**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

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

 

**For thequarterly period ended September 24, 2005**

 

**OR**

 
| **o** | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|-------|------------|----------------------------------------------------------------------------------------------------------|

 

**For thetransition period from              to**

 

**CommissionFile Number 000-50845**

 

**McCormick & Schmick’s Seafood Restaurants, Inc.**

(Exact name of registrant asspecified in its charter)

 
| **Delaware**                                                   | ** ** | **20-1193199**                        |
|----------------------------------------------------------------|------------|---------------------------------------|
| (State or  other jurisdiction of                               |       | (IRS  Employer Identification Number) |
| incorporation  or organization)                                |       |                                  |
|                                                           |       |                                  |
| **720 SW  Washington Street, Suite 550 Portland, Oregon** | ** ** | **97205**                             |
| (Address of  principal executive offices)                      |       | (Zip Code)                            |

 

**(503) 226-3440**

(Registrant’s telephone number,including area code)

 

Indicate by check mark whether theregistrant:  (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.   Yes  ý   No  o

 

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

 

There were 13,783,502 shares of common stockoutstanding as of September 24, 2005.

 

 

----

 

**INDEX**

 
| **PART I. FINANCIAL INFORMATION**                                                                                                          | **3**  |
|-------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                            |   |
| Item 1 - Financial Statements—(Unaudited)                                                                                                  | 3      |
|                                                                                                                                            |   |
| Consolidated Balance Sheets as of December 25,  2004 and September 24, 2005                                                           | 3      |
|                                                                                                                                            |   |
| Consolidated Statements of Operations for  the thirteen and thirty-nine week periods ended September 25, 2004 and September 24,  2005 | 4      |
|                                                                                                                                            |   |
| Consolidated Statements of Cash Flows for  the thirty-nine week periods ended September 25, 2004 and September 24,  2005              | 5      |
|                                                                                                                                            |   |
| Notes to Consolidated Financial Statements                                                                                                      | 6      |
|                                                                                                                                            |   |
| Item 2 - Management’s Discussion and Analysis of Financial Condition  and Results of Operations                                            | 10     |
|                                                                                                                                            |   |
| Item 3 - Quantitative and Qualitative  Disclosures About Market Risk                                                                            | 25     |
|                                                                                                                                            |   |
| Item 4 - Controls and Procedures                                                                                                                | 26     |
|                                                                                                                                            |   |
| **PART II. OTHER INFORMATION**                                                                                                             | **26** |
|                                                                                                                                            |   |
| Item 1 - Legal Proceedings                                                                                                                      | 26     |
|                                                                                                                                            |   |
| Item  2 - Unregistered Sales of Equity Securities and Use of Proceeds                                                                           | 26     |
|                                                                                                                                            |   |
| Item 3 - Defaults Upon Senior Securities                                                                                                        | 26     |
|                                                                                                                                            |   |
| Item 4 - Submissions of Matters to a Vote  of Security Holders                                                                                  | 26     |
|                                                                                                                                            |   |
| Item 5 - Other Information                                                                                                                      | 26     |
|                                                                                                                                            |   |
| Item 6 - Exhibits                                                                                                                               | 26     |
|                                                                                                                                            |   |
| Signatures                                                                                                                                      | 28     |

 

2

----

 

**PART I — FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

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

**Consolidated Balance Sheets-Unaudited**

**(Inthousands, except per share data)**

 
| ** **                                                                                                   | ** ** | **December 25,** | ** ** | **September 24,** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                                                                                                   | ** ** | **2004**              | ** ** | **2005**               | ** ** |
| **Assets**                                                                                                   |       |                  |       |                   |       |
| Current  assets                                                                                              |       |                  |       |                   |       |
| Cash and  cash equivalents                                                                                   |       | $                     | 451        |                   | $          | 444 |   |
| Trade  accounts receivable, net                                                                              |       | 4,641                 |       | 4,653                  |       |
| Tenant  improvement allowance receivables                                                                    |       | 347                   |       | 3,158                  |       |
| Inventories                                                                                                  |       | 3,384                 |       | 3,685                  |       |
| Prepaid  expenses and other current assets                                                                   |       | 2,846                 |       | 2,861                  |       |
| Deferred  income taxes                                                                                       |       | 830                   |       | 2,973                  |       |
| Total  current assets                                                                                        |       | 12,499                |       | 17,774                 |       |
| Equipment  and leasehold improvements, net                                                                   |       | 92,744                |       | 102,880                |       |
| Other assets                                                                                                 |       | 53,821                |       | 53,645                 |       |
| Goodwill                                                                                                     |       | 19,996                |       | 19,996                 |       |
| Total assets                                                                                                 |       | $                     | 179,060    |                   | $          | 194,295 |   |
|                                                                                                         |       |                  |       |                   |       |
| **Liabilities  and Stockholders’ Equity**                                                               |       |                  |       |                   |       |
| Current  liabilities                                                                                         |       |                  |       |                   |       |
| Book  overdraft                                                                                              |       | $                     | 429        |                   | $          | 2,354 |   |
| Accounts  payable                                                                                            |       | 12,875                |       | 12,939                 |       |
| Accrued  expenses                                                                                            |       | 15,197                |       | 18,240                 |       |
| Capital  lease obligations, current portion                                                                  |       | 433                   |       | 379                    |       |
| Total  current liabilities                                                                                   |       | 28,934                |       | 33,912                 |       |
| Revolving  credit facility                                                                                   |       | 12,000                |       | 8,000                  |       |
| Other  long-term liabilities                                                                                 |       | 11,791                |       | 14,946                 |       |
| Capital  lease obligations, noncurrent portion                                                               |       | 707                   |       | 433                    |       |
| Deferred  income taxes                                                                                       |       | 1,558                 |       | 6,371                  |       |
| Total  liabilities                                                                                           |       | 54,990                |       | 63,662                 |       |
|                                                                                                         |       |                  |       |                   |       |
| Contingencies  (Note 7)                                                                                      |       |                  |       |                   |       |
|                                                                                                         |       |                  |       |                   |       |
| Stockholders’  equity                                                                                   |       |                  |       |                   |       |
| Common  stock, $0.001 par value, 120,000 shares authorized, 13,782 and 13,784 shares  issued and outstanding |       | 14                    |       | 14                     |       |
| Additional  paid in capital                                                                                  |       | 127,917               |       | 127,931                |       |
| Retained  earnings (accumulated deficit)                                                                     |       | (3,861                | )          | 2,688                  |       |
| Total  stockholders’ equity                                                                             |       | 124,070               |       | 130,633                |       |
| Total liabilities  and stockholders’ equity                                                             |       | $                     | 179,060    |                   | $          | 194,295 |   |
|                                                                                                              |            |                       |            |                        |            |  |  |  |  |

 

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

 

3

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

**Consolidated Statements of Operations-Unaudited**

**(Inthousands, except per share data)**

 
| ** **                                                                 | ** ** | **Thirteen week period ended** | ** ** | **Thirty-nine week period ended** | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------|------------|-----------------------------------|------------|
| ** **                                                                 | ** ** | **September 25,**         | ** ** | **September 24,**            | ** ** | **September 25,** | ** ** | **September 24,** | ** ** |
| ** **                                                                 | ** ** | **2004**                       | ** ** | **2005**                          | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                                 | ** ** | **Restated**                   | ** ** | ** **                        | ** ** | **Restated** | ** ** | ** ** | ** ** |
| Revenues                                                                   |       | $                              | 59,597     |                              | $          | 68,014 |   | $ | 173,833 |   | $ | 196,785 |   |
|                                                                       |       |                           |       |                              |       |   |   |   |   |
| Restaurant  operating costs                                                |       |                           |       |                              |       |   |   |   |   |
| Food and  beverage                                                         |       | 17,776                         |       | 20,013                            |       | 51,993 |   | 57,700 |   |
| Labor                                                                      |       | 19,013                         |       | 21,421                            |       | 55,555 |   | 62,157 |   |
| Operating                                                                  |       | 8,947                          |       | 10,447                            |       | 25,565 |   | 29,462 |   |
| Occupancy                                                                  |       | 5,434                          |       | 6,267                             |       | 15,679 |   | 17,933 |   |
| Total  restaurant operating costs                                          |       | 51,170                         |       | 58,148                            |       | 148,792 |   | 167,252 |   |
| General and  administrative expenses                                       |       | 3,340                          |       | 3,541                             |       | 8,505 |   | 10,444 |   |
| Restaurant  pre-opening costs                                              |       | 112                            |       | 760                               |       | 2,226 |   | 2,048 |   |
| Depreciation  and amortization                                             |       | 2,690                          |       | 2,483                             |       | 8,275 |   | 7,095 |   |
| Management  fees and covenants not to compete                              |       | —                         |       | —                            |       | 4,241 |   | — |   |
| Total costs  and expenses                                                  |       | 57,312                         |       | 64,932                            |       | 172,039 |   | 186,839 |   |
| Operating  income                                                          |       | 2,285                          |       | 3,082                             |       | 1,794 |   | 9,946 |   |
| Interest  expense                                                          |       | 570                            |       | 131                               |       | 2,366 |   | 454 |   |
| Accrued  dividends and accretion on mandatorily redeemable preferred stock |       | 3,693                          |       | —                            |       | 5,759 |   | — |   |
| Write-off of  deferred loan costs on early extinguishment of debt          |       | 1,288                          |       | —                            |       | 1,288 |   | — |   |
| Income  (loss) before income taxes                                         |       | (3,266                         | )          | 2,951                             |       | (7,619 | ) | 9,492 |   |
| Income tax  expense (benefit)                                              |       | 71                             |       | 915                               |       | (678 | ) | 2,942 |   |
| Net income  (loss)                                                         |       | $                              | (3,337     | )                                 | $          | 2,036 |   | $ | (6,941 | ) | $ | 6,550 |   |
| Net income  (loss) per share(1)                                            |       |                           |       |                              |       |   |   |   |   |
| Basic                                                                      |       | $                              | (0.27      | )                                 | $          | 0.15 |   | $ | (0.75 | ) | $ | 0.48 |   |
| Diluted                                                                    |       | $                              | (0.27      | )                                 | $          | 0.15 |   | $ | (0.75 | ) | $ | 0.47 |   |
| Shares used  in computing net income (loss) per share(1)                   |       |                           |       |                              |       |   |   |   |   |
| Basic                                                                      |       | 12,200                         |       | 13,783                            |       | 9,255 |   | 13,782 |   |
| Diluted                                                                    |       | 12,200                         |       | 14,026                            |       | 9,255 |   | 13,983 |   |

 

----

(1)   Forthe thirteen and thirty-nine week periods ended September 25, 2004, forthe purposes of calculating outstanding shares used in computing net loss pershare, the presentation gives retroactive effect to the completion, on July 20,2004, of the Company’s corporate reorganization.

 

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

 

4

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

**Consolidated Statements of Cash Flows-Unaudited**

**(Inthousands)**

 
| ** **                                                                               | ** ** | **Thirty-nine week period ended** | ** ** |
|------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                               | ** ** | **September 25,**            | ** ** | **September 24,** | ** ** |
| ** **                                                                               | ** ** | **2004**                          | ** ** | **2005** | ** ** |
| ** **                                                                               | ** ** | **Restated**                      | ** ** | ** ** | ** ** |
| **Operating activities**                                                                 |       |                              |       |   |   |
| Net income (loss)                                                                        |       | $                                 | (6,941     | ) | $ | 6,550 |   |
| Adjustments to reconcile net income (loss)  to net cash provided by operating activities |       |                              |       |   |   |
| Depreciation  and amortization                                                           |       | 8,275                             |       | 7,095 |   |
| Amortization  of unearned compensation                                                   |       | 42                                |       | — |   |
| Deferred  income taxes                                                                   |       | (678                              | )          | 2,670 |   |
| Accrued  dividends and accretion on mandatorily redeemable preferred stock               |       | 5,759                             |       | — |   |
| Write-off of  deferred loan costs on early extinguishment of debt                        |       | 1,288                             |       | — |   |
| Changes in  operating assets and liabilities                                             |       |                              |       |   |   |
| Trade  accounts receivable                                                               |       | (1,120                            | )          | (12 | ) |
| Tenant  improvement allowance receivables                                                |       | (615                              | )          | (2,811 | ) |
| Inventories                                                                              |       | (515                              | )          | (301 | ) |
| Prepaid  expenses and other current assets                                               |       | (524                              | )          | (15 | ) |
| Accounts  payable                                                                        |       | (377                              | )          | 64 |   |
| Accrued  expenses                                                                        |       | 2,608                             |       | 3,038 |   |
| Other  long-term liabilities                                                             |       | 4,588                             |       | 3,160 |   |
| Net cash  provided by operating activities                                               |       | 11,790                            |       | 19,438 |   |
| **Investing activities**                                                                 |       |                              |       |   |   |
| Acquisition of equipment and leasehold  improvements                                     |       | (22,466                           | )          | (17,036 | ) |
| Other assets                                                                             |       | (116                              | )          | (20 | ) |
| Net cash  used in investing activities                                                   |       | (22,582                           | )          | (17,056 | ) |
| **Financing activities**                                                                 |       |                              |       |   |   |
| Book overdraft                                                                           |       | (2,456                            | )          | 1,925 |   |
| Loan costs                                                                               |       | (775                              | )          | — |   |
| Borrowings made on revolving credit  facility                                            |       | 62,500                            |       | 7,000 |   |
| Payments made on revolving credit facility                                               |       | (84,000                           | )          | (11,000 | ) |
| Proceeds from issuance of common stock, net  of issuance costs                           |       | 64,854                            |       | — |   |
| Redemption of senior preferred stock                                                     |       | (28,896                           | )          | — |   |
| Payments on capital lease obligations                                                    |       | (309                              | )          | (328 | ) |
| Proceeds from exercise of stock options                                                  |       | —                            |       | 14 |   |
| Purchase of Class B units                                                           |       | (6                                | )          | — |   |
| Net cash  provided by (used in) financing activities                                     |       | 10,912                            |       | (2,389 | ) |
| Net increase  (decrease) in cash and cash equivalents                                    |       | 120                               |       | (7 | ) |
| Cash and cash equivalents, beginning of  period                                          |       | 2,453                             |       | 451 |   |
| Cash and cash equivalents, end of period                                                 |       | $                                 | 2,573      |   | $ | 444 |   |
|                                                                                     |       |                              |       |   |   |
| **Supplemental disclosure of cash flow  information**                                    |       |                              |       |   |   |
| Cash paid during the period                                                              |       |                              |       |   |   |
| Interest                                                                                 |       | $                                 | 2,706      |   | $ | 702 |   |
| Income taxes                                                                             |       | 56                                |       | 273 |   |

 

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

 

5

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

**Notes to Consolidated Financial Statements-Unaudited**

 

**1.****     TheBusiness and Organization**

 

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

 

The financial statements for the periodcovered by this report are those of McCormick & Schmick’s SeafoodRestaurants, Inc. for periods beginning after July 19, 2004 and thoseof the LLC for periods ended on or before July 19, 2004. Except withrespect to information regarding the membership units in the LLC and the commonstock issued upon the reorganization, there was no impact to the financialstatements as a result of converting from a limited liability company to acorporation. Before July 20, 2004, the Company’s operations were conductedby subsidiaries of the LLC, which were taxable corporations. Accordingly, thefinancial statements of the Company have historically included a provision forincome taxes and related deferred income taxes. Throughout this report,McCormick & Schmick’s Seafood Restaurants, Inc. and the LLC arereferred to collectively as “the Company.”

 

**2.****     Basisof Presentation**

 

As of September 24, 2005 the Companyowned and operated 55 restaurants in 24 states throughout the United States ofAmerica and provided management services to two additional restaurants.

 

The accompanying unaudited consolidatedfinancial statements have been prepared in accordance with U.S. generallyaccepted accounting principles for interim financial information and with theinstructions to Form 10-Q and Article 10 of Regulation S-X.Accordingly, they do not include all of the information and footnotes requiredby U.S. generally accepted accounting principles for complete financialstatements. In the opinion of management, all adjustments (consisting of normalrecurring accruals) considered necessary for a fair statement have beenincluded. Operating results for the thirteen week and thirty-nine week periodsended September 24, 2005 are not necessarily indicative of the resultsthat may be expected for the fiscal year ending December 31, 2005.

 

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

 

Certain prior period amounts have beenreclassified to conform to current period presentation.

 

**3.****     Restatementof Financial Information**

 

As previously reported in the Company’sAnnual Report on Form 10-K for the year ended December 25, 2004, likemany other restaurant companies and retailers, the Company conducted a reviewof its accounting policies applicable to leases, leasehold improvements, rentcommencement, deferred rent, and other related items. This review was promptedin part by a February 7, 2005 letter from the Office of the ChiefAccountant of the Securities and Exchange Commission to the American Instituteof Certified Public Accountants regarding proper accounting for certainoperating lease matters under generally accepted accounting principles. Based onthe review, the Company determined that it had incorrectly accounted forcertain operating lease transactions under generally accepted accountingprinciples.  Accordingly, the Companyadjusted its consolidated financial statements for fiscal years and quartersended prior to December 25, 2004. These restatement adjustments increased net loss by $0.2 million andincreased basic and diluted net loss per share by ($0.02) for the thirteen weekperiod ended September 25, 2004 and increased net loss by $0.8 million andincreased basic and diluted net loss per share by ($0.08) for the thirty-nineweek period ended September 25, 2004. The restatement adjustments were non-cash and had no impact on revenuesor cash and cash equivalents.

 

**Lease Term**

 

Historically, the Company amortized itsleasehold improvements on leased properties over the shorter of the combinedinitial term and all option periods of the lease (generally ranging from 20 to30 years) or the useful life of the asset. In addition, the Company recognizedrent expense on the straight-line basis from the opening date of the restaurantthrough the initial term of the lease. The Company concluded that itscalculation of straight line rent expense should be based on the lease term asdefined in Statement of Financial Accounting Standards (“SFAS”) No. 13, “Accountingfor Leases,” as amended, which in most cases exceeds the initial term of thelease. As a result, it restated its financial statements to recognize rentexpense on the straight-line basis over the lease term, including optionperiods which are reasonably assured of renewal primarily due to the presenceof certain economic penalties. For purposes of calculating straight-line rents,the lease term commences on the date the lessee obtains control over theproperty, which is generally when the lessor’s property is substantiallycomplete and is ready for tenant improvements. In addition, the Companyamortizes leasehold improvements over the shorter of the lease term or theuseful life of the assets.

 

6

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**Tenant Improvement Allowances**

 

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

 

**4.****     Summaryof Selected Accounting Policies**

 

**Principles of Consolidation**

 

The consolidated financial statements includethe assets, liabilities and results of operations of McCormick &Schmick’s Seafood Restaurants, Inc. and its subsidiaries. All intercompanybalances and transactions have been eliminated upon consolidation.

 

**Management Estimates**

 

The preparation of financial statements inconformity with U.S. generally accepted accounting principles requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenue andexpenses during the reporting period. The Company bases its estimates onhistorical experience and on various assumptions that are believed to bereasonable under the circumstances at the time. Actual results could differfrom those estimates under different assumptions or conditions.

 

**Revenue Recognition**

 

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

 

**Equity-Based Compensation Plan**

 

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

 

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

 

The table below shows the effects on netincome (loss) and net income (loss) per share had compensation cost beenmeasured with the fair value method pursuant to SFAS 123:

 
| ** **                                                   | ** ** | **Thirteen week****period ended**             | ** ** | **Thirty-nine week****period ended**          | ** ** |
|--------------------------------------------------------------|------------|-----------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                   | ** ** | **September 25,  2004**                  | ** ** | **September 24,  2005**                  | ** ** | **September 25,  2004** | ** ** | **September 24,  2005** | ** ** |
| ** **                                                   | ** ** | **Restated**                                  | ** ** | ** **                                    | ** ** | **Restated** | ** ** | ** ** | ** ** |
| ** **                                                   | ** ** | **(in thousands, except****per  share data)** | ** ** | **(in thousands, except****per  share data)** | ** ** |
| Net income  (loss), as reported                              |       | $                                             | (3,337     | )                                             | $          | 2,036 |   | $ | (6,941 | ) | $ | 6,550 |   |
| Compensation  expense included in net income (loss)          |       | 37                                            |       |                                          |       | 42 |   |   |   |
| Compensation  cost based on the fair value method            |       | (178                                          | )          | (200                                          | )          | (183 | ) | (635 | ) |
| Pro forma  net income (loss)                                 |       | $                                             | (3,478     | )                                             | $          | 1,836 |   | $ | (7,082 | ) | $ | 5,915 |   |
|                                                         |       |                                          |       |                                          |       |   |   |   |   |
| Basic and  fully diluted net income (loss) per share         |       |                                          |       |                                          |       |   |   |   |   |
| As reported                                                  |       |                                          |       |                                          |       |   |   |   |   |
| Basic                                                        |       | $                                             | (0.27      | )                                             | $          | 0.15 |   | $ | (0.75 | ) | $ | 0.48 |   |
| Fully  diluted                                               |       | $                                             | (0.27      | )                                             | $          | 0.15 |   | $ | (0.75 | ) | $ | 0.47 |   |
| Pro forma                                                    |       |                                          |       |                                          |       |   |   |   |   |
| Basic                                                        |       | $                                             | (0.28      | )                                             | $          | 0.13 |   | $ | (0.77 | ) | $ | 0.43 |   |
| Fully  diluted                                               |       | $                                             | (0.28      | )                                             | $          | 0.13 |   | $ | (0.77 | ) | $ | 0.42 |   |
|                                                         |       |                                          |       |                                          |       |   |   |   |   |
| Shares used  in computing net income (loss) per common share |       |                                          |       |                                          |       |   |   |   |   |
| Basic                                                        |       | 12,200                                        |       | 13,783                                        |       | 9,255 |   | 13,782 |   |
| Fully  diluted                                               |       | 12,200                                        |       | 14,026                                        |       | 9,255 |   | 13,983 |   |

 

7

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The preceding proforma results werecalculated using the Black-Scholes option pricing model and the followingassumptions:

 

(1)   risk-freeinterest rate of 3.9%;

 

(2)   dividendyield of 0%;

 

(3)   expectedlife of 5.5 years; and

 

(4)   volatilityof 24.3%.

 

Results may vary depending on the assumptionsapplied within the model.

 

**Basic and Diluted Net Income (Loss) per Share**

 

Basic income (loss) per share is computedbased on the weighted-average number of common shares outstanding during theperiod since the Company’s initial public offering. For periods prior to theinitial public offering the 7,179,357 shares of common stock of the Companyissued to the former unit holders of the LLC and the 602,292 shares issuableupon the exercise of certain warrants (because the warrants have a nominalexercise price) are assumed to be outstanding for all periods presented. Thesewarrants were exercised on October 20, 2004. Diluted earnings per shareare computed using the weighted average number of shares of common stock andpotentially dilutive securities assumed to be outstanding during the year.Potentially dilutive shares from stock options and other common stockequivalents are excluded from the computation when their effect is anti-dilutive.

 

The diluted weighted-average shares for thethirteen and thirty-nine week periods ended September 24, 2005 include853,600 shares subject to stock options.  Options to purchase 851,150 shares of common stock were outstanding at September 24,2005.

 

**Operating Leases**

 

The Company has entered into operatingleases, which have accelerating minimum base rent terms and contingent rentterms if individual restaurant sales exceed certain levels. The Company recordsthe minimum base rents on a straight-line basis over the life of the leaseterm, including option periods which are reasonably assured of renewal due tothe presence of certain economic penalties. For purposes of calculatingstraight-line rents, the lease term commences on the date the lessee obtainscontrol of the property, which is normally when the property is ready fornormal tenant improvements (build-out-period), when no rent payments aretypically due under the terms of the lease. For certain leases the Company onlyhas the right to exercise its option for renewal if certain sales targets areachieved at or near the renewal date. These renewal option periods have beenincluded in the lease term when the Company determines at lease inception or atthe acquisition date of the restaurant, if later, that the sales targets arenon-substantive and achievement of such sales targets is virtually certain. Thedifference between rent expense calculated on a straight-line basis and rentpaid is recorded as deferred rent liability. The Company receives certaintenant improvement allowances which are considered lease incentives and areamortized as reduction of rent expense over the lease term.  Accordingly, the Company has recorded adeferred rent liability for the straight-lining of rents and lease incentives,which is included in other long-term liabilities of $10.8 million and $13.9million as of December 25, 2004 and September 24, 2005,respectively.  Non-cash rent expense was$0.6 million and $1.6 million in the thirteen and thirty-nine week periodsended September 24, 2005, respectively, compared to $0.5 million and $1.4million in the thirteen and thirty-nine week periods ended September 25,2004, respectively.

 

8

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**Recent Accounting Pronouncements**

 

In December 2004, the FinancialAccounting Standards Board (‘‘FASB’’) issued SFAS No. 123(R), (“SFAS123(R)”) ‘‘Share-Based Payment’’, which is a revision of SFAS 123 andsupercedes APB 25. SFAS 123(R) requires all share-based payments to employees,including grants of employee stock options, to be valued at fair value on thedate of grant, and to be expensed over the applicable vesting period. Pro formadisclosure of share-based payments effect on the statement of operations is notpermissible under SFAS 123(R).  SFAS123(R) is effective for all stock-based awards granted on or after January 1,2006. In addition, companies must also recognize compensation expense relatedto any awards that are not fully vested as of January 1, 2006.Compensation expense for the unvested awards will be measured based on the fairvalue of the awards previously calculated in developing the pro formadisclosures in accordance with the provisions of SFAS 123. The adoption of SFAS123(R) will increase compensation expense.

 

In March 2005, the Securities and ExchangeCommission (“SEC”) issued Staff Accounting Bulletin No. 107 (“SAB 107”)regarding the Staff’s interpretation of SFAS 123(R). This interpretationexpresses the views of the Staff regarding the interaction between SFAS 123(R)and certain SEC rules and regulations and provides the Staff’s viewsregarding the valuation of share-based payment arrangements by publiccompanies. In particular, this SAB provides guidance related to share-basedpayment transactions with non-employees, the transition from nonpublic topublic entity status, valuation methods, the accounting for certain redeemablefinancial instruments issued under share-based payment arrangements, theclassification of compensation expense, non-GAAP financial measures, first-timeadoption of SFAS 123(R) in an interim period, capitalization of compensationcost related to share-based payment arrangements, the accounting for income taxeffects of share-based payment arrangements upon adoption of SFAS 123(R), themodification of employee share options prior to adoption of SFAS 123(R) anddisclosures in Management’s Discussion and Analysis subsequent to adoption ofSFAS 123(R).  The Company will adopt SAB107 in connection with its adoption of SFAS 123(R).

 

In May 2005, the FASB issued SFAS No. 154 (“SFAS 154”), “Accounting Changes and Error Corrections—A Replacement of APB Opinion No.20 and FASB Statement No. 3.” SFAS 154 requires retrospective application to prior periods’ financial statements for changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change.  SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.

 

In September 2005, theEmerging Issues Task Force (“EITF”) issued EITF 05-06, “ Determining theAmortization Period for Leasehold Improvements after Lease Inception orAcquired in a Business Combination”. EITF 05-06 requires that leasehold improvements acquired in a businesscombination be capitalized over the shorter of the useful life of the assets ora term that includes required lease periods and renewals that are deemed to bereasonably assured at the date of acquisition. EITF 05-06 also requires leasehold improvements that are placed inservice significantly after and not contemplated at or near the beginning ofthe lease term should be amortized over the shorter of the useful life of theassets or a term that includes required lease periods and renewals that aredeemed to be reasonably assured (as defined in paragraph 5 of Statement 13) atthe date the leasehold improvements are purchased.EITF 05-06 is effective for leaseholdimprovements that are purchased or acquired in reporting periods beginning afterJune 29, 2005. Early adoption of the consensus is permitted in periods forwhich financial statements have not been issued.  The Company does not believe that theadoption of EITF 05-06 will have a material effect on its consolidatedfinancial position, results of operations or cash flows.

 

In October 2005, theFASB issued FASB Staff Position (“FSP”) No. FAS 13-1 (“FAS 13-1”) “Accountingfor Rental Costs Incurred during a Construction Period”.  FAS 13-1 requires rental costs associatedwith ground or building operating leases that are incurred during aconstruction period to be recognized as rental expense. The rental costs shallbe included in income from continuing operations.  FAS 13-1 is effective for the first reportingperiod beginning after December 15, 2005. Early adoption is permitted for financial statements or interimfinancial statements that have not yet been issued.  The Company does not believe that theadoption of FAS 13-1 will have a material effect on its consolidated financialposition, results of operations or cash flows.

 

**5.****     Long-TermDebt and Standby Letter of Credit**

 

On July 23,2004, the Company repaid the $51.5 million outstanding balance on its revolvingcredit facility with net proceeds from its initial public offering and $18.1million borrowed under a new revolving credit facility agreement, whichprovides among other things for $50.0 million in revolving credit loans. Loansunder the facility are collateralized by a first priority security interest inall of the Company’s assets and mature on July 23, 2009.  The outstanding balance on the Company’srevolving credit facility was $8.0 million as of September 24, 2005 and$12.0 million as of December 25, 2004. The interest rate on the credit facility is based on the financial institution’sprime rate plus a margin of 0.25% to 0.75% or the Eurodollar rate plus a marginof 1.75% to 2.25%, with margins determined by certain financial ratios.

 

The revolving creditfacility agreement also provides for bank guarantee under standby letter ofcredit arrangements in the normal course of business operations. Our commercialbank issues standby letters of credit to secure our obligations to pay orperform when required to do so pursuant to the requirements of an underlyingagreement or the provision of goods and services. The standby letters of creditare cancelable only at the option of the beneficiary who is authorized to drawdrafts on the issuing bank up to the face amount of the standby letter ofcredit in accordance with its terms. As of September 24, 2005 and December 25,2004 the maximum exposure under these standby letters of credit was $1.5million and $0.3 million, respectively. At September 24, 2005 and December 25,2004

 

9

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there were no amounts drawn upon these letters ofcredit.  At September 24, 2005 theCompany had $40.5 million available under its revolving credit facility.

 

Under the revolving credit facilityagreement, the Company is subject to certain financial and non-financialcovenants, including an adjusted leverage ratio, a consolidated cash flowratio, and a growth capital expenditures limitation. The Company was incompliance with these covenants as of September 24, 2005.

 

**6.****     RelatedParty Transactions**

 

Prior to the Company’s initial publicoffering, it paid annual management fees of $1.1 million to each of Bruckmann,Rosser, Sherrill & Co., L.L.C. (“BRS”) and Castle Harlan, Inc. (“CastleHarlan”), affiliates of which had significant ownership interests in the LLC atthe time of the agreement terminations. These management agreements were terminated in conjunction with theCompany’s initial public offering in July 2004.  Management fees recognized as expensestotaled $3.3 million in the thirty-nine week period ended September 25,2004.  Pursuant to covenants not tocompete agreements with the Company’s co-founders, William P. McCormick andDouglas L. Schmick, the Company expensed $0.9 in the thirty-nine week periodended September 25, 2004.  Thesecovenants not to compete agreements were terminated in connection with theCompany’s initial public offering.  Therewere no management fee expenses or covenants not to compete expenses for thethirteen week periods ended September 24, 2005 and September 25,2004.

 

The Company leases properties from landlordscontrolled by certain stockholders of the Company. Total rent paid to theselandlords was $0.3 million and $0.7 million for the thirteen and thirty-nineweek periods ended September 24, 2005, respectively, and $0.2 million and $0.6million for the thirteen and thirty-nine week periods ended September 25,2004, respectively.

 

**7.****     Contingencies**

 

The Company is subject to various claims,possible legal actions, and other matters arising out of the normal course ofbusiness.  While it is not possible topredict the outcome of these issues, management is of the opinion that adequateprovision for potential losses has been made in the accompanying consolidatedfinancial statements and that the ultimate resolution of these matters will nothave a material adverse effect on the Company’s financial position, results ofoperations or cash flows.

 

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

 

**FORWARD LOOKING STATEMENTS**

 

This information should beread in conjunction with the consolidated financial statements and notesthereto included in Item 1 of Part I of this Quarterly Report and theaudited consolidated financial statements and notes thereto and Management’sDiscussion and Analysis of Financial Condition and Results of Operations forthe year ended December 25, 2004 contained in our 2004 Annual Report on Form 10-K.

 

The following section containsforward-looking statements which involve risks and uncertainties. Theseforward-looking statements include those regarding anticipated restaurantopenings, anticipated costs and sizes of future restaurants and the adequacy ofanticipated sources of cash to fund our future capital requirements. Our actualresults may differ materially from those discussed in the forward-lookingstatements. Words such as “believes,” “anticipates,” “expects,” “intends,” “plans”and similar expressions are intended to identify forward-looking statements,but are not the exclusive means of identifying such statements.

 

Important factors that could cause actualresults to differ materially from our expectations include those discussedbelow under “Factors That May Affect Our Business and the Price of OurStock.”  We do not undertake any duty toupdate forward-looking statements after the date they are made or to conformthem to actual results or to changes in circumstances or expectations.

 

**Restatement of Financial Information**

 

As previously reported in the Company’s 2004Annual Report on Form 10-K, like many other restaurant companies andretailers, we have conducted a review of our accounting policies applicable toleases, leasehold improvements, rent commencement, deferred rent, and otherrelated items. This review was prompted in part by a February 7, 2005letter from the Office of the Chief Accountant of the Securities and ExchangeCommission to the American Institute of Certified Public Accountants regardingproper accounting for certain operating lease matters under generally acceptedaccounting principles. Accordingly, we have adjusted our consolidated financialstatements for fiscal years and quarters ended prior to December 25,2004.  These restatement adjustmentsincreased net loss by $0.2 million and increased basic and diluted net loss pershare by ($0.02) for the thirteen week period ended September 25, 2004 andincreased net loss by $0.8 million and increased basic and diluted net loss pershare by ($0.08) for the thirty-nine week period ended September 25,2004.  The restatement adjustments arenon-cash and had no impact on revenues or cash and cash equivalents.

 

10

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**Reorganization in Connection with InitialPublic Offering**

 

In connection with our initial publicoffering in July 2004, we converted McCormick & Schmick HoldingsLLC, a Delaware limited liability company, into McCormick & Schmick’sSeafood Restaurants, Inc., a Delaware corporation. Because our operationsare conducted by wholly owned subsidiaries, the conversion did not affect ourfinancial statements, except with respect to information regarding themembership units in McCormick & Schmick Holdings LLC. Except wherespecifically noted, references in this Quarterly Report on Form 10-Q to “we”or to “the Company” means McCormick & Schmick Holdings LLC for periodsbefore July 20, 2004 and McCormick & Schmick’s SeafoodRestaurants, Inc. for periods on and after July 20, 2004.

 

**Overview**

 

Our Company was founded in 1972 with WilliamP. McCormick’s acquisition of Jake’s Famous Crawfish in Portland, Oregon. Wegrew our family of restaurants slowly through the next two decades and in 1994,when we owned 14 restaurants, a majority interest in our Company was purchasedby Castle Harlan Partners II, L.P., a private investment firm. Avado Brandspurchased us in 1997. We operated as a division of Avado Brands and added 18new restaurants in just under four and a half years. In August 2001, AvadoBrands sold our Company to Castle Harlan Partners III, L.P. and Bruckmann,Rosser, Sherrill & Co. II, L.P., private equity investment firms thatactively invest in restaurant companies. As of September 24, 2005 we ownedand operated 55 restaurants in 24 states throughout the United States ofAmerica and provided management services to two additional restaurants.

 

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

 

We measure performance using key operatingindicators such as comparable restaurant sales, food and beverage costs, laborcosts, restaurant operating expenses, and total occupancy costs, with a focuson those costs and expenses as a percentage of revenues. For purposes ofcomparable restaurant sales, a restaurant is included in the comparablerestaurant base in the first full quarter following the eighteenth month ofoperations.  We also track trends inaverage weekly revenues at both the restaurant level and on a consolidatedbasis as an indicator of our performance. The key operating measure used bymanagement in evaluating our operating results is operating income. Operatingincome is calculated by deducting restaurant operating costs, general andadministrative expenses, restaurant pre-opening costs, depreciation andamortization and other corporate costs from revenues. Restaurant pre-openingcosts are analyzed based on the number and timing of restaurant openings and bycomparison to budgeted amounts, with an overall target of approximately $0.3 to$0.4 million per restaurant opening, which may include up to $0.1 million innon-cash rent expense during the construction period.

 

The most significant restaurant operatingcosts are food and beverage costs and labor and related employee benefits. Webelieve our national and regional presence allows us to achieve better qualityand pricing on key products than most of our competitors. We closely monitorfood and beverage costs and regularly review our selection of preferred vendorson the basis of several key metrics, including pricing. In addition, because weprint our menu daily at the majority of our restaurants, we are able to adaptthe seafood items we offer to changes in vendor pricing to optimize our revenuemix and mitigate the impact of cost increases in any particular seafood item bysubstituting a lower-cost alternative on our menu or by adjusting the price.With respect to labor costs, we believe the combination of future growth inrevenues and the resulting greater leverage of our vice presidents ofoperations and regional managers will allow us to better leverage payrollexpenses over time. Our employee benefits include health insurance, the cost ofwhich continues to increase faster than the general rate of inflation. Wecontinually monitor this cost and review strategies to effectively controlincreases.

 

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

 

Identification of appropriate new restaurantsites is essential to our growth strategy. We evaluate and invest in newrestaurants based on site-specific projected returns on investment. We believeour store model and flexible real estate strategy provide us with continuedopportunities to find attractive real estate locations on favorable terms.

 

**Strategic Focus and Operating Outlook**

 

Our primary business focus for over 33 yearshas been to consistently offer a broad selection of high quality, freshseafood, which we believe commands strong loyalty from our customers. We havesuccessfully expanded our McCormick & Schmick’s seafood restaurantconcept throughout the United States and have competed effectively withnational and regional restaurant chains and with local operators.

 

11

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Our objective is to continue to prudentlygrow McCormick & Schmick’s seafood restaurants in existing and new markets.Our 2005 plan includes opening seven new restaurants, five of which were openedas of September 24, 2005. In addition to new unit growth, we are committedto improving comparable restaurant sales and operating margins over the levelsachieved in 2004.

 

**Financial Performance Overview**

 

The following are highlights of our financialperformance for the thirteen week period ended September 24, 2005:

 

•      Comparablerestaurant sales in the thirteen week period ended September 24, 2005increased 3.5% compared to an increase of 1.6% over the comparable restaurantsales in the thirteen week period ended September 25, 2004.

 

•      Revenuesincreased 14.1% in the thirteen week period ended September 24, 2005compared to the thirteen week period ended September 25, 2004, to $68.0million. The increase was primarily due to revenues generated by the sixcompany-owned restaurants opened in the last twenty-six weeks of 2004 and thefirst thirty-nine weeks of 2005 coupled with a comparable restaurant salesincrease of 3.5%.

 

•      Net income was$2.0 million in the thirteen week period ended September 24, 2005 comparedto net loss of $3.3 million in the thirteen week period ended September 25,2004, an increase of $5.4 million due primarily to the following:

 

•      Operatingincome increased $0.8 million in the thirteen week period ended September 24,2005 compared to the thirteen week period ended September 25, 2004,primarily due to a an increase in revenues of $8.4 million.

 

•      Restaurantpre-opening costs increased $0.6 million due to the increased number ofrestaurant openings or restaurants under construction in the thirteen weekperiod ended September 24, 2005.

 

•      Depreciationand amortization decreased by $0.2 million primarily due to three-year livedassets acquired in August of 2001 which became fully depreciated in 2004.

 

•      Redemption ofour preferred stock and repayment of the outstanding balance on our priorrevolving credit facility with the proceeds from our initial public offering,and the substantial decrease in our average outstanding debt balance,eliminated accrued dividends and accretion on our mandatorily redeemablepreferred stock, reduced interest expense and required a write-off ofunamortized deferred loan costs. The aggregate of these items decreased from$5.6 million for the thirteen week period ended September 25, 2004 to $0.1million for the thirteen week period ended September 24, 2005.

 

**Thirteen Week Period Ended September 25,2004 Compared to Thirteen Week Period Ended September 24, 2005**

 

The following table sets forth our operatingresults and our operating results expressed as a percentage of revenues for thethirteen week periods ended September 25, 2004 and September 24, 2005**.**

 
| ** **                                                                 | ** ** | **Thirteen week period ended** | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                 | ** ** | **September 25, 2004**    | ** ** | **September 24, 2005** | ** ** |
| ** **                                                                 | ** ** | **Restated**                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                 | ** ** | **(in thousands)**             | ** ** |
| Revenues                                                                   |       | $                              | 59,597     |   | 100.0 | % | $ | 68,014 |   | 100.0 | % |
|                                                                       |       |                           |       |   |   |   |   |   |   |
| Restaurant operating costs                                                 |       |                           |       |   |   |   |   |   |   |
| Food and  beverage                                                         |       | 17,776                         |       | 29.8 | % | 20,013 |   | 29.4 | % |
| Labor                                                                      |       | 19,013                         |       | 31.9 | % | 21,421 |   | 31.5 | % |
| Operating                                                                  |       | 8,947                          |       | 15.0 | % | 10,447 |   | 15.4 | % |
| Occupancy                                                                  |       | 5,434                          |       | 9.1 | % | 6,267 |   | 9.2 | % |
| Total  restaurant operating costs                                          |       | 51,170                         |       | 85.9 | % | 58,148 |   | 85.5 | % |
| General and administrative expenses                                        |       | 3,340                          |       | 5.6 | % | 3,541 |   | 5.2 | % |
| Restaurant pre-opening costs                                               |       | 112                            |       | 0.2 | % | 760 |   | 1.1 | % |
| Depreciation and amortization                                              |       | 2,690                          |       | 4.5 | % | 2,483 |   | 3.7 | % |
| Total costs  and expenses                                                  |       | 57,312                         |       | 96.2 | % | 64,932 |   | 95.5 | % |
| Operating income                                                           |       | 2,285                          |       | 3.8 | % | 3,082 |   | 4.5 | % |
| Interest  expense                                                          |       | 570                            |       | 1.0 | % | 131 |   | 0.2 | % |
| Accrued  dividends and accretion on mandatorily redeemable preferred stock |       | 3,693                          |       | 6.2 | % | — |   | — | % |
| Write-off of  deferred loan costs on early extinguishment of debt          |       | 1,288                          |       | 2.2 | % | — |   | — | % |
| Income  (loss) before income taxes                                         |       | (3,266                         | )          | (5.5 | )% | 2,951 |   | 4.3 | % |
| Income tax  expense                                                        |       | 71                             |       | 0.1 | % | 915 |   | 1.3 | % |
| Net income  (loss)                                                         |       | $                              | (3,337     | ) | (5.6 | )% | $ | 2,036 |   | 3.0 | % |

 

12

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***Revenues and RestaurantOperating Costs***

 

The following table sets forth revenues andrestaurant operating costs, including food and beverage, labor, operating and occupancycosts from our unaudited consolidated statements of operations.

 
| ** **                        | ** ** | **Thirteen week period ended** | ** ** | ** **             | ** ** |
|-----------------------------------|------------|--------------------------------|------------|------------------------|------------|
| ** **                        | ** ** | **September 25,**         | ** ** | **September 24,** | ** ** | **Change** | ** ** |
| ** **                        | ** ** | **2004**                       | ** ** | **2005**               | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                        | ** ** | **Restated**                   | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | ** **                     | ** ** | **(in thousands)**     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                          |       | $                              | 59,597     |                   | $          | 68,014 |   | $ | 8,417 |   | 14.1 | % |
|                              |       |                           |       |                   |       |   |   |   |   |
| Restaurant operating costs        |       |                           |       |                   |       |   |   |   |   |
| Food and  beverage                |       | $                              | 17,776     |                   | $          | 20,013 |   | $ | 2,237 |   | 12.6 | % |
| Labor                             |       | 19,013                         |       | 21,421                 |       | 2,408 |   | 12.7 | % |
| Operating                         |       | 8,947                          |       | 10,447                 |       | 1,500 |   | 16.8 | % |
| Occupancy                         |       | 5,434                          |       | 6,267                  |       | 833 |   | 15.3 | % |
| Total  restaurant operating costs |       | $                              | 51,170     |                   | $          | 58,148 |   | $ | 6,978 |   | 13.6 | % |

 

*Revenues*.   Revenuesincreased by $8.4 million, or 14.1%, to $68.0 million in the thirteen weekperiod ended September 24, 2005 from $59.6 million in the thirteen weekperiod ended September 25, 2004. This increase was primarily attributable to revenues generated by sixcompany-owned restaurants opened in the last twenty-six weeks of 2004 and thefirst thirty-nine weeks of 2005 and an increase in comparable restaurant salesof $1.8 million, or 3.5%. The comparable restaurant sales increase was theresult of increased guest counts coupled with higher menu pricing.

 

*Food and Beverage Costs*.   Foodand beverage costs increased by $2.2 million, or 12.6%, to $20.0 million in thethirteen week period ended September 24, 2005 from $17.8 million in thethirteen week period ended September 25, 2004. This increase was primarilyattributable to the six company-owned restaurants opened in the last twenty-sixweeks of 2004 and the first thirty-nine weeks of 2005. Food and beverage costsas a percentage of revenues decreased to 29.4% in the thirteen week periodended September 24, 2005 from 29.8% in the thirteen week period ended September 25,2004, primarily related to menu pricing increases and improved food andbeverage costs at the restaurants opened in 2004.

 

*Labor Costs*.   Laborcosts increased by $2.4 million, or 12.7%, to $21.4 million in the thirteenweek period ended September 24, 2005 from $19.0 million in thirteen weekperiod ended September 25, 2004. This increase was primarily attributableto the six company-owned restaurants opened in the last twenty-six weeks of2004 and the first thirty-nine weeks of 2005. Labor costs as a percentage ofrevenue decreased to 31.5 % in the thirteen week period ended September 24,2005 from 31.9% in the thirteen week period ended September 25, 2004.  The decrease in labor costs as a percentageof revenues was primarily due to the additional revenues and improved laborcosts at the restaurants opened in 2004.

 

*Operating Costs*.   Operatingcosts increased by $1.5 million, or 16.8%, to $10.4 million in the thirteenweek period ended September 24, 2005 from $8.9 million in the thirteenweek period ended September 25, 2004. This increase was primarilyattributable to the six company-owned restaurants opened in the last twenty-sixweeks of 2004 and the first thirty-nine weeks of 2005.  Operating costs as a percentage of revenuesincreased to 15.4% in the thirteen week period ended September 24, 2005from 15.0% in the thirteen week period ended September 25, 2004 primarilydue to higher marketing and utility costs. Non-cash rent expense was $0.6 million in the thirteen week period endedSeptember 24, 2005 and $0.5 million in the thirteen week periods ended September 25,2004.

 

*Occupancy Costs*.   Occupancycosts increased by $0.8 million, or 15.3%, to $6.3 million in the thirteen weekperiod ended September 24, 2005 from $5.4 million in the thirteen weekperiod ended September 25, 2004, primarily due to the six company-ownedrestaurants opened in the last twenty-six weeks of 2004 and the firstthirty-nine weeks of 2005. Occupancy costs as a percentage of revenues were9.2% the thirteen week period ended September 24, 2005 and 9.1% inthirteen week period ended September 25, 2004.

 

***General and Administrative Expenses, Restaurant Pre-Opening Costs andDepreciation and Amortization***

 

The following table sets forth general andadministrative, restaurant pre-opening and depreciation and amortization costsfrom our unaudited consolidated statements of operations.

 

13

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| ** **                          | ** ** | **Thirteen week period ended** | ** ** | ** **             | ** ** | ** ** | ** ** |
|-------------------------------------|------------|--------------------------------|------------|------------------------|------------|------------|------------|
| ** **                          | ** ** | **September 25,**         | ** ** | **September 24,** | ** ** | **Change** | ** ** |
| ** **                          | ** ** | **2004**                       | ** ** | **2005**               | ** ** | **$**      | ** ** | **%** | ** ** |
| ** **                          | ** ** | **Restated**                   | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                          | ** ** | ** **                     | ** ** | **(in thousands)**     | ** ** | ** ** | ** ** | ** ** | ** ** |
| General and administrative expenses |       | $                              | 3,340      |                   | $          | 3,541      |       | $ | 201 |   | 6.0 | % |
| Restaurant pre-opening costs        |       | 112                            |       | 760                    |       | 648        |       | 578.6 | % |
| Depreciation and amortization       |       | 2,690                          |       | 2,483                  |       | (207       | )          | (7.7 | )% |
|                                     |            |                                |            |                        |            |            |            |  |  |  |  |  |

 

*General and Administrative Expenses*.   Generaland administrative expenses increased by $0.2 million, or 6.0%, to $3.5 millionin the thirteen week period ended September 24, 2005 from $3.3 million inthe thirteen week period ended September 25, 2004. General andadministrative expenses as a percentage of revenues were 5.2% in the thirteenweek period ended September 24, 2005 compared to 5.6% in the thirteen weekperiod ended September 25, 2004. The decrease in general andadministrative expenses as a percentage of revenues was primarily due to theincrease in revenues of $8.4 million, partially offset by the increase ingeneral and administrative expenses of $0.2 million.

 

*Restaurant Pre-Opening Costs*.  Restaurant pre-opening costs increased by $0.6 million, or 578.6%, to $0.8million in the thirteen week period ended September 24, 2005 from $0.1million in the thirteen week period ended September 25, 2004, primarilydue to the increased number of restaurant openings or restaurants underconstruction in the thirteen week period ended September 24, 2005 comparedto the thirteen week period ended September 25, 2004.

 

*Depreciation and Amortization*.   Depreciationand amortization decreased by $0.2 million, or 7.7%, to $2.5 million in thethirteen week period ended September 24, 2005 from $2.7 million in thethirteen week period ended September 25, 2004. The decrease was primarilydue to three-year lived assets acquired in August of 2001 which becamefully depreciated in 2004.

 

***Interest Expense, Accrued Dividends and Accretion on MandatorilyRedeemable Preferred Stock, Income Tax Expense and Net Income (Loss)***

 

The following table sets forth interestexpense, accrued dividends and accretion on mandatorily redeemable preferredstock, income tax expense and net income (loss) from our unaudited consolidatedstatements of operations.

 
| ** **                                                                 | ** ** | **Thirteen week period ended** | ** ** | ** **             | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------|------------|------------------------|------------|------------|------------|
| ** **                                                                 | ** ** | **September 25,**         | ** ** | **September 24,** | ** ** | **Change** | ** ** |
| ** **                                                                 | ** ** | **2004**                       | ** ** | **2005**               | ** ** | **$**      | ** ** | **%** | ** ** |
| ** **                                                                 | ** ** | **Restated**                   | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                 | ** ** | ** **                     | ** ** | **(in thousands)**     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest  expense                                                          |       | $                              | 570        |                   | $          | 131        |       | $ | (439 | ) | (77.0 | )% |
| Accrued  dividends and accretion on mandatorily redeemable preferred stock |       | $                              | 3,693      |                   | $          | —     |       | $ | (3,693 | ) | (100.0 | )% |
| Write-off of  deferred loan costs on early extinguishment of debt          |       | 1,288                          |       | —                 |       | (1,288     | )          | (100.0 | )% |
| Income  (loss) before income taxes                                         |       | $                              | (3,266     | )                      | $          | 2,951      |       | $ | 6,217 |   | * |   |
| Income tax  expense                                                        |       | 71                             |       | 915                    |       | 844        |       | 1,188.7 | % |
| Net income  (loss)                                                         |       | $                              | (3,337     | )                      | $          | 2,036      |       | $ | 5,373 |   | * |   |

 

----

*      Percentagechange is not meaningful.

 

*Interest Expense*.   Interestexpense decreased by $0.4 million, or 77.0%, to $0.1 million in the thirteenweek period ended September 24, 2005 from $0.6 million in the thirteenweek period ended September 25, 2004. This was primarily due to a decrease of approximately $16.3 million inour average outstanding debt balance as a result of the paydown of ourrevolving credit facility with proceeds from our initial public offering andcash provided by operating activities.

 

*Accrued Dividends and Accretion onMandatorily Redeemable Preferred Stock*.   Dividendsand accretive rights of a subsidiary’s redeemable preferred stock are reflectedas accrued dividends and accretion on mandatorily redeemable preferred stock inthe consolidated financial statements. Proceeds from our initial public offeringwere used to redeem all of the preferred stock.

 

*Income Tax Expense*.   Incometax expense was $0.9 million in the thirteen week period ended September 24,2005, which reflects an estimated effective annualized tax rate ofapproximately 31% including the benefit of FICA tip credits.  In the thirteen week period ended September 25,2004, income tax expense was $0.1 million.

 

*Net Income (Loss).  *Netincome was $2.0 million in the thirteen week period ended September 24,2005 compared to net loss of $3.3 million in the thirteen week period ended September 25,2004, an increase of $5.4 million due to the following:

 

•   Operating incomeincreased $0.8 million in the thirteen week period ended September 24,2005 compared to the thirteen week period ended September 25, 2004,primarily due to an increase in revenues of $8.4 million.

 

14

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•   Restaurantpre-opening costs increased $0.6 million due to the increased number ofrestaurant openings and restaurants under construction in the thirteen weekperiod ended September 24, 2005.

 

•   Depreciation andamortization decreased by $0.2 million primarily due to three-year lived assetsacquired in August of 2001 which became fully depreciated in 2004.

 

•   Redemption of ourpreferred stock and repayment of the outstanding balance on our prior revolvingcredit facility with the proceeds from our initial public offering, and thesubstantial decrease in our average outstanding debt balance, eliminatedaccrued dividends and accretion on our mandatorily redeemable preferred stock,reduced interest expense and required a write-off of unamortized deferred loancosts. The aggregate of these items decreased from $5.6 million for thethirteen week period ended September 25, 2004 to $0.1 million for thethirteen week period ended September 24, 2005.

 

**Thirty-Nine Week Period Ended September 25,2004 Compared to Thirty-Nine Week Period Ended September 24, 2005**

 

The following table sets forth our operatingresults and our operating results expressed as a percentage of revenues for thethirty-nine week periods ended September 25, 2004 and September 24,2005.

 
| ** **                                                                 | ** ** | **Thirty-nine week period ended** | ** ** |
|----------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                 | ** ** | **September 25, 2004**       | ** ** | **September 24, 2005** | ** ** |
| ** **                                                                 | ** ** | **Restated**                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                 | ** ** | **(in thousands)**                | ** ** |
| Revenues                                                                   |       | $                                 | 173,833    |   | 100.0 | % | $ | 196,785 |   | 100.0 | % |
|                                                                       |       |                              |       |   |   |   |   |   |   |
| Restaurant operating costs                                                 |       |                              |       |   |   |   |   |   |   |
| Food and  beverage                                                         |       | 51,993                            |       | 29.9 | % | 57,700 |   | 29.3 | % |
| Labor                                                                      |       | 55,555                            |       | 32.0 | % | 62,157 |   | 31.6 | % |
| Operating                                                                  |       | 25,565                            |       | 14.7 | % | 29,462 |   | 15.0 | % |
| Occupancy                                                                  |       | 15,679                            |       | 9.0 | % | 17,933 |   | 9.1 | % |
| Total  restaurant operating costs                                          |       | 148,792                           |       | 85.6 | % | 167,252 |   | 85.0 | % |
| General and administrative expenses                                        |       | 8,505                             |       | 4.9 | % | 10,444 |   | 5.3 | % |
| Restaurant pre-opening costs                                               |       | 2,226                             |       | 1.3 | % | 2,048 |   | 1.0 | % |
| Depreciation and amortization                                              |       | 8,275                             |       | 4.8 | % | 7,095 |   | 3.6 | % |
| Management fees and covenants not to  compete                              |       | 4,241                             |       | 2.4 | % | — |   | — | % |
| Total costs  and expenses                                                  |       | 172,039                           |       | 99.0 | % | 186,839 |   | 94.9 | % |
| Operating income                                                           |       | 1,794                             |       | 1.0 | % | 9,946 |   | 5.1 | % |
| Interest  expense                                                          |       | 2,366                             |       | 1.4 | % | 454 |   | 0.2 | % |
| Accrued  dividends and accretion on mandatorily redeemable preferred stock |       | 5,759                             |       | 3.3 | % | — |   | — |   |
| Write-off of  deferred loan costs on early extinguishment of debt          |       | 1,288                             |       | 0.7 | % | — |   | — |   |
| Income  (loss) before income taxes                                         |       | (7,619                            | )          | (4.4 | )% | 9,492 |   | 4.8 | % |
| Income tax  expense (benefit)                                              |       | (678                              | )          | (0.4 | )% | 2,942 |   | 1.5 | % |
| Net income  (loss)                                                         |       | $                                 | (6,941     | ) | (4.0 | )% | $ | 6,550 |   | 3.3 | % |

 

***Revenues and RestaurantOperating Costs***

 

The following table sets forth revenues andrestaurant operating costs, including food and beverage, labor, operating andoccupancy costs from our unaudited consolidated statements of operations.

 
| ** **                        | ** ** | **Thirty-nine week period ended** | ** ** | ** **             | ** ** | ** ** | ** ** |
|-----------------------------------|------------|-----------------------------------|------------|------------------------|------------|------------|------------|
| ** **                        | ** ** | **September 25,**            | ** ** | **September 24,** | ** ** | **Change** | ** ** |
| ** **                        | ** ** | **2004**                          | ** ** | **2005**               | ** ** | **$**      | ** ** | **%** | ** ** |
| ** **                        | ** ** | **Restated**                      | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | ** **                        | ** ** | **(in thousands)**     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                          |       | $                                 | 173,833    |                   | $          | 196,785    |       | $ | 22,952 |   | 13.2 | % |
|                              |       |                              |       |                   |       |       |       |   |   |
| Restaurant operating costs        |       |                              |       |                   |       |       |       |   |   |
| Food and  beverage                |       | $                                 | 51,993     |                   | $          | 57,700     |       | $ | 5,707 |   | 11.0 | % |
| Labor                             |       | 55,555                            |       | 62,157                 |       | 6,602      |       | 11.9 | % |
| Operating                         |       | 25,565                            |       | 29,462                 |       | 3,897      |       | 15.2 | % |
| Occupancy                         |       | 15,679                            |       | 17,933                 |       | 2,254      |       | 14.4 | % |
| Total restaurant  operating costs |       | $                                 | 148,792    |                   | $          | 167,252    |       | $ | 18,460 |   | 12.4 | % |

 

15

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*Revenues*.   Revenuesincreased by $23.0 million, or 13.2%, to $196.8 million in the thirty-nine weekperiod ended September 24, 2005 from $173.8 million in the thirty-nineweek period ended September 25, 2004. This increase was primarily attributable to the revenues generated bythe company-owned restaurants opened in 2004 and 2005 and an increase incomparable restaurant sales of $4.0 million, or 2.7%. The comparable restaurantsales increase was primarily a result of higher menu pricing.

 

*Food and Beverage Costs*.   Foodand beverage costs increased by $5.7 million, or 11.0%, to $57.7 million in thethirty-nine week period ended September 24, 2005 from $52.0 million in thethirty-nine week period ended September 25, 2004. This increase wasprimarily attributable to the company-owned restaurants opened in 2004 and2005. Food and beverage costs as a percentage of revenues decreased to 29.3% inthe thirty-nine week period ended September 24, 2005 compared to 29.9% inthe thirty-nine week period ended September 25, 2004, primarily related tomenu pricing increases and improved food and beverage costs at the restaurantsopened in 2004.

 

*Labor Costs*.   Laborcosts increased by $6.6 million, or 11.9%, to $62.2 million in the thirty-nineweek period ended September 24, 2005 from $55.6 million in the thirty-nineweek period ended September 25, 2004.  This increase was primarily attributable to the company-ownedrestaurants opened in 2004 and 2005. Labor costs as a percentage of revenuedecreased to 31.6 % in the thirty-nine week period ended September 24,2005 compared to 32.0% in the thirty-nine week period ended September 25,2004.  The decrease in labor costs as apercentage of revenues was primarily due to the additional revenues andimproved labor costs at the restaurants opened in 2004.

 

*Operating Costs*.   Operatingcosts increased by $3.9 million, or 15.2%, to $29.5 million in the thirty-nineweek period ended September 24, 2005 from $25.6 million in the thirty-nineweek period ended September 25, 2004.  This increase was primarily attributable to the company-ownedrestaurants opened in 2004 and 2005. Operating costs as a percentage of revenues increased to 15.0% in thethirty-nine week period ended September 24, 2005 compared to 14.7% in thethirty-nine week period ended September 25, 2004, primarily because ofhigher marketing and utility costs.

 

*Occupancy Costs*.   Occupancycosts increased by $2.3 million, or 14.4%, to $17.9 million in the thirty-nineweek period ended September 24, 2005 from $15.7 million in the thirty-nineweek period ended September 25, 2004, primarily due to the company-ownedrestaurants opened in 2004 and 2005. Occupancy costs as a percentage ofrevenues increased to 9.1% in the thirty-nine week periods ended September 24,2005 compared to 9.0% in the thirty-nine week period ended September 25,2004. Non-cash rents were $1.6 million in the thirty-nine week period ended September 24,2005 and $1.4 million in the thirty-nine week period ended September 25,2004.

 

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

 

The following table sets forth general andadministrative, restaurant pre-opening, depreciation and amortization andmanagement fees and covenants not to compete costs from our unauditedconsolidated statements of operations.

 
| ** **                                    | ** ** | **Thirty-nine week period ended** | ** ** | ** **             | ** ** | ** ** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|------------------------|------------|------------|------------|
| ** **                                    | ** ** | **September 25,**            | ** ** | **September 24,** | ** ** | **Change** | ** ** |
| ** **                                    | ** ** | **2004**                          | ** ** | **2005**               | ** ** | **$**      | ** ** | **%** | ** ** |
| ** **                                    | ** ** | **Restated**                      | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | ** **                        | ** ** | **(in thousands)**     | ** ** | ** ** | ** ** | ** ** | ** ** |
| General and administrative expenses           |       | $                                 | 8,505      |                   | $          | 10,444     |       | $ | 1,939 |   | 22.8 | % |
| Restaurant pre-opening costs                  |       | 2,226                             |       | 2,048                  |       | (178       | )          | (8.0 | )% |
| Depreciation and amortization                 |       | 8,275                             |       | 7,095                  |       | (1,180     | )          | (14.3 | )% |
| Management fees and covenants not to  compete |       | 4,241                             |       | —                 |       | (4,241     | )          | (100.0 | )% |
|                                               |            |                                   |            |                        |            |            |            |  |  |  |  |  |

 

*General and Administrative Expenses*.   Generaland administrative expenses increased by $1.9 million, or 22.8%, to $10.4million in the thirty-nine week period ended September 24, 2005 from $8.5million in the thirty-nine week period ended September 25, 2004. Theincrease in general and administrative expenses was primarily due to costsassociated with being a public company. General and administrative expenses asa percentage of revenues were 5.3% in the thirty-nine week period ended September 24,2005 compared to 4.9% in the thirty-nine week period ended September 25,2004.

 

*Restaurant Pre-Opening Costs*.  Restaurant pre-opening costs decreased by $0.2 million, or 8.0%, to $2.0million in the thirty-nine week period ended September 24, 2005 from $2.2million in the thirty-nine week period ended September 25, 2004, primarilydue to the decreased number of restaurant openings or restaurants underconstruction in the thirty-nine week period ended September 24, 2005compared to the thirty-nine week period ended September 25, 2004.

 

*Depreciation and Amortization*.   Depreciationand amortization decreased by $1.2 million, or 14.3%, to $7.1 million in thethirty-nine week period ended September 24, 2005 from $8.3 million in thethirty-nine week period ended September 25, 2004. The decrease wasprimarily due to three-year lived assets acquired in August of 2001 whichbecame fully depreciated in 2004.

 

16

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*Management Fees and Covenants Not to Compete*.  In the thirty-nine week period ended September 25, 2004, we recognized asexpense an aggregate of $3.3 million in management fees paid to BRS and CastleHarlan, Inc. and an aggregate of $0.9 million paid to William P. McCormickand Douglas L. Schmick pursuant to management and covenants not to competeagreements.  These agreements wereterminated effective June 25, 2004 in connection with our public offeringfor an aggregate payment of $2.8 million, which payment is included inmanagement fees and covenants not to compete expense in the thirty-nine weekperiod ended September 25, 2004.

 

***Interest Expense, Accrued Dividends and Accretion on MandatorilyRedeemable Preferred Stock, Write-off of Deferred Loan Costs on EarlyExtinguishment of Debt, Income Tax Expense (Benefit) and Net Income (Loss)***

 

The followingtable sets forth interest expense, accrued dividends and accretion onmandatorily redeemable preferred stock, write-off of deferred loan costs onearly extinguishment of debt, income tax expense (benefit), net income (loss)from our unaudited consolidated statements of operations.

 
| ** **                                                                 | ** ** | **Thirty-nine week period ended** | ** ** | ** **             | ** ** |
|----------------------------------------------------------------------------|------------|-----------------------------------|------------|------------------------|------------|
| ** **                                                                 | ** ** | **September 25,**            | ** ** | **September 24,** | ** ** | **Change** | ** ** |
| ** **                                                                 | ** ** | **2004**                          | ** ** | **2005**               | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                                                 | ** ** | **Restated**                      | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                 | ** ** | ** **                        | ** ** | **(in thousands)**     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest expense                                                           |       | $                                 | 2,366      |                   | $          | 454 |   | $ | (1,912 | ) | (80.8 | )% |
| Accrued dividends and accretion on  mandatorily redeemable preferred stock |       | $                                 | 5,759      |                   | $          | — |   | $ | (5,759 | ) | (100.0 | )% |
| Write-off of deferred loan costs on early extinguishment  of debt          |       | 1,288                             |       | —                 |       | (1,288 | ) | (100.0 | )% |
| Income (loss) before income taxes                                          |       | $                                 | (7,619     | )                      | $          | 9,492 |   | $ | 17,111 |   | * |   |
| Income tax expense (benefit)                                               |       | (678                              | )          | 2,942                  |       | 3,620 |   | * |   |
| Net income (loss)                                                          |       | $                                 | (6,941     | )                      | $          | 6,550 |   | $ | 13,491 |   | * |   |

 

----

*      Percentagechange is not meaningful.

 

*InterestExpense*.   Interest expense decreased by $1.9million, or 80.8%, to $0.5 million in the thirty-nine week period ended September 24,2005, from $2.4 million in the thirty-nine week period ended September 25,2004.  This was primarily due to adecrease of approximately $30.5 million in the average outstanding debt balanceof our credit facility.

 

*Accrued Dividends and Accretion onMandatorily Redeemable Preferred Stock*.   Dividendsand accretive rights of a subsidiary’s redeemable preferred stock are reflectedas accrued dividends and accretion on mandatorily redeemable preferred stock inthe consolidated financial statements. Proceeds from our initial publicoffering were used to redeem all of the preferred stock.

 

*Income Tax (Benefit) Expense*.   Incometax expense was $2.9 million in the thirty-nine week period ended September 24,2005, which reflects an estimated effective annualized tax rate ofapproximately 31% including the benefit of FICA tip credits.  In the thirty-nine week period ended September 25,2004 income tax benefit was $0.7 million.

 

*Net Income (Loss).  *Netincome was $6.6 million in the thirty-nine week period ended September 24,2005 compared to net loss of $6.9 million in the thirty-nine week period ended September 25,2004, an increase of $13.5 million due primarily to the following:

 

•      Operatingincome increased $8.2 million in the thirty-nine week period ended September 24,2005 compared to the thirty-nine week period ended September 25, 2004,primarily due to a decrease of $4.2 million in management fees and covenantsnot to compete expense and additional operating income due to an increase inrevenues of $23.0 million, partially offset by an increase in general andadministrative expenses of $1.9 million primarily due to additional expensesrelated to being a public company.

 

•      Restaurantpre-opening costs decreased $0.2 million due to the decreased number ofrestaurant openings or restaurants under construction in the thirty-nine weekperiod ended September 24, 2005.

 

•      In connectionwith the initial public offering, we terminated certain management agreementsand covenants not to compete agreements resulting in the elimination ofmanagement fees and covenants not to compete expense.  The expense related to these items was $4.2million for the thirty-nine week period ended September 25, 2004.

 

•      Redemption ofour preferred stock and repayment of the outstanding balance on our priorrevolving credit facility with the proceeds from our initial public offering,and the substantial decrease in our average outstanding debt balance, eliminatedaccrued dividends and accretion on our mandatorily redeemable 

 

17

----

 

preferred stock, reduced interest expense andrequired a write-off of unamortized deferred loan costs. The aggregate of theseitems decreased from $9.4 million for the thirty-nine week period ended September 25,2004 to $0.5 million for the thirty-nine week period ended September 24,2005.

 

**Liquidity and Capital Resources**

 

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

 

On July 20, 2004, we completed ourinitial public offering.  In connectionwith the initial public offering we raised approximately $65.0 million,borrowed $18.1 million under a new revolving credit facility, repaid $51.5million of indebtedness, paid $28.9 million to redeem senior exchangeablepreferred stock and paid $2.8 million in connection with the termination ofmanagement fee and covenants not to compete agreements.

 

The following table summarizes our sourcesand uses of cash and cash equivalents from our unaudited consