****UNITED STATES****************SECURITIES AND EXCHANGE COMMISSION****

****Washington, D.C. 20549****

 

****FORM 10-Q****

**** ****

| **ý** | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                           |
|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                             |
| ** ** | ** ** | **For the quarterly period ended  September 25, 2005**                                                                                                                                                                                                                                                                                 |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                             |
| **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.****

(Exactname of Registrant as specified in its charter)

 

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

 

**5660Katella Avenue, Suite 100**

**Cypress,CA 90630**

(Address ofprincipal executive offices)

 

Registrant’stelephone number, including area code:**(562)-346-1200**

 

Indicate by check mark whetherthe registrant:  (1) has filed allreports required to be filed by Section 13 or 15(d) of the Securities ExchangeAct of 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports) and (2) has been subject to suchfiling requirements for the past 90 days. Yes ý No o

 

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

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). o Yes  ýNo

 

As of November 5, 2005, theregistrant had outstanding 300,423 shares of Class A Common Stock, par value$0.001 per share, and 15,867 shares of Class B Common Stock, par value $0.001per 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                                 |   |
| PART II OTHER INFORMATION    |                                                                                        |
|                         |                                                                                        |   |
| Item 1.                      | Legal Proceedings                                                                           |   |
| 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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**PARTIFINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

 

**Real Mex Restaurants, Inc. andSubsidiaries**

**ConsolidatedBalance Sheets**

**(in thousands, except for sharedata)**

 
| ** **                                                                                                                                                                                                                                                                         | ** ** | **September 25,** | ** ** | **December 26,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                                                                                                                                                                                                                         | ** ** | **2005**          | ** ** | **2004**         | ** ** |
| ** **                                                                                                                                                                                                                                                                         | ** ** | **(unaudited)**   | ** ** | ** **       | ** ** |
| **Assets**                                                                                                                                                                                                                                                                         |       |              |       |             |       |
| Current assets:                                                                                                                                                                                                                                                                    |       |              |       |             |       |
| Cash and cash  equivalents                                                                                                                                                                                                                                                         |       | $                 | 20,195     |             | $          | 10,690 |   |
| Trade  receivables, net                                                                                                                                                                                                                                                            |       | 8,222             |       | 4,312            |       |
| Other  receivables                                                                                                                                                                                                                                                                 |       | 1,151             |       | 157              |       |
| Inventories                                                                                                                                                                                                                                                                        |       | 11,946            |       | 6,616            |       |
| Deferred tax  asset                                                                                                                                                                                                                                                                |       | 1,371             |       | 1,371            |       |
| Prepaid expenses  and supplies                                                                                                                                                                                                                                                     |       | 5,769             |       | 3,754            |       |
| Total current assets                                                                                                                                                                                                                                                               |       | 48,654            |       | 26,900           |       |
|                                                                                                                                                                                                                                                                               |       |              |       |             |       |
| Property and equipment, net                                                                                                                                                                                                                                                        |       | 80,794            |       | 35,848           |       |
| Goodwill, net                                                                                                                                                                                                                                                                      |       | 155,315           |       | 105,387          |       |
| Deferred charges                                                                                                                                                                                                                                                                   |       | 6,815             |       | 5,003            |       |
| Deferred tax asset                                                                                                                                                                                                                                                                 |       | 7,769             |       | 7,769            |       |
| Other assets                                                                                                                                                                                                                                                                       |       | 6,965             |       | 6,044            |       |
| Total assets                                                                                                                                                                                                                                                                       |       | $                 | 306,312    |             | $          | 186,951 |   |
|                                                                                                                                                                                                                                                                               |       |              |       |             |       |
| **Liabilities and stockholders’ equity**                                                                                                                                                                                                                                      |       |              |       |             |       |
| Current liabilities:                                                                                                                                                                                                                                                               |       |              |       |             |       |
| Accounts payable  and accrued liabilities                                                                                                                                                                                                                                          |       | $                 | 65,717     |             | $          | 42,505 |   |
| Current portion  of long-term debt                                                                                                                                                                                                                                                 |       | 116               |       | 63               |       |
| Current portion  of capital lease obligations                                                                                                                                                                                                                                      |       | 206               |       | 242              |       |
| Total current liabilities                                                                                                                                                                                                                                                          |       | 66,039            |       | 42,810           |       |
|                                                                                                                                                                                                                                                                               |       |              |       |             |       |
| Long-term debt, less current portion                                                                                                                                                                                                                                               |       | 180,730           |       | 105,000          |       |
| Capital lease obligations, less current portion                                                                                                                                                                                                                                    |       | 1,041             |       | 1,198            |       |
| Other liabilities                                                                                                                                                                                                                                                                  |       | 11,549            |       | 8,094            |       |
| Total liabilities                                                                                                                                                                                                                                                                  |       | 259,359           |       | 157,102          |       |
|                                                                                                                                                                                                                                                                               |       |              |       |             |       |
| Commitments and contingencies                                                                                                                                                                                                                                                      |       |              |       |             |       |
|                                                                                                                                                                                                                                                                               |       |              |       |             |       |
| Stockholders’ equity:                                                                                                                                                                                                                                                         |       |              |       |             |       |
| Redeemable  Preferred Stock:                                                                                                                                                                                                                                                       |       |              |       |             |       |
| Series A, 12 1/2%  Cumulative Compounding Preferred Stock—18,240 and 15,881 shares issued and  outstanding at September 25, 2005 and December 26, 2004 respectively;  liquidation preference of $34,598 and $29,644 at September 25, 2005 and  December 26, 2004 respectively |       | 34,598            |       | 29,644           |       |
| Series B, 13.5%  Cumulative Compounding Preferred Stock—12,323 and 10,722 shares issued and  outstanding at September 25, 2005 and December 26, 2004 respectively;  liquidation preference of $24,565 and $20,970 at September 25, 2005 and  December 26, 2004 respectively;  |       | 24,565            |       | 20,970           |       |
| Series C, 15%  Cumulative Compounding Preferred Stock—17,478 and 14,975 shares issued and  outstanding at September 25, 2005 and December 26, 2004 respectively;  liquidation preference of $56,029 and $46,544 at September 25, 2005 and  December 26, 2004 respectively;    |       | 56,029            |       | 46,544           |       |
| Common Stock,  $.001 par value, 2,000,000 shares authorized, 316,290 and 274,523 shares  issued and outstanding at September 25, 2005 and December 26, 2004  respectively;                                                                                                         |       | —            |       | 1                |       |
| Warrants                                                                                                                                                                                                                                                                           |       | 4,027             |       | 4,027            |       |
| Additional  paid-in capital                                                                                                                                                                                                                                                        |       | 16,203            |       | 16,202           |       |
| Accumulated  deficit                                                                                                                                                                                                                                                               |       | (88,469           | )          | (87,539          | )          |
| Total stockholders’ equity                                                                                                                                                                                                                                                    |       | 46,953            |       | 29,849           |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                                                    |       | $                 | 306,312    |             | $          | 186,951 |   |

 

See accompanying notes.

 

3

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**Real Mex Restaurants, Inc. andSubsidiaries**

**ConsolidatedStatements of Operations (unaudited)**

**(in thousands)**

 
| ** **                                    | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                    | ** ** | **September 25,**      | ** ** | **September 26,**     | ** ** | **September 25,** | ** ** | **September 26,** | ** ** |
| ** **                                    | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues:                                     |       |                   |       |                  |       |   |   |   |   |
| Restaurant  revenues                          |       | $                      | 131,275    |                  | $          | 78,845 |   | $ | 389,229 |   | $ | 241,845 |   |
| Other revenues                                |       | 5,204                  |       | 3,049                 |       | 14,218 |   | 7,194 |   |
| Royalty and  franchise fees                   |       | 1,110                  |       | 39                    |       | 2,791 |   | 129 |   |
| Total revenues                                |       | 137,589                |       | 81,933                |       | 406,238 |   | 249,168 |   |
| Costs and expenses:                           |       |                   |       |                  |       |   |   |   |   |
| Cost of sales                                 |       | 35,367                 |       | 20,203                |       | 103,584 |   | 61,324 |   |
| Labor                                         |       | 47,103                 |       | 29,663                |       | 141,691 |   | 90,326 |   |
| Direct operating  and occupancy expense       |       | 34,721                 |       | 19,799                |       | 98,297 |   | 58,142 |   |
| General and  administrative expense           |       | 6,919                  |       | 4,066                 |       | 20,954 |   | 12,986 |   |
| Depreciation                                  |       | 4,237                  |       | 2,746                 |       | 14,207 |   | 8,755 |   |
| Pre-opening costs                             |       | 67                     |       | —                |       | 397 |   | 125 |   |
| Loss on  impairment of property and equipment |       | —                 |       | 128                   |       | 216 |   | 136 |   |
|                                          |       |                   |       |                  |       |   |   |   |   |
| Operating income                              |       | 9,175                  |       | 5,368                 |       | 26,892 |   | 17,374 |   |
|                                          |       |                   |       |                  |       |   |   |   |   |
| Other (expense) income:                       |       |                   |       |                  |       |   |   |   |   |
| Casualty gain                                 |       | —                 |       | 450                   |       | (14 | ) | 998 |   |
| Interest expense                              |       | (5,768                 | )          | (3,140                | )          | (17,069 | ) | (9,512 | ) |
| Debt termination  costs                       |       | —                 |       | —                |       | — |   | (4,677 | ) |
| Other income  (expense), net                  |       | (110                   | )          | 231                   |       | (23 | ) | 225 |   |
|                                          |       |                   |       |                  |       |   |   |   |   |
| Total other  expense, net                     |       | (5,878                 | )          | (2,459                | )          | (17,106 | ) | (12.966 | ) |
|                                          |       |                   |       |                  |       |   |   |   |   |
| Income before income tax provision            |       | 3,297                  |       | 2,909                 |       | 9,786 |   | 4,408 |   |
|                                          |       |                   |       |                  |       |   |   |   |   |
| Income tax provision                          |       | 29                     |       | 3                     |       | 31 |   | 70 |   |
|                                          |       |                   |       |                  |       |   |   |   |   |
| Net income                                    |       | 3,268                  |       | 2,906                 |       | 9,755 |   | 4,338 |   |
|                                          |       |                   |       |                  |       |   |   |   |   |
| Redeemable preferred stock accretion          |       | (3,860                 | )          | (3,154                | )          | (10,685 | ) | (8,687 | ) |
|                                          |       |                   |       |                  |       |   |   |   |   |
| Net loss attributable to common stockholders  |       | $                      | (592       | )                     | $          | (248 | ) | $ | (930 | ) | $ | (4,349 | ) |

 

See accompanying notes.

