****UNITED STATESSECURITIES 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  June 26, 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  incorporation or organization) |       | (I.R.S. Employer  Identification No.) |

 

**4001 ViaOro Avenue, Suite 200Long Beach, California 90810**(Address of principal executive offices)

 

Registrant’stelephone number, including area code:****(310)513-7500****

 

Indicate by check mark whether theregistrant:  (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 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

 

As of July 30, 2005, the registrant hadoutstanding 300,016 shares of Class A Common Stock, par value $0.001 per share,and 15,867 shares of Class B Common Stock, par value $0.001 per share.

 

 

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

 
| PART I FINANCIAL INFORMATION |                                                                                        |
|------------------------------|---------------------------------------------------------------------------------------------|
|                         |                                                                                        |
| Item 1.                      | Financial Statements                                                                        |   |
|                         | Consolidated  Balance Sheets                                                                |   |
|                         | Consolidated Statements of Operations                                                       |   |
|                         | Consolidated Statements of Cash Flows                                                       |   |
|                         | Notes to  Consolidated Financial Statements                                                 |   |
| Item 2.                      | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |   |
| Item 3.                      | Quantitative and  Qualitative Disclosures About Market Risk                                 |   |
| 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)**

 
| ** **                                                                                                                                                                                                                                                               | ** ** | **June 26,**    | ** ** | **December  26,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|-------------------|------------|
| ** **                                                                                                                                                                                                                                                               | ** ** | **2005**        | ** ** | **2004**          | ** ** |
| ** **                                                                                                                                                                                                                                                               | ** ** | **(unaudited)** | ** ** | ** **        | ** ** |
| **Assets**                                                                                                                                                                                                                                                               |       |            |       |              |       |
| Current assets:                                                                                                                                                                                                                                                          |       |            |       |              |       |
| Cash and cash  equivalents                                                                                                                                                                                                                                               |       | $               | 6,079      |              | $          | 10,690 |   |
| Trade  receivables, net                                                                                                                                                                                                                                                  |       | 8,581           |       | 4,312             |       |
| Other  receivables                                                                                                                                                                                                                                                       |       | 507             |       | 157               |       |
| Inventories                                                                                                                                                                                                                                                              |       | 12,054          |       | 6,616             |       |
| Deferred tax  asset                                                                                                                                                                                                                                                      |       | 1,371           |       | 1,371             |       |
| Prepaid expenses  and supplies                                                                                                                                                                                                                                           |       | 6,360           |       | 3,754             |       |
| Total current  assets                                                                                                                                                                                                                                                    |       | 34,952          |       | 26,900            |       |
|                                                                                                                                                                                                                                                                     |       |            |       |              |       |
| Property and  equipment, net                                                                                                                                                                                                                                             |       | 81,241          |       | 35,848            |       |
| Goodwill, net                                                                                                                                                                                                                                                            |       | 154,377         |       | 105,387           |       |
| Deferred charges                                                                                                                                                                                                                                                         |       | 7,036           |       | 5,003             |       |
| Deferred tax  asset                                                                                                                                                                                                                                                      |       | 7,769           |       | 7,769             |       |
| Other assets                                                                                                                                                                                                                                                             |       | 7,175           |       | 6,044             |       |
| Total assets                                                                                                                                                                                                                                                             |       | $               | 292,550    |              | $          | 186,951 |   |
|                                                                                                                                                                                                                                                                     |       |            |       |              |       |
| **Liabilities  and stockholders’ equity**                                                                                                                                                                                                                           |       |            |       |              |       |
| Current  liabilities:                                                                                                                                                                                                                                                    |       |            |       |              |       |
| Accounts payable  and accrued liabilities                                                                                                                                                                                                                                |       | $               | 55,698     |              | $          | 42,505 |   |
| Current portion  of long-term debt                                                                                                                                                                                                                                       |       | 115             |       | 63                |       |
| Current portion  of capital lease obligations                                                                                                                                                                                                                            |       | 209             |       | 242               |       |
| Total current  liabilities                                                                                                                                                                                                                                               |       | 56,022          |       | 42,810            |       |
|                                                                                                                                                                                                                                                                     |       |            |       |              |       |
| Long-term debt,  less current portion                                                                                                                                                                                                                                    |       | 180,744         |       | 105,000           |       |
| Capital lease  obligations, less current portion                                                                                                                                                                                                                         |       | 1,094           |       | 1,198             |       |
| Other  liabilities                                                                                                                                                                                                                                                       |       | 11,005          |       | 8,094             |       |
| Total  liabilities                                                                                                                                                                                                                                                       |       | 248,865         |       | 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 June 26, 2005 and December 26, 2004 respectively;  liquidation preference of $33,567 and $29,644 at June 26, 2005 and December  26, 2004 respectively |       | 33,567          |       | 29,644            |       |
| Series B, 13.5%  Cumulative Compounding Preferred Stock—12,323 and 10,722 shares issued and  outstanding at June 26, 2005 and December 26, 2004 respectively; liquidation  preference of $23,773 and $20,970 at June 26, 2005 and December 26, 2004  respectively;  |       | 23,773          |       | 20,970            |       |
| Series C, 15%  Cumulative Compounding Preferred Stock—17,478 and 14,975 shares issued and  outstanding at June 26, 2005 and December 26, 2004 respectively; liquidation  preference of $53,991 and $46,544 at June 26, 2005 and December 26, 2004  respectively;    |       | 53,991          |       | 46,544            |       |
| Common Stock,  $.001 par value, 2,000,000 shares authorized, 315,883 and 274,523 shares  issued and outstanding at June 26, 2005 and December 26, 2004 respectively;                                                                                                     |       | —          |       | 1                 |       |
| Warrants                                                                                                                                                                                                                                                                 |       | 4,027           |       | 4,027             |       |
| Additional paid-in  capital                                                                                                                                                                                                                                              |       | 16,203          |       | 16,202            |       |
| Accumulated  deficit                                                                                                                                                                                                                                                     |       | (87,876         | )          | (87,539           | )          |
| Total  stockholders’ equity                                                                                                                                                                                                                                         |       | 43,685          |       | 29,849            |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                                                                         |       | $               | 292,550    |              | $          | 186,951 |   |

 

See accompanying notes.

