**FORM 10-Q**

 

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, DC  20549**

 
| **ý**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |       |                                                                                          |
| **For the quarterly period ended   July 3, 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     1-12692**

 

**MORTON’S RESTAURANT GROUP, INC.**

(Exact name of registrant as specified in its charter)

 
| **Delaware**                                                    |   | **13-3490149**                       |
|-----------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of incorporation or  organization) |   | (I.R.S. employer identification no.) |
|                                                            |   |                                 |
| **3333 New Hyde Park Road, Suite 210, New Hyde Park, New York** |   | **11042**                            |
| (Address of principal executive offices)                        |   | (Zip code)                           |
|                                                            |   |                                 |
| **516-627-1515**                                                |
| (Registrant’s telephone number, including area code)       |

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes ý or No o.

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act). Yes o or No ý.

 

As ofAugust 15, 2005, the registrant had 1,000 shares of its Common Stock, $0.01 parvalue, outstanding.

 

 

----

 

MORTON’S RESTAURANT GROUP, INC. AND SUBSIDIARIES

 

INDEX

 
| Part I - Financial  Information                                                                                             |   |
|-----------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                        |   |
| Item 1.  Financial Statements                                                                                               |   |
|                                                                                                                        |   |
| Consolidated Balance  Sheets as of July 3, 2005 (unaudited) and January 2, 2005                                             |   |
|                                                                                                                        |   |
| Consolidated  Statements of Operations for the three and six month periods ended July 3,  2005 and July 4, 2004 - unaudited |   |
|                                                                                                                        |   |
| Consolidated  Statements of Cash Flows for the six month periods ended July 3, 2005 and  July 4, 2004 - unaudited           |   |
|                                                                                                                        |   |
| Notes  to Unaudited Consolidated Financial Statements                                                                       |   |
|                                                                                                                        |   |
| Item 2. Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         |   |
|                                                                                                                        |   |
| Item 3.  Quantitative and Qualitative Disclosure about Market Risk                                                          |   |
|                                                                                                                        |   |
| Item 4. Controls  and Procedures                                                                                            |   |
|                                                                                                                        |   |
| Part  II - Other Information                                                                                                |   |
|                                                                                                                        |   |
| Item  1. Legal Proceedings                                                                                                  |   |
|                                                                                                                        |   |
| Item 6.  Exhibits                                                                                                           |   |
|                                                                                                                        |   |
| Signatures                                                                                                                  |   |

 

2

----

 

Part I - Financial Information

 

Item 1.  FinancialStatements

 

MORTON’S RESTAURANT GROUP, INC. AND SUBSIDIARIES

 

Consolidated Balance Sheets

 

(amounts in thousands)

 
| ** **                                      | ** ** | **July 3,  2005** | ** ** | **January 2,  2005** | ** ** |
|-------------------------------------------------|------------|-------------------|------------|----------------------|------------|
| ** **                                      | ** ** | **(unaudited)**   | ** ** | ** **           | ** ** |
| Assets                                          |       |              |       |                 |       |
| Current assets:                                 |       |              |       |                 |       |
| Cash and cash equivalents                       |       | $                 | 9,479      |                 | $          | 10,179 |   |
| Restricted cash                                 |       | 417               |       | 548                  |       |
| Marketable securities                           |       | 4,183             |       | 4,112                |       |
| Accounts receivable                             |       | 3,950             |       | 4,346                |       |
| Inventories                                     |       | 9,026             |       | 9,302                |       |
| Prepaid expenses and other current  assets |       | 5,517             |       | 6,600                |       |
| Deferred income taxes                           |       | 2,999             |       | 5,237                |       |
|                                            |       |              |       |                 |       |
| Total current assets                            |       | 35,571            |       | 40,324               |       |
|                                            |       |              |       |                 |       |
| Property and equipment, at cost:                |       |              |       |                 |       |
| Furniture, fixtures and equipment               |       | 18,897            |       | 16,499               |       |
| Buildings and leasehold improvements            |       | 52,578            |       | 45,139               |       |
| Land                                            |       | 8,474             |       | 8,474                |       |
| Construction in progress                        |       | 1,819             |       | 5,234                |       |
|                                            |       | 81,768            |       | 75,346               |       |
| Less accumulated depreciation and  amortization |       | 17,267            |       | 13,859               |       |
| Net property and equipment                      |       | 64,501            |       | 61,487               |       |
|                                            |       |              |       |                 |       |
| Intangible asset                                |       | 92,000            |       | 92,000               |       |
| Goodwill                                        |       | 61,528            |       | 61,789               |       |
| Other assets and deferred expenses, net         |       | 8,459             |       | 8,836                |       |
|                                            |       | $                 | 262,059    |                 | $          | 264,436 |   |

 

3

----

 

MORTON’S RESTAURANT GROUP, INC.AND SUBSIDIARIES

 

Consolidated Balance Sheets,Continued

 

(amounts in thousands, exceptshare and per share amounts)

 
| ** **                                                                                                                    | ** ** | **July 3,  2005** | ** ** | **January 2,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|----------------------|------------|
| ** **                                                                                                                    | ** ** | **(unaudited)**   | ** ** | ** **           | ** ** |
| Liabilities and Stockholder’s Equity                                                                                     |       |              |       |                 |       |
|                                                                                                                          |       |              |       |                 |       |
| Current liabilities:                                                                                                          |       |              |       |                 |       |
| Accounts payable                                                                                                              |       | $                 | 5,313      |                 | $          | 6,390 |   |
| Accrued expenses                                                                                                              |       | 28,089            |       | 30,902               |       |
| Current portion of obligations to financial  institutions                                                                     |       | 109               |       | 521                  |       |
| Accrued income taxes                                                                                                          |       | 217               |       | 379                  |       |
|                                                                                                                          |       |              |       |                 |       |
| Total current liabilities                                                                                                     |       | 33,728            |       | 38,192               |       |
|                                                                                                                          |       |              |       |                 |       |
| 7.5% senior secured notes, net of  unamortized discount of $12,362 and $13,283 at July 3, 2005 and January 2,  2005           |       | 92,638            |       | 91,717               |       |
| Obligations to financial institutions, less  current maturities                                                               |       | 3,525             |       | 6,636                |       |
| Deferred income taxes                                                                                                         |       | 23,004            |       | 23,004               |       |
| Other liabilities                                                                                                             |       | 9,832             |       | 7,546                |       |
|                                                                                                                          |       |              |       |                 |       |
| Total liabilities                                                                                                             |       | 162,727           |       | 167,095              |       |
|                                                                                                                          |       |              |       |                 |       |
| Commitments and contingencies                                                                                                 |       |              |       |                 |       |
|                                                                                                                          |       |              |       |                 |       |
| Stockholder’s equity:                                                                                                    |       |              |       |                 |       |
| Common stock, $0.01 par value per share. Authorized,  issued and outstanding 1,000 shares at July 3, 2005 and January 2, 2005 |       | —            |       | —               |       |
| Additional paid-in capital                                                                                                    |       | 97,077            |       | 97,077               |       |
| Accumulated other comprehensive income                                                                                        |       | 100               |       | 189                  |       |
| Retained earnings                                                                                                             |       | 2,155             |       | 75                   |       |
|                                                                                                                          |       |              |       |                 |       |
| Total stockholder’s equity                                                                                               |       | 99,332            |       | 97,341               |       |
|                                                                                                                          |       |              |       |                 |       |
|                                                                                                                          |       | $                 | 262,059    |                 | $          | 264,436 |   |

 

Seeaccompanying notes to unaudited consolidated financial statements.

 

4

----

 

MORTON’S RESTAURANT GROUP, INC. AND SUBSIDIARIES

 

Consolidated Statements of Operations

 

(amounts in thousands)

 
| ** **                                           | ** ** | **Three month periods ended** | ** ** | **Six month periods ended** | ** ** |
|------------------------------------------------------|------------|-------------------------------|------------|-----------------------------|------------|
| ** **                                           | ** ** | **July 3,  2005**             | ** ** | **July 4,  2004**           | ** ** | **July 3,  2005** | ** ** | **July 4,  2004** | ** ** |
| ** **                                           | ** ** | **(unaudited)**               | ** ** |
| Revenues                                             |       | $                             | 72,940     |                        | $          | 64,911 |   | $ | 150,278 |   | $ | 137,892 |   |
|                                                 |       |                          |       |                        |       |   |   |   |   |
| Food and beverage costs                              |       | 24,047                        |       | 21,988                      |       | 50,049 |   | 46,462 |   |
| Restaurant operating expenses                        |       | 34,954                        |       | 31,453                      |       | 69,730 |   | 64,049 |   |
| Pre-opening costs, depreciation and  amortization    |       | 2,031                         |       | 1,746                       |       | 4,755 |   | 3,380 |   |
| General and administrative expenses                  |       | 5,438                         |       | 4,662                       |       | 10,638 |   | 9,548 |   |
| Marketing and promotional expenses                   |       | 1,481                         |       | 2,240                       |       | 2,904 |   | 4,869 |   |
| Costs associated with the repayment of  certain debt |       | —                        |       | —                      |       | 174 |   | 264 |   |
| Gain on sale of investment                           |       | (16                           | )          | —                      |       | (664 | ) | — |   |
| Interest expense, net                                |       | 2,699                         |       | 2,866                       |       | 5,379 |   | 5,937 |   |
| Management fee paid to related party                 |       | 700                           |       | 700                         |       | 1,400 |   | 1,400 |   |
|                                                 |       |                          |       |                        |       |   |   |   |   |
| Income (loss) before income taxes                    |       | 1,606                         |       | (744                        | )          | 5,913 |   | 1,983 |   |
|                                                 |       |                          |       |                        |       |   |   |   |   |
| Income tax expense (benefit)                         |       | 685                           |       | (223                        | )          | 2,838 |   | 595 |   |
|                                                 |       |                          |       |                        |       |   |   |   |   |
| Net income (loss)                                    |       | $                             | 921        |                        | $          | (521 | ) | $ | 3,075 |   | $ | 1,388 |   |

 

See accompanying notes to unaudited consolidated financial statements.