 

4

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**Real MexRestaurants, Inc.Consolidated Statementsof Cash Flows (unaudited)(in thousands)**
| ** **                                                                         | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                         | ** ** | **September 25,**     | ** ** | **September 26,** | ** ** |
| ** **                                                                         | ** ** | **2005**              | ** ** | **2004** | ** ** |
| **Operating activities**                                                           |       |                  |       |   |   |
| Net income                                                                         |       | $                     | 9,755      |   | $ | 4,338 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                  |       |   |   |
| Depreciation                                                                       |       | 14,207                |       | 8,755 |   |
| Amortization of:                                                                   |       |                  |       |   |   |
| Deferred  financing                                                                |       | 1,255                 |       | 674 |   |
| Debt discount                                                                      |       | —                |       | 114 |   |
| Loss (gain) on  disposal of property and equipment                                 |       | 166                   |       | (346 | ) |
| Debt termination  costs                                                            |       | —                |       | 4,247 |   |
| Casualty gain                                                                      |       | —                |       | (998 | ) |
| Impairment of  property and equipment                                              |       | 216                   |       | 136 |   |
| Changes in  operating assets and liabilities:                                      |       |                  |       |   |   |
| Trade and other  receivables                                                       |       | (2,261                | )          | 297 |   |
| Inventories                                                                        |       | (3,948                | )          | (1,599 | ) |
| Prepaid expenses  and supplies                                                     |       | (586                  | )          | (217 | ) |
| Deferred  charges, net                                                             |       | (17                   | )          | (59 | ) |
| Other assets                                                                       |       | 600                   |       | (1,428 | ) |
| Accounts payable  and accrued liabilities                                          |       | 5,039                 |       | 6,208 |   |
| Other  liabilities                                                                 |       | 1,189                 |       | (261 | ) |
| Net cash provided by operating activities                                          |       | 25,615                |       | 19,861 |   |
|                                                                               |       |                  |       |   |   |
| **Investing activities**                                                           |       |                  |       |   |   |
| Additions to property and equipment                                                |       | (12,518               | )          | (5,439 | ) |
| Chevys Acquisition, net of cash acquired of $3,913                                 |       | (76,011               | )          | — |   |
| Net proceeds from disposal of property                                             |       | 692                   |       | 13,173 |   |
| Net cash (used in) provided by investing activities                                |       | (87,837               | )          | 7,734 |   |
|                                                                               |       |                  |       |   |   |
| **Financing activities**                                                           |       |                  |       |   |   |
| Borrowings under long-term debt agreements                                         |       | 75,000                |       | 105,000 |   |
| Payments on long-term debt agreements and capital  lease obligations               |       | (226                  | )          | (115,985 | ) |
| Payment of financing costs                                                         |       | (3,047                | )          | (5,706 | ) |
| Purchase of common stock                                                           |       | —                |       | (53 | ) |
| Redemption of Series A Redeemable Preferred Stock                                  |       | —                |       | (35 | ) |
| Redemption of Series B Redeemable Preferred Stock                                  |       | —                |       | (24 | ) |
| Payments received on stockholder loans for stock  subscription notes               |       | —                |       | 462 |   |
| Interest receivable decrease on stockholder loans                                  |       | —                |       | 22 |   |
| Net cash provided by (used in) financing activities                                |       | 71,727                |       | (16,319 | ) |
| Net increase in cash and cash equivalents                                          |       | 9,505                 |       | 11,276 |   |
|                                                                               |       |                  |       |   |   |
| Cash and cash equivalents at beginning of period                                   |       | 10,690                |       | 2,605 |   |
| Cash and cash equivalents at end of period                                         |       | $                     | 20,195     |   | $ | 13,881 |   |
|                                                                               |       |                  |       |   |   |
| **Supplemental disclosure of cash flow information**                               |       |                  |       |   |   |
| Interest paid                                                                      |       | $                     | 12,828     |   | $ | 3,838 |   |
| Income taxes paid                                                                  |       | $                     | 322        |   | $ | 70 |   |
|                                                                               |       |                  |       |   |   |
| **Supplemental disclosure of noncash investing and  financing activities**         |       |                  |       |   |   |
| Preferred and common stock issued as consideration  for the Chevys Acquisition     |       | $                     | 7,349      |   | $ | — |   |
| Deferral of gain on sale-leaseback recorded in other  liabilities                  |       | $                     | —     |   | $ | 3,927 |   |
| In kind accrued interest transferred to debt                                       |       | $                     | —     |   | $ | 407 |   |

 

See accompanying notes.

 

5

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**Real Mex Restaurants, Inc. andSubsidiaries**

**Notes to Consolidated FinancialStatements (unaudited)**

**September 25, 2005**

**(in thousands, except for sharedata)**

 

**1.****             Basisof Presentation**

 

Real MexRestaurants, Inc., a Delaware corporation (together with its subsidiaries, the “Company”),was formed on May 15, 1998.

 

The Company,primarily through its major subsidiaries El Torito Restaurants, Inc. (ElTorito), Chevys Restaurants, LLC (Chevys) and Acapulco Restaurants, Inc. (Acapulco),currently operates 196 restaurants, of which 161 are located in California andthe remainder are located in 12 other states, primarily under the trade namesEl Torito Restaurant, Chevys Fresh Mex and Acapulco Mexican Restaurant YCantina. The Company’s other major subsidiary, Real Mex Foods, Inc. (Real Mex)provides internal production, purchasing and distribution services for therestaurant operations. On a limited basis, Real Mex also manufactures specialtyproducts for sale to outside customers.

 

The accompanyingconsolidated financial statements have been prepared by the Company inaccordance with accounting principles generally accepted in the United Statesand with the instructions to Form 10-Q and Article 10 of Regulation S-X. In theopinion of management, the accompanying unaudited interim financial statementsinclude all adjustments (consisting of normal recurring adjustments), which arenecessary for a fair statement of the Company’s consolidated financialcondition, results of operations and cash flows for the periods presented.However, these results are not necessarily indicative of results for any otherinterim periods or for the full fiscal year. The consolidated balance sheetdata presented herein for December 26, 2004 was derived from the Company’saudited consolidated financial statements for the fiscal year then ended, butdoes not include all disclosures required by accounting principles generallyaccepted in the United States. The preparation of financial statements inaccordance with accounting principles generally accepted in the United Statesrequires the Company to make certain estimates and assumptions for thereporting periods covered by the financial statements. These estimates andassumptions affect the reported amounts of assets, liabilities, revenues andexpenses. Actual amounts could differ from these estimates.

 

Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with accounting principles generally accepted in theUnited States have been omitted pursuant to the requirements of the Securitiesand Exchange Commission. The Company believes the disclosures included in theaccompanying interim consolidated financial statements and footnotes areadequate to make the information not misleading, but should be read inconjunction with the consolidated financial statements and notes theretoincluded in our filings with the Securities and Exchange Commission.

 

**2.****             ChevysAcquisition**

 

On January 11,2005, the Company completed the acquisition (the “Chevys Acquisition”) ofsubstantially all of the assets of Chevys, Inc. and certain of its subsidiaries(the “Sellers”) out of the Sellers’ Chapter 11 bankruptcy proceeding, including69 Chevys Fresh Mex® restaurants and five Fuzio Universal Pasta®restaurants.  In addition, the Companyassumed franchise agreements for 37 franchised Chevys Fresh Mex restaurants andfive franchised Fuzio Universal Pasta restaurants. Chevys’ results ofoperations have been included in the Company’s consolidated financialstatements since the date of acquisition.

 

The aggregatepurchase price for the Chevys Acquisition of $90,113 consisted of approximately$77,900 in cash, the issuance of common stock, stock options and preferredstock to certain affiliates of the Sellers valued at $7,349, transaction andother costs of  $4,048 and the assumptionof an $816 mortgage loan. Additionally, the Company assumed certainliabilities, including ordinary course post-petition current and long-termliabilities of the Sellers, and delivered approximately $6,300 of letters ofcredit as security for an insurance plan and certain leases.

 

The cash portionof the purchase price and related transaction expenses were financed with$75,000 of borrowings under a Senior Unsecured Credit Facility, acquired cashand cash on hand.  The common stock,stock options and preferred stock issued to the affiliates of the Sellersincluded an aggregate of 41,360 shares of our Class A Common Stock, 2,064shares of our Series A 12.5% Cumulative Compounding Preferred Stock (Series A),1,393 shares of our Series B 13.5% Cumulative Compounding Preferred Stock(Series B), 1,946 shares of our Series C 15% Cumulative CompoundingParticipating Preferred Stock (Series C) and options to purchase 3,485 sharesof our Class A Common Stock. The value of the common stock was determined to beits par value, which was $0.001 per share. The value of the preferred stock wasits liquidation preference value upon issuance of $1, $1, and $2 per share forthe Series A, Series B and Series C, respectively.

 

6

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The followingtable presents the preliminary allocation of the acquisition costs, includingprofessional fees and other related transaction costs, to the assets acquiredand liabilities assumed, based on their estimated fair values:

 

| Cash and cash  equivalents               |   | $       | 3,913  |   |
|------------------------------------------|--------|---------|--------|--------|
| Trade accounts receivable                |   | 2,644   |   |
| Inventories                              |   | 1,382   |   |
| Other current assets                     |   | 1,429   |   |
| Property and equipment                   |   | 47,839  |   |
| Other assets                             |   | 3,564   |   |
| Goodwill                                 |   | 49,928  |   |
| Total assets  acquired                   |   | 110,699 |   |
|                                     |   |    |   |
| Accounts payable and accrued liabilities |   | 18,296  |   |
| Other liabilities                        |   | 2,290   |   |
| Total  liabilities assumed               |   | 20,586  |   |
| Net assets  acquired                     |   | $       | 90,113 |   |

 

The primary reason for the Chevys Acquisitionwas to add a complementary growth vehicle in the full-service Mexican segmentof the restaurant industry. The Company attributes the goodwill associated withthe Chevys Acquisition to the historical financial performance and theanticipated future performance of Chevys. The Company is currently obtainingcertain valuations of the tax benefits that may be acquired in the ChevysAcquisition and is determining the final values of certain liabilitiesacquired; accordingly, the purchase price allocation required by SFAS No. 141has not yet been finalized. The allocation of the purchase price is based onpreliminary data and could change when the final valuations are completed.

 

The following unaudited pro forma consolidated resultsof operations have been prepared as if the Chevys Acquisition had occurred onDecember 29, 2003 (the first day of fiscal year 2004):

 
| ** **                                              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                              | ** ** | **September 25,**      | ** ** | **September 26,**     | ** ** | **September 25,** | ** ** | **September 26,** | ** ** |
| ** **                                              | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Total revenues                                          |       | $                      | 137,589    |                  | $          | 133,637 |   | $ | 414,260 |   | $ | 404,280 |   |
| Net income before redeemable preferred stock  accretion |       | 3,268                  |       | 1490                  |       | 9,461 |   | 90 |   |
|                                                         |            |                        |            |                       |            |  |  |  |  |  |  |  |  |

 

The pro forma informationis presented for informational purposes only and is not necessarily indicativeof the results of operations that actually would have been achieved had theChevys Acquisition been consummated as of that time, nor is it intended to be aprojection of future results.