 

3

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**Real Mex Restaurants, Inc. andSubsidiaries**

**ConsolidatedStatements of Operations (unaudited)**

**(in thousands)**

 
| ** **                                             | ** ** | **Three  Months Ended** | ** ** | **Six  Months Ended** | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                             | ** ** | **June 26,**            | ** ** | **June 27,**          | ** ** | **June 26,** | ** ** | **June 27,** | ** ** |
| ** **                                             | ** ** | **2005**                | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues:                                              |       |                    |       |                  |       |   |   |   |   |
| Restaurant  revenues                                   |       | $                       | 138,516    |                  | $          | 84,873 |   | $ | 257,954 |   | $ | 163,000 |   |
| Other revenues                                         |       | 5,144                   |       | 2,481                 |       | 9,014 |   | 4,145 |   |
| Royalty and  franchise fees                            |       | 1,000                   |       | 57                    |       | 1,681 |   | 90 |   |
| Total revenues                                         |       | 144,660                 |       | 87,411                |       | 268,649 |   | 167,235 |   |
| Costs and  expenses:                                   |       |                    |       |                  |       |   |   |   |   |
| Cost of sales                                          |       | 37,182                  |       | 21,508                |       | 68,217 |   | 41,121 |   |
| Labor                                                  |       | 49,996                  |       | 30,855                |       | 94,588 |   | 60,663 |   |
| Direct operating  and occupancy expense                |       | 34,371                  |       | 19,751                |       | 63,576 |   | 38,383 |   |
| General and  administrative expense                    |       | 6,445                   |       | 4,501                 |       | 14,035 |   | 8,920 |   |
| Depreciation                                           |       | 5,456                   |       | 2,754                 |       | 9,970 |   | 6,009 |   |
| Pre-opening  costs                                     |       | 159                     |       | (53                   | )          | 330 |   | 125 |   |
| Loss on  impairment of property and equipment          |       | —                  |       | 8                     |       | 216 |   | 8 |   |
|                                                   |       |                    |       |                  |       |   |   |   |   |
| Operating income                                       |       | 11,051                  |       | 8,087                 |       | 17,717 |   | 12,006 |   |
|                                                   |       |                    |       |                  |       |   |   |   |   |
| Other income  (expense):                               |       |                    |       |                  |       |   |   |   |   |
| Casualty gain  (loss)                                  |       | (14                     | )          | (14                   | )          | (14 | ) | 548 |   |
| Interest expense                                       |       | (5,907                  | )          | (3,130                | )          | (11,301 | ) | (6,372 | ) |
| Debt termination  costs                                |       | —                  |       | (4,677                | )          | — |   | (4,677 | ) |
| Other income  (expense), net                           |       | (38                     | )     | 213                   |       | 87 |   | (6 | ) |
|                                                   |       |                    |       |                  |       |   |   |   |   |
| Total other  expense, net                              |       | (5,959                  | )          | (7,608                | )          | (11,228 | ) | (10,507 | ) |
|                                                   |       |                    |       |                  |       |   |   |   |   |
| Income before  income tax provision                    |       | 5,092                   |       | 479                   |       | 6,489 |   | 1,499 |   |
|                                                   |       |                    |       |                  |       |   |   |   |   |
| Income tax  provision                                  |       | —                  |       | 56                    |       | 2 |   | 67 |   |
|                                                   |       |                    |       |                  |       |   |   |   |   |
| Net income                                             |       | 5,092                   |       | 423                   |       | 6,487 |   | 1,432 |   |
|                                                   |       |                    |       |                  |       |   |   |   |   |
| Redeemable  preferred stock accretion                  |       | (3,433                  | )          | (2,747                | )          | (6,824 | ) | (5,532 | ) |
|                                                   |       |                    |       |                  |       |   |   |   |   |
| Net income  (loss) attributable to common stockholders |       | $                       | 1,659      |                  | $          | (2,324 | ) | $ | (337 | ) | $ | (4,100 | ) |
|                                                        |            |                         |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |

 

See accompanying notes.

 

4

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**Real MexRestaurants, Inc.Consolidated Statementsof Cash Flows (unaudited)(in thousands)**
| ** **                                                                         | ** ** | **Six  Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                         | ** ** | **June 26,**          | ** ** | **June 27,** | ** ** |
| ** **                                                                         | ** ** | **2005**              | ** ** | **2004** | ** ** |
| **Operating  activities**                                                          |       |                  |       |   |   |
| Net income                                                                         |       | $                     | 6,487      |   | $ | 1,432 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                  |       |   |   |
| Depreciation                                                                       |       | 9,970                 |       | 6,009 |   |
| Amortization of:                                                                   |       |                  |       |   |   |
| Deferred  financing                                                                |       | 873                   |       | 440 |   |
| Debt discount                                                                      |       | —                |       | 114 |   |
| Gain on disposal  of property and equipment                                        |       | (79                   | )          | (203 | ) |
| Debt termination  costs                                                            |       | —                |       | 4,247 |   |
| Casualty gain                                                                      |       | —                |       | (548 | ) |
| Impairment of  property and equipment                                              |       | 216                   |       | 8 |   |
| Changes in  operating assets and liabilities:                                      |       |                  |       |   |   |
| Trade and other  receivables                                                       |       | (1,971                | )          | (356 | ) |
| Inventories                                                                        |       | (4,056                | )          | (714 | ) |
| Prepaid expenses  and supplies                                                     |       | (1,177                | )          | (647 | ) |
| Deferred  charges, net                                                             |       | (12                   | )          | (15 | ) |
| Other assets                                                                       |       | 449                   |       | (1,247 | ) |
| Accounts payable  and accrued liabilities                                          |       | (4,852                | )     | 376 |   |
| Other  liabilities                                                                 |       | 550                   |       | (263 | ) |
| Net cash  provided by operating activities                                         |       | 6,398                 |       | 8,633 |   |
|                                                                               |       |                  |       |   |   |
| **Investing  activities**                                                          |       |                  |       |   |   |
| Additions to  property and equipment                                               |       | (7,737                | )          | (2,951 | ) |
| Chevys  Acquisition, net of cash acquired of $3,913                                |       | (75,199               | )          | — |   |
| Leasehold  acquisition costs                                                       |       | (26                   | )          | — |   |
| Net proceeds  (costs) from disposal of property                                    |       | (10                   | )     | 12,725 |   |
| Net cash provided  by (used in) investing activities                               |       | (82,972               | )          | 9,774 |   |
|                                                                               |       |                  |       |   |   |
| **Financing  activities**                                                          |       |                  |       |   |   |
| Borrowings under  long-term debt agreements                                        |       | 75,000                |       | 105,000 |   |
| Payments on long-term  debt agreements and capital lease obligations               |       | (157                  | )          | (115,890 | ) |
| Payment of  financing costs                                                        |       | (2,880                | )          | (298 | ) |
| 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               |       | —                |       | 169 |   |
| Interest  receivable decrease on stockholder loans                                 |       | —                |       | 16 |   |
| Net cash  provided by (used in) financing activities                               |       | 71,963                |       | (16,231 | ) |
| Net increase  (decrease) in cash and cash equivalents                              |       | (4,611                | )          | 2,176 |   |
|                                                                               |       |                  |       |   |   |
| Cash and cash  equivalents at beginning of period                                  |       | 10,690                |       | 2,605 |   |
| Cash and cash  equivalents at end of period                                        |       | $                     | 6,079      |   | $ | 4,781 |   |
|                                                                               |       |                  |       |   |   |
| **Supplemental  disclosure of cash flow information**                              |       |                  |       |   |   |
| Interest paid                                                                      |       | $                     | 9,960      |   | $ | 3,605 |   |
| Income taxes  paid                                                                 |       | $                     | 2          |   | $ | 67 |   |
|                                                                               |       |                  |       |   |   |
| **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)**