 

5

----

 

MORTON’S RESTAURANT GROUP, INC. AND SUBSIDIARIES

 

Consolidated Statements of Cash Flows

 

(amounts in thousands)

 
| ** **                                                                         | ** ** | **Six month periods ended** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                         | ** ** | **July 3, 2005**            | ** ** | **July 4, 2004** | ** ** |
| ** **                                                                         | ** ** | **(unaudited)**             | ** ** |
| Cash flows from operating activities:                                              |       |                        |       |   |   |
| Net income                                                                         |       | $                           | 3,075      |   | $ | 1,388 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                        |       |   |   |
| Depreciation, amortization and other  non-cash charges                             |       | 5,352                       |       | 5,338 |   |
| Deferred income taxes                                                              |       | 2,499                       |       | 553 |   |
| Change in assets and liabilities:                                                  |       |                        |       |   |   |
| Accounts receivable                                                                |       | 392                         |       | 784 |   |
| Inventories                                                                        |       | 265                         |       | (399 | ) |
| Prepaid expenses and other assets                                                  |       | 923                         |       | (792 | ) |
| Accounts payable, accrued expenses and  other liabilities                          |       | (2,108                      | )          | (4,158 | ) |
| Accrued income taxes                                                               |       | (176                        | )          | (254 | ) |
| Net cash provided by operating activities                                          |       | 10,222                      |       | 2,460 |   |
|                                                                               |       |                        |       |   |   |
| Cash flows from investing activities:                                              |       |                        |       |   |   |
| Purchases of property and equipment                                                |       | (6,454                      | )          | (3,638 | ) |
| Increase in marketable securities                                                  |       | (71                         | )          | (1,741 | ) |
| Net cash used in investing activities                                              |       | (6,525                      | )          | (5,379 | ) |
|                                                                               |       |                        |       |   |   |
| Cash flows from financing activities:                                              |       |                        |       |   |   |
| Principal reduction on obligations to financial  institutions                      |       | (3,523                      | )          | (5,532 | ) |
| Payment of deferred financing costs                                                |       | —                      |       | (550 | ) |
| Dividends paid                                                                     |       | (995                        | )          | (6,789 | ) |
| Decrease in restricted cash                                                        |       | 131                         |       | 79 |   |
| Net cash used in financing activities                                              |       | (4,387                      | )          | (12,792 | ) |
|                                                                               |       |                        |       |   |   |
| Effect of exchange rate changes on cash                                            |       | (10                         | )          | (8 | ) |
|                                                                               |       |                        |       |   |   |
| Net decrease in cash and cash equivalents                                          |       | (700                        | )          | (15,719 | ) |
|                                                                               |       |                        |       |   |   |
| Cash and cash equivalents at beginning of  period                                  |       | 10,179                      |       | 17,997 |   |
|                                                                               |       |                        |       |   |   |
| Cash and cash equivalents at end of period                                         |       | $                           | 9,479      |   | $ | 2,278 |   |

 

Seeaccompanying notes to unaudited consolidated financial statements.

 

6

----

 

MORTON’S RESTAURANT GROUP, INC. AND SUBSIDIARIES

 

Notes to Unaudited Consolidated FinancialStatements

 

July 3, 2005 and July 4, 2004

 

**1)**            **Basis of Presentation**

 

Theaccompanying unaudited consolidated financial statements of Morton’s RestaurantGroup, Inc. and its subsidiaries (the “Company,” “we,” “us” and “our”) havebeen prepared in accordance with accounting principles generally accepted inthe United States of America for interim financial information and with theinstructions to Form 10-Q.****Accordingly,they do not include all information and footnotes required by accountingprinciples generally accepted in the United States of America for completefinancial statements and should be read in conjunction with the Annual Reporton Form 10-K for the fiscal year ended January 2, 2005.

 

Theaccompanying consolidated financial statements are unaudited and include alladjustments (consisting of normal recurring adjustments and accruals) thatmanagement considers necessary for a fair presentation of its financialposition and results of operations for the interim periods presented.  The results of operations for the interimperiods are not necessarily indicative of the results that may be expected forthe full year.

 

Thepreparation of financial statements in conformity with generally acceptedaccounting principles requires management of the Company to make estimates andassumptions relating to the reported amount of assets, liabilities, revenuesand expenses reported during the period. Actual results could differ from those estimates.

 

The Company uses a 52/53week fiscal year which ends on the Sunday closest to January 1. Approximatelyevery six or seven years, a 53rd week will be added.

 

Morton’s RestaurantGroup, Inc. (“MRG”) was incorporated as a Delaware corporation on October 3,1988 and is a wholly-owned subsidiary of Morton’s Holding Company, Inc. (“MHCI”),which was incorporated as a Delaware corporation on March 10, 2004 and becamethe direct parent of MRG on June 4, 2004. MHCI is a wholly owned subsidiary ofMorton’s Holdings, LLC (“MHLLC”), a Delaware limited liability company formedon April 4, 2002.

 

**2)****           ****Recent Events**

 

During2005, the Company received proceeds of approximately $674,000 from the sale ofstock in Charlie Brown’s Acquisition Corp., an affiliate of Castle Harlan,Inc., and recorded a gain on the sale of its investment of approximately$664,000 in the consolidated statement of operations for the six month periodended July 3, 2005.

 

**3)**            **Statements of Cash Flows**

 

Forthe purposes of the consolidated statements of cash flows, the Companyconsiders all highly liquid instruments purchased with an original maturity ofthree months or less to be cash equivalents. The Company paid cash interest of approximately $4,315,000 (whichincludes capitalized interest of approximately $108,000) and $4,811,000, andincome taxes, net of refunds, of approximately $525,000 and $318,000, for the sixmonth periods ended July 3, 2005 and July 4, 2004, respectively.

 

7

----

 

**4)**            **Restricted Cash**

 

Restrictedcash of $417,000 and $548,000 as of July 3, 2005 and January 2, 2005,respectively, represents cash collateral relating to an interest rate swapagreement with Bank of America, formerly Fleet National Bank (“B of A”). SeeNote 6.

 

**5)****            Intangible Asset and Goodwill**

 

The identifiableintangible asset acquired represents the Company’s trade name “Morton’s,” whichhas an indefinite life and accordingly is not subject to amortization, but issubject to impairment testing. The trade name is used in the advertising andmarketing of the restaurants and is widely recognized and accepted by consumersin its respective market as an indication of and recognition of service, valueand quality. Goodwill represents the excess of costs over fair value of assetsof the business acquired. During fiscal 2005, goodwill was reduced by $261,000which represents an adjustment in purchase accounting as a result of a revisionto a deferred tax asset valuation allowance assumed at the time of purchase.

 

**6)****           ****DerivativeFinancial Instruments**

 

The Company accounts for its derivative financialinstruments in accordance with SFAS No. 133, “Accounting for DerivativeInstruments and Hedging Activities,” as amended by SFAS No. 137 and SFAS No.138.  SFAS No. 133 establishes accountingand reporting standards for derivative instruments, including certainderivative instruments embedded in other contracts, and for hedgingactivities.  It requires that an entityrecognize all derivatives as either assets or liabilities in the statement offinancial position and measures those instruments at fair value.  As of July 3, 2005, the Company’s derivativefinancial instrument consists of one interest rate swap agreement with anotional amount of $20,000,000. Additionally, one interest rate swap agreementwith a notional amount of $20,000,000 expired in October 2004. The Company’sinterest rate swap agreements are accounted for as speculative instruments andresulting changes in fair market value have been charged or credited tointerest expense, net in the consolidated statements of operations.  As of July 3, 2005, in accordance with SFASNo. 133 the receivable was approximately $26,000. As of January 2, 2005, inaccordance with SFAS No. 133, the liability was approximately $77,000.

 

**7)****           ****ComprehensiveIncome**

 

The components of comprehensive income for the sixmonth periods ended July 3, 2005 and July 4, 2004 are as follows (amounts inthousands):

 
| ** **                         | ** ** | **Six month periods ended** | ** ** |
|------------------------------------|------------|-----------------------------|------------|
| ** **                         | ** ** | **July 3, 2005**            | ** ** | **July 4, 2004** | ** ** |
|                               |       |                        |       |   |   |
| Net income                         |       | $                           | 3,075      |   | $ | 1,388 |   |
| Other comprehensive income (loss): |       |                        |       |   |   |
| Foreign currency translation       |       | (89                         | )          | (58 | ) |
| Total comprehensive income         |       | $                           | 2,986      |   | $ | 1,330 |   |

 

**8)****            Dividend**

 

On June 4,2004, MHCI completed a $40,000,000 14% senior secured notes offering. The notesare secured by the assets of MHCI, which include the stock of MRG.  The notes are not secured by the assets of,nor are they guaranteed by, MRG or any of its subsidiaries.

 

Pursuant to the MHCI notes, if at the end of a fiscal quarter theCompany has cash and cash equivalents and marketable securities in excess of$5,000,000, excluding up to $750,000 of cash and cash equivalents held by oneor more of the Company’s foreign subsidiaries, and is permitted to pay adividend under the Restricted Payments covenant of the 7.5% senior securednotes (defined therein), the Company is required to pay a dividend, to theextent permitted, to MHCI to repay outstanding PIK notes.  The dividend will be in the amount of thelesser of the excess cash and cash equivalents and marketable securities overthe

 

8

----

 

$5,000,000 threshold or the aggregate outstanding PIK notes. On May 12,2005, the Company paid such a dividend of approximately $995,000 to MHCI.

 

9

----

 

**9)****            EmployeeSubscription Agreements**

 

Certain of our executives and other employees have been granted commonunits of MHLLC, which represent an ownership interest in MHLLC, pursuant toemployee subscription agreements.  MHLLC’sBoard approved 1,711,344 common units available for grant of which 1,497,585,28,600, 20,800 and 1,600 were granted in fiscal 2003, fiscal 2004, on January25, 2005 and on May 24, 2005, respectively. The fair value of each common unit granted during fiscal 2003, fiscal2004, on January 25, 2005 and on May 24, 2005 was $0.01.  Common units granted to an employee pursuantto employee subscription agreements are granted at no cost to the employee.These common units are subject to vesting. Fifty percent of the granted common units vest upon certain dates if theemployee is employed as of such date. However, if the employee has been continuously employed by the Companyfrom the date of grant to the date of a change of control, any unvested timevesting units will immediately vest simultaneously with the consummation of thechange of control. In addition, fifty percent of the common units will vestupon certain change of control or liquidation events if, upon the occurrence ofsuch an event, Castle Harlan Partners III, L.P. achieves an internal rate ofreturn of at least 30% and the employee is employed as of such date.  Upon termination of employment, unvestedcommon units will be forfeited and vested common units will be subject torepurchase pursuant to the terms of MHLLC’s operating agreement.  Stock-based employee compensation expenserelated to this plan is charged to the Company based on the recognition andmeasurement provisions of Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees,” and related interpretations.  Accordingly, the Company recognizedcompensation expense relating to the vesting of common units granted in ourconsolidated statements of operations for the three and six month periods endedJuly 3, 2005 and July 4, 2004.  Thecompensation expense recorded during the three and six month periods ended July3, 2005 and July 4, 2004, represents the straight-line amortization of thedifference between the fair value at the date of grant of $0.01 per common unitand the exercise price (which is zero) of the common units of the outstandingtime-vesting common units for the respective period.  The remaining compensation expense that wasmeasured at the date of grant will be amortized on a straight-line basis overthe remaining vesting period. Compensation expense relating to the other 50% of common units granted,which vest upon certain change of control or liquidation events if, upon theoccurrence of such an event, Castle Harlan Partners III, L.P. achieves aninternal rate of return of at least 30%, will be measured and recognized if andwhen these events occur.

 

Activity relating to the common units granted pursuant to employeesubscription agreements is as follows:

 
| Unvested common units outstanding as of January 4,  2004 |   | 1,482,385 | ** ** |
|----------------------------------------------------------|--------|-----------|------------|
| Granted units                                            |   | 28,600    |       |
| Vested units                                             |   | —    |       |
| Forfeited units                                          |   | (17,600   | )          |
| Unvested common units outstanding as of  January 2, 2005 |   | 1,493,385 |       |
| Granted units                                            |   | 22,400    |       |
| Vested units                                             |   | —    |       |
| Forfeited units                                          |   | (172,734  | )          |
| Unvested common units outstanding as of  July 3, 2005    |   | 1,343,051 |       |

 

As of July 3, 2005, there were 368,293 common unitsavailable for grant.