 

**3.****             Long-TermDebt**

 

Long-term debtconsists of the following:

 
| ** **                       | ** ** | **September 25,  2005** | ** ** | **December 26,  2004** | ** ** |
|----------------------------------|------------|-------------------------|------------|------------------------|------------|
| Senior secured notes due 2010    |       | $                       | 105,000    |                   | $          | 105,000 |   |
| Senior Unsecured Credit Facility |       | 75,000                  |       | —                 |       |
| Mortgage                         |       | 783                     |       | —                 |       |
| Other                            |       | 63                      |       | 63                     |       |
|                             |       | 180,846                 |       | 105,063                |       |
|                             |       |                    |       |                   |       |
| Less current portion             |       | (116                    | )          | (63                    | )          |
|                             |       |                    |       |                   |       |
|                             |       | $                       | 180,730    |                   | $          | 105,000 |   |

 

7

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On March 31, 2004,the Company retired the then existing Revolving Credit and Term Loan Agreementand entered into a new Amended and Restated Revolving Credit Agreement (the “Line”)providing for $30,000 of Senior Secured Credit Facilities with a lead bankacting as Lead Arranger and Administrative Agent. The Line includes a $15,000letter of credit facility and a $15,000 revolving credit facility, which canalso be used for letters of credit. No revolving credit loans were outstandingunder the Line as of September 25, 2005. Letters of credit issued under theLine were $20.6 million as of September 25, 2005. As Of September 25, 2005,availability under the Line was $9.4 million

 

On March 31, 2004,the Company sold $105,000 aggregate principal amount of 10% Senior SecuredNotes due 2010 (the “Notes”). Interest on the Notes is payable semiannually onApril 1 and October 1 each year. The proceeds of the Notes were used to repayin full the term loans then outstanding under our prior credit facility, oursubordinated notes and to pay the fees associated with the sale of the Notesand the Line. Concurrent with the retirement of the subordinated notes and theterm loans, the company wrote-off the unamortized cost of the associateddeferred debt fees in the amount of $4,677, recorded in Debt Termination Costsin the income statement. The Company completed the exchange offer for 100% ofthe Notes on June 7, 2005.

 

On January 11,2005, the Company entered into a $75,000 senior unsecured credit facility (the “SeniorUnsecured Credit Facility”), consisting of a single term loan maturing onDecember 31, 2008, all of the proceeds of which were used to finance a portionof the cash consideration for the Chevys Acquisition and pay related fees andexpenses.  Obligations under the SeniorUnsecured Credit Facility are guaranteed by the Company’s subsidiaries.  Interest on the term loan outstanding underthe Senior Unsecured Credit Facility accrues, at the Company’s option, at either(i) the greater of prime or the rate which is 0.5% in excess of the federalfunds rate, plus 8.5% or (ii) a reserve adjusted Eurodollar rate, plus9.5%.  As of November 5, 2005, theinterest rate on the term loan was 13.37%.

 

On January 11,2005, the Company assumed a $0.8 million mortgage (the “Mortgage”), secured bythe building and improvements of one of the restaurants acquired in the ChevysAcquisition. The Mortgage carries a fixed annual interest rate of 9.28% andrequires equal monthly payments of principal and interest through April 1,2015.

 

The terms of theAmended and Restated Credit Agreement, the Notes and the Senior UnsecuredCredit Facility include specified financial and other covenants, all of whichthe Company was in compliance with at September 25, 2005.

 

**4.****             Capitalization**

 

**Common Stock**

 

The Company isauthorized to issue 1,000,000 shares of par value $0.001 Class A Common Stockand 1,000,000 shares of par value $0.001 Class B Common Stock. The terms of theClass B Common Stock are identical to the Class A Common Stock except that theholders of Class B Common Stock have no voting rights, except as provided bylaw. Each holder of Class B Common Stock has the right to convert any or allshares of Class B Common Stock into an equal number of shares of Class A CommonStock at any time. There were 300,423 and 258,656 shares issued and outstandingof Class A Common Stock at September 25, 2005 and December 26, 2004,respectively. There were 15,867 shares issued and outstanding of Class B CommonStock at September 25, 2005 and December 26, 2004.

 

**Redeemable Preferred Stock**

 

The Company isauthorized to issue 100,000 shares of nonvoting $0.001 par value redeemablepreferred stock. Shares are issued upon approval of the board of directors.

 

Series A 12.5%Cumulative Compounding Redeemable Preferred Stock (Series A) and Series B 13.5%Cumulative Compounding Redeemable Preferred Stock (Series B) have a liquidationpreference of $1 per share, plus accreted dividends associated with each share.With respect to dividend rights and rights of liquidation, Series A rankssenior to all classes of common stock and Series B, and Series B ranks seniorto all classes of common stock.

 

8

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Series C 15%Cumulative Compounding Participating Preferred stock (Series C) ranks seniorwith respect to payment of dividends, liquidation, and redemption to the SeriesA and Series B preferred stock and common stock of the Company. The Series Chas a liquidation preference equal to two times the original issue price of $1per share, plus accreted dividends.

 

Dividends on theSeries A and Series B preferred stock accrete at the stated rates on theliquidation preference value thereof, and the dividends on Series C accrete atthe stated rate on the liquidation preference value thereof; dividends(representing the accreted liquidation preference) are to be paid from legallyavailable funds, when and if declared by the board of directors. Dividends willaccrue and will be payable only when and if declared, or upon a sale orliquidation of the Company or upon redemption of the applicable series ofpreferred stock. Accretion of the liquidation preference on the redeemablepreferred stock is reflected as an increase in the preferred stock values andan increase in the accumulated deficit.

 

Net lossattributable to common stockholders includes the effect of the accretion of theliquidation preference on the redeemable preferred stock, which reduces netincome and increases net loss attributable to common stockholders for therelevant periods.

 

**Stock Option Plans**

 

The Company’s 1998and 2000 Stock Option Plans (the Plans) authorize the grant of options tocertain employees, directors and independent contractors for up to 12,000 and100,000 shares, respectively, of the Company’s Common Stock. All optionsgranted under both Plans have 10-year terms.

 

The Company haselected to follow APB Opinion No. 25, “Accounting for Stock Issued toEmployees,” and related interpretations in accounting for its employee stockoptions because, as discussed below, the alternative fair value accountingprovided for under SFAS No. 123, “Accounting for Stock Based Compensation,”requires use of option valuation models that were not developed for use invaluing employee stock options. Under APB Opinion No. 25, if the exercise priceof the Company’s employee stock options equals the market price of theunderlying stock on the date of the grant, no compensation expense isrecognized. The Company follows the required disclosures of SFAS No. 148, “Accountingfor Stock Based Compensation—Transition and Disclosure,” which amends SFAS No.123, “Accounting for Stock Based Compensation”, which requires more prominentand more frequent disclosures in financial statements of the effects of stockbased compensation.

 

For options grantsin 2004, the Plan provides for 20% of the option grants to become exercisableeach year on the anniversary date of the grants.

 

A summary of the status of the Company’s two stockoption plans as of September 25, 2005, and December 26, 2004, and changesduring the periods ending on these dates, is presented below:

 
| ** **                          | ** ** | **1998 Plan**                 | ** ** | **2000 Plan**                           | ** ** |
|-------------------------------------|------------|-------------------------------|------------|-----------------------------------------|------------|
| ** **                          | ** ** | **Number of  Stock  Options** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Number of  Stock   Options** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
| Outstanding—December 26, 2004  |       | 5,250                         |       | $                                       | 10.00      |   | 81,333 |   | $ | 33.19 |   |
|                                |       |                          |       |                                    |       |   |   |   |   |
| Granted                             |       | 682                           |       | $                                       | 10.00      |   | 4,839 |   | $ | 30.52 |   |
| Exercised                           |       | —                        |       | —                                  |       | (407 | ) | $ | 0.01 |   |
| Canceled                            |       | —                        |       | —                                  |       | (12,481 | ) | $ | 92.00 |   |
| Outstanding—September 25, 2005 |       | 5,932                         |       | $                                       | 10.00      |   | 73,284 |   | $ | 23.18 |   |
|                                |       |                          |       |                                    |       |   |   |   |   |
| Exercisable at September 25, 2005   |       | 5,932                         |       | $                                       | 10.00      |   | 34,810 |   | $ | 43.48 |   |

 

The fair value ofeach option grant was estimated on the date of grant using the Black-Scholesoption pricing model with the following assumptions for 2004 and 2005 optionsrespectively: risk-free interest rates of 3.96% and 3.87%; and expected livesof six years and volatility of 35% for both years. The weighed-averageremaining contractual life of the employee stock options granted under the 1998Stock-Based Incentive Compensation Plan is approximately 3.5 years and theweighted-average fair value of the employee stock options granted under the1998 Stock-Based Incentive Compensation Plan is $4.37 per share. Theweighted-average remaining contractual life of the employee stock optionsgranted under the 2000 Stock-Based Incentive Compensation Plan is approximately7.5 years and the weighted-average fair value of the employee stock optionsgranted under the 2000 Stock-Based Incentive Compensation Plan is $8.91 pershare.

 

 

9

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For options whichare based on performance criteria and where the criteria have not been met,their expense is determined using variable accounting and applying theCompany’s per share common stock value as of September 26, 2005 which is$32.60, reduced by expense previously recognized against those options. TheBlack-Scholes value of those options as of September 26, 2005 is $3.21 peroption as to the March 15, 2001 grant.

 

At September 25, 2005, the Company has granted stockoptions under the 1998 Stock-Based Incentive Compensation Plan and the 2000Stock-Based Incentive Compensation Plan. The Company accounts for those plansunder the recognition and measurement principles of APB Opinion No. 25, *Accounting for Stock Issued to Employees,*and relatedinterpretations. No stock-based employee compensation cost is reflected in netincome, as all options granted under those plans had an exercise price equal tothe market value of the underlying common stock on the date of grant, or in thecase of performance based options have an exercise price above the market valueof the underlying common stock on September 25, 2005. For purposes of pro formadisclosures, the estimated fair value of the options is amortized to expenseover the options’ vesting period. Under SFAS No. 148, the Company wouldhave incurred an $8 reduction in compensation expense for the 3 months endedSeptember 25, 2005 and $504 additional compensation expense for the nine monthsended September 25, 2005.

 

**5.****             RelatedParty Transactions**

 

The Company has amanagement agreement with two of its stockholders Bruckman, Rosser, Sherrill& Co., L.P. and FS Private Investments, LLC. The stockholders are paidannual fees equating to .667% and .333%, respectively, of consolidated earningsbefore interest, income taxes, depreciation and amortization of the Company.Expenses relating to the agreement of $133 and $120 were recorded as generaland administrative expense in the three months ended September 25, 2005 andSeptember 26, 2004, respectively,  and$415 and $258 for the nine months ended September 25, 2005 and September 26,2004, respectively.

 

On January 19,2005, the Company paid $833,333 and $166,667 to Bruckman, Rosser, Sherrill &Co., L.P. and FS Private Investments, LLC, respectively, for advisory andtransactional services provided to the Company in connection with the ChevysAcquisition.

 

Effective March31, 2004, the Company cancelled its management agreement with Restaurant AssociatesCorp. to provide services for the benefit of the Company, including general andstrategic management, treasury, tax, financial reporting, benefitsadministration, insurance, information technology, real estate and legalservices. Two of the Company’s directors are employees of Restaurant AssociatesCorp. Expenses relating to this agreement of $74 were recorded as general andadministrative expense for the nine months ended September 26, 2004.