**June 26, 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 198 restaurants, of which 163 are located inCalifornia and the remainder are located in 12 other states, primarily underthe trade names El Torito Restaurant, Chevys Fresh Mex and Acapulco MexicanRestaurant Y Cantina. The Company’s other major subsidiary, Real Mex Foods,Inc., (Real Mex) provides internal production, purchasing and distributionservices for the restaurant operations. On a limited basis, Real Mex alsomanufactures specialty products 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 $89,302 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 costsof  $3,237 and the assumption of an $816mortgage loan. Additionally, the Company assumed certain liabilities, includingordinary course post-petition current and long-term liabilities of the Sellers,and issued approximately $6,300 of letters of credit as security for aninsurance 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 Compounding ParticipatingPreferred Stock (Series C) and options to purchase 3,485 shares of our Class ACommon Stock. The value of the common stock was determined to be its par valuewhich was $0.001 per share. The value of the preferred stock was itsliquidation preference value upon issuance of $1, $1, and $2 per share for theSeries 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                |   | 2,648   |   |
| Inventories                               |   | 1,382   |   |
| Other current  assets                     |   | 1,429   |   |
| Property and  equipment                   |   | 47,839  |   |
| Other assets                              |   | 3,604   |   |
| Goodwill                                  |   | 48,991  |   |
| Total assets  acquired                    |   | 109,806 |   |
|                                      |   |    |   |
| Accounts payable  and accrued liabilities |   | 18,045  |   |
| Other  liabilities                        |   | 2,459   |   |
| Total  liabilities assumed                |   | 20,504  |   |
| Net assets  acquired                      |   | $       | 89,302 |   |

 

 

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 in the process ofobtaining certain opinions and valuations of the tax benefits acquired in theChevys Acquisition and is also in the process of determining the leasetermination costs of the Seller’s former headquarters; accordingly, thepurchase price allocation required by SFAS No. 141 has not yet been finalized. The allocation of the purchase price isbased on preliminary data and could change when the final valuation of certainproperty and equipment and certain intangible assets is 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** | ** ** | **Six  Months Ended** | ** ** |
|----------------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                                     | ** ** | **June 26,**            | ** ** | **June 27,**          | ** ** | **June 26,** | ** ** | **June 27,** | ** ** |
| ** **                                                     | ** ** | **2005**                | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Total revenues                                                 |       | $                       | 144,660    |                  | $          | 139,115 |   | $ | 276,671 |   | $ | 270,643 |   |
| Net income  (loss) before redeemable preferred stock accretion |       | 5,092                   |       | (993                  | )          | 6,193 |   | (1,400 | ) |
|                                                                |            |                         |            |                       |            |  |  |  |  |  |  |  |  |

 

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:

 

 
| ** **                        | ** ** | **June 26,  2005** | ** ** | **December  26,  2004** | ** ** |
|-----------------------------------|------------|--------------------|------------|-------------------------|------------|
| Senior secured  notes due 2010    |       | $                  | 105,000    |                    | $          | 105,000 |   |
| Senior Unsecured  Credit Facility |       | 75,000             |       | —                  |       |
| Mortgage                          |       | 796                |       | —                  |       |
| Other                             |       | 63                 |       | 63                      |       |
|                              |       | 180,859            |       | 105,063                 |       |
|                              |       |               |       |                    |       |
| Less current  portion             |       | (115               | )          | (63                     | )          |
|                              |       |               |       |                    |       |
|                              |       | $                  | 180,744    |                    | $          | 105,000 |   |

 

7

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On March 31, 2004,the Company retired the existing Revolving Credit and Term Loan Agreement andentered 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, with a$15,000 sub-limit for letters of credit. No amounts were outstanding under theLine as of June 26, 2005.

 

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, and commenced October 1, 2004. The proceeds ofthe Notes were used to repay a portion of the Senior A, B and C term loans, theSubordinated Debt and the fees associated with the sale of the Notes and theLine. Concurrent with the retirement of the Subordinated notes and the SeniorA, B and C term loans, the company wrote-off the unamortized cost of theassociated deferred debt fees in the amount of $4,677, recorded in DebtTermination Costs in the income statement. As a result of the failure of the Company to consummate an exchangeoffer of registered notes for the Notes, on November 8, 2004, the interest rateon the Notes increased by 0.25% per annum and an additional 0.25% per annum onFebruary 6, 2005.  The Company completedthe exchange offer for 100% of the 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 our subsidiaries.  Interest on the term loan outstanding underthe Senior Unsecured Credit Facility accrues, at the Company’s option, ateither (i) the greater of prime or the rate which is 0.5% in excess of thefederal funds rate, plus 8.5% or (ii) a reserve adjusted Eurodollar rate, plus9.5%.  As of August 1, 2005, the interestrate on the term loan was 12.88%.