 

In December 2002, the FASB issued SFAS No. 148, “Accountingfor Stock-Based Compensation-Transition and Disclosure.” SFAS No. 148 providesalternative methods of transition for a voluntary change to the fair valuemethod of accounting for stock-based employee compensation as originallyprovided by SFAS No. 123, “Accounting for Stock-Based Compensation.”Additionally, SFAS No. 148 amends the disclosure requirements of SFAS No. 123to require prominent disclosure in both the annual and interim financialstatements about the method of accounting for stock-based compensation and theeffect of the

 

10

----

 

method used onreported results. The transitional requirements of SFAS No. 148 are effectivefor all financial statements for fiscal years ending after December 15, 2002.Due to the fact that the compensation expense on the unvested common units isbased on the fair value of the common units of MHLLC at the date of grant,there is no difference between reported net income and the pro forma net incomethat would be recognized under SFAS No. 123.

 

In December 2004, the FASB issued SFAS No. 123(revised 2004), “Share-Based Payment.” This statement replaces SFAS No. 123, “Accountingfor Stock-Based Compensation” and supersedes APB Opinion No. 25, “Accountingfor Stock Issued to Employees.” SFAS No. 123(R) requires all stock-basedemployee compensation to be recorded as an expense in the consolidatedstatement of operations and that such cost be measured according to the fairvalue of stock options. SFAS No. 123(R) will be effective the first annualreporting period that begins after June 15, 2005.  As the Company already charges stock-basedemployee compensation expense related to units issued pursuant to employeesubscription agreements based on the fair value of such units, the adoption ofthis statement will not have any effect on the Company’s consolidated financialstatements.

 

**10)****          Financial Information about Geographic Areas**

 

Income (loss) before income taxes for the Company’sdomestic and foreign operations are as follows (amounts in thousands):

 
| ** ** | ** ** | **Three month periods ended** | ** ** | **Six month periods ended** | ** ** |
|------------|------------|-------------------------------|------------|-----------------------------|------------|
| ** ** | ** ** | **July 3,  2005**             | ** ** | **July 4,  2004**           | ** ** | **July 3,  2005** | ** ** | **July 4,  2004** | ** ** |
|       |       |                          |       |                        |       |   |   |   |   |
| Domestic   |       | $                             | 994        |                        | $          | (1,020 | ) | $ | 4,738 |   | $ | 1,324 |   |
| Foreign    |       | 612                           |       | 276                         |       | 1,175 |   | 659 |   |
| Total      |       | $                             | 1,606      |                        | $          | (744 | ) | $ | 5,913 |   | $ | 1,983 |   |

 

**11)****          Restaurant Activity**

 

During July 2004, a new Morton’s steakhouse was opened in White Plains,New York. During the first quarter of 2005, new Morton’s steakhouses wereopened in Bethesda, Maryland; Charlotte, North Carolina and Chicago, Illinois.During August 2005, a new Morton’s steakhouse opened in Atlantic City, NewJersey. No restaurants were closed during the six month periods ended July 3,2005 and July 4, 2004. The Company has signed leases to open new Morton’ssteakhouses in Troy, Michigan, Coral Gables, Florida and Fort Lauderdale,Florida.

 

The Company records rental expense on a straight-line basis from thedate that the Company takes control of the premises over the lease term. Anydifference between the calculated expense and the amounts actually paid arereflected as a deferred rent liability included in other liabilities in theconsolidated balance sheets. The Company also includes landlord allowances forleasehold improvements, furniture, fixtures and equipment in the deferred rentliability. These amounts are amortized as a reduction of rent expense on astraight-line basis from the date that the Company takes control of thepremises over the lease term. The Company has a policy of capitalizing theportion of deferred rent during the construction period in leaseholdimprovements.

 

**12)****          Legal Matters and Contingencies**

 

Since August 2002, a number of the Company’s currentand former employees in New York, Boston and Florida have initiatedarbitrations with the American Arbitration Association in their respectivestates alleging that the Company has violated state (Boston arbitration), stateand federal (New York arbitrations) and federal (Florida arbitrations) wage andhour laws regarding the sharing of tips with other employees and

 

11

----

 

failure to pay forall hours worked. There are two group arbitrations pending in Florida. One isproceeding in West Palm Beach as a collective action (hereafter referred to as “WestPalm Beach arbitration”) with approximately thirty claimants. The second isproceeding in Miami as a consolidated action (hereafter “Miami arbitration”)with approximately six claimants. Potential class members in the West Palm Beach arbitration were sentnotices notifying them of the arbitration and advising them if they wish toparticipate in the arbitration they must sign and return a consent form.  In addition, there are two individual demandsfor arbitration pending in Florida which may ultimately be joined to the Miamiarbitration.

 

In general, thecomplainants are seeking restitution of tips, the difference between the tipcredit wage and the minimum wage, payment for hours worked off the clock (inthe Miami arbitration and in the individual Florida arbitrations only),liquidated damages and attorneys’ fees and costs. The arbitrator in the NewYork arbitrations has permitted the complainants to consolidate theirarbitrations into one action and proceed as a collective action. The Miami claimantsare also seeking to consolidate their arbitrations. The arbitrator has ruledthat the claims cannot be consolidated but is allowing the case to proceed as acollective action. The Boston arbitrator has ruled that the claimants mayproceed as a class, but to date there are only three people in the class and noclass has been certified. The Company intends to and is contesting thesematters vigorously. Management believes an adverse opinion in any one of thesecases would not have a material adverse impact on the Company’s financialcondition.

 

In November 2004, current and former employees of theSacramento Morton’s steakhouse commenced a federal lawsuit assertingindividual, representative and class claims against the Sacramento Morton’ssteakhouse and several other Morton’s steakhouses.  The plaintiffs asserted claims based on theCompany’s alleged failure to provide them with meal and rest periods, and forunlawful tip sharing and unfair competition. The plaintiffs seek restitution of tips, meal and break periodcompensation and attorneys’ fees. Dismissals with prejudice for all defendants,except the Sacramento Morton’s steakhouse, were granted.  The claims against the Sacramento Morton’ssteakhouse have been moved to arbitration.

 

In May 2005,a former employee of the Boston restaurant filed a nationwide class actioncomplaint in federal court in Massachusetts alleging that the tip out violatesthe Fair Labor Standards Act. The Company moved to dismiss the complaint andcompel arbitration.  While the motion waspending, the plaintiff filed a nationwide collective action demand forarbitration with the American Arbitration Association.  The demand for arbitration alleges the samefacts as the lawsuit filed in federal court. The motion to dismiss is still pending in federal court.

 

The Company is involved in various other claims andlegal actions arising in the ordinary course of business. Management does notbelieve that the ultimate resolution of these actions will have a materialadverse effect on the Company’s consolidated financial position, results ofoperations, liquidity and capital resources.

 

**13)****          Supplemental Condensed ConsolidatingFinancial Information**

 

The obligations of Morton’s Restaurant Group, Inc.(the “Issuer”) related to the 7.5% senior secured notes are fully andunconditionally guaranteed on a joint and several basis and on a senior basisby certain of the Company’s wholly-owned domestic subsidiaries (the “Guarantors”).These guarantees are senior secured obligations of the Guarantors, subject toliens permitted under the indenture governing the 7.5% senior secured notes,rank senior in right of payment to all subordinated indebtedness of theGuarantors and rank *pari passu* inright of payment with all existing and future senior indebtedness of theGuarantors. There are no restrictions on the Company’s ability to obtain cashdividends or other distributions of funds from the Guarantors, except thoseimposed by applicable law and certain contractual restrictions, which do notexceed 25% of consolidated net assets of any Guarantor, that are permittedunder the indenture governing the 7.5% senior secured notes. The followingsupplemental financial information sets forth, on a condensed consolidatingbasis, balance sheets, statements of operations and statements of cash flowsfor the Issuer, domestic subsidiaries of the Company that are Guarantors andforeign subsidiaries and domestic subsidiaries of the Company that are notGuarantors (collectively, the “Non-Guarantor Subsidiaries”). The Company hasnot presented separate financial statements and other disclosures concerningthe Guarantor Subsidiaries because management has determined that suchinformation is not material to investors.

 

12

----

 

**Supplemental Consolidating Balance Sheet**

**July 3, 2005**

**(unaudited)**

 

**(amounts in thousands)**

 
| ** **                                | ** ** | **Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| Assets                                    |       |       |       |                        |       |                            |       |             |       |             |       |
| Current assets:                           |       |       |       |                        |       |                            |       |             |       |             |       |
| Cash and cash equivalents                 |       | $          | 6,863      |                        | $          | 2,313                           |       | $                | 303        |             | $          | — |   | $ | 9,479 |   |
| Restricted cash                           |       | 417        |       | —                      |       | —                          |       | —           |       | 417              |       |
| Marketable securities                     |       | 4,183      |       | —                      |       | —                          |       | —           |       | 4,183            |       |
| Accounts receivable                       |       | —     |       | 3,768                       |       | 182                             |       | —           |       | 3,950            |       |
| Inventories                               |       | —     |       | 8,500                       |       | 526                             |       | —           |       | 9,026            |       |
| Prepaid expenses and other current assets |       | 392        |       | 5,074                       |       | 51                              |       | —           |       | 5,517            |       |
| Deferred income taxes                     |       | (3,230     | )          | 6,229                       |       | —                          |       | —           |       | 2,999            |       |
|                                      |       |       |       |                        |       |                            |       |             |       |             |       |
| Total current assets                      |       | 8,625      |       | 25,884                      |       | 1,062                           |       | —           |       | 35,571           |       |
|                                      |       |       |       |                        |       |                            |       |             |       |             |       |
| Property and equipment, net               |       | 134        |       | 63,560                      |       | 807                             |       | —           |       | 64,501           |       |
| Intangible asset                          |       | —     |       | 92,000                      |       | —                          |       | —           |       | 92,000           |       |
| Goodwill                                  |       | —     |       | 61,528                      |       | —                          |       | —           |       | 61,528           |       |
| Other assets and deferred expenses, net   |       | 7,215      |       | 3,466                       |       | 298                             |       | (2,520           | )          | 8,459            |       |
| Amounts due from affiliates               |       | 109,510    |       | —                      |       | 1,583                           |       | (111,093         | )          | —           |       |
|                                      |       | $          | 125,484    |                        | $          | 246,438                         |       | $                | 3,750      |             | $          | (113,613 | ) | $ | 262,059 |   |

 

13

----

** **

**Supplemental Consolidating Balance Sheet**

**July 3, 2005**

**(unaudited)**

 

**(amounts in thousands, except share and pershare amounts)**

 
| ** **                                                                                | ** ** | **Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| Liabilities and Stockholder’s Equity                                                 |       |       |       |                        |       |                            |       |             |       |             |       |
| Current liabilities:                                                                      |       |       |       |                        |       |                            |       |             |       |             |       |
| Accounts payable and accrued expenses                                                     |       | $          | 3,717      |                        | $          | 28,701                          |       | $                | 984        |             | $          | — |   | $ | 33,402 |   |
| Current portion of obligations to financial  institution                                  |       | —     |       | 109                         |       | —                          |       | —           |       | 109              |       |
| Accrued income taxes                                                                      |       | (8,139     | )          | 9,120                       |       | (764                            | )          | —           |       | 217              |       |
| Amounts due to affiliates                                                                 |       | —     |       | 111,093                     |       | —                          |       | (111,093         | )          | —           |       |
|                                                                                      |       |       |       |                        |       |                            |       |             |       |             |       |
| Total current liabilities                                                                 |       | (4,422     | )          | 149,023                     |       | 220                             |       | (111,093         | )          | 33,728           |       |
|                                                                                      |       |       |       |                        |       |                            |       |             |       |             |       |
| 7.5% senior secured notes, net of  unamortized discount of $12,362                        |       | 92,638     |       | —                      |       | —                          |       | —           |       | 92,638           |       |
| Obligations to financial institution, less  current maturities                            |       | —     |       | 3,525                       |       | —                          |       | —           |       | 3,525            |       |
| Deferred income taxes                                                                     |       | —     |       | 23,004                      |       | —                          |       | —           |       | 23,004           |       |
| Other liabilities                                                                         |       | (38        | )          | 9,768                       |       | 102                             |       | —           |       | 9,832            |       |
|                                                                                      |       |       |       |                        |       |                            |       |             |       |             |       |
| Total liabilities                                                                         |       | 88,178     |       | 185,320                     |       | 322                             |       | (111,093         | )          | 162,727          |       |
|                                                                                      |       |       |       |                        |       |                            |       |             |       |             |       |
| Commitments and contingencies                                                             |       |       |       |                        |       |                            |       |             |       |             |       |
|                                                                                      |       |       |       |                        |       |                            |       |             |       |             |       |
| Stockholder’s equity:                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
| Common stock, $0.01 par value per share.  Authorized, issued and outstanding 1,000 shares |       | —     |       | —                      |       | —                          |       | —           |       | —           |       |
| Additional paid-in capital                                                                |       | 97,077     |       | 2,520                       |       | —                          |       | (2,520           | )          | 97,077           |       |
| Accumulated other comprehensive income  (loss)                                            |       | —     |       | 292                         |       | (192                            | )          | —           |       | 100              |       |
| (Accumulated deficit) retained earnings                                                   |       | (59,771    | )          | 58,306                      |       | 3,620                           |       | —           |       | 2,155            |       |
|                                                                                      |       |       |       |                        |       |                            |       |             |       |             |       |
| Total stockholder’s equity                                                           |       | 37,306     |       | 61,118                      |       | 3,428                           |       | (2,520           | )          | 99,332           |       |
|                                                                                      |       |       |       |                        |       |                            |       |             |       |             |       |
|                                                                                      |       | $          | 125,484    |                        | $          | 246,438                         |       | $                | 3,750      |             | $          | (113,613 | ) | $ | 262,059 |   |

 

14

----

 

**Supplemental Consolidating Balance Sheet**

**January 2, 2005**

 

**(Amounts in thousands)**

 
| ** **                                | ** ** | **Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| Assets                                    |       |       |       |                        |       |                            |       |             |       |             |       |
| Current assets:                           |       |       |       |                        |       |                            |       |             |       |             |       |
| Cash and cash equivalents                 |       | $          | 9,014      |                        | $          | 535                             |       | $                | 630        |             | $          | — |   | $ | 10,179 |   |
| Restricted cash                           |       | 548        |       | —                      |       | —                          |       | —           |       | 548              |       |
| Marketable securities                     |       | 4,112      |       | —                      |       | —                          |       | —           |       | 4,112            |       |
| Accounts receivable                       |       | 1          |       | 4,172                       |       | 173                             |       | —           |       | 4,346            |       |
| Inventories                               |       | —     |       | 8,717                       |       | 585                             |       | —           |       | 9,302            |       |
| Prepaid expenses and other current assets |       | 677        |       | 5,866                       |       | 57                              |       | —           |       | 6,600            |       |
| Deferred income taxes                     |       | (991       | )          | 6,228                       |       | —                          |       | —           |       | 5,237            |       |
|                                      |       |       |       |                        |       |                            |       |             |       |             |       |
| Total current assets                      |       | 13,361     |       | 25,518                      |       | 1,445                           |       | —           |       | 40,324           |       |
|                                      |       |       |       |                        |       |                            |       |             |       |             |       |
| Property and equipment, net               |       | 147        |       | 60,227                      |       | 1,113                           |       | —           |       | 61,487           |       |
| Intangible asset                          |       | —     |       | 92,000                      |       | —                          |       | —           |       | 92,000           |       |
| Goodwill                                  |       | —     |       | 61,789                      |       | —                          |       | —           |       | 61,789           |       |
| Other assets and deferred expenses, net   |       | 7,774      |       | 3,297                       |       | 285                             |       | (2,520           | )          | 8,836            |       |
| Amounts due from affiliates               |       | 119,894    |       | —                      |       | 179                             |       | (120,073         | )          | —           |       |
|                                      |       | $          | 141,176    |                        | $          | 242,831                         |       | $                | 3,022      |             | $          | (122,593 | ) | $ | 264,436 |   |

 

15

----

 

**Supplemental Consolidating Balance Sheet**

**January 2, 2005**

 

**(Amounts in thousands, except share and pershare amounts)**

 
| ** **                                                                                | ** ** | **Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| Liabilities and Stockholder’s Equity                                                 |       |       |       |                        |       |                            |       |             |       |             |       |
| Current liabilities:                                                                      |       |       |       |                        |       |                            |       |             |       |             |       |
| Accounts payable and accrued expenses                                                     |       | $          | 4,348      |                        | $          | 31,698                          |       | $                | 1,246      |             | $          | — |   | $ | 37,292 |   |
| Current portion of obligations to financial  institutions                                 |       | —     |       | 521                         |       | —                          |       | —           |       | 521              |       |
| Accrued income taxes                                                                      |       | (3,850     | )          | 4,827                       |       | (598                            | )          | —           |       | 379              |       |
| Amounts due from affiliates                                                               |       | —     |       | 120,073                     |       | —                          |       | (120,073         | )          | —           |       |
|                                                                                      |       |       |       |                        |       |                            |       |             |       |             |       |
| Total current liabilities                                                                 |       | 498        |       | 157,119                     |       | 648                             |       | (120,073         | )          | 38,192           |       |
|                                                                                      |       |       |       |                        |       |                            |       |             |       |             |       |
| 7.5% senior secured notes, net of  unamortized discount of $13,283                        |       | 91,717     |       | —                      |       | —                          |       | —           |       | 91,717           |       |
| Obligations to financial institutions, less  current maturities                           |       | —     |       | 6,636                       |       | —                          |       | —           |       | 6,636            |       |
| Deferred income taxes                                                                     |       | —     |       | 23,004                      |       | —                          |       | —           |       | 23,004           |       |
| Other liabilities                                                                         |       | (42        | )          | 7,493                       |       | 95                              |       | —           |       | 7,546            |       |
|                                                                                      |       |       |       |                        |       |                            |       |             |       |             |       |
| Total liabilities                                                                         |       | 92,173     |       | 194,252                     |       | 743                             |       | (120,073         | )          | 167,095          |       |
|                                                                                      |       |       |       |                        |       |                            |       |             |       |             |       |
| Commitments and contingencies                                                             |       |       |       |                        |       |                            |       |             |       |             |       |
|                                                                                      |       |       |       |                        |       |                            |       |             |       |             |       |
| Stockholder’s equity:                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
| Common stock, $0.01 par value per share.  Authorized, issued and outstanding 1,000 shares |       | —     |       | —                      |       | —                          |       | —           |       | —           |       |
| Additional paid-in capital                                                                |       | 97,077     |       | 2,520                       |       | —                          |       | (2,520           | )          | 97,077           |       |
| Accumulated other comprehensive income  (loss)                                            |       | —     |       | 355                         |       | (166                            | )          | —           |       | 189              |       |
| (Accumulated deficit) retained earnings                                                   |       | (48,074    | )          | 45,704                      |       | 2,445                           |       | —           |       | 75               |       |
|                                                                                      |       |       |       |                        |       |                            |       |             |       |             |       |
| Total stockholder’s equity                                                           |       | 49,003     |       | 48,579                      |       | 2,279                           |       | (2,520           | )          | 97,341           |       |
|                                                                                      |       |       |       |                        |       |                            |       |             |       |             |       |
|                                                                                      |       | $          | 141,176    |                        | $          | 242,831                         |       | $                | 3,022      |             | $          | (122,593 | ) | $ | 264,436 |   |

 

16

----

 

**Supplemental Consolidating Statement ofOperations**

**Three month period ended July 3, 2005**

**(unaudited)**

 

**(amounts in thousands)**

 
| ** **                                        | ** ** | **Issuer** | ** ** | **Guarantor Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------|------------|------------|------------|----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| Revenues                                          |       | $          | 4,361      |                       | $          | 69,228                          |       | $                | 3,712      |             | $          | (4,361 | ) | $ | 72,940 |   |
|                                              |       |       |       |                       |       |                            |       |             |       |             |       |
| Food and beverage costs                           |       | —     |       | 22,840                     |       | 1,207                           |       | —           |       | 24,047           |       |
| Restaurant operating expenses                     |       | —     |       | 33,273                     |       | 1,681                           |       | —           |       | 34,954           |       |
| Pre-opening costs, depreciation and  amortization |       | 15         |       | 1,861                      |       | 155                             |       | —           |       | 2,031            |       |
| General and administrative expenses               |       | 5,438      |       | 4,361                      |       | —                          |       | (4,361           | )          | 5,438            |       |
| Marketing and promotional expenses                |       | —     |       | 1,424                      |       | 57                              |       | —           |       | 1,481            |       |
| Gain on sale of investment                        |       | (16        | )          | —                     |       | —                          |       | —           |       | (16              | )          |
| Interest expense, net                             |       | 2,616      |       | 83                         |       | —                          |       | —           |       | 2,699            |       |
| Management fee paid to related party              |       | 700        |       | —                     |       | —                          |       | —           |       | 700              |       |
|                                              |       |       |       |                       |       |                            |       |             |       |             |       |
| (Loss) income before income taxes                 |       | (4,392     | )          | 5,386                      |       | 612                             |       | —           |       | 1,606            |       |
|                                              |       |       |       |                       |       |                            |       |             |       |             |       |
| Income tax expense                                |       | 685        |       | —                     |       | —                          |       | —           |       | 685              |       |
|                                              |       |       |       |                       |       |                            |       |             |       |             |       |
| Net (loss) income                                 |       | $          | (5,077     | )                          | $          | 5,386                           |       | $                | 612        |             | $          | — |   | $ | 921 |   |

 

**Supplemental Consolidating Statement ofOperations**

**Three month period ended July 4, 2004**

**(unaudited)**

 

**(amounts in thousands)**

 
| ** **                                        | ** ** | **Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| Revenues                                          |       | $          | 3,887      |                        | $          | 61,745                          |       | $                | 3,166      |             | $          | (3,887 | ) | $ | 64,911 |   |
|                                              |       |       |       |                        |       |                            |       |             |       |             |       |
| Food and beverage costs                           |       | —     |       | 20,929                      |       | 1,059                           |       | —           |       | 21,988           |       |
| Restaurant operating expenses                     |       | —     |       | 29,855                      |       | 1,598                           |       | —           |       | 31,453           |       |
| Pre-opening costs, depreciation and  amortization |       | 3          |       | 1,600                       |       | 143                             |       | —           |       | 1,746            |       |
| General and administrative expenses               |       | 4,662      |       | 3,887                       |       | —                          |       | (3,887           | )          | 4,662            |       |
| Marketing and promotional expenses                |       | —     |       | 2,150                       |       | 90                              |       | —           |       | 2,240            |       |
| Interest expense, net                             |       | 2,693      |       | 173                         |       | —                          |       | —           |       | 2,866            |       |
| Management fee paid to related party              |       | 700        |       | —                      |       | —                          |       | —           |       | 700              |       |
|                                              |       |       |       |                        |       |                            |       |             |       |             |       |
| (Loss) income before income taxes                 |       | (4,171     | )          | 3,151                       |       | 276                             |       | —           |       | (744             | )          |
|                                              |       |       |       |                        |       |                            |       |             |       |             |       |
| Income tax benefit                                |       | (223       | )          | —                      |       | —                          |       | —           |       | (223             | )          |
|                                              |       |       |       |                        |       |                            |       |             |       |             |       |
| Net (loss) income                                 |       | $          | (3,948     | )                           | $          | 3,151                           |       | $                | 276        |             | $          | — |   | $ | (521 | ) |
|                                                   |            |            |            |                             |            |                                 |            |                  |            |                  |            |  |  |  |  |  |  |  |  |

 

17

----

 

**Supplemental Consolidating Statement ofOperations**

**Six month period ended July 3, 2005**

**(unaudited)**

 

**(amounts in thousands)**

 
| ** **                                           | ** ** | **Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| Revenues                                             |       | $          | 8,984      |                        | $          | 143,046                         |       | $                | 7,232      |             | $          | (8,984 | ) | $ | 150,278 |   |
|                                                 |       |       |       |                        |       |                            |       |             |       |             |       |
| Food and beverage costs                              |       | —     |       | 47,734                      |       | 2,315                           |       | —           |       | 50,049           |       |
| Restaurant operating expenses                        |       | —     |       | 66,395                      |       | 3,335                           |       | —           |       | 69,730           |       |
| Pre-opening costs, depreciation and  amortization    |       | 30         |       | 4,429                       |       | 296                             |       | —           |       | 4,755            |       |
| General and administrative expenses                  |       | 10,638     |       | 8,984                       |       | —                          |       | (8,984           | )          | 10,638           |       |
| Marketing and promotional expenses                   |       | —     |       | 2,793                       |       | 111                             |       | —           |       | 2,904            |       |
| Costs associated with the repayment of  certain debt |       | 174        |       | —                      |       | —                          |       | —           |       | 174              |       |
| Gain on sale of investment                           |       | (664       | )          | —                      |       | —                          |       | —           |       | (664             | )          |
| Interest expense, net                                |       | 5,270      |       | 109                         |       | —                          |       | —           |       | 5,379            |       |
| Management fee paid to related party                 |       | 1,400      |       | —                      |       | —                          |       | —           |       | 1,400            |       |
|                                                 |       |       |       |                        |       |                            |       |             |       |             |       |
| (Loss) income before income taxes                    |       | (7,864     | )          | 12,602                      |       | 1,175                           |       | —           |       | 5,913            |       |
|                                                 |       |       |       |                        |       |                            |       |             |       |             |       |
| Income tax expense                                   |       | 2,838      |       | —                      |       | —                          |       | —           |       | 2,838            |       |
|                                                 |       |       |       |                        |       |                            |       |             |       |             |       |
| Net (loss) income                                    |       | $          | (10,702    | )                           | $          | 12,602                          |       | $                | 1,175      |             | $          | — |   | $ | 3,075 |   |

 

**Supplemental Consolidating Statement ofOperations**

**Six month period ended July 4, 2004**

**(unaudited)**

 

**(amounts in thousands)**

** **
| ** **                                           | ** ** | **Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| Revenues                                             |       | $          | 8,258      |                        | $          | 131,449                         |       | $                | 6,443      |             | $          | (8,258 | ) | $ | 137,892 |   |
|                                                 |       |       |       |                        |       |                            |       |             |       |             |       |
| Food and beverage costs                              |       | —     |       | 44,334                      |       | 2,128                           |       | —           |       | 46,462           |       |
| Restaurant operating expenses                        |       | —     |       | 60,800                      |       | 3,249                           |       | —           |       | 64,049           |       |
| Pre-opening costs, depreciation and  amortization    |       | 6          |       | 3,148                       |       | 226                             |       | —           |       | 3,380            |       |
| General and administrative expenses                  |       | 9,548      |       | 8,258                       |       | —                          |       | (8,258           | )          | 9,548            |       |
| Marketing and promotional expenses                   |       | —     |       | 4,688                       |       | 181                             |       | —           |       | 4,869            |       |
| Costs associated with the repayment of  certain debt |       | 264        |       | —                      |       | —                          |       | —           |       | 264              |       |
| Interest expense, net                                |       | 5,481      |       | 456                         |       | —                          |       | —           |       | 5,937            |       |
| Management fee paid to related party                 |       | 1,400      |       | —                      |       | —                          |       | —           |       | 1,400            |       |
|                                                 |       |       |       |                        |       |                            |       |             |       |             |       |
| (Loss) income before income taxes                    |       | (8,441     | )          | 9,765                       |       | 659                             |       | —           |       | 1,983            |       |
|                                                 |       |       |       |                        |       |                            |       |             |       |             |       |
| Income tax expense                                   |       | 595        |       | —                      |       | —                          |       | —           |       | 595              |       |
|                                                 |       |       |       |                        |       |                            |       |             |       |             |       |
| Net (loss) income                                    |       | $          | (9,036     | )                           | $          | 9,765                           |       | $                | 659        |             | $          | — |   | $ | 1,388 |   |

 

18

----

 

**Supplemental Consolidating Statement of CashFlows**

**Six month period ended July 3, 2005**

**(unaudited)**

 

**(amounts in thousands)**

 
| ** **                                                                                          | ** ** | **Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|
| Cash flows from operating activities:                                                               |       |       |       |                        |       |                            |       |             |       |
| Net (loss) income                                                                                   |       | $          | (10,702    | )                           | $          | 12,602                          |       | $                | 1,175      |   | $ | 3,075 |   |
| Adjustments to reconcile net (loss) income  to net cash (used in) provided by operating activities: |       |       |       |                        |       |                            |       |             |       |
| Depreciation, amortization and other  non-cash charges                                              |       | 1,500      |       | 3,545                       |       | 307                             |       | 5,352            |       |
| Deferred income taxes                                                                               |       | 2,239      |       | 260                         |       | —                          |       | 2,499            |       |
| Change in assets and liabilities:                                                                   |       |       |       |                        |       |                            |       |             |       |
| Accounts receivable                                                                                 |       | 1          |       | 403                         |       | (12                             | )          | 392              |       |
| Inventories                                                                                         |       | —     |       | 220                         |       | 45                              |       | 265              |       |
| Prepaid expenses and other assets                                                                   |       | 10,679     |       | (8,356                      | )          | (1,400                          | )          | 923              |       |
| Accounts payable, accrued expenses and  other liabilities                                           |       | (627       | )          | (1,247                      | )          | (234                            | )          | (2,108           | )          |
| Accrued income taxes                                                                                |       | (4,289     | )          | 4,294                       |       | (181                            | )          | (176             | )          |
| Net cash (used in) provided by operating  activities                                                |       | (1,199     | )          | 11,721                      |       | (300                            | )          | 10,222           |       |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |
| Cash flows from investing activities:                                                               |       |       |       |                        |       |                            |       |             |       |
| Purchases of property and equipment                                                                 |       | (17        | )          | (6,420                      | )          | (17                             | )          | (6,454           | )          |
| Increase in marketable securities                                                                   |       | (71        | )          | —                      |       | —                          |       | (71              | )          |
| Net cash used in investing activities                                                               |       | (88        | )          | (6,420                      | )          | (17                             | )          | (6,525           | )          |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |
| Cash flows from financing activities:                                                               |       |       |       |                        |       |                            |       |             |       |
| Principal reduction on obligations to  financial institutions                                       |       | —     |       | (3,523                      | )          | —                          |       | (3,523           | )          |
| Dividends paid                                                                                      |       | (995       | )          | —                      |       | —                          |       | (995             | )          |
| Decrease in restricted cash                                                                         |       | 131        |       | —                      |       | —                          |       | 131              |       |
| Net cash used in financing activities                                                               |       | (864       | )          | (3,523                      | )          | —                          |       | (4,387           | )          |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |
| Effect of exchange rate changes on cash                                                             |       | —     |       | —                      |       | (10                             | )          | (10              | )          |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |
| Net (decrease) increase in cash and cash  equivalents                                               |       | (2,151     | )          | 1,778                       |       | (327                            | )          | (700             | )          |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |
| Cash and cash equivalents at beginning of  period                                                   |       | 9,014      |       | 535                         |       | 630                             |       | 10,179           |       |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |
| Cash and cash equivalents at end of period                                                          |       | $          | 6,863      |                        | $          | 2,313                           |       | $                | 303        |   | $ | 9,479 |   |

 

19

----

 

**Supplemental Consolidating Statement of CashFlows**

**Six month period ended July 4, 2004**

**(unaudited)**

 

**(amounts in thousands)**

 
| ** **                                                                                          | ** ** | **Issuer** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|
| Cash flows from operating activities:                                                               |       |       |       |                        |       |                            |       |             |       |
| Net (loss) income                                                                                   |       | $          | (9,036     | )                           | $          | 9,765                           |       | $                | 659        |   | $ | 1,388 |   |
| Adjustments to reconcile net (loss) income  to net cash (used in) provided by operating activities: |       |       |       |                        |       |                            |       |             |       |
| Depreciation, amortization and other  non-cash charges                                              |       | 1,394      |       | 3,664                       |       | 280                             |       | 5,338            |       |
| Deferred income taxes                                                                               |       | 2,525      |       | (1,972                      | )          | —                          |       | 553              |       |
| Change in assets and liabilities:                                                                   |       |       |       |                        |       |                            |       |             |       |
| Accounts receivable                                                                                 |       | (55        | )          | 826                         |       | 13                              |       | 784              |       |
| Inventories                                                                                         |       | —     |       | (437                        | )          | 38                              |       | (399             | )          |
| Prepaid expenses and other assets                                                                   |       | 10,360     |       | (10,293                     | )          | (859                            | )          | (792             | )          |
| Accounts payable, accrued expenses and  other liabilities                                           |       | (385       | )          | (3,567                      | )          | (206                            | )          | (4,158           | )          |
| Accrued income taxes                                                                                |       | (12,968    | )          | 12,798                      |       | (84                             | )          | (254             | )          |
| Net cash (used in) provided by operating  activities                                                |       | (8,165     | )          | 10,784                      |       | (159                            | )          | 2,460            |       |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |
| Cash flows from investing activities:                                                               |       |       |       |                        |       |                            |       |             |       |
| Purchases of property and equipment                                                                 |       | (50        | )          | (3,564                      | )          | (24                             | )          | (3,638           | )          |
| Increase in marketable securities                                                                   |       | (1,741     | )          | —                      |       | —                          |       | (1,741           | )          |
| Net cash used in investing activities                                                               |       | (1,791     | )          | (3,564                      | )          | (24                             | )          | (5,379           | )          |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |
| Cash flows from financing activities:                                                               |       |       |       |                        |       |                            |       |             |       |
| Principal reduction on obligations to  financial institutions                                       |       | —     |       | (5,532                      | )          | —                          |       | (5,532           | )          |
| Payment of deferred financing costs                                                                 |       | (550       | )          | —                      |       | —                          |       | (550             | )          |
| Dividends paid                                                                                      |       | (6,789     | )          | —                      |       | —                          |       | (6,789           | )          |
| Decrease in restricted cash                                                                         |       | 79         |       | —                      |       | —                          |       | 79               |       |
| Net cash used in financing activities                                                               |       | (7,260     | )          | (5,532                      | )          | —                          |       | (12,792          | )          |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |
| Effect of exchange rate changes on cash                                                             |       | —     |       | —                      |       | (8                              | )          | (8               | )          |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |
| Net (decrease) increase in cash and cash  equivalents                                               |       | (17,216    | )          | 1,688                       |       | (191                            | )          | (15,719          | )          |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |
| Cash and cash equivalents at beginning of  period                                                   |       | 17,911     |       | (614                        | )          | 700                             |       | 17,997           |       |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |
| Cash and cash equivalents at end of period                                                          |       | $          | 695        |                        | $          | 1,074                           |       | $                | 509        |   | $ | 2,278 |   |

 

20

----

 

MORTON’S RESTAURANT GROUP, INC. ANDSUBSIDIARIES

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations

 

Results of Operations

 

Our net income for the three month period ended July 3, 2005was $0.9 million compared to a net loss of $0.5 million for the three monthperiod ended July 4, 2004.  The increaseis primarily due to an increase in comparable restaurant revenues and theimpact of new restaurants, net of the related food and beverage costs, partiallyoffset by an increase in income tax expense as discussed below.  Net income increased $1.7 million, or 121.5%,to $3.1 million for the six month period ended July 3, 2005 from $1.4 millionfor the six month period ended July 4, 2004. The increase is primarily due to an increase in comparable restaurantrevenues and the impact of new restaurants, net of the related food andbeverage costs, and a decrease in marketing and promotional expenses partiallyoffset by increases in pre-opening costs and income tax expense as discussedbelow.

 

Revenues increased$8.0 million, or 12.4%, to $72.9 million for the three month period ended July3, 2005 from $64.9 million for the three month period ended July 4, 2004.Revenues increased $3.0 million due to an increase in comparable revenues fromrestaurants open all of both fiscal years. Revenues increased $5.0 million dueto the opening of four new restaurants (three in fiscal 2005 and one in fiscal2004). Average revenue per restaurant open all of either period increased 6.0%.Revenues for the three month period ended July 3, 2005 also reflect the impactof an aggregate menu price increase of approximately 0.5% in May 2005.

 

Revenuesincreased $12.4 million, or 9.0%, to $150.3 million for the six month periodended July 3, 2005 from $137.9 million for the six month period ended July 4,2004. Revenues increased $3.5 million due to an increase in comparable revenuesfrom restaurants open all of both fiscal years. Revenues increased $8.9 milliondue to the opening of four new restaurants (three in fiscal 2005 and one infiscal 2004). Average revenue per restaurant open all of either periodincreased 7.2%. Revenues for the six month period ended July 3, 2005 alsoreflect the impact of aggregate menu price increases of approximately 3% inFebruary 2004 and approximately 0.5% in May 2005.

 

Percentagechanges in comparable restaurant revenues for the three and six month periodsended July 3, 2005 versus July 4, 2004 for restaurants open all of both periodsare as follows:

 

| ** **       | ** ** | **Three month period  ended July 3, 2005  vs. July 4, 2004  Percentage Change** | ** ** | **Six month period  ended July 3, 2005  vs. July 4, 2004  Percentage Change** | ** ** |
|------------------|------------|---------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|
|             |       |                                                                            |       |                                                                          |       |
| Morton’s    |       | 4.7                                                                             | %          | 2.6                                                                           | %          |
| Bertolini’s |       | 3.7                                                                             | %          | 2.3                                                                           | %          |
| Total            |       | 4.6                                                                             | %          | 2.6                                                                           | %          |

 

Our business is somewhatseasonal in nature, with revenues generally being less in the third quarterprimarily due to our reduced summer volume. We believe we may incur a net loss in the third quarter of fiscal 2005.

 

Food andbeverage costs increased $2.1 million, or 9.4%, to $24.0 million for the threemonth period ended July 3, 2005 from $22.0 million for the three month periodended July 4, 2004. These costs increased $3.6 million, or 7.7%, to $50.0million for the six month period ended July 3, 2005 from $46.5 million for

 

21

----

 

the six monthperiod ended July 4, 2004. This increase was primarily due to the opening ofthree additional restaurants in fiscal 2005. These costs as a percentage ofrevenues decreased by 0.9 % to 33.0% for the three month period ended July 3,2005 from 33.9% for the three month period ended July 4, 2004 and decreased by0.4% to 33.3% for the six month period ended July 3, 2005 from 33.7% for thesix month period ended July 4, 2004. During fiscal 2004 high demand for U.S. beef products decreased theavailability of USDA prime beef which resulted in increased food costs.  We were generally able to offset such costincreases with the benefit of menu price increases, which resulted in a slightincrease in food and beverage costs as a percentage of revenues for fiscal2004.

 

Restaurantoperating expenses, which include labor, occupancy and other operatingexpenses, increased $3.5 million, or 11.1%, to $35.0 million for the threemonth period ended July 3, 2005 from $31.5 million for the three month periodended July 4, 2004. These costs increased $5.7 million, or 8.9%, to $69.7million for the six month period ended July 3, 2005 from $64.0 million for thesix month period ended July 4, 2004. These increases were primarily due to theopening of three additional restaurants in fiscal 2005 and increases in laborand benefit costs. Restaurant operating expenses as a percentage of revenuesdecreased 0.6% to 47.9% for the three month period ended July 3, 2005 from48.5% for the three month period ended July 4, 2004 and remained consistent at46.4% for the six month periods ended July 3, 2005 and July 4, 2004. Includedin the three month periods ended July 3, 2005 and July 4, 2004 is non-cash rentrecorded in accordance with SFAS No. 13 of $0.2 million and $0.4 million, respectively.Included in the six month periods ended July 3, 2005 and July 4, 2004 isnon-cash rent recorded in accordance with SFAS No. 13 of $0.5 million and $0.8 million,respectively.

 

Pre-openingcosts, depreciation and amortization increased $0.3 million, or 16.3%, to $2.0million for the three month period ended July 3, 2005 from $1.7 million for thethree month period ended July 4, 2004. These costs as a percentage of revenuesincreased by 0.1% to 2.8% for the three month period ended July 3, 2005 from2.7% for the three month period ended July 4, 2004.  These costs increased $1.4 million, or 40.7%,to $4.8 million for the six month period ended July 3, 2005 from $3.4 millionfor the six month period ended July 4, 2004. These costs as a percentage ofrevenues increased by 0.7% to 3.2% for the six month period ended July 3, 2005from 2.5% for the six month period ended July 4, 2004.  We expense all costs incurred during start-upactivities, including pre-opening costs, as incurred. Pre-opening costs incurredand recorded as expense remained consistent at $0.2 million for the three monthperiods ended July 3, 2005 and July 4, 2004 and increased $1.1 million to $1.3million for the six month period ended July 3, 2005 from $0.2 for the six monthperiod ended July 4, 2004. The number of restaurants opened, the timing ofrestaurant openings and the costs per restaurant opened affected the amount ofthese costs.

 

General andadministrative expenses increased $0.8 million, or 16.6%, to $5.4 million forthe three month period ended July 3, 2005 from $4.7 million for the three monthperiod ended July 4, 2004. These costs increased $1.1 million, or 11.4%, to$10.6 million for the six month period ended July 3, 2005 from $9.5 million forthe six month period ended July 4, 2004. These costs as a percentage ofrevenues increased 0.3% to 7.5% for the three month periods ended July 3, 2005from 7.2% for the three month period ended July 4, 2004 and increased 0.2% to7.1% for the six month period ended July 3, 2005 from 6.9% for the six monthperiod ended July 4, 2004.  Theseincreases were primarily due to increased legal and professional costs andsalary, bonus and benefit costs.

 

Marketing andpromotional expenses decreased $0.8 million, or 33.9%, to $1.5 million for thethree month period ended July 3, 2005 from $2.2 million for the three monthperiod ended July 4, 2004. These costs decreased $2.0 million, or 40.4%, to$2.9 million for the six month period ended July 3, 2005 from $4.9 million forthe six month period ended July 4, 2004. These costs as a percentage ofrevenues decreased 1.5% to 2.0% for the three month period ended July 3, 2005from 3.5% for the three month period ended July 4, 2004 and decreased 1.6% to1.9% for the six month period ended July 3, 2005 from 3.5% for the six

 

22

----

 

month periodended July 4, 2004. These decreases were primarily due to decreased spendingfor print media advertising.

 

Costsassociated with the repayment of certain debt of $0.2 million and $0.3 millionfor the six month periods ended July 3, 2005 and July 4, 2004, respectively,represent prepayment penalties that were incurred with the early repayment ofcertain mortgages.

 

Gain on saleof investment of $0.7 million for the six month period ended July 3, 2005represents a gain from the sale of stock in a privately owned company.

 

Interestexpense, net, decreased $0.2 million, or 5.8%, to $2.7 million for the threemonth period ended July 3, 2005 from $2.9 million for the three monthperiod ended July 4, 2004 and decreased $0.6 million, or 9.4%, to $5.4 millionfor the six month period ended July 3, 2005 from $5.9 million for the six monthperiod ended July 4, 2004.  Thesedecreases are primarily due to the repayment of certain mortgages in April 2004and February 2005. Interest income was not significant in any of these periods.

 

Management feepaid to related party was $0.7 million for the three month periods ended July3, 2005 and July 4, 2004 and $1.4 million for the six month periods endedJuly 3, 2005 and July 4, 2004. We paid this fee pursuant to MHLLC’s managementagreement with Castle Harlan, Inc.

 

Provision forincome taxes consisted of income tax expense of $2.8 million and $0.6 millionfor the six month periods ended July 3, 2005 and July 4, 2004, respectively.Our 2005 effective tax rate differs from the statutory rate due tonon-deductible interest relating to our 7.5% senior secured notes and othernon-deductible items. Our 2005 effective tax rate differs from our 2004 effectivetax rate due to the fact that during the third quarter of fiscal 2004, theCompany determined it would elect to treat certain of its employee-portion FICAtax payments as current income tax deductions rather than income tax credits.

 

Liquidity and Capital Resources

 

Our principal liquidityrequirements are to service our debt and meet our working capital and capitalexpenditure needs. Subject to our operating performance, which, ifsignificantly adversely affected, would adversely affect the availability offunds, we expect to be able to meet our liquidity requirements for theforeseeable future through cash provided by operations and through borrowingsavailable under our working capital facility. We cannot be sure, however, thatthis will be the case. As of July 3, 2005, we had cash and cash equivalents of$9.5 million compared to $10.2 million as of January 2, 2005.

 

*Working Capital and Cash Flows*

 

In the past we have had,and in the future we may have, negative working capital balances. We do not havesignificant receivables and we receive trade credit based upon negotiated termsin purchasing food and supplies. Funds available from cash sales not neededimmediately to pay for food and supplies or to finance receivables orinventories historically have typically been used for noncurrent capitalexpenditures and or payments of long-term debt balances under our priorrevolving credit agreement.

 

*Operating Activities*.  Cash flows provided by operating activitiesfor the six month period ended July 3, 2005 were $10.2 million, consistingprimarily of a net increase in cash of $8.4 million resulting from net incomebefore depreciation, amortization and other non-cash charges, a change indeferred income taxes of $2.5 million and a decrease in prepaid expenses andother current assets of $0.9 million partially offset by a decrease in accountspayable, accrued expenses and other liabilities of $2.1 million.

 

23

----

 

*Investing Activities*.  Cash flows used in investing activities forthe six month period ended July 3, 2005 were $6.5 million primarily due topurchases of property and equipment of $6.5 million, which include capitalexpenditures related to the three Morton’s steakhouses opened during the firstquarter of fiscal 2005.