 

**6.****             SaleLeaseback Transaction**

 

On March 31, 2004,the Company sold and leased back the land and building underlying five of theCompany’s restaurants (three in Missouri and two in California) for total netproceeds of $12,012 (the “Sale-Leaseback Transaction”). The Sale-LeasebackTransaction resulted in deferred gain of $3,927 that is being amortized overthe lives of the related leases. The Company recognized $49 of deferred gainfor the three month periods ended September 25, 2005 and September 26, 2004 and$147 and $98 for the nine month periods ended September 25, 2005 and September26, 2004, respectively. The deferred gain is recorded in other income(expense), net.

 

The leasesunderlying the Sale-Leaseback Transaction have initial 20-year non-cancelableterms and qualify for operating lease treatment. The proceeds of theSale-Leaseback Transaction were used to repay a portion of the term loansoutstanding under the Company’s prior credit facility.

 

10

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**Item 2.**    Management’s Discussion and Analysis of FinancialCondition and Results of Operations

** **

*Youshould read the following discussion together with our consolidated financialstatements and related notes thereto included elsewhere in this report.  The following discussion and analysis of ourfinancial condition and results of operations contains forward-lookingstatements within the meaning of the federal securities laws.  See “Forward-Looking Statements” below.*

 

**Overview**

** **

Real MexRestaurants, Inc. (referred to hereafter as “we”, “our” and “Company”) is one ofthe largest full service, casual dining Mexican restaurant chain operators inthe United States in terms of number of restaurants. We currently operate 195restaurants, of which 160 are located in California, with additionalrestaurants in Arizona, Florida, Indiana, Illinois, Maryland, Missouri, Nevada,New Jersey, New York, Oregon, Virginia and Washington. Our four majorsubsidiaries are El Torito Restaurants, Inc., which we acquired in June 2000,Acapulco Restaurants, Inc., Chevys Restaurants, LLC, which we formed inconnection with the Chevys Acquisition in January 2005, and a purchasing,distribution, and manufacturing subsidiary, Real Mex Foods, Inc.

 

El Torito, ElTorito Grill, Acapulco and Chevys, our primary restaurant concepts, offer highquality Mexican food, a wide selection of alcoholic beverages and excellentguest service.  In addition to the ElTorito, El Torito Grill, Acapulco and Chevys concepts, we operate 16 additionalrestaurant locations, most of which are also full service Mexican formats,under the following brands: Las Brisas; Casa Gallardo; El Paso Cantina;GuadalaHARRY’S; Who**·**Song &Larry’s; Keystone Grill; and Fuzio Universal Pasta.

 

On January 11,2005, we completed the Chevys Acquisition, acquiring 69 Chevys restaurants andfive Fuzio Universal Pasta restaurants and assumed franchise agreements for 37franchised Chevys restaurants and five franchised Fuzio Universal Pastarestaurants.  The purchase price for theChevys Acquisition included approximately $77.9 million in cash and theassumption of certain liabilities, plus the issuance of Real Mex common andpreferred stock to J.W. Childs Equity Partners L.P. and its affiliate, JWCChevys Co-Invest, LLC.  See “Notes toConsolidated Financial Statements”. Chevys’ results of operations have beenincluded in our Company’s consolidated financial statements since the date ofacquisition.

 

In December 2004,we opened our first new El Torito restaurant in five years, located inEncinitas, California.  We opened oursecond new El Torito restaurant in Corona, California in April 2005, and planto open three additional restaurants in 2005.

 

Our revenues arecomprised of restaurant sales, other revenues and royalty and franchisefees.  Restaurant revenues include salesof food and alcoholic and other beverages. Other revenues consist primarily ofsales by Real Mex to outside customers of processed and packaged prepared foodsand 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 of controlswe 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 bonus,vacation pay, payroll taxes, workers’ compensation insurance and healthinsurance.

 

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 other relatedoccupancy costs.

 

General andadministrative expense includes all Restaurant Support Center and otheradministrative functions that support our operations. Expenses within thiscategory include executive management, supervisory and staff salaries, bonusand related employee benefits, travel and relocation costs, informationsystems, training, Restaurant Support Center rent, professional fees and otherconsulting fees.

 

Depreciationprincipally includes depreciation of capital expenditures for restaurants.Pre-opening costs are expensed as incurred and include costs associated withthe opening of a new restaurant or the conversion of an existing restaurant toa different concept.

 

Our fiscal yearconsists of 52 or 53 weeks and ends on the last Sunday in December of eachyear. The three months ended September 25, 2005 and September 26, 2004 consistof 13 weeks and the nine months ended September 25, 2005 and September 26, 2004consist of 26 weeks. When calculating same store sales, we include a restaurantthat has been open for more than 18 months and for the entirety of eachcomparable period. References to same store sales contained in this report donot include the sales of Chevys or new restaurants opened this year.

 

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**Critical Accounting Policies**

** **

The preparation ofour financial statements requires us to make estimates and judgments thataffect the reported amounts of assets, liabilities, revenues and expenses, andrelated disclosure of contingent assets and liabilities. On an ongoing basis,we evaluate our estimates, including those related to goodwill, impairment oflong-lived assets, income taxes and self-insurance reserves. We base ourestimates on historical experience and on various other assumptions and factorsthat we believe to be reasonable under the circumstances, the results of whichform the basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources. Based on ourongoing review, we plan to adjust our judgments and estimates where facts andcircumstances dictate. Actual results could differ from our estimates.

 

In June 2005, theFASB Emerging Issues Task Force reached a consensus on Issue No. 05-6, “Determiningthe Amortization Period for Leasehold Improvements” (“EITF 05-6”). The guidancerequires that leasehold improvements acquired in a business combination orpurchased subsequent to the inception of a lease be amortized over the lesserof the useful life of the assets or a term that includes renewals that arereasonably assured at the date of the business combination or purchase. Theguidance is effective for periods beginning after June 29, 2005. The adoptionof EITF 05-6 will not have an impact on the Company’s consolidated financialstatements.

 

In October 2005, the FASB issued Staff Position No.FAS 13-1, “Accounting for Rental Costs during a Construction Period,” whichrequires that rental costs associated with operating leases incurred during aconstruction period be recognized as rental expense. As permitted under currentGAAP, the Company currently capitalizes rent incurred during the constructionphase. This Staff Position is effective for reporting periods beginning afterDecember 15, 2005. Retroactive application is permitted but not required. TheCompany will adopt the FASB Staff Position FAS 13-1 on December 25, 2005, atwhich time rent will no longer be capitalized related to leases with propertiesunder construction.

 

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 our form 10-Kfiled for the fiscal year ended December 26, 2004.

 

**Impact of Recently Issued Accounting Principles**

 

In April 2005, the Securities and Exchange Commission (“SEC”) approveda new rule that delays the effective date of Statement of Financial AccountingStandards (“SFAS”) No. 123R, *Share-Based Payment*.Except for the deferral of the effective date, the guidance in SFAS No. 123R isunchanged. Under the SEC’s rule, SFAS No.123R is now effective for the Companyfor our first fiscal year beginning on or after June 15, 2005. The Company willapply this Statement to all awards granted on or after December 25, 2005 and toawards modified, repurchased, or cancelled after that date. We expect that theimplementation of the provisions of SFAS No. 123R will have an impactconsistent with our disclosures included under SFAS No. 148 in our fiscal 2004Form 10-K.

 

**Results of Operations**

** **

Our operatingresults for the three and nine month periods ended September 25, 2005 andSeptember 26, 2004 are expressed as a percentage of total revenues below:

 
| ** **                             | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|----------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                             | ** ** | **September 25,  2005** | ** ** | **September 26,  2004** | ** ** | **September 25,  2005** | ** ** | **September 26,  2004** | ** ** |
| Total revenues                         |       | 100.0                   | %          | 100.0                   | %          | 100.0 | % | 100.0 | % |
| Cost of sales                          |       | 25.7                    |       | 24.7                    |       | 25.5 |   | 24.6 |   |
| Labor                                  |       | 34.2                    |       | 36.2                    |       | 34.9 |   | 36.3 |   |
| Direct operating and occupancy expense |       | 25.2                    |       | 24.1                    |       | 24.2 |   | 23.3 |   |
| Total operating costs                  |       | 85.2                    |       | 85.0                    |       | 84.6 |   | 84.2 |   |
| General and administrative expense     |       | 5.0                     |       | 5.0                     |       | 5.2 |   | 5.2 |   |
| Depreciation and amortization          |       | 3.1                     |       | 3.4                     |       | 3.5 |   | 3.5 |   |
| Operating income                       |       | 6.7                     |       | 6.6                     |       | 6.6 |   | 7.0 |   |
| Interest expense                       |       | 4.2                     |       | 3.8                     |       | 4.2 |   | 3.8 |   |
| Debt termination costs                 |       | —                  |       | —                  |       | — |   | 1.9 |   |
| Total other expense, net               |       | 4.3                     |       | 3.0                     |       | 4.2 |   | 5.2 |   |
| Income before tax provision            |       | 2.4                     |       | 3.6                     |       | 2.4 |   | 1.8 |   |
| Net income                             |       | 2.4                     |       | 3.5                     |       | 2.4 |   | 1.7 |   |

 

**Three months ended September 25, 2005 comparedto the three months ended September 26, 2004**

** **

*TotalRevenues*.  Total revenues increased by $55.7 million, or67.9%, to $137.6 million in the third quarter of 2005 from $81.9 million in thethird quarter of 2004 due to a $52.4 million increase in restaurant revenues, a$2.2 million increase in other revenues and a $1.1 million increase in royaltyand franchise fees.  The increase inrestaurant revenues was the result of the inclusion in our results ofoperations of the Chevys restaurant sales of $50.8 million combined withcomparable store sales increases of 3.2% in the quarter.  The increase in comparable store sales wasdriven by increases in pricing in El Torito concept restaurants ofapproximately 1.2% and in Acapulco concept restaurants of approximately 1.9%,increases in customer counts of 1.9% in the El Torito restaurants and decreaseddiscounting in the Acapulco restaurants. The $2.2 million increase in other revenues was primarily due to anincrease in sales to outside customers by our distribution facility.  The $1.1 million increase in royalty andfranchise fees was due to fees earned from franchises acquired in the ChevysAcquisition.

 

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*Cost ofSales*.  Total cost of sales of $35.4 million in thethird quarter of 2005 increased $15.2 million or 75.1% as compared to the thirdquarter of 2004, primarily due to the inclusion in our results of operations ofthe Chevys restaurants’ cost of sales of $12.7 million combined with highercosts associated with the increase in sales to outside customers by ourdistribution facility and higher commodity costs.  As a percentage of total revenues, cost ofsales increased to 25.7% for the third quarter of 2005 from 24.7% for the thirdquarter of 2004 primarily due to higher commodity costs, mainly in the beef anddairy markets, and in higher packaging costs.

 

*Labor*. Labor costs of $47.1 million in the third quarter of 2005 increased by$17.4 million or 58.8% as compared to the third quarter of 2004. The increasein labor costs associated with the inclusion in our results of operations ofthe Chevys restaurants was $17.6 million. Payroll and benefits remain subject to inflation and governmentregulation, especially wage rates currently at or near the minimum wage, andexpenses for health insurance and workers’ compensation insurance.  As a percent of total revenues, labor costsdecreased to 34.2% for the third quarter of 2005 from 36.2% for the thirdquarter of 2004 primarily due to lower hourly labor expense achieved as aresult of our continued focus on hourly labor controls and scheduling.

 

*DirectOperating and Occupancy Expense*.  Directoperating and occupancy expense of $34.7 million in the third quarter of 2005increased by $15.0 million or 75.7% as compared to the third quarter of 2004.The increase in direct operating and occupancy expense associated with theinclusion in our results of operations of the Chevys restaurants was $15.1million.  Direct operating and occupancyexpense as a percentage of sales increased to 25.2% in the third quarter of2005 from 24.1% in the third quarter of 2004 primarily due to higher occupancyexpense associated with the Chevys restaurants.

 

*Generaland Administrative Expense*.  General andadministrative expense of $6.9 million in the third quarter of 2005 increasedby $2.9 million or 70.2% primarily due to increased staffing associated withthe Chevys Acquisition partially offset by lower corporate bonus expense.  General and administrative expense as apercentage of sales was 5.0% in both the third quarter of 2005 and the thirdquarter of 2004.

 

*Depreciation*.  Depreciation expense of $4.2 million in thethird quarter of 2005 increased $1.5 million or 54.3% as compared to the thirdquarter of 2004.  The increase associatedwith the inclusion in our results of operations of the Chevys restaurants was$1.8 million.  As a percentage of totalrevenues, depreciation decreased to 3.1% for the third quarter of 2005 from3.4% for the third quarter of 2004 primarily due to the cessation ofdepreciation on certain assets with a 5 year life acquired in the El Toritoacquisition in June 2000.

 

*InterestExpense*.  Interest expense of $5.8 million in the thirdquarter of 2005 increased $2.6 million or 83.7% as compared to the thirdquarter of 2004 primarily due to interest on the $75.0 million Senior UnsecuredCredit Facility which was used to finance a portion of the Chevys Acquisitionand an increase in interest on letters of credit issued as security forcontracts assumed in connection with the Chevys Acquisition.  As a percentage of total revenues, interestexpense increased to 4.2% for the third quarter of 2005 from 3.8% for the thirdquarter of 2004.

 

**Nine months ended September 25, 2005 compared tothe nine months ended September 26, 2004**

** **

*TotalRevenues*.  Total revenues increased by $157.1 million,or 63.0%, to $406.2 million in the first nine months of 2005 from $249.2million in the first nine months of 2004 due to a $147.4 million increase inrestaurant revenues, a $7.0 million increase in other revenues and a $2.7million increase in royalty and franchise fees. The increase in restaurant revenues was the result of the inclusion inour results of operations of the Chevys restaurant sales of $144.1 millioncombined with comparable store sales increases of 3.2% in the nine monthperiod, partially offset by restaurant closures.  The increase in comparable store sales wasdriven by increases in pricing in El Torito concept restaurants ofapproximately 1.2% and in Acapulco concept restaurants of approximately 1.9%,increases in customer counts of 2.6% in the El Torito restaurants and decreaseddiscounting in the Acapulco restaurants. The $7.0 million increase in other revenues was primarily due to an increasein sales to outside customers by our distribution facility.  The $2.7 million increase in royalty andfranchise fees was due to fees earned from franchises acquired in the ChevysAcquisition.

 

*Cost ofSales*.  Total cost of sales of $103.6 million in thefirst nine months of 2005 increased $42.3 million or 68.9% as compared to thefirst nine months of 2004, primarily due to the inclusion in our results ofoperations of the Chevys restaurants’ cost of

sales of $36.1 million combined with higher costs associated with theincrease in sales to outside customers by our distribution facility and highercommodity costs.  As a percentage oftotal revenues, cost of sales increased to 25.5% for the first nine months of2005

versus24.6% for the first nine months of 2004, primarily due to higher commoditycosts for beef, shrimp, dairy and vegetable products.

 

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*Labor*. Labor costs of $141.7 million in the first nine months of 2005 increasedby $51.4 million or 56.9% as compared to the first nine months of 2004. Theincrease in labor cost dollars associated with the inclusion in our results ofoperations of the Chevys restaurants was $50.9 million.  Payroll and benefits remain subject toinflation and government regulation, especially wage rates currently at or nearthe minimum wage, and expenses for health insurance and workers’ compensationinsurance.  As a percent of totalrevenues, labor costs decreased to 34.9% for the first nine months of 2005 from36.3% for the first nine months of 2004 primarily due to lower hourly laborexpense achieved as a result of our continued focus on hourly labor controlsand scheduling combined with lower field management bonus expense.

 

*DirectOperating and Occupancy Expense*.  Directoperating and occupancy expense of $98.3 million in the first nine months of2005 increased by $40.2 million or 69.1% as compared to the first nine monthsof 2004. The increase in direct operating and occupancy expense associated withthe inclusion in our results of operations of the Chevys restaurants was $40.5million.  Direct operating and occupancyexpense as a percentage of sales increased to 24.2% in the first nine months of2005 from 23.3% in the first nine months of 2004 primarily due to higher occupancyexpense associated with the Chevys restaurants.

 

*Generaland Administrative Expense*.  General andadministrative expense of $21.0 million in the first nine months of 2005increased by $8.0 million or 61.4% primarily due to increased staffingassociated with the Chevys Acquisition. General and administrative expense as apercentage of sales was 5.2% in both the first nine months of 2005 and in thefirst nine months of 2004.

 

*Depreciation*. Depreciation expense of $14.2 million in the first nine months of 2005increased $5.5 million or 62.3% as compared to the first nine months of 2004.The increase associated with the inclusion in our results of operations of theChevys restaurants was $5.0 million. As a percentage of total revenues,depreciation was stable at 3.5% for both the first nine months of 2005 and forthe first nine months of 2004.

 

*InterestExpense*.  Interest expense of $17.1 million in thefirst nine months of 2005 increased $7.6 million or 79.4% as compared to thefirst nine months of 2004 primarily due interest on the $75.0 million SeniorUnsecured Credit Facility which was used to finance a portion of the ChevysAcquisition and interest on letters of credit issued as security for certaincontracts assumed in connection with the Chevys Acquisition.

 

**Liquidity and Capital Resources**

** **

Our principalliquidity requirements are to service our debt and meet our capital expenditureand working capital needs.  Ourindebtedness, including capital lease obligations, at September 25, 2005 was$182.1 million, and we had $9.4 million of revolving credit availability underour Line. Our ability to make principal and interest payments and to fundplanned capital expenditures will depend on our ability to generate cash in thefuture, which, to a certain extent, is subject to general economic, financial,competitive, legislative, regulatory and other factors that are beyond ourcontrol.  Based on our current level ofoperations, we believe our cash flow from operations, available cash andavailable borrowings under our Line will be adequate to meet our liquidityneeds for the near future. In addition, we may partially fund restaurantopenings through credit received from trade suppliers and landlordcontributions, if favorable terms are available. We cannot assure you, however,that our business will generate sufficient cash flow from operations or thatfuture borrowings will be available to us under our Line in an amountsufficient to enable us to service our indebtedness or to fund our otherliquidity needs. If we consummate an acquisition, our debt service requirementscould increase. We may need to refinance all or a portion of our indebtednesson or before maturity. We cannot assure you that we will be able to refinanceany of our indebtedness on commercially reasonable terms or at all.

 

**Working Capital and Cash 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 liability balances that exceed current assetbalances. The largest components of accrued liabilities include reserves forself-insured workers’ compensation and general liability insurance, accruedpayroll and related employee benefits costs, and gift certificate liabilities.We do not have significant receivables and we receive trade credit based uponnegotiated terms in purchasing food and supplies. Funds available from cashsales not needed immediately to pay for food and supplies or to financereceivables or inventories typically have been used for capital expendituresand debt service payments under our existing indebtedness.

 

*OperatingActivities*.  We had net cash provided by operatingactivities of $25.6 million for the nine months ended September 25, 2005compared with net cash provided by operating activities of $19.9 million forthe nine months ended September 26, 2004. The increase in cash provided byoperating activities was primarily attributable to an increase in net incomeresulting from the results of operations of the restaurants acquired in theChevys Acquisition.

 

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*InvestingActivities*.  We completed the Chevys Acquisition onJanuary 11, 2005.  Cash used in investingactivities associated with the Chevys Acquisition, included in our results ofoperations for the nine months ended September 25, 2005, was $76.0 million, netof cash acquired of $3.9 million.  Weexpect to make capital expenditures totaling approximately $20.5 million in fiscal2005. Of this, $7.6 million in capital expenditures is estimated to be spent inChevys and Fuzio Universal Pasta restaurants of which approximately $2.0million is for an upgrade of the POS system and $5.6 million is for maintenancecapital expenditures.  The remaining$13.1 million in capital expenditures includes approximately $6.8 million inmaintenance capital expenditures for the Acapulco and El Torito restaurants andapproximately $6.3 million to build four new El Torito or El Torito Grillrestaurants.  As of September 25, 2005,we had made capital expenditures totaling approximately $12.5 million comprisedof $9.9 million for maintenance capital expenditures and $2.6 million for newrestaurant development.

 

These and othersimilar costs may be higher in the future due to inflation and otherfactors.  We expect to fund the new ElTorito restaurants and the other capital expenditures described above from cashflow from operations, available cash, available borrowings under our SeniorCredit Facility, landlord contributions (if favorable terms are available) andtrade financing received from trade suppliers.

 

*FinancingActivities*.  We had netcash provided by financing activities of $71.7 million for the nine monthsended September 25, 2005 compared with net cash used in financing activities of$16.3 million for the nine months ended September 26, 2004. The increase incash provided by financing activities was primarily due to the issuance of$75.0 million in notes under a Senior Unsecured Credit Facility to partiallyfund the Chevys Acquisition.

 

**Debt and Other Obligations**

** **

On March 31, 2004,we sold $105.0 million aggregate principal amount of 10% Senior Secured Notesdue 2010.  We used the proceeds from thesale of the Notes and the Sale-Leaseback Transaction to repay in full term loansthen outstanding under our prior credit facility of $70.2 million andsubordinated notes of $44.4 million, and entered into a new senior securedcredit facility.  Concurrent with theretirement of our term loans then outstanding, we took a charge of $4.7 millionconsisting of deferred financing costs and discounts on the retired debt andtermination of an interest rate swap agreement at a cash cost of $0.2 million.

 

In June 2005, wecompleted an exchange offer to exchange all of the notes issued in March 2004 fornotes registered with the SEC having substantially identical terms. Exceptwhere the context requires otherwise, references to “Notes” means both thenotes issued in March 2004 and those issued in exchange therefor in 2005.

 

**Senior Unsecured Credit Facility**.  Concurrent with the closing of the ChevysAcquisition, we entered into a $75.0 million 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 forthe Chevys Acquisition and pay related fees and expenses.  Our obligations under the Senior UnsecuredCredit Facility are guaranteed by our subsidiaries.  Interest on the term loan outstanding underthe Senior Unsecured Credit Facility accrues, at our option, at either (i) thegreater of prime or the rate which is 0.5% in excess of the federal funds rate,plus 8.5% or (ii) a reserve adjusted Eurodollar rate, plus 9.5%.  As of November 5, 2005, the interest rate onthe term loan was 13.37%.

 

Our Senior Unsecured Credit Facility contains variousaffirmative and negative covenants, which among other things, requires us tomeet certain financial tests (including certain leverage and interest coverageratios) and limits our and our subsidiaries’ ability to incur or guaranteeadditional indebtedness, grant certain liens, make certain restricted payments,make capital expenditures, engage in transactions with affiliates, make certaininvestments, sell our assets, make acquisitions, effect a consolidation ormerger and amend or modify instruments governing certain indebtedness(including relating to the notes).  Weare required to maintain certain minimum interest coverage ratios of(i) 1.85 to 1.00 for the four fiscal quarters ending on or prior toSeptember 30, 2005 through March 31, 2006, (ii) 2.00 to 1.00 forthe four fiscal quarters ending on or prior to June 30, 2006 throughDecember 31, 2006, (iii) 2.15 to 1.00 for the fiscal quarters endingon or prior to March 31, 2007 through December 31, 2007, and(iv) 2.30 to 1.00 thereafter until maturity.  Pursuant to the terms of the Senior UnsecuredCredit Facility, the interest coverage ratio is defined as the ratio as of thelast day of any fiscal quarter of (a) Consolidated EBITDA (as definedtherein) for the four-fiscal quarter period then ended to (b) ConsolidatedInterest Expense (as defined therein) for such four-fiscal quarter period.

 

**Line**.  Our Line was initially comprised of a $15.0million revolving credit facility, which had a $2.0 million sub-limit forletters of credit (the “Revolving Credit Facility”) and a $15.0 million lettersof credit facility (the “Letters of Credit Facility”).  At the closing of the sale of the Notes, weutilized the Letters of Credit Facility in its entirety and utilized anadditional $2.0 million from the Revolving Credit Facility to secureapproximately $17.0 million in then outstanding letters of credit, which servedas collateral for our various self-insured workers’ compensation and otherinsurance programs.  On January 11, 2005,concurrent with the closing of the Chevys Acquisition, we amended the Line to,among other things, modify certain covenants, change the maturity date to June30, 2008 (subject to extension to March 31, 2009 provided that the SeniorUnsecured Credit Facility has been repaid and terminated in full on or prior toJune 29, 2008), and increased the sub-limit for letters of credit availabilityunder the Revolving Credit Facility from $2.0 million to $15.0 million (subjectto an overall limitation of $30.0 million availability under the Line).  At the closing of the Chevys Acquisition, weutilized an additional $6.4 million from the Revolving Credit Facility forletters of credit which serve as collateral for Chevys’ workers’ compensationinsurance programs and to guarantee performance under certain of Chevys’operating leases. As of September 25, 2005, availability under the Line was$9.4 million.

 

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Under the Line,interest accrues based upon a total leverage ratio calculation. The interestunder the Line accrues, at our option, at either (i) the base rate of interestin effect from time to time, which is the higher of the lender’s prime rate asannounced from time to time or the federal funds rate plus 0.50%, plus thecurrent applicable margin of 1.75% or (ii) a London Inter Bank Offering Ratefor deposits as reported by a generally recognized financial reporting serviceplus the current applicable margin of 3.5%. Our Line is guaranteed by oursubsidiaries and secured by, among other things, perfected first prioritypledges of all of the equity interests of our direct and indirect subsidiaries,and perfected first priority security interests (subject to customaryexceptions) in substantially all of our current and future property and assets,with certain limited exceptions. The lien on the collateral securing the Lineis senior to the lien on the collateral securing the Notes and the subsidiaryguarantees of the Notes.

 

Our Line containsvarious affirmative and negative covenants and restrictions, which among otherthings, requires us to meet certain financial tests (including certain leverageand cash flow ratios), and limits our and our subsidiaries’ ability to incur orguarantee additional indebtedness, make certain capital expenditures, paydividends or make other equity distributions, purchase or redeem capital stock,make certain investments, enter into arrangements that restrict dividends fromsubsidiaries, sell assets, engage in transactions with affiliates and effect aconsolidation or merger.  We are requiredto maintain certain cash flow ratios determined on an annual basis equal to (i)1.40 to 1.00 for the period December 31, 2004 to December 31, 2005, (ii) 1.70to 1.00 for the period January 1, 2006 to December 31, 2006, (iii) 1.80 to 1.00for the period January 1, 2007 to December 31, 2007, and (iv) 1.90 to 1.00 forthe period January 1, 2008 and thereafter until maturity.  Pursuant to the terms of the Line, cash flowratio is defined as the ratio of (a) Consolidated Cash Flow (as definedtherein) to (b) Consolidated Financial Obligations (as defined therein).

 

**Senior Secured Notes due 2010**.  Interest on the Notes accrues at a rate of10% per annum and is payable semiannually on April 1 and October 1 of eachyear. The Notes are fully and unconditionally guaranteed on a senior securedbasis by all of our present and future domestic subsidiaries which arerestricted subsidiaries under the indenture governing the Notes.  The Notes and related guarantees are securedby substantially all of our domestic restricted subsidiaries’ tangible andintangible assets, subject to the prior ranking claims on such assets by thelenders under our Line.  The indenturegoverning the Notes contains various affirmative and negative covenants,subject to a number of important limitations and exceptions, including but notlimited those limiting our ability to incur additional indebtedness, makecapital expenditures, pay dividends, redeem stock or make other distributions,issue stock of our subsidiaries, make certain investments or acquisitions,grant liens on assets, enter into transactions with affiliates, merge,consolidate or transfer substantially all of our assets, and transfer and sellassets.  The covenant that limits ourincurrence of indebtedness requires that, after giving effect to any suchincurrence of indebtedness and the application of the proceeds thereof, ourfixed charge coverage ratio as of the date of such incurrence will be at least(i) 2.25 to 1.00 in the case of any incurrence on or before April 1, 2006 and(ii) 2.50 to 1.00 in the case of any incurrence after April 1, 2006.  The indenture defines consolidated fixedcharge coverage ratio as the ratio of Consolidated Cash Flow (as definedtherein) to Fixed Charges (as defined therein).

 

We can redeem theNotes on or after April 1, 2007, except that we may redeem up to 35% of theNotes before April 1, 2007 with the proceeds of one or more public equityofferings.  We are required to redeem theNotes under certain circumstances involving a change of control.  Additionally, if we or any of our domesticrestricted subsidiaries engage in assets sales, we generally must either investthe net cash proceeds from such sales in our business within 360 days, prepaythe indebtedness obligations under our Revolving Credit Facility or certainother secured indebtedness or make an offer to purchase a portion of the Notes.

 

On June 9, 2004,we filed a registration statement with respect to notes having substantiallyidentical terms as the Notes, as part of an offer to exchange registered notesfor the Notes (the “Exchange Offer”).  Wetemporarily suspended and extended the Exchange Offer on October 27, 2004 dueto the pending acquisition of Chevys.  Asa result of the suspension of the Exchange Offer and pursuant to the terms of aregistration rights agreement entered into with the initial purchasers of theNotes issued in March 2004, we began paying additional interest on these Noteson November 8, 2004 at the rate of 0.25% per annum, which rate increased by anadditional 0.25% per annum on February 6, 2005. We completed the Exchange Offeron June 7, 2005 reducing the interest rate to 10% per annum.

 

*Mortgage.*  Concurrent with the closing of the ChevysAcquisition, we assumed a $0.8 million mortgage (the “Mortgage”) secured by thebuilding and improvements of one of the restaurants acquired in thetransaction. The Mortgage carries a fixed annual interest rate of 9.28% andrequires equal monthly payments of principal and interest through April 1,2015.

 

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Our acquisition ofEl Torito included the assumption of capital lease obligations, collateralizedwith leasehold improvements, in an aggregate amount of $9.2 million.  The capital lease obligations have aweighted-average interest rate of 10.0%. As of September 25, 2005, the principal amount due relating to thecapital lease obligations was $1.3 million. Principal and interest payments on the capital lease obligations are duemonthly and range from $1,100 to $7,500 per month.  The capital lease obligations mature between2005 and 2027.

 

**Risk Factors**

** **

*Food-borne illnessincidents could reduce our restaurant sales.*

* *

Wecannot guarantee that our internal controls and training at our restaurants anddistribution and manufacturing facilities will be fully effective in preventingall food-borne illnesses. Furthermore, our reliance on third party suppliersmakes it difficult to monitor food safety compliance and increases the riskthat food-borne illness would affect multiple locations rather than singlerestaurants. Third party food suppliers and transporters outside of our controlcould cause some food borne illness incidents. New illnesses resistant to ourcurrent precautions may develop in the future, or diseases with long incubationperiods could arise, that could give rise to claims or allegations on aretroactive basis. One or more instances of food-borne illness in one of ourrestaurants could negatively affect our restaurant sales if highly publicized.This risk exists even if it were later determined that the illness was wronglyattributed to one of our restaurants. A number of other restaurant chains haveexperienced incidents related to food borne illnesses that have had a materialadverse impact on their operations, and we cannot assure you that we can avoida similar impact upon the occurrence of a similar incident at our restaurants.

 

*Increases in the cost ofingredients could materially adversely affect our business, financialcondition, results of operations and cash flows.*

* *

Thecost, availability and quality of the ingredients we use to prepare our foodand beverages are subject to a range of factors, many of which are beyond ourcontrol. Changes in the cost of such ingredients can result from a number offactors, including seasonality, political conditions, weather conditions,shortages of ingredients and other factors. If we fail to anticipate and reactto increasing ingredient costs by adjusting our purchasing practices and menuprice adjustments, our cost of sales may increase and our operating resultscould be adversely affected.

 

*We depend upon frequentdeliveries of food and other supplies.*

* *

Ourability to maintain consistent quality menu items depends in part upon ourability to acquire fresh food products and related items, including essentialingredients used in the Mexican restaurant business such as avocados, fromreliable sources in accordance with our specifications. Shortages orinterruptions in the supply of fresh food products caused by unanticipateddemand, problems in production or distribution, contamination of food products,an outbreak of food-borne diseases, inclement weather or other conditions couldmaterially adversely affect the availability, quality and cost of ingredients,which could adversely affect our business, financial condition, results ofoperations and cash flows.

 

Wehave contracts with a large number of suppliers of most food, beverages andother supplies for our restaurants. In addition, we distribute substantiallyall of the products we receive from suppliers through our distributionfacility. If suppliers do not perform adequately or if any one or more of suchentities seeks to terminate its agreement or fails to perform as anticipated,or if there is any disruption in any of our supply relationships ordistribution operations for any reason, it could have a material adverse effecton our business, financial condition, results of operations and cash flows. Ourinability to replace our distribution operations and our suppliers in a shortperiod of time on acceptable terms could increase our costs and could causeshortages at our restaurants of food and other items that may cause ourrestaurants to remove certain items from a restaurant’s menu or temporarilyclose a restaurant. If we temporarily close a restaurant or remove popularitems from a restaurant’s menu, that restaurant may experience a significantreduction in revenue during the time affected by the shortage or thereafter, asour customers may change their dining habits as a result.

 

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*We are vulnerable tochanges in consumer preferences and economic and other conditions that couldharm our business, financial condition, cash flows and results of operations.*

* *

Foodservice businesses are often affected by changes in consumer tastes, national,regional and local economic conditions, demographic trends, consumer confidencein the economy and discretionary spending priorities. Factors such as trafficpatterns, weather conditions, local demographics and the type, number andlocation of competing restaurants may adversely affect the performance ofindividual locations. In addition, inflation and increased food and energy costsmay harm the restaurant industry in general and our locations in particular.Adverse changes in any of these factors could reduce consumer traffic or imposepractical limits on pricing, which could harm our business, financialcondition, results of operations and cash flows. There can be no assurance thatconsumers will continue to regard our products favorably or that we will beable to develop new products that appeal to consumer preferences, which couldhave a materially adverse affect on our business. Our continued success willdepend in part on our ability to anticipate, identify and respond to changingconsumer preferences and economic conditions.

 

*Our business is highlysensitive to events and conditions in the State of California.*

* *

Amajority of our restaurants are located in California. Because of thisgeographic concentration, we are susceptible to local and regional risks, suchas energy shortages and related increased costs, increased governmentregulation, adverse economic conditions, adverse weather conditions,earthquakes and other natural disasters, any of which could have a materialadverse effect on our business, financial condition and results of operations.In light of our current geographic concentration, adverse publicity relating toour restaurants could have a more pronounced adverse effect on overall salesthan might be the case if our restaurants were more broadly dispersed.

 

*There is intensecompetition in the restaurant industry.*

* *

Therestaurant business is intensely competitive with respect to food quality,price value relationships, ambiance, service and location, and there are manywell-established competitors with substantially greater financial, marketing,personnel and other resources. In addition, many of our competitors are wellestablished in the markets where we operate. While we believe that ourrestaurants are distinctive in design and operating concept, other companiesmay develop restaurants that operate with similar concepts.

 

*We intend to openadditional restaurants, which could have a material adverse effect on ourbusiness, financial condition, results of operations and cash flows.*

* *

We arereviewing additional sites for potential future restaurants. Historically,there is a “ramp-up” period before we expect a new restaurant to achieve ourtargeted level of performance. This is due to higher operating costs caused bystart-up and other temporary inefficiencies such as customer acceptance andunavailability of experienced staff. Our ability to open new restaurants is dependentupon a number of factors, many of which are beyond our control, including ourability to:

 

•              find quality locations;

 

•              reach acceptable agreements regarding thelease or purchase of locations;

 

•              raise or have available an adequateamount of money for construction and opening costs;

 

•              timely hire, train and retain the skilledmanagement and other employees necessary to meet staffing needs; and

 

•              obtain, for an acceptable cost, requiredpermits and regulatory approvals.

 

We maynot be able to attract enough customers to new restaurants because potentialcustomers may be unfamiliar with our restaurants or the atmosphere or menu ofour restaurants might not appeal to them. In addition, as part of our growthstrategy, we intend to open new restaurants in our existing markets. Since wetypically draw customers from a relatively small radius around each of ourrestaurants, the operating results and comparable unit sales for existingrestaurants that are near the area in which a new restaurant opens may decline,and the new restaurant itself may not be successful, due to the close proximityof other restaurants and market saturation.

 

Forthese same reasons, many markets would not successfully support one of ourrestaurants. Our existing business support systems, management informationsystems, financial controls and other systems and procedures may be inadequateto support our expansion, which could require us to incur substantialexpenditures that could materially adversely affect our operating results orcash flows.

 

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*Negative publicity relating to one of ourrestaurants could reduce sales at some or all of our other restaurants.*

 

Weare, from time to time, faced with negative publicity relating to food quality,health inspection reports, restaurant facilities, employee relationships orother matters at specific restaurants. Adverse publicity may negatively affectus, regardless of whether the allegations are valid or whether we are liable.In addition, the negative impact of adverse publicity relating to onerestaurant may extend far beyond the restaurant involved to affect some or allof our other restaurants. A similar risk exists with respect to totallyunrelated food service businesses, if customers mistakenly associate suchunrelated businesses with our own operations.

 

*Uninsured losses couldoccur.*

* *

Wehave comprehensive insurance, including general liability and property(including business interruption) extended coverage. However, there are certaintypes of losses that may be uninsurable or that we believe are not economicalto fully insure, such as earthquakes and other natural disasters. In view ofthe location of many of our existing and planned restaurants in California, ouroperations are particularly susceptible to damage and disruption caused byearthquakes. In the event of an earthquake or other natural disaster affectingour geographic area of operations, we could suffer a loss of the capitalinvested in, as well as anticipated earnings from, the damaged or destroyedproperties.

 

*Changes in employmentlaws may adversely affect our business.*

* *

Variousfederal and state labor laws govern the relationship with our employees andaffect operating costs. These laws include minimum wage requirements, overtime,unemployment tax rates, workers’ compensation rates and citizenshiprequirements. Significant additional government imposed increases in thefollowing areas could materially affect our business, financial condition,operating results or cash flow:

 

•              minimum wages;

 

•              paid leaves of absence;

 

•              tax reporting; and

 

•              revisions in the tax payment requirementsfor employees who receive gratuities.

 

*If we face laborshortages or increased labor costs, our growth and operating results could beadversely affected.*

* *

Laboris a primary component in the cost of operating our restaurants. If we facelabor shortages or increased labor costs because of increased competition foremployees, higher employee turnover rates or increases in the federal orapplicable state minimum wage or other employee benefits costs (including costsassociated with health insurance coverage), our operating expenses couldincrease and our growth could be adversely affected. In addition, our successdepends in part upon our ability to attract, motivate and retain a sufficientnumber of well-qualified restaurant operators and management personnel, as wellas a sufficient number of other qualified employees, including guest serviceand kitchen staff, to keep pace with our expansion schedule. Qualifiedindividuals needed to fill these positions are in short supply in somegeographic areas. In addition, full service casual dining segment restaurantoperators have traditionally experienced relatively high employee turn overrates. Although we have not yet experienced any significant problems inrecruiting or retaining employees, our ability to recruit and retain suchindividuals may delay the planned openings of new restaurants or result inhigher employee turnover in existing restaurants, which could have a materialadverse effect on our business, financial condition, results of operations andcash flows.

 

Wehave been affected by increasing healthcare and workers’ compensation expensesaffecting business in most industries, including ours. To manage premiumincreases we have elected to self-insure. Higher deductibles could result ingreater exposure to our operating results and liquidity. If we are exposed tomaterial liabilities that are not insured it could materially adversely affectour financial condition and results of operations.

 

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*We may be locked intolong-term and non-cancelable leases and may be unable to renew leases at theend of their terms.*

 

Manyof our current leases are non-cancelable and typically have initial terms of 10to 20 years and one or more renewal terms of three or more years that we mayexercise at our option. Leases that we enter into in the future likely willalso be long-term and non-cancelable and have similar renewal options. If weclose a restaurant, we may remain committed to perform our obligations underthe applicable lease, which would include, among other things, payment of thebase rent for the balance of the lease term. Alternatively, at the end of the leaseterm and any renewal period for a restaurant, we may be unable to renew thelease without substantial additional cost, if at all. We may close or relocatethe restaurant, which could subject us to construction and other costs andrisks, and could have a material adverse effect on our business. Additionally,the revenue and profit, if any, generated at a relocated restaurant may notequal the revenue and profit generated at the existing restaurant. Furthermore,in the past, we have been forced to close profitable restaurants due to theinability to renew a lease upon the expiration of its lease term and we expectthis to occur from time to time in the future.

 

*We face risks associatedwith government regulations.*

* *

We aresubject to extensive government regulation at a federal, state and localgovernment level. These include, but are not limited to, regulations relatingto the preparation and sale of food and beverages, zoning and building codes,land use and employee, public health, sanitation and safety matters. We arerequired to obtain and maintain governmental licenses, permits and approvals.Difficulty or failure in obtaining them in the future could result in delayingor canceling the opening of new restaurants or could materially adverselyaffect the operation of existing restaurants. Local authorities may suspend ordeny renewal of our governmental licenses if they determine that our operationsdo not meet the standards for initial grant or renewal. This risk would be evenhigher if there were a major change in the licensing requirements affecting ourtypes of restaurants.

 

Typicallyour restaurants’ licenses to sell alcoholic beverages must be renewed annuallyand may be suspended or revoked at any time for cause. Alcoholic beveragecontrol regulations relate to various aspects of daily operations of ourrestaurants, including the minimum age of patrons and employees, hours ofoperation, advertising, wholesale purchasing and inventory control, handlingand storage. In fiscal 2004, approximately 28% of our restaurant revenues wereattributable to the sale of alcoholic beverages, and we believe that ourability to serve alcoholic beverages, such as our signature margarita drinks,is an important factor in attracting customers. The failure of any of our restaurantsto timely obtain and maintain liquor or other licenses, permits or approvalsrequired to serve alcoholic beverages or food could delay or prevent theopening of, or adversely impact the viability of, the restaurant and we couldlose significant revenue. In each state in which we operate, our restaurantsare also subject to “dram shop” laws, which allow a person to sue us if thatperson was injured by an intoxicated person who was wrongfully served alcoholicbeverages at one of our restaurants. A judgment against us under a dram shoplaw could exceed our liability insurance coverage policy limits and couldresult in substantial liability for us and have a material adverse effect onour profitability. Our inability to continue to obtain such insurance coverageat reasonable costs also could have a material adverse effect on us.

 

Thefederal Americans with Disabilities Act and similar state laws prohibitdiscrimination on the basis of disability in public accommodations andemployment. Mandated modifications to our facilities (or related litigation) inthe future to make different accommodations for persons with disabilities couldresult in material unanticipated expenses.

 

Ourdistribution and manufacturing operations are subject to extensive regulationby the FDA, USDA and other state and local authorities. Our processingfacilities and products are subject to periodic inspection by federal, stateand local authorities. We cannot assure you, however, that we are in fullcompliance with all currently applicable governmental laws, or that we will beable to comply with any or all future laws and regulations. Failure by us tocomply with applicable laws and regulations could subject us to civil remedies,including fines, injunctions, recalls or seizures, as well as potentialcriminal sanctions, which could have a material adverse effect on our business,financial condition or results of operations.

 

*We may be subject tosignificant liability should the consumption of any of our specialty productscause injury, illness or death.*

* *

We maybe required to recall specialty products that we manufacture and co-package atour manufacturing facility in the event of contamination, product tampering,mislabeling or damage to our products. We cannot assure you that productliability claims will not be asserted against us or that we will not beobligated to recall our products. A product liability judgment against us, or aproduct recall, could have a material adverse effect on our business, financialcondition or results of operations.

 

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*The failure to enforceand maintain our trademarks could materially adversely affect our ability toestablish and maintain brand awareness.*

 

Wehave registered or filed applications to register certain names used by ourrestaurants and our food manufacturing operations as trademarks or servicemarks with the United States Patent and Trademark Office and in certain foreigncountries, including the names Acapulco®, El Torito®, Real Mex FoodsTM, ChevysFresh Mex® and Fuzio Universal Pasta®. The success of our business strategy depends on our continued ability touse our existing trademarks and service marks in order to increase brand awarenessand further develop our branded products. If our efforts to protect ourintellectual property are not adequate, or if any third party misappropriatesor infringes on our intellectual property, either in print or on the Internet,the value of our brands may be harmed, which could have a material adverse effecton our business, including the failure of our brands and branded products toachieve and maintain market acceptance.

