $18.1 million in the first nine monthsof 2007 increased $3.9 million or 27.9% as compared to the first nine months of2006. As a percentage of total revenues, depreciation and amortizationincreased to 4.2% in the first nine months of 2007 from 3.3% in the first ninemonths of 2006. The increase in expense is due to the increase in thedepreciable basis of furniture, fixtures and equipment to fair market value andnet favorable lease asset and unfavorable lease liability amortization requiredunder purchase accounting rules due to the Merger on August 21, 2006and depreciation on the assets of new restaurants.

 

*LegalSettlement Costs.*Legalsettlement costs of $0.4 million in the first nine months of 2007 decreased by$3.8 million or 90.8% in the first nine months of 2007 as compared to the firstnine months of 2006. The legal settlement expense in the first nine months of2006 related to lawsuits filed against us in 2004 and 2006.

 

*InterestExpense*. Interestexpense of $14.5 million in the first nine months of 2007 decreased $4.4million or 23.5% as compared to the first nine months of 2006 primarily due toa $10.0 million reduction in our senior unsecured credit facility and areduction in the weighted average interest rate on our senior unsecured creditfacility from 14.45% in the first nine months of 2006 to 10.38% in the firstnine months of 2007. As a percentage of total revenues, interest expense was3.4% in the first nine months of 2007 and 4.5% in the first nine months of2006.

 

*OtherIncome*. Otherincome, net, of $1.7 million in the first nine months of 2007 increased by $0.8million or 89.4% as compared to the first nine months of 2006. The increase inother income was primarily the result of a $1.5 million gain on the sale of theassets, net of associated expenses, of four Company-owned Fuzio restaurants toa franchisee and the sale of the Fuzio trademark, trade name and Fuziofranchise rights to the franchisee.

 

*Income tax provision.*The income tax provision for the first nine months of 2007 and 2006 was basedon estimated annual effective tax rates. A rate of 40.9% was applied to thefirst nine months of 2007 versus a rate of 39.0% in the first nine months of2006. The rates are comprised of the combined federal and state statutoryrates.

 

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**Liquidity and CapitalResources**

** **

Our principalliquidity requirements are to service our debt and meet our capital expenditureand working capital needs. Our indebtedness, including capital leaseobligations, at September 30, 2007 was $185.0 million, and we had $5.2million of revolving credit availability under our revolving credit facility.Our ability to make principal and interest payments and to fund planned capitalexpenditures will depend on our ability to generate cash in the future, which,to a certain extent, is subject to general economic, financial, competitive,legislative, regulatory and other factors that are beyond our control. Based onour current level of operations, we believe our cash flow from operations,available cash and available borrowings ‘under our revolving credit facilitywill be adequate to meet our liquidity needs for the near future. In addition,we may partially fund restaurant openings through credit received fromtrade suppliers and landlord contributions, if favorable terms are available.We cannot assure you, however, that our business will generate sufficient cashflow from operations or that future borrowing will be available to us under ourrevolving credit facility in an amount sufficient to enable us to service ourindebtedness or to fund our other liquidity needs. If we consummate anacquisition, our debt service requirements could increase. We may need torefinance all or a portion of our indebtedness on or before maturity. We cannotassure you that we will be able to refinance any of our indebtedness oncommercially reasonable terms or at all.

 

**Working Capital andCash Flows**

** **

We presently have,in the past have had, and in the future are likely to have, negative workingcapital balances. The working capital deficit principally is the result ofaccounts payable and accrued liabilities being in excess of current asset levels.The largest components of our accrued liabilities include reserves for ourself-insured workers’ compensation and general liability insurance, accruedcompensation and related employee benefits costs, sales and property taxes andgift certificate and gift card liabilities. We do not have significantreceivables and we receive trade credit based upon negotiated terms inpurchasing food and supplies. Funds available from cash sales not neededimmediately to pay for food and supplies or to finance receivables orinventories typically have been used for capital expenditures and debt servicepayments under our existing indebtedness.

 

*OperatingActivities*. Wehad net cash provided by operating activities of $19.0 million and $22.3million in the nine months ended September 30, 2007 and September 24,2006, respectively. The decrease in cash provided by operating activities wasprimarily attributable to an increase in receivables from outside customers ofReal Mex Foods of $2.0 million due to the addition of new customers, anincrease in inventories used to supply the new outside customers of Real MexFoods of $2.4 million, an increase in prepaid rent of $3.8 million, partiallyoffset by a decrease in deferred tax assets of $3.1 million and a decrease of$1.2 million in furniture and equipment inventories purchased for the futureremodel of existing restaurants.

 

*InvestingActivities*. Wehad net cash used in investing activities of $21.1 million and $18.1 million inthe nine months ended September 30, 2007 and September 24, 2006,respectively. The increase in cash used in investing activities was primarilydue to an increase in capital expenditures of $8.8 million, resulting from a$3.2 million increase in new store construction, a $3.0 million acquisition ofthree Chevys stores from a franchisee and $2.5 million in expenditures for thepartial cost of finishing out and equipping a new, larger manufacturingfacility of Real Mex Foods, Inc. The increase in expenditures was offsetby $5.8 million in proceeds primarily from the sale of five Fuzio restaurantsand the Fuzio trademark to a franchisee and an unrelated sale of Company ownedland.

 

Weexpect to make capital expenditures totaling approximately $34.0 million infiscal year 2007. Approximately $5.4 million is expected to be spent onrestaurant remodels and refurbishment and approximately $11.4 million isexpected to be used to purchase, build or complete the building of up to sevennew El Torito, El Torito Grill or Chevys restaurants. We expect pre-openingexpenses associated with the new restaurants to total approximately $1.2million. We expect fiscal year 2007 capital expenditures for informationtechnology to be approximately $2.0 million, including approximately $1.5million for restaurant point of sale and back office equipment. In 2007, wewill move the existing manufacturing facility of Real Mex Foods, Inc. to anew, larger, location and expect the cost to finish out and equip the newfacility to be approximately $3.8 million. Maintenance capital expenditures forour restaurants are expected to be approximately $11.4 million. These and othersimilar costs may be higher in the future due to inflation and otherfactors. We expect to fund the expenditures for new restaurants and othercapital expenditures from cash flow from operations, available cash, availableborrowings under our senior secured revolving credit facility, landlordallowances (if favorable terms are available) and trade financing received fromtrade suppliers.

 

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*Financing Activities*. We had netcash provided by financing activities of $1.5 million in the nine months ended September 30,2007 compared with net cash used in financing activities of $10.3 million inthe nine months ended September 24, 2006. The decrease in cash used infinancing activities was primarily due to the dividend distribution of $10.0million to RM Restaurant Holding, our parent company, in September 2006,combined with an increase in net borrowings during 2007 of $2.2 million.

 

**Debt and OtherObligations**

 

*Senior Secured Notes due 2010*.Interest on our senior secured registered notes (“senior secured notes”)accrues at a contract rate of 10% per annum. (The interest rate was 10.25%through March 31, 2007 as, in fiscal year 2005, we exceeded the capitalexpenditure limit under the indenture governing the senior secured notes and asa result were required to pay a 0.25% increase in the stated rate. Exceedingthe capital expenditure limit did not constitute a default with respect to thesenior secured notes or indenture.) Interest is payable semiannually on April 1and October 1 of each year. Our senior secured notes are fully andunconditionally guaranteed on a senior secured basis by all of our present andfuture domestic subsidiaries which are restricted subsidiaries under theindenture governing our senior secured notes. Our senior secured notes andrelated guarantees are secured by substantially all of our and our domesticrestricted subsidiaries’ tangible and intangible assets, subject to the priorranking claims on such assets by the lenders under our New Senior SecuredRevolving Credit Facilities. The indenture governing our senior secured notescontains various affirmative and negative covenants, subject to a number of importantlimitations and exceptions, including but not limited those limiting ourability to incur additional indebtedness, make capital expenditures, paydividends, redeem stock or make other distributions, issue stock of oursubsidiaries, make certain investments or acquisitions, grant liens on assets,enter into transactions with affiliates, merge, consolidate or transfersubstantially all of our assets, and transfer and sell assets. The covenantthat limits our incurrence of indebtedness requires that, after giving effectto any such incurrence of indebtedness and the application of the proceedsthereof, our fixed charge coverage ratio as of the date of such incurrence willbe at least 2.50 to 1.00 in the case of any incurrence after September 30,2006. The indenture defines consolidated fixed charge coverage ratio as theratio of Consolidated Cash Flow (as defined therein) to Fixed Charges (asdefined therein). The Company was in compliance with all specified financialand other covenants under the senior secured notes indenture at September 30,2007.

 

Wecan redeem our senior secured notes at any time after April 1, 2007. Weare required to offer to redeem our senior secured notes under certaincircumstances involving a change of control. Additionally, if we or any of ourdomestic restricted subsidiaries engage in assets sales, we generally musteither invest the net cash proceeds from such sales in our business within 360days, prepay the indebtedness obligations under our New Senior SecuredRevolving Credit Facility or certain other secured indebtedness or make anoffer to purchase a portion of our senior secured notes.

 

On September 19, 2006, the Company commenced achange of control offer (the “Offer”) to purchase any or all of its notes thatremained outstanding under the indenture dated March 31, 2004 by and amongthe Company, the guarantors thereto and Wells Fargo Bank, National Association,as trustee. The Offer was made pursuant to Section 4.15 of the indentureas the Merger constituted a “change of control” under the indenture. Inaccordance with the terms of the indenture, the Company offered to repurchasethe notes at a purchase price in cash equal to 101% of the aggregate principalamount of the notes or portion of notes validly tendered for payment thereof,plus accrued and unpaid interest up to, but not including, the date of payment,upon the terms and subject to the conditions of the Offer. The Offer expired onOctober 19, 2006. No notes were tendered pursuant to the Offer and as ofthe expiration date of the Offer, $105.0 million aggregate principal amount ofnotes remained outstanding.

 

As a result of the Merger and under purchaseaccounting rules we recorded $4.2 million of unamortized debt premium asadditional debt related to our senior secured notes as the fair market value ofthe debt on the Merger date was greater than its carrying value. The premium isamortized to interest expense over the remaining life of the debt.

 

*Senior Secured Revolving Credit Facilities*. In 2004, the Company entered into anamended and restated revolving credit agreement providing for $30.0 million ofsenior secured credit facilities. The revolving credit agreement included a$15.0 million letter of credit facility and a $15.0 million revolving creditfacility that could be used for letters of credit.

 

OnOctober 5, 2006, the Company entered into a new amended and restatedrevolving credit facility, pursuant to which the existing $15.0 millionrevolving credit facility and $15.0 million letter of credit facility, wasincreased to a $15.0 million revolving credit facility (the “Old Senior SecuredRevolving Credit Facility”) and a $25.0 million letter of credit facility (the “OldSenior Secured Letter of Credit Facility”, together with the Old Senior SecuredRevolving Credit Facility, the “Old Senior Secured Revolving Credit Facilities”)maturing on October 5, 2008, pursuant to which the Lenders agreed to makeloans to the Company and its subsidiaries (all of the proceeds of which were tobe used for working capital purposes) and issue letters of credit on behalf ofthe Company and its subsidiaries.

 

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OnJanuary 29, 2007, the Company entered into a Second Amended and RestatedCredit Agreement pursuant to which the Old Senior Secured Revolving CreditFacilities were refinanced with a new agent and administrative agent, GeneralElectric Capital Corporation, and a new $15.0 million revolving credit facility(the “New Senior Secured Revolving Credit Facility”) and $25.0 million letterof credit facility (the “New Senior Secured Letter of Credit Facility”,together with the New Senior Secured Revolving Credit Facility, the “New SeniorSecured Revolving Credit Facilities”), maturing on January 29, 2009, wereput into place, pursuant to which the lenders agree to make loans and issueletters of credit to and on behalf of the Company and its subsidiaries.

 

Obligations under the New Senior Secured Revolving Credit Facilitiesare guaranteed by all of the Company’s subsidiaries as well as by RM RestaurantHolding, which wholly owns the Company and has made a first priority pledge ofall of its equity interests in the Company as security for the obligations. Intereston the New Senior Secured Revolving Credit Facility accrues pursuant to anApplicable Margin as set forth in the Second Amended and Restated CreditAgreement. The New Senior Secured Revolving Credit Facilities are secured by,among other things, first priority pledges of all of the equity interests ofthe Company’s direct and indirect subsidiaries, and first priority securityinterests (subject to customary exceptions) in substantially all of the currentand future property and assets of the Company and its direct and indirectsubsidiaries, with certain limited exceptions. In connection with the Company’sentrance into the New Senior Secured Revolving Credit Facilities on January 29,2007, the Company borrowed $7.4 million under the New Senior Secured RevolvingCredit Facility, the proceeds of which were used to pay the outstandingrevolving borrowings under the Old Senior Secured Revolving Credit Facility. Asof September 30, 2007, there was $9.9 million outstanding under the NewSenior Secured Revolving Credit Facility.

 

TheSecond Amended and Restated Credit Agreement contains various affirmative andnegative covenants and restrictions, which among other things, require us tomeet certain financial tests (including certain leverage and cash flow ratios),and limits our and our subsidiaries’ ability to incur or guarantee additionalindebtedness, make certain capital expenditures, pay dividends or make otherequity distributions, purchase or redeem capital stock, make certaininvestments, enter into arrangements that restrict dividends from subsidiaries,sell assets, engage in transactions with affiliates and effect a consolidationor merger. Under the terms of the Second Amended and Restated Credit Agreementwe are required to maintain a cash flow ratio determined on an annual basisequal to 1.70 to 1.00 until maturity, except for the fiscal quarters endedSeptember 30, 2007 and December 30, 2007, when compliance with theCash Flow Ratio is not to be tested. Pursuant to the terms of the SecondAmended and Restated Credit Agreement, the Cash Flow Ratio is defined as theratio of (a) Consolidated Cash Flow (as defined therein) to (b) ConsolidatedFinancial Obligations (as defined therein).

 

TheCompany was in compliance with all specified financial and other covenantsunder the New Senior Secured Revolving Credit Facilities at September 30,2007.

 

*Senior Unsecured Credit Facility*. In 2005 we entered into a $75.0 millionsenior unsecured credit facility (the “Old Senior Unsecured Credit Facility”)consisting of a single term loan maturing on December 31, 2008, all of theproceeds of which were used to finance a portion of the cash consideration ofan acquisition and pay related fees and expenses. On October 5, 2006, theCompany entered into an Amended and Restated Senior Unsecured Credit Facility,pursuant to which the Old Senior Unsecured Credit Facility was decreased to a$65.0 million senior unsecured credit facility (the “ New Senior UnsecuredCredit Facility”), consisting of a single term loan maturing on October 5,2010. All of the proceeds of the New Senior Unsecured Credit Facility were usedto repay in full any term loans outstanding under the Old Senior UnsecuredCredit Facility and not continued on the restatement date. The total amount ofterm loans repaid was $10.0 million. Obligations under the New Senior UnsecuredCredit Facility are guaranteed by all of the Company’s subsidiaries. Intereston the term loan outstanding under the New Senior Unsecured Credit Facilityaccrues, at the Company’s option, at either (i) the greater of the primerate or the rate which is 0.5% in excess of the federal funds rate, plus 4.0%or (ii) a reserve adjusted Eurodollar rate, plus 5.0%. As of September 30,2007, the interest rate on the New Senior Unsecured Credit Facility term loanwas 10.41%.

 

OurNew Senior Unsecured Credit Facility contains various affirmative and negativecovenants which, among other things, require us to meet certain financial tests(including certain leverage and interest coverage ratios) and limits our andour subsidiaries’ ability to incur or guarantee additional indebtedness, grantcertain liens, make certain restricted payments, make capital expenditures,engage in transactions with affiliates, make certain investments, sell ourassets, make acquisitions, effect a consolidation or merger and amend or modifyinstruments governing certain indebtedness (including relating to our seniorsecured notes and the New Senior Secured Revolving Credit Facilities). We arerequired to maintain certain minimum interest coverage ratios ranging from (i) 2.15to 1.00 for the fiscal quarters ending on or after March 31, 2007 through December 31,2007 and (ii) 2.30 to 1.00 thereafter until maturity. Pursuant to theterms of the New Senior Unsecured Credit Facility, the Interest Coverage Ratiois defined as the ratio as of the last day of any fiscal quarter of (a) ConsolidatedEBITDA (as defined therein) for the four-fiscal quarter period then ending to (b) ConsolidatedInterest Expense (as defined therein) for such four-fiscal quarter period. TheCompany was in compliance with all specified financial and other covenantsunder the New Senior Unsecured Credit Facility at September 30, 2007.

 

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*Mortgage.* In 2005, concurrent with an acquisition, we assumed a $0.8 millionmortgage secured by the building and improvements of one of the restaurantsacquired in the transaction. The mortgage carries a fixed annual interest rateof 9.28% and requires equal monthly payments of principal and interest through April 2015.As of September 30, 2007, the principal amount due on the mortgage was$0.7 million.

 

*Capital Leases*. The Company leases certain leasehold improvements under agreementsthat are classified as capital leases. The capital lease obligations have aweighted-average interest rate of 10.0%. As of September 30, 2007, theprincipal amount due relating to capital lease obligations was $0.8 million.Principal and interest payments on the capital lease obligations are duemonthly and range from $2,200 to $7,000 per month. The capital leaseobligations mature between 2009 and 2025.

 

**Inflation**

** **

Over the past fiveyears, inflation has not significantly affected our operations. However, theimpact of inflation on labor, food and occupancy costs could, in the future,significantly affect our operations. We pay many of our employees hourly ratesrelated to the federal or applicable state minimum wage, and increases in theminimum wage increase our expenses and reduce our net income. Our workers’compensation and health insurance costs have been and are subject to continuedinflationary pressures. Costs for construction, taxes, repairs, maintenance andinsurance all impact our occupancy costs. Many of our leases require us to paytaxes, maintenance, repairs, insurance and utilities, all of which may besubject to inflationary increases. We believe that our current practice ofmaintaining operating margins through a combination of periodic menu priceincreases, cost controls, careful evaluation of property and equipment needs,and efficient purchasing practices is our most effective tool for dealing withinflation.

 

**Item 3.**    Quantitative and Qualitative DisclosuresAbout Market Risk

** **

The inherent riskin market risk sensitive instruments and positions primarily relates topotential losses arising from adverse changes in foreign exchange rates andinterest rates.

 

We consider theU.S. dollar to be the functional currency for all of our entities. All of ournet sales and our expenses in fiscal years 2007 and 2006 were denominated inU.S. dollars. Therefore, foreign currency fluctuations did not materiallyaffect our financial results in those periods.

 

We are alsosubject to market risk from exposure to changes in interest rates based on ourfinancing activities. This exposure relates to borrowings under our seniorsecured and unsecured credit facilities that are payable at floating rates ofinterest. As of September 30, 2007, we had $65.0 million outstanding underour Senior Unsecured Credit Facility and $9.9 million outstanding under our NewSenior Secured Revolving Credit Facility. A hypothetical 10% fluctuation ininterest rates, as of September 30, 2007, would result in an after taxreduction of $0.4 million in earnings on an annualized basis.

 

Many of the foodproducts purchased by us are affected by changes in weather, production,availability, seasonality and other factors outside our control. In an effortto control some of this risk, we have entered into certain fixed price purchaseagreements with varying terms of generally no more than year duration. Inaddition, we believe that almost all of our food and supplies are availablefrom several sources, which helps to control food commodity risks.

 

**Item 4.****   ****Controls and Procedures**

 

As of the end ofthe period covered by this report, we conducted an evaluation, under thesupervision and with the participation of the principal executive officer (“CEO”)and principal financial officer (“CFO”), of the effectiveness of the design andoperation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)).Based on this evaluation, the CEO and CFO concluded that, as of the end of therecord period covered by this report, our disclosure controls and proceduresare effective to provide reasonable assurance that information required to bedisclosed by us in reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin Securities and Exchange Commission rules and forms. There was no changein our internal control over financial reporting during our most recentlycompleted fiscal quarter that has materially affected, or is reasonably likelyto materially affect, our internal control over financial reporting.

 

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**PART IIOTHER INFORMATION**

 

**Item 1. LegalProceedings**

** **

We areperiodically a defendant in cases involving personal injury, labor andemployment and other matters incidental to our business. While any pending orthreatened litigation has an element of uncertainty, we believe that theoutcome of these lawsuits or claims, individually or combined, will notmaterially adversely affect our consolidated financial position, results ofoperations or cash flows.

 

**Item 1A. Risk Factors**

 

No materialchanges from the risk factors disclosed in Item 1A of our report on Form 10-Kfor the fiscal year ended December 31, 2006.

 

**Item 2. UnregisteredSales of Equity Securities and Use of Proceeds**

** **

Not applicable.

 

**Item 3. Defaults UponSenior Securities**

 

Not applicable.

 

**Item 4. Submission ofMatters to a Vote of Security Holders**

** **

Not applicable.

 

**Item 5. OtherInformation**

** **

Not applicable.

 

**Item 6.**    Exhibits

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                     |
|----------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                                |
| 31.1                 |       | Certification pursuant  to Rule 13a-14(a) or Rule 15d-14(a) of the Securities  Exchange Act of 1934 of the Chief Executive Officer.             |
|                 |       |                                                                                                                                                                |
| 31.2                 |       | Certification pursuant  to Rule 13a-14(a) or Rule 15d-14(a) of the Securities  Exchange Act of 1934 of the Chief Financial Officer.             |
|                 |       |                                                                                                                                                                |
| 32.1                 |       | Certification pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002, of the Chief Executive Officer. |
|                 |       |                                                                                                                                                                |
| 32.2                 |       | Certification pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002, of the Chief Financial Officer. |

 

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**SIGNATURE**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                          |   | REAL MEX  RESTAURANTS, INC.                                             |   |
|--------------------------|--------|------------------------------------------------------------------------------|--------|
|                     |   |                                                                         |   |   |
|                     |   |                                                                         |   |   |
| Dated: November 14, | By:    | /s/ Frederick F. Wolfe                                                       |
| 2007                     |   |                                                                         |   |
|                     |   | Frederick F. Wolfe                                                           |   |
|                     |   | President &  Chief Executive Officer  (principal executive officer) |   |
|                     |   |                                                                         |   |   |
| Dated: November 14, | By:    | /s/ Steven Tanner                                                            |
| 2007                     |   |                                                                         |   |
|                     |   | Steven Tanner                                                                |   |
|                     |   | Chief Financial Officer  (principal financial officer)                       |   |

 

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