 

*Financing Activities*.  Cash flows used in financing activities forthe six month period ended July 3, 2005 were $4.4 million primarily consistingof net principal reduction on obligations to financial institutions of $3.5million, primarily due to the early repayment of two mortgages aggregating $3.4million, and the payment of a dividend of $1.0 million.

 

*Debt and Other Obligations*.

 

*7.5% Senior Secured Notes*.  On July 7, 2003, we completed a privateoffering of $105.0 million in aggregate principal amount at maturity of 7.5%senior secured notes due July 1, 2010. The notes were issued at a discount of 15% and a yield to maturity of12.005% including the accretion of the discount and the amortization of therelated deferred financing costs.  Thenotes are fully and unconditionally guaranteed on a senior secured basis by allof our present and future domestic restricted subsidiaries.  On December 22, 2003, we filed a registrationstatement with the Securities and Exchange Commission with respect to noteshaving substantially identical terms as the original notes, as part of an offerto exchange registered notes for the privately-issued original notes. The newnotes evidence the same debt as the original notes, are entitled to thebenefits of the indenture governing the original notes and are treated underthe indenture as a single class with the original notes. The exchange offer wascompleted on January 28, 2004.  We referto these notes as our 7.5% senior secured notes.

 

Our domesticrestricted subsidiaries presently consist of all of our domestic subsidiariesthat either own restaurants or own subsidiaries that own restaurants. Asrestricted subsidiaries, each of these guarantors of the 7.5% senior securednotes is subject to all of the terms, conditions and covenants contained in theindenture governing the 7.5% senior secured notes that apply to restrictedsubsidiaries. The 7.5% senior secured notes are not guaranteed by our foreignsubsidiaries due to the tax implications of providing such guarantees, or byour unrestricted subsidiaries, which presently consist of subsidiaries thathave no material assets. Our unrestricted subsidiaries are not subject to theterms, conditions or covenants contained in the indenture, and must interactwith MRG and our restricted subsidiaries on the same basis as unrelated thirdparties. From time to time, we may designate other subsidiaries as unrestrictedsubsidiaries subject to the terms and conditions set forth in the indenture.

 

The 7.5%senior secured notes and the guarantees are secured by substantially all ofour, and our domestic restricted subsidiaries’, tangible and intangible assets,as well as by a pledge of a portion of the stock of the subsidiaries owned byus and by our domestic restricted subsidiaries, in each case subject to theprior ranking claims on such assets by the lender under our working capitalfacility and holders of any capital lease obligations and certain other securedindebtedness. The indenture governing the 7.5% senior secured notes permits usto incur other senior secured indebtedness and to grant liens on our assetsunder certain circumstances.

 

We payinterest on the 7.5% senior secured notes semi-annually in cash, in arrears, onJanuary 1 and July 1 at an annual rate of 7.5%. The indenture governing the7.5% senior secured notes contains various affirmative and negative covenants,subject to a number of important limitations and exceptions, including but notlimited to those limiting our ability to incur additional indebtedness or enterinto sale and leaseback transactions; pay dividends, redeem stock or make otherdistributions; issue stock of our subsidiaries; make certain investments oracquisitions; grant liens on assets; enter into transactions with affiliates;merge, consolidate or transfer substantially all of our assets; and transferand sell assets. Our indenture has a covenant that limits our incurrence ofadditional indebtedness other than Permitted Indebtedness (defined therein)unless on the date of the incurrence of additional indebtedness ourConsolidated Fixed Charge

 

24

----

 

Coverage Ratio(defined therein) will be, after giving effect to the incurrence thereof andthe application of the proceeds thereof, greater than 2.25 to 1.0. Theindenture defines Consolidated Fixed Charge Coverage Ratio as the ratio ofConsolidated EBITDA to Consolidated Fixed Charges (defined therein).

 

The indenturegoverning the 7.5% senior secured notes contains various events of default,including but not limited to those related to non-payment of principal,interest or fees; violations of certain covenants; certain bankruptcy-relatedevents; invalidity of liens; non-payment of certain legal judgments; and crossdefaults with certain other indebtedness. As of July 3, 2005, we were incompliance with all of our financial covenants.

 

We can redeemthe 7.5% senior secured notes on or after July 1, 2007, except we may redeem upto 35% of the 7.5% senior secured notes prior to July 1, 2006 with the proceedsof one or more public equity offerings. We are required to redeem the 7.5%senior secured notes under certain circumstances involving changes of control.Additionally, if we or any of our domestic restricted subsidiaries engage inasset sales, we generally must either invest the net cash proceeds from suchsales in our business within 360 days, prepay the debt under our workingcapital facility or certain other secured debt or make an offer to purchase aportion of the 7.5% senior secured notes having an accreted value equal to theexcess net cash proceeds.

 

*Working Capital Facility.*On July 7, 2003, weentered into a $15.0 million senior secured working capital facility with WellsFargo Foothill, Inc. Our working capital facility matures on July 7, 2007.Availability under our working capital facility is limited to the lesser of (i)$15.0 million and (ii) the borrowing base amount, in each case, less the sum of(a) the revolving loans then outstanding (including letters of credit) and (b)reserves required by the lender. The borrowing base amount is defined as thelesser of (A) 80% of our twelve-month trailing EBITDA, as determined inaccordance with the most recently delivered financial statements, or (B) 25% ofour “enterprise value,” determined to be $168.0 million as of July 7, 2003, andthereafter to be the amount determined by a third party appraiser. We arepermitted to repay and reborrow such advances until the maturity date. As ofJuly 3, 2005, we had no borrowings outstanding under our working capitalfacility. At our option, up to $7.5 million of the facility can consist of oneor more letters of credit issued by the lender. As of July 3, 2005, $1.0million was restricted for letters of credit under our working capitalfacility. Our working capital facility is guaranteed by all of our domesticrestricted subsidiaries and secured by a first priority perfected securityinterest in all of the collateral securing the 7.5% senior secured notes.Interest will accrue on borrowings under our working capital facility at afloating rate of interest per annum equal to the rate of interest announcedfrom time to time within the lender’s principal office in San Francisco as its “primerate” plus 1.75%, or a LIBOR-based equivalent thereof. Interest is calculatedon the basis of a 360-day year and will be payable monthly for base rate loansand at the end of each interest period for LIBOR loans (but not less frequentlythan quarterly). Our working capital facility contains certain customary fees,including a closing fee, anniversary fees, servicing fees and pre-payment fees.

 

Our workingcapital facility contains various affirmative and negative covenants customaryfor similar working capital facilities, including but not limited to covenantspertaining to mergers and sales of assets outside the ordinary course ofbusiness; use of proceeds; granting of liens; incurrence of indebtedness;restricted payments; voluntary prepayment of indebtedness, including the 7.5%senior secured notes; payment of dividends; business activities; investmentsand acquisitions; transactions with affiliates; certain restrictions affectingsubsidiaries; fundamental changes; and amendments or modifications toinstruments governing certain indebtedness. Our working capital facility alsorequires us to achieve and maintain a twelve-month trailing EBITDA (as definedtherein) of not less than $16.0 million. As of July 3, 2005, we were incompliance with all of our financial covenants.

 

Our workingcapital facility contains customary events of default, including but notlimited to those related to non-payment of principal, interest or fees;violations of certain covenants; change of control;

 

25

----

 

certainbankruptcy-related events; inaccuracy of representations and warranties in anymaterial respect; and cross defaults with certain other indebtedness andagreements, including without limitation the indenture governing the 7.5%senior secured notes.

 

*CNL Loan*. In March 1997, one of our subsidiaries entered into a $2.5 million loanagreement with CNL Financial I, Inc. (“CNL”). We repaid this loan in February 2005. This loan was scheduled to matureon April 1, 2007 and bore interest at 10.002% per annum.  This loan was secured by a security interestin the assets of the Morton’s steakhouses located in Chicago (State Street) andDenver (downtown).  Principal andinterest payments were due monthly over the term of the loan. On January 2,2005, the outstanding principal balance of the CNL loan was approximately $0.8million, of which approximately $0.3 million of principal was included in “Currentportion of obligations to financial institutions” in the accompanyingconsolidated balance sheet.

 

*Mortgages*. During 1998 and 1999, certain of our subsidiaries entered into a totalof six mortgage loans with GE Capital Franchise Finance aggregating $18.9million, the proceeds of which were used to fund the purchases of land andconstruction of restaurants.  The loansgenerally require monthly payments of principal and interest.  On July 3, 2005 and January 2, 2005 theaggregate outstanding principal balance due on these loans was approximately$3.6 million and $6.4 million, respectively, of which approximately $0.1million and $0.2 million, respectively, of principal is included in “Currentportion of obligations to financial institutions” in the accompanyingconsolidated balance sheets.  We repaidone mortgage in May 2003, one in September 2003, two mortgages in April 2004and one mortgage in February 2005.  The remainingmortgage outstanding as of July 3, 2005 bears interest at 8.98% and isscheduled to mature in March 2021.

 

*Restaurant Operating Leases*.  Our obligations for restaurant operatingleases include certain restaurant operating leases for which we, or one of oursubsidiaries guarantees, for a portion of the lease term, the performance ofthe lease by the operating company that is a party thereto.

 

*Contractual Commitments*.  The following table represents ourcontractual commitments associated with our debt and other obligationsdisclosed above as of July 3, 2005:

 
| ** **                                                           | ** ** | **Remainder of**           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------|------------|----------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|----------------|------------|------------|------------|
| ** **                                                           | ** ** | **2005**                   | ** ** | **2006**   | ** ** | **2007**   | ** ** | **2008**   | ** ** | **2009**   | ** ** | **Thereafter** | ** ** | **Total**  | ** ** |
| ** **                                                           | ** ** | **(amounts in thousands)** | ** ** |
| 7.5% senior secured notes, including  interest                       |       | $                          | 3,937      |       | $          | 7,875      |       | $          | 7,875      |       | $          | 7,875          |       | $          | 7,875      |   | $ | 108,938 |   | $ | 144,375 |   |
| Mortgage loan with GE Capital Franchise  Finance, including interest |       | 218                        |       | 436        |       | 436        |       | 435        |       | 435        |       | 4,888          |       | 6,848      |       |
| Subtotal                                                             |       | 4,155                      |       | 8,311      |       | 8,311      |       | 8,310      |       | 8,310      |       | 113,826        |       | 151,223    |       |
| Operating leases                                                     |       | 9,628                      |       | 19,181     |       | 19,606     |       | 19,351     |       | 18,857     |       | 112,451        |       | 199,074    |       |
| Purchase commitments                                                 |       | 17,815                     |       | —     |       | —     |       | —     |       | —     |       | —         |       | 17,815     |       |
| Construction commitment                                              |       | 149                        |       | —     |       | —     |       | —     |       | —     |       | —         |       | 149        |       |
| Letters of credit                                                    |       | 1,000                      |       | —     |       | —     |       | —     |       | —     |       | —         |       | 1,000      |       |
| Total                                                                |       | $                          | 32,747     |       | $          | 27,492     |       | $          | 27,917     |       | $          | 27,661         |       | $          | 27,167     |   | $ | 226,277 |   | $ | 369,261 |   |

 

During the first sixmonths of fiscal 2005, our net investment in fixed assets and relatedinvestment costs, including pre-opening costs, approximated $7.8 million. Weestimate that we will spend up to approximately $19.0 million in fiscal 2005,including the $7.8 million recorded in the first six months of fiscal 2005, tofinance ordinary refurbishment of existing restaurants and capital expendituresfor new restaurants, which is expected to be reduced by landlord developmentallowances of approximately $3.0 million. We anticipate that funds generatedthrough operations and through borrowings under our working capital facilitywill be sufficient to fund planned expansion. We cannot be sure, however, that this will be the case.

 

26

----

 

New Accounting Standards

 

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-BasedPayment.” This statement replaces SFAS No. 123, “Accounting for Stock-Based Compensation”and supersedes Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees.” SFAS No. 123(R) requires all stock-based employeecompensation to be recorded as an expense in the consolidated statement ofoperations and that such cost be measured according to the fair value of stockoptions. SFAS No. 123(R) will be effective the first annual reporting periodthat begins after June 15, 2005.  As theCompany already charges stock-based employee compensation expense related tounits issued pursuant to employee subscription agreements based on the fairvalue of such units the adoption of this statement will not have any effect onthe Company’s consolidated financial statements. See Note 8 to our unauditedconsolidated financial statements.

 

In December2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets – anamendment of APB Opinion No. 29.” SFAS No. 153 addresses the measurement ofexchanges of non-monetary assets. It eliminates the exception from fair value measurementfor non-monetary exchanges of similar productive assets in paragraph 21(b) ofAccounting Principles Board (“APB”) Opinion No. 29 “Accounting for Non-monetaryTransactions” and replaces it with an exception for exchanges that do not havecommercial substance. A non-monetary exchange has commercial substance if thefuture cash flows of the entity are expected to change significantly as aresult of the exchange. SFAS No. 153 will be effective for nonmonetary assetexchanges occurring in fiscal periods beginning after June 15, 2005.  The adoption of this statement will not haveany effect on the Company’s consolidated financial statements.

 

In January 2003, the FASB issued FASB InterpretationNo. (“FIN”) 46, “Consolidation of Variable Interest Entities, an interpretationof ARB No. 51.” FIN 46 was subject to significant interpretation by the FASB,and was revised and reissued in December 2003 (“FIN 46R”).  FIN 46R states that if an entity has acontrolling financial interest in a variable interest entity, the assets, theliabilities and results of activities of the variable interest entity should beincluded in the consolidated financial statements to the entity.  The adoption of FIN 46 and FIN 46R did nothave any effect on the Company’s consolidated financial statements, as theCompany does not have any special purpose entities and no other arrangementsthat meet the definition of a variable interest entity which would requireconsolidation.

 

In March 2005,the FASB issued FIN 47, “Accounting for Conditional Asset RetirementObligations.” FIN 47 clarifies that a conditional asset retirement obligation,as used in SFAS 143, “Accounting for Asset Retirement Obligations,” refers to alegal obligation to perform an asset retirement activity in which the timingand/or method of the settlement are conditional on a future event that may ormay not be within the control of the entity. Accordingly, an entity is requiredto recognize a liability for the fair value of a conditional asset retirementobligation if the fair value can be reasonably estimated. FIN 47 is effectiveJanuary 1, 2006, with early adoption allowed. We have not yet determined theimpact, if any, FIN 47 will have on the Company’s consolidated financialstatements.

 

In June 2005,the FASB issued Emerging Issues Task Force (“EITF”) 05-06 “Determining theAmortization Period for Leasehold Improvements.” EITF 05-06 addresses theamortization period for leasehold improvements in operating leases that areeither placed in service significantly after and not contemplated at or nearthe beginning of the initial lease term or acquired in a business combination.The adoption of EITF 05-06 will not have a material effect on the Company’sconsolidated financial statements.

 

27

----

 

Forward-Looking Statements

 

This quarterly reportcontains various “forward-looking statements” within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended. Forward-looking statements, written, oral or otherwise made, representthe Company’s expectation or belief concerning future events.  Without limiting the foregoing, the words “believes,”“thinks,” “anticipates,” “plans,” “expects,” and similar expressions areintended to identify forward-looking statements.  The Company cautions that these statementsare further qualified by important economic and competitive factors that couldcause actual results to differ materially, or otherwise, from those in the forward-lookingstatements, including, without limitation, risks of the restaurant industry,including a highly competitive environment and industry with manywell-established competitors with greater financial and other resources thanthe Company, and the impact of changes in consumer tastes, local, regional andnational economic and market conditions, restaurant profitability levels,expansion plans, demographic trends, traffic patterns, employee availabilityand benefits, cost increases, product safety and availability, governmentregulation and other risks detailed from time to time in the Company’s reportsfiled with the Securities and Exchange Commission.  In addition, the Company’s ability to expandis dependent upon various factors, such as the availability of attractive sitesfor new restaurants, the ability to negotiate suitable lease terms, the abilityto generate or borrow funds to develop new restaurants and obtain variousgovernment permits and licenses and the recruitment and training of skilledmanagement and restaurant employees. Accordingly, such forward-looking statements do not purport to bepredictions of future events or circumstances and therefore there can be noassurance that any forward-looking statement contained herein will prove to beaccurate. The Company assumes no obligation to update the forward-lookingstatements.

 

Item 3.  Quantitative andQualitative Disclosure about Market Risk

 

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

 

As of July 3,2005, we owned and operated four international restaurants, one in Hong Kong,one in Singapore, one in Toronto, Canada and one in Vancouver, Canada. As aresult, we are subject to risk from changes in foreign exchange rates. Thesechanges result in cumulative translation adjustments, which are included inaccumulated other comprehensive income (loss). We do not consider the potentialloss resulting from a hypothetical 10% adverse change in quoted foreigncurrency exchange rates, as of July 3, 2005, to be material.

 

We also aresubject to market risk from exposure to changes in interest rates based on ourfinancing activities. This exposure relates to borrowings under our workingcapital facility that will be payable at floating rates of interest. Our otherindebtedness, our 7.5% senior secured notes and our mortgage, are payable at afixed rate of interest. As of July 3, 2005, there were no borrowings outstandingunder our floating rate working capital facility. As a result, a hypothetical10% fluctuation in interest rates would not have any impact on earnings for thesix month period ended July 3, 2005.

 

Item4.  Controls and Procedures

 

As of the end of theperiod covered by this report, an evaluation of the effectiveness of the designand operation of our disclosure controls and procedures (as defined under theSecurities and Exchange Commission rules) was carried out under the supervisionand with the participation of the Company’s management, including our ChiefExecutive Officer and Chief Financial Officer. The Company’s disclosure controls and procedures are designed to ensurethat information that the Company must disclose

 

28

----

 

in its reports filed under the SecuritiesExchange Act of 1934 is communicated and processed in a timely manner.  Based upon that evaluation, the ChiefExecutive Officer and the Chief Financial Officer concluded that the design andoperation of these disclosure controls and procedures were effective.  No significant changes were made in ourinternal controls or in other factors that could significantly affect thesecontrols subsequent to the date of their evaluation.

 

29

----

 

MORTON’SRESTAURANT GROUP, INC. AND SUBSIDIARIES

 

Part II  - Other Information

 

Item 1.  Legal Proceedings

 

Since August 2002, a number of the Company’s currentand former employees in New York, Boston and Florida have initiatedarbitrations with the American Arbitration Association in their respectivestates alleging that the Company has violated state (Boston arbitration), stateand federal (New York arbitrations) and federal (Florida arbitrations) wage andhour laws regarding the sharing of tips with other employees and failure to payfor all hours worked. There are two group arbitrations pending in Florida. Oneis proceeding in West Palm Beach as a collective action (hereafter referred toas “West Palm Beach arbitration”) with approximately thirty claimants. Thesecond is proceeding in Miami as a consolidated action (hereafter “Miamiarbitration”) with approximately six claimants. Potential class members in the West Palm Beach arbitration were sentnotices notifying them of the arbitration and advising them if they wish toparticipate in the arbitration they must sign and return a consent form.  In addition, there are two individual demandsfor arbitration pending in Florida which may ultimately be joined to the Miamiarbitration.

 

In general, the complainants are seeking restitutionof tips, the difference between the tip credit wage and the minimum wage,payment for hours worked off the clock (in the Miami arbitration and in theindividual Florida arbitrations only), liquidated damages and attorneys’ feesand costs. The arbitrator in the New York arbitrations has permitted thecomplainants to consolidate their arbitrations into one action and proceed as acollective action. The Miami claimants are also seeking to consolidate theirarbitrations. The arbitrator has ruled that the claims cannot be consolidatedbut is allowing the case to proceed as a collective action. The Bostonarbitrator has ruled that the claimants may proceed as a class, but to datethere are only three people in the class and no class has been certified. TheCompany intends to and is contesting these matters vigorously. Managementbelieves an adverse opinion in any one of these cases would not have a materialadverse impact on the Company’s financial condition.

 

In November 2004, current and former employees of theSacramento Morton’s commenced a federal lawsuit asserting individual,representative and class claims against the Sacramento Morton’s and severalother Morton’s restaurants.  The plaintiffsasserted claims based on the Company’s alleged failure to provide them withmeal and rest periods, and for unlawful tip sharing and unfaircompetition.  The plaintiffs seekrestitution of tips, meal and break period compensation and attorney’s fees.Dismissals with prejudice for all defendants, except the Sacramento Morton’s, weregranted.  The claims against theSacramento Morton’s steakhouse have been move to arbitration.

 

In May 2005, a former employee of the Bostonrestaurant filed a nationwide class action complaint in federal court inMassachusetts alleging that the tip out violates the Fair Labor Standards Act.The Company moved to dismiss the complaint and compel arbitration.   While the motion was pending, the plaintifffiled a nationwide collective action demand for arbitration with the AmericanArbitration Association.  The demand forarbitration alleges the same facts as the lawsuit filed in federal court.  The motion to dismiss is still pending infederal court.

 

The Company is involved in various other claims andlegal actions arising in the ordinary course of business. Management does notbelieve that the ultimate resolution of these actions will have a materialadverse effect on the Company’s consolidated financial position, results of operations,liquidity and capital resources.

 

Item 6.  Exhibits

 
| **Exhibit  No.** | ** ** | **Description**                                                                                                                               |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                                          |
| 31.1             |       | Certification of Allen J. Bernstein Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                                |
|             |       |                                                                                                                                          |
| 31.2             |       | Certification  of Thomas J. Baldwin Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002                                                |
|             |       |                                                                                                                                          |
| 32.1             |       | Certification of Allen J. Bernstein Pursuant to 18 U.S.C. Section  1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
|             |       |                                                                                                                                          |
| 32.2             |       | Certification of Thomas J. Baldwin Pursuant to 18 U.S.C. Section  1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002  |

 

30

----

 

SIGNATURES

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, asamended, the Registrant has duly caused this report to be signed on its behalfby the undersigned thereunto duly authorized.

 

 
|   |            | MORTON’S RESTAURANT GROUP, INC. |
|--------|-----------------|--------------------------------------|
|   |            | (Registrant)                         |
|   |            |                                 |   |
|   |            |                                 |   |
| Date   | August 15, 2005 | By:                                  | /s/ ALLEN J. BERNSTEIN |   |
|   |            |                                 | Allen J. Bernstein |   |
|   |            |                                 | Chairman of the Board, President |
|   |            |                                 | and Chief Executive Officer |   |
|   |            |                                 |   |   |
|   |            |                                 |   |   |
| Date   | August 15, 2005 | By:                                  | /s/ THOMAS J. BALDWIN |   |
|   |            |                                 | Thomas J. Baldwin |
|   |            |                                 | Executive Vice President, |
|   |            |                                 | Chief Financial Officer and Director |

 

31

----