 

Therecan be no assurance that all of the steps we have taken to protect ourintellectual property in the U.S. and foreign countries will be adequate. Inaddition, the laws of some foreign countries do not protect intellectualproperty rights to the same extent as the laws of the U.S.

 

*We face risks associatedwith environmental laws.*

* *

We aresubject to federal, state and local laws, regulations and ordinances that:

 

•              govern activities or operations that mayhave adverse environmental effects, such as discharges to air and water, aswell as handling and disposal practices for solid and hazardous wastes; and

 

•              impose liability for the costs ofcleaning up, and damage resulting from, sites of past spills, disposals orother releases of hazardous materials.

 

Inparticular, under applicable environmental laws, we may be responsible forremediation of environmental conditions and may be subject to associatedliabilities, including liabilities resulting from lawsuits brought by privatelitigants, relating to our restaurants and the land on which our restaurantsare located, regardless of whether we lease or own the restaurants or land inquestion and regardless of whether such environmental conditions were createdby us or by a prior owner or tenant. If we are found liable for the costs ofremediation of contamination at any of our properties, our operating expenseswould likely increase and our operating results would be materially adverselyaffected.

 

*We depend on the servicesof key executives, the loss of whom could materially harm our business.*

* *

Someof our senior executives are important to our success because they have beeninstrumental in setting our strategic direction, operating and marketing ourbusiness, identifying, recruiting and training key personnel, identifyingexpansion opportunities and arranging necessary financing. Losing the servicesof any of these individuals could materially adversely affect our businessuntil a suitable replacement could be found. We believe that they could noteasily be replaced with executives of equal experience and capabilities. We donot maintain key person life insurance policies on any of our executives.

 

*Compliance withregulation of corporate governance and public disclosure will result inadditional expenses.*

* *

Keepingabreast of, and in compliance with, laws, regulations and standards relating tocorporate governance and public disclosure, including the Sarbanes Oxley Act of2002 and related SEC regulations will require a significant amount ofmanagement attention and external resources. We are committed to observing highstandards of corporate governance and public disclosure. As a result, we intendto invest all reasonably necessary resources to comply with evolving standards,and this investment will result in increased general and administrativeexpenses and a diversion of management time and attention from revenuegenerating activities to compliance activities.

 

*We may make acquisitionsor enter into similar transactions.*

* *

We mayexpand by pursuing acquisitions, business combinations and joint ventures. Wemay encounter difficulties in integrating the expanded operations, enteringinto markets, or conducting operations where we have no or limited priorexperience. Furthermore, we may not realize the benefits we anticipated when weentered into these transactions. In addition, the negotiation of potentialacquisitions, business combinations or joint ventures as well as theintegration of an acquired business could require us to incur significant costsand cause diversion of management’s time and resources.

 

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***Our substantial level of indebtedness could adversely affect ourfinancial condition.***

 

We have substantial indebtedness.  As of September 25, 2005, we had $182.1million of indebtedness including obligations under capital leases.  Subject to restrictions in the indenture forthe Notes and our senior secured and unsecured credit facilities, we may incuradditional indebtedness.  Our high levelof indebtedness could have important consequences to holders of ourindebtedness and significant effects on our business, including the following:

 

•              our ability to obtain additionalfinancing for working capital, capital expenditures, acquisitions or generalcorporate purposes may be impaired;

 

•              we must use a substantial portion of ourcash flow from operations to pay interest on our indebtedness, which willreduce the funds available to use for operations and other purposes;

 

•              our high level of indebtedness couldplace us at a competitive disadvantage compared to those of our competitorsthat may have proportionately less debt;

 

•              our flexibility in planning for, orreacting to, changes in our business and the industry in which we operate maybe limited; and

 

•              our high level of indebtedness makes usmore vulnerable to economic downturns and adverse developments in our business.

 

We expect to use cash flow from operations to pay ourexpenses and amounts due under our outstanding indebtedness.  Our ability to make these payments thusdepends on our future performance, which will be affected by financial,business, economic and other factors, many of which we cannot control.  Our business may not generate sufficient cashflow from operations in the future and our anticipated growth in revenue andcash flow may not be realized, either or both of which could result in ourbeing unable to repay indebtedness, or to fund other liquidity needs.  If we do not have enough money, we may berequired to refinance all or part of our then-existing debt, sell assets orborrow more money.  We cannot make anyassurances that we will be able to accomplish any of these alternatives onterms acceptable to us, or at all.  Inaddition, the terms of existing or future debt agreements, including theindenture for the Notes and our senior secured and unsecured credit facilities,may restrict us from adopting any of these alternatives.

 

***The indenture for the Notes and our senior secured and unsecured creditfacilities impose significant operating and financial restrictions, which mayprevent us from pursuing certain business opportunities and taking certainactions.***

** **

Our current debt agreements impose, and future debtagreements may impose, significant operating and financial restrictions onus.  These restrictions will limit orprohibit, among other things, our ability to:

 

•              incur additional indebtedness;

 

•              repay indebtedness before statedmaturities;

 

•              pay dividends on, redeem or repurchaseour stock or make other distributions;

 

•              make acquisitions or investments;

 

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•              create or incur liens;

 

•              transfer or sell certain assets or mergeor consolidate with or into other companies;

 

•              enter into certain transactions withaffiliates;

 

•              sell stock in our subsidiaries;

 

•              restrict dividends, distributions orother payments from our subsidiaries; and

 

•              otherwise conduct necessary corporateactivities.

 

In addition, our senior secured and unsecured creditfacilities require us to maintain compliance with specified financialcovenants.

 

These covenants could adversely affect our ability tofinance our future operations or capital needs and pursue available businessopportunities.  A breach of any of thesecovenants could result in default in respect of the related indebtedness.  If default occurs, the relevant lenders couldelect to declare the indebtedness, together with accrued interest and otherfees, to be immediately due and payable and proceed against any collateralsecuring that indebtedness.

 

*Bruckmann, Rosser,Sherrill & Co., LLC and Jefferies Capital Partners together controlour Company, and their interests may conflict with the interests of the holdersof our indebtedness.*

* *

As aresult of their stock ownership, Bruckmann, Rosser, Sherrill & Co.,LLC, or BRS, and Jefferies Capital Partners, or JCP, together own beneficiallyapproximately 65.8% of our outstanding capital stock. By virtue of their stockownership and the terms of the securities holders agreement, these entitieshave significant influence over our management and will be able to determinethe outcome of all matters required to be submitted to the stockholders forapproval, including the election of our directors and the approval of mergers,consolidations and the sale of all or substantially all of our assets. Theinterests of BRS and JCP as equity owners of our Company may differ from theinterests of the holders of our indebtedness, and, as such, BRS and JCP maytake actions that may not be in the interests of the holders of ourindebtedness. For example, if we encounter financial difficulties or are unableto pay our debts as they mature, the interests of our equity owners mightconflict with the interests of the holders of our indebtedness. In addition,our equity owners may have an interest in pursuing acquisitions, divestitures,financings or other transactions that, in their judgment, could enhance theirequity investments, although such transactions might involve risks to theholders of our indebtedness.

 

**Forward Looking Statements**

** **

This reportincludes “forward looking statements” within the meaning of the federalsecurities laws.  Forward lookingstatements are those that do not relate solely to historical fact. Theyinclude, but are not limited to, any statement that may predict, forecast,indicate or imply future results, performance, achievements or events. They maycontain words such as “believe,” “anticipate,” “expect,” “estimate,” “intend,” “project,”“plan,” “will,” “should,” “may,” or “could” or words or phrases of similarmeaning. They may relate to, among other things: our liquidity and capitalresources; legal proceedings and regulatory matters involving our Company;food-borne illness incidents; increases in the cost of ingredients; ourdependence upon frequent deliveries of food and other supplies; ourvulnerability to changes in consumer preferences and economic conditions; ourability to compete successfully with other casual dining restaurants; ourability to expand; and anticipated growth in the restaurant industry and ourmarkets.

 

These forwardlooking statements reflect our current views with respect to future events andare based on assumptions and subject to risks and uncertainties, including, butnot limited to, economic, competitive, governmental and technological factorsoutside of our control, that may cause actual results to differ materially fromtrends, plans or expectations set forth in the forward looking statements. Inaddition, these forward-looking statements present our estimates andassumptions 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.

 

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**Item 3.**    Quantitative and Qualitative Disclosures aboutMarket Risk

** **

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

 

Weconsider the U.S. dollar to be the functional currency for all of our entities.All of our net sales and our expenses for the nine months ended September 25,2005 and in fiscal year 2004 were denominated in U.S. dollars. Therefore,foreign currency fluctuations did not materially affect our financial resultsin those periods.

 

We arealso subject to market risk from exposure to changes in interest rates based onour financing activities. This exposure relates to borrowings under our seniorsecured and unsecured credit facilities that are payable at floating rates ofinterest. We currently do not have any borrowings outstanding under our Line.We currently have $75.0 million outstanding under our Senior Unsecured CreditFacility. A hypothetical 10% fluctuation in interest rates, as of November 5,2005, would have a net after tax impact of $0.6 million on earnings in fiscal2005.

 

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 certain fixed price purchaseagreements with varying terms of generally no more than a year in 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 Rules13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “ExchangeAct”)).  Based on this evaluation, theCEO and CFO concluded that our disclosure controls and procedures are effectiveto provide reasonable assurance that information required to be disclosed by usin reports that we file or submit under the Exchange Act is recorded,processed, summarized and reported within the time periods specified inSecurities and Exchange Commission rules and forms. There was no change in ourinternal control over financial reporting during our most recently completedfiscal quarter that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

**PARTIIOTHER INFORMATION**

** **

**Item1.  Legal Proceedings**

 

Our Company isperiodically a defendant in cases involving personal injury and other mattersthat arise in the normal course of business. While any pending or threatenedlitigation has an element of uncertainty, we believe that the outcome of theselawsuits or claims, individually or combined, will not materially adverselyaffect the consolidated financial position, results of operations or cash flowsof our Company.

 

**Item2.  Unregistered Sales of Equity Securities and Use of Proceeds**

 

Not applicable.

 

**Item3.  Defaults upon Senior Securities**

 

Not applicable.

 

**Item4.  Submission of Matters to a Vote of Security Holders**

 

Not applicable.

 

**Item5.  Other Information**

 

Not applicable.

 

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**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 8,  2005 | By:                        | /s/ Frederick F. Wolfe |
|                     |                       | Frederick F. Wolfe |
|                     |                       | President & Chief Executive Officer  (principal executive officer) |
|                     |                       |   |
|                     |                       |   |
| Dated: November 8,  2005 | By:                        | /s/ Steven Tanner |
|                     |                       | Steven Tanner |
|                     |                       | Chief Financial Officer  (principal financial and accounting officer) |

 

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