 

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, 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 June 26, 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 300,016 and 258,655 shares issued and outstandingof Class A Common Stock at June 26, 2005 and December 26, 2004, respectively.There were 15,867 shares issued and outstanding of Class B Common Stock at June26, 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 andare redeemable at any time at the option of the Company.

 

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 ranks senior to all classesof 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 income (loss)attributable 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) have authorized 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 option grantsprior to 2004, the Plans provide for 50% of the options to become exercisablebased on “annual vesting,” with 10% of the grant vesting per year during thefirst five years after the grant date, and the remaining 50% to becomeexercisable based on a “cliff vesting” schedule. The 50% portion of the optionshares with the cliff vesting feature will 1) vest at an accelerated rate of20% per year (i.e., 10% of the total options granted), provided that the equityof the Company (as defined in the Plans) is greater than or equal to thespecified annual targets, 2) on any vesting anniversary date, the cumulativeunvested shares through that date would vest if the required threshold is met,and 3) if after the fifth anniversary date the required threshold is not met,unvested options shall expire and terminate. For options grants in 2004, thePlan provides for 20% of the option grants to become exercisable each year onthe anniversary date of the grants.

 

A summary of the status of the Company’s two stockoption plans as of June 26, 2005, and December 26, 2004, and changes during theperiods 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                           |       | —                         |       | —                                  |       | — |   | — |   |
| Canceled                            |       | —                         |       | —                                  |       | — |   | — |   |
| Outstanding—June  26, 2005     |       | 5,932                          |       | $                                       | 10.00      |   | 86,172 |   | $ | 33.04 |   |
|                                |       |                           |       |                                    |       |   |   |   |   |
| Exercisable at  June 26, 2005       |       | 5,932                          |       | $                                       | 10.00      |   | 21,123 |   | $ | 60.01 |   |

 

Under the 1998 Stock-Based Incentive CompensationPlan, the Company granted stock options 50% of whose vesting is contingent onone or more performance conditions. For stock options granted in 2000, thevesting is contingent on the Company’s Equity Value, as defined in its Plan,exceeding a specified threshold. If as of June 30, 2005, the Equity Valuehas not exceeded the prescribed threshold, then the performance-based portionof the option will be cancelled. For the stock option granted in 2001, 50% ofthe vesting is conditional on a change in control.

 

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 four years and theweighted-average fair value of the employee stock options granted under the1998 Stock-Based Incentive Compensation Plan is $41.14 per share. Theweighted-average remaining contractual life of the employee stock optionsgranted under the 2000 Stock-Based Incentive Compensation Plan is approximatelyseven years and the weighted-average fair value of the employee stock optionsgranted under the 2000 Stock-Based Incentive Compensation Plan is $0.47 pershare.

 

9

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At June 26, 2005, the Company has outstanding stockoptions granted under the 1998 Stock-Based Incentive Compensation Plan and the2000 Stock-Based Incentive Compensation Plan. The Company accounts for thoseplans under the recognition and measurement principles of APB OpinionNo. 25, *Accounting for Stock Issued to Employees,*andrelated interpretations. No stock-based employee compensation cost is reflectedin net income, as all options granted under those plans had an exercise priceequal to the market value as of the underlying common stock on the date ofgrant, or in the case of performance based options have an exercise price abovethe market value as of the underlying common stock on June 26, 2005. Forpurposes of pro forma disclosures, the estimated fair value of the options isamortized to expense over the options’ vesting period. Under SFAS No. 148,the Company would have incurred a $55 reduction in compensation expense for the3 months ended June 26, 2005 and $512 additional compensation expense for thesix months ended June 26, 2005.

 

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

 

The Company has amanagement agreement with two of its stockholders; Bruckman, Rosser, Sherrill& Co., L.P. and FS Private Investments, LLP. The stockholders are paid feesequating to .667% and .333%, respectively, of consolidated earnings beforeinterest, income taxes, depreciation and amortization of the Company. Expensesrelating to the agreement of $166 and $79 were recorded as general andadministrative expense in the three months ended June 26, 2005 and June 27,2004, respectively,  and $283 and $139for the six months ended June 26, 2005 and June 27, 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, LLP, respectively, for advisory andtransactional services provided to the Company pursuant to the managementagreement in connection with the Chevys Acquisition.

 

Effective March31, 2004, the Company cancelled its management agreement with RestaurantAssociates Corp. to provide services for the benefit of the Company, includinggeneral and strategic 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 $10 and $74 were recorded asgeneral and administrative expense for the three and six months, respectively,ended June 27, 2004.

 

Notes receivablefrom stockholders consisted of amounts due from stockholders related to the acquisitionof the Company’s Common and Preferred Stock. The notes bore interest at 8.0%and were fully repaid on June 28, 2004.

 

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

 

On March 31, 2004,the Company sold and leased back the land and building underlying five of the Company’srestaurants (three in Missouri and two in California) for total net proceeds of$12,012 (the “Sale Leaseback Transaction”). The Sale-Leaseback Transactionresulted in deferred gain of $3,927 that is being amortized over the lives ofthe related leases. The company recognized $49 of deferred gain for the threemonth periods ended June 26, 2005 and June 27, 2004 and $98 and $49 for the sixmonth periods ended June 26, 2005 and June 27, 2004, respectively. The deferredgain was 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 loans outstandingunder the Company’s prior credit facility.

 

10

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**Item 2.**           Management’s Discussion and Analysis ofFinancial Condition 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 looking statementswithin 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 oneof the largest full service, casual dining Mexican restaurant chain operatorsin the United States in terms of number of restaurants. We currently operate198 restaurants, of which 163 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, and a purchasing, distribution, and manufacturingsubsidiary, Real Mex Foods, Inc.

 

Our three primaryrestaurant concepts, El Torito, Acapulco and Chevys, offer high quality Mexicanfood, a wide selection of alcoholic beverages and excellent guest service.  In addition to the El Torito, El ToritoGrill, Acapulco and Chevys concepts, we operate 16 additional restaurantlocations, most of which are also full service Mexican formats, under thefollowing 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 assuming franchise agreements for 37franchised Chevys restaurants and five franchised Fuzio Universal Pastarestaurants.  The purchase price for theChevys Acquisition was approximately $77.9 million in cash and the assumptionof certain liabilities, plus the issuance of Real Mex common and preferredstock to J.W. Childs Equity Partners L.P. and its affiliate, JWC ChevysCo-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 bonusexpense, vacation pay, payroll taxes and workers’ compensation insurance andhealth insurance expenses.

 

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

 

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

 

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 June 26, 2005 and June 27, 2004 consist of 13weeks and the six months ended June 26, 2005 and June 27, 2004 consist of 26weeks. When calculating same store sales, we include a restaurant that has beenopen for more than 12 months and for the entirety of each comparable period.References to same store sales contained in this report do not include the salesof 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, income taxes,impairment of long-lived assets and self-insurance reserves. We base ourestimates on historical experience and on various other assumptions and factorsthat are believed to be reasonable under the circumstances, the results ofwhich form 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 make adjustments to our judgments and estimateswhere facts and circumstances dictate. Actual results could differ from ourestimates under different assumptions or conditions.

 

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 beginning on or after June 15, 2005. TheCompany will apply this Statement to all awards granted on or after December25, 2005 and to awards modified, repurchased, or cancelled after that date. Weexpect that the implementation of the provisions of SFAS No. 123R will have animpact consistent with our disclosures included under SFAS No. 148 in ourfiscal 2004 Form 10-K.

 

**Results of Operations**

** **

Our operatingresults for the three and six month periods ended June 26, 2005 and June 27,2004 are expressed as a percentage of total revenues below:

 
| ** **                              | ** ** | **Three  Months Ended** | ** ** | **Six  Months Ended** | ** ** |
|-----------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                              | ** ** | **June 26,  2005**      | ** ** | **June 27,  2004**    | ** ** | **June 26,  2005** | ** ** | **June 27,  2004** | ** ** |
| Total revenues                          |       | 100.0                   | %          | 100.0                 | %          | 100.0 | % | 100.0 | % |
| Cost of sales                           |       | 25.7                    |       | 24.6                  |       | 25.4 |   | 24.6 |   |
| Labor                                   |       | 34.6                    |       | 35.3                  |       | 35.2 |   | 36.3 |   |
| Direct operating  and occupancy expense |       | 23.8                    |       | 22.6                  |       | 23.7 |   | 23.0 |   |
| Total operating  costs                  |       | 84.1                    |       | 82.5                  |       | 84.3 |   | 83.9 |   |
| General and  administrative expense     |       | 4.5                     |       | 5.1                   |       | 5.2 |   | 5.3 |   |
| Depreciation and  amortization          |       | 3.8                     |       | 3.2                   |       | 3.7 |   | 3.6 |   |
| Operating income                        |       | 7.6                     |       | 9.3                   |       | 6.6 |   | 7.2 |   |
| Interest expense                        |       | 4.1                     |       | 3.6                   |       | 4.2 |   | 3.8 |   |
| Debt termination  costs                 |       | —                  |       | 5.4                   |       | — |   | 2.8 |   |
| Total other  expense, net               |       | 4.1                     |       | 8.7                   |       | 4.2 |   | 6.3 |   |
| Income before  tax provision            |       | 3.5                     |       | 0.5                   |       | 2.4 |   | 0.9 |   |
| Net income                              |       | 3.5                     |       | 0.5                   |       | 2.4 |   | 0.9 |   |

 

**Three months ended June 26, 2005 compared to thethree months ended June 27, 2004**

** **

*TotalRevenues*.  Total revenues increased by $57.2 million, or65.5%, to $144.7 million in the second quarter of 2005 from $87.4 million inthe second quarter of 2004 due to a $53.6 million increase in restaurantrevenues, a $2.7 million increase in other revenues and a $0.9 million increasein royalty and franchise fees.  Theincrease in restaurant revenues was the result of the inclusion in our resultsof operations of the Chevys restaurant sales of $52.4 million combined withcomparable store sales increases of 3.2% in the quarter, partially offset byrestaurant closures.  The increase incomparable store sales was driven by increases in pricing in El Torito conceptrestaurants of approximately 1.2% and in Acapulco concept restaurants ofapproximately 1.9%, increases in customer counts of 2.9% in the El Toritorestaurants and decreased discounting in the Acapulco restaurants.  The $2.7 million increase in other revenueswas primarily due to an increase in sales to outside customers by ourdistribution facility.  The $0.9 millionincrease in royalty and franchise fees was due to fees earned from franchisesacquired in the Chevys Acquisition.

 

*Cost ofSales*.  Total cost of sales of $37.2 million in thesecond quarter of 2005 increased $15.7 million or 72.9% as compared to thesecond quarter of 2004 primarily due to the inclusion in our results ofoperations of the Chevys restaurants cost of sales of $13.2

 

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millioncombined with higher costs associated with the increase in sales to outsidecustomers by our distribution facility and higher commodity costs.  As a percentage of total revenues, cost ofsales increased to 25.7% for the second quarter of 2005 from 24.6% for thesecond quarter of 2004 primarily due to higher commodity costs mainly in thebeef, shrimp, dairy and vegetable markets.

 

*Labor*. Labor costs of $50.0 million in the second quarter of 2005 increased by$19.1 million or 62.0% as compared to the second quarter of 2004. The increasein labor cost dollars associated with the inclusion in our results ofoperations of the Chevys restaurants was $18.5 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 34.6% for the second quarter of 2005 from35.3% for the second quarter of 2004 primarily due to lower hourly laborexpense achieved as a result of our continued focus on hourly labor controlsand scheduling.

 

*DirectOperating and Occupancy Expense*.  Directoperating and occupancy expense of $34.4 million in the second quarter of 2005increased by $14.6 million or 74.0% as compared to the second quarter of 2004.The increase in direct operating and occupancy expense associated with theinclusion in our results of operations of the Chevys restaurants was $14.7million.  Direct operating and occupancyexpense as a percentage of sales increased to 23.8% in the second quarter of2005 from 22.6% in the second quarter of 2004 primarily due to higher occupancyexpense associated with the Chevys restaurants.

 

*Generaland Administrative Expense*.  General andadministrative expense of $6.4 million in the second quarter of 2005 increasedby $1.9 million or 43.2% primarily due to increased staffing associated withthe Chevys Acquisition partially offset by lower corporate bonus expense.  General and administrative expense as apercentage of sales decreased to 4.5% in the second quarter of 2005 from 5.1%in the second quarter of 2004.

 

*Depreciation*. Depreciation expense of $5.5 million in the second quarter of 2005increased $2.7 million or 98.1% as compared to the second quarter of 2004.  The increase associated with the inclusion inour results of operations of the Chevys restaurants was $1.8 million.  As a percentage of total revenues,depreciation increased to 3.8% for the second quarter of 2005 from 3.2% for thesecond quarter of 2004.

 

*InterestExpense*.  Interest expense of $5.9 million in thesecond quarter of 2005 increased $2.8 million or 88.7% as compared to thesecond quarter of 2004 primarily due to interest on the $75.0 million SeniorUnsecured Credit Facility which was used to finance a portion of the ChevysAcquisition and an increase in interest on letters of credit issued as securityfor contracts assumed in connection with the Chevys Acquisition.  As a percentage of total revenues, interestexpense increased to 4.1% for the second quarter of 2005 from 3.6% for thesecond quarter of 2004.

 

**Six months ended June 26, 2005 compared to thesix months ended June 27, 2004**

** **

*TotalRevenues*.  Total revenues increased by $101.4 million,or 60.6%, to $268.6 million in the first six months of 2005 from $167.2 millionin the first six months of 2004 due to a $94.9 million increase in restaurantrevenues, a $4.9 million increase in other revenues and a $1.6 million increasein royalty and franchise fees.  Theincrease in restaurant revenues was the result of the inclusion in our resultsof operations of the Chevys restaurant sales of $93.3 million combined withcomparable store sales increases of 3.3% year-to-date, partially offset by restaurantclosures.  The increase in comparablestore sales was driven by increases in pricing in El Torito concept restaurantsof approximately 1.2% and in Acapulco concept restaurants of approximately1.9%, increases in customer counts of 2.9% in the El Torito restaurants anddecreased discounting in the Acapulco restaurants.  The $4.9 million increase in other revenueswas primarily due to an increase in sales to outside customers by ourdistribution facility.  The $1.6 millionincrease in royalty and franchise fees was due to fees earned from franchisesacquired in the Chevys Acquisition.

 

*Cost ofSales*.  Total cost of sales of $68.2 million in thefirst six months of 2005 increased $27.1 million or 65.9% as compared to thefirst six months of 2004 primarily due to the inclusion in our results ofoperations of the Chevys restaurants cost of sales of $23.4

 

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millioncombined with higher costs associated with the increase in sales to outsidecustomers by our distribution facility and higher commodity costs.  As a percentage of total revenues, cost ofsales increased to 25.4% for the first six months of 2005 from 24.6% for thefirst six months of 2004 primarily due to higher commodity costs mainly in thebeef, shrimp, dairy and vegetable markets.

 

*Labor*. Labor costs of $94.6 million in the first six months of 2005 increasedby $33.9 million or 55.9% as compared to the first six months of 2004. Theincrease in labor cost dollars associated with the inclusion in our results ofoperations of the Chevys restaurants was $33.3 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 35.2% for the first six months of 2005 from36.3% for the first six months of 2004 primarily due to lower hourly laborexpense achieved as a result of our continued focus on hourly labor controlsand scheduling.

 

*DirectOperating and Occupancy Expense*.  Directoperating and occupancy expense of $63.6 million in the first six months of2005 increased by $25.2 million or 65.6% as compared to the first six months of2004. The increase in direct operating and occupancy expense associated withthe inclusion in our results of operations of the Chevys restaurants was $25.4million.  Direct operating and occupancyexpense as a percentage of sales increased to 23.7% in the first six months of2005 from 23.0% in the first six months of 2004 primarily due to higheroccupancy expense associated with the Chevys restaurants.

 

*Generaland Administrative Expense*.  General andadministrative expense of $14.0 million in the first six months of 2005increased by $5.1 million or 57.3% primarily due to increased staffingassociated with the Chevys Acquisition. General and administrative expense as apercentage of sales decreased to 5.2% in the first six months of 2005 from 5.3%in the first six months of 2004.

 

*Depreciation*. Depreciation expense of $10.0 million in the first six months of 2005increased $4.0 million or 65.9% as compared to the first six months of 2004.The increase associated with the inclusion in our results of operations of theChevys restaurants was $3.2 million. As a percentage of total revenues,depreciation was relatively stable at 3.7% for the first six months of 2005compared to 3.6% for the first six months of 2004.

 

*InterestExpense*.  Interest expense of $11.3 million in thefirst six months of 2005 increased $4.9 million or 77.4% as compared to thefirst six months of 2004 primarily due interest on the $75.0 million SeniorUnsecured Credit Facility which was used to finance a portion of the ChevysAcquisition, interest on replacement letters of credit issued as security forcertain contracts 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 June 26, 2005 was $182.2million, and we had $5.4 million of revolving credit availability under ourLine. Our ability to make principal and interest payments and to fund plannedcapital expenditures will depend on our ability to generate cash in the future,which, to a certain extent, is subject to general economic, financial,competitive, legislative, regulatory and other factors that are beyond 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 foreseeable 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 indebtedness onor before maturity. We cannot assure you that we will be able to refinance anyof 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 liabilities being in excess of current assetlevels. The largest components of our accrued liabilities include reserves forour self-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/or debt service payments under our existing indebtedness.

 

*OperatingActivities*.  We had net cash provided by operatingactivities of $6.4 million for the six months ended June 26, 2005 compared withnet cash provided by operating activities of $8.6 million for the six monthsended June 27, 2004. The decrease in cash provided by operating activities wasprimarily attributable to an increase in inventories resulting from theinitiation of distribution services to the Chevys restaurants by Real Mex, anincrease in inventory levels of certain commodities to take advantage offavorable pricing and an increase in credit card receivables due to seasonallyhigh sales levels.

 

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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 six months ended June 26, 2005, were $75.2 million, net ofcash acquired of $3.9 million.  We expectto make capital expenditures totaling approximately $20.1 million in fiscal2005. $7.6 million is expected to be spent on Chevys and Fuzio Universal Pastarestaurants of which approximately $2.0 million is for an upgrade of the POSsystems and $5.6 million is for maintenance capital expenditures.  The remaining $12.5 million in capitalexpenditures includes approximately $6.2 million in maintenance capitalexpenditures for the Acapulco and El Torito restaurants and approximately $6.3million to build four new El Torito or El Torito Grill restaurants.  As of June 26, 2005, we had made capitalexpenditures totaling approximately $7.7 million comprised of $5.9 million formaintenance capital expenditures and $1.8 million for new restaurantdevelopment.

 

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 $72.0 million for the six months endedJune 26, 2005 compared with net cash used in financing activities of $16.2million for the six months ended June 27, 2004. The increase in cash providedby financing activities was primarily due to the issuance of $75.0 million innotes under a Senior Unsecured Credit Facility to partially fund the ChevysAcquisition.

 

**Debt and Other Obligations**

** **

On March 31, 2004,we sold $105.0 million aggregate principal amount of old notes.  At the closing of the sale of the old notes,we used the proceeds from the sale of the Notes and the Sale-LeasebackTransaction to repay term loans then outstanding under our prior creditfacility of $70.2 million and subordinated notes of $44.4 million in full, andentered into a new senior secured credit facility.  In connection with the retirement of our termloans then outstanding, we took a charge of $4.7 million consisting of deferredfinancing costs and discounts on the retired debt and termination of aninterest rate swap agreement at a cash cost of $0.2 million.

 

**Senior Unsecured Credit Facility**.  Concurrently 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 August 8, 2005, the interest rate onthe term loan was 12.88%.

 

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 ranging from(i) 1.75 to 1.00 for the four fiscal quarters ending on or prior toJune 30, 2005, (ii) 1.85 to 1.00 for the four fiscal quarters endingon or prior to September 30, 2005 through March 31, 2006,(iii) 2.00 to 1.00 for the four fiscal quarters ending on or prior toJune 30, 2006 through December 31, 2006, (iv) 2.15 to 1.00 forthe fiscal quarters ending on or prior to March 31, 2007 throughDecember 31, 2007, and (v) 2.30 to 1.00 thereafter untilmaturity.  Pursuant to the terms of theSenior Unsecured Credit Facility, interest coverage ratio is defined as theratio as of the last day of any fiscal quarter of (a) Consolidated EBITDA(as defined therein) for the four-fiscal quarter period then ending to(b) Consolidated Interest Expense (as defined therein) for suchfour-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 old notes,we utilized 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 outstanding letters of credit, which serve ascollateral 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 tosecure assumed letters of credit which serve as collateral for Chevys’ workers’compensation insurance programs and to guarantee performance under certain ofChevys’ operating leases.

 

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 4.0%. 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 guaranteesof the notes.

 

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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, commencing October 1, 2004.  Thenotes are fully and unconditionally guaranteed on a senior secured basis by allof our present and future domestic subsidiaries which are restrictedsubsidiaries under the indenture governing the notes.  The notes and related guarantees are securedby substantially all of our and our domestic restricted subsidiaries’ tangibleand intangible assets, subject to the prior ranking claims on such assets bythe lenders under our Line.  Theindenture governing the notes contains various affirmative and negativecovenants, subject to a number of important limitations and exceptions,including but not limited those limiting our ability to incur additionalindebtedness, make capital expenditures, pay dividends, redeem stock or makeother distributions, issue stock of our subsidiaries, make certain investmentsor acquisitions, grant liens on assets, enter into transactions withaffiliates, merge, consolidate or transfer substantially all of our assets, andtransfer and sell assets.  The covenantthat limits our incurrence of indebtedness requires that, after giving effectto any such incurrence of indebtedness and the application of the proceedsthereof, our fixed charge coverage ratio as of the date of such incurrence willbe at least (i) 2.25 to 1.00 in the case of any incurrence on or before April1, 2006 and (ii) 2.50 to 1.00 in the case of any incurrence after April 1,2006.  The indenture defines consolidatedfixed charge 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 prior to April 1, 2007 with the proceeds of one or more public equityofferings.  We are required to redeem theold notes 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 old notes, as part of an offer to exchange registerednotes for the Notes (the “Exchange Offer”). We temporarily suspended and extended the Exchange Offer on October 27,2004 in connection with the pending acquisition of Chevys.  As a result of the suspension of the ExchangeOffer, pursuant to the terms of a registration rights agreement entered intowith the initial purchasers of the old notes, we began paying additionalinterest on the old notes on November 8, 2004 at the rate of 0.25% per annum,which rate increased by an additional 0.25% per annum on February 6, 2005.  We completed the Exchange Offer on June 7,2005 reducing the interest rate to 10% per annum.

 

*Mortgage.*  Concurrently 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, 2015.

 

In connection withour acquisition of El Torito, we assumed capitalized lease obligations,collateralized with leasehold improvements, in an aggregate amount of $9.2million.  The capitalized leaseobligations have a weighted average interest rate of

 

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10.0%.  As of June 26, 2005, the principal amount duerelating to capitalized lease obligations was $1.3 million.  Principal and interest payments on thecapital lease obligations are due monthly and range from $1,100 to $7,500 permonth.  The capital lease obligationsmature between 2005 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. Some food borne illness incidents could be caused by third partyfood suppliers and transporters outside of our control. New illnesses resistantto our current precautions may develop in the future, or diseases with longincubation periods could arise, that could give rise to claims or allegationson a retroactive basis. One or more instances of food-borne illness in one ofour restaurants could negatively affect our restaurant sales if highlypublicized. This risk exists even if it were later determined that the illnesswas wrongly attributed to one of our restaurants. A number of other restaurantchains have experienced incidents related to food borne illnesses that have hada material adverse impact on their operations, and we cannot assure you that wecan avoid a similar impact upon the occurrence of a similar incident at ourrestaurants.

 

*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 keyingredients 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 our restaurantsto remove certain items from a restaurant’s menu or temporarily close arestaurant. If we temporarily close a restaurant or remove popular items from arestaurant’s menu, that restaurant may experience a significant reduction inrevenue during the time affected by the shortage or thereafter, as ourcustomers 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, results of operations and cash flows.*

* *

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 energycosts may harm the restaurant industry in general and our locations inparticular. Adverse changes in any of these factors could reduce consumertraffic or impose practical limits on pricing, which could harm our business,financial condition, results of operations and cash flows. There can be noassurance that consumers will continue to regard our products favorably or thatwe will be able to develop new products that appeal to consumer preferences,which could have a materially adverse affect on our business. Our continuedsuccess will depend in part on our ability to anticipate, identify and respondto changing consumer 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 of time before we expect a new restaurant toachieve our targeted level of performance. This is due to higher operatingcosts caused by start-up and other temporary inefficiencies such as customeracceptance and unavailability of experienced staff. Our ability to open newrestaurants is dependent upon a number of factors, many of which are beyond ourcontrol, including our ability 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

 

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expansion,which could require us to incur substantial expenditures that could materiallyadversely affect our operating results or cash flows.

 

*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,restaurant facilities, health inspection scores, 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 totally unrelatedfood service businesses, if customers mistakenly associate such unrelatedbusinesses 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 capital investedin, as well as anticipated earnings from, the damaged or destroyed properties.

 

*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 in higheremployee turnover in existing restaurants, which could have a material adverseeffect on our business, financial condition, results of operations and cashflows.

 

Wehave been affected by increasing healthcare and workers’ compensation expensesimpacting 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.

 

*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

 

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termsof three or more years that we may exercise at our option. Leases that we enterinto in the future likely will also be long-term and non-cancelable and havesimilar renewal options. If we close a restaurant, we may remain committed toperform our obligations under the applicable lease, which would include, amongother things, payment of the base rent for the balance of the lease term.Alternatively, at the end of the lease term and any renewal period for arestaurant, we may be unable to renew the lease without substantial additionalcost, if at all. We may close or relocate the restaurant, which could subjectus to construction and other costs and risks, and could have a material adverseeffect on our business. Additionally, the revenue and profit, if any, generatedat a relocated restaurant may not equal the revenue and profit generated at theexisting restaurant. Furthermore, in the past, we have been forced to closeprofitable restaurants due to the inability to renew a lease upon theexpiration of its lease term and we expect this to occur from time to time inthe 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, handling andstorage. 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 ourrestaurants to timely obtain and maintain liquor or other licenses, permits orapprovals required to serve alcoholic beverages or food could delay or preventthe opening of, or adversely impact the viability of, the restaurant and wecould lose significant revenue. Our restaurants are also subject in each statein which we operate 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 which 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.

 

*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

 

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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 adverseeffect on our business, including the failure of our brands and brandedproducts to achieve 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 or 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.

 

*The integration of Chevys mayresult in substantial costs, delays and other problems.*

 

Our future performance will depend heavily on ourability to integrate Chevys.  Tointegrate a newly acquired business such as Chevys, we must integraterestaurant resources and extend our financial and management controls andoperating, administrative and information systems in a timely manner and onsatisfactory terms and conditions.  Wemay not be able to successfully integrate Chevys or realize projected costsavings and synergies in connection with the Chevys Acquisition on thetimetable contemplated or at all.

 

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Furthermore, the costs of the Chevys Acquisition couldsignificantly impact our short-term operating results. These costs couldinclude:

 

**•**                                          restructuring charges associated with theChevys Acquisition; and

 

**•**                                          acquisition costs including accounting and legal fees,investment banking fees, recognition of transaction-related obligations andvarious other acquisition-related costs.

 

The integration of Chevys will require the expenditureof substantial managerial, operating, financial and other resources and mayalso lead to a diversion of management’s attention from our ongoing businessconcerns.

 

**Our substantial level of indebtednesscould adversely affect our financial condition.**

** **

We have substantial indebtedness.  As of June 26, 2005, we had $182.2 million ofindebtedness 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 oursenior secured and unsecured credit facilities impose significant operating andfinancial restrictions, which may prevent us from pursuing certain businessopportunities and taking certain actions.**

** **

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 prior to stated maturities;

 

**•**                                          pay dividends on, redeem or repurchase our stock ormake other distributions;

 

**•**                                          make acquisitions or investments;

 

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**•**                                          create or incur liens;

 

**•**                                          transfer or sell certain assets or merge orconsolidate with or into other companies;

 

**•**                                          enter into certain transactions with affiliates;

 

**•**                                          sell stock in our subsidiaries;

 

**•**                                          restrict dividends, distributions or other paymentsfrom our subsidiaries; and

 

**•**                                          otherwise conduct necessary corporate activities.

 

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 business opportunities.  A breach of any of these covenants couldresult in a default in respect of the related indebtedness.  If a default occurs, the relevant lenderscould elect to declare the indebtedness, together with accrued interest andother fees, to be immediately due and payable and proceed against anycollateral securing 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 which 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, even though 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.Also, these forward looking statements present our estimates and assumptionsonly as of the date of this report. Except for our ongoing obligation todisclose material information as required by federal securities laws, we do notintend to update you concerning any future revisions to any forward lookingstatements to reflect events or circumstances occurring after the date of thisreport.

 

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

** **

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

 

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 six month ended June 26, 2005 andin fiscal year 2004 were denominated in U.S. dollars. Therefore, foreigncurrency fluctuations did not materially affect our financial results in 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 August 1,2005, 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 into 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 to materiallyaffect, our internal control over financial reporting.

 

**PARTIIOTHER INFORMATION**

** **

**Item1.  Legal Proceedings**

** **

Our Company isperiodically a defendant in cases involving personal injury and other matterswhich 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: August 8, 2005 | By:                        | /s/ Frederick F. Wolfe |
|                  |                       | Frederick F. Wolfe |
|                  |                       | President & Chief Executive Officer  (principal executive officer) |
|                  |                       |   |
|                  |                       |   |
| Dated: August 8, 2005 | By:                        | /s/ Steven Tanner |
|                  |                       | Steven Tanner |
|                  |                       | Chief Financial Officer  (principal financial and accounting officer) |

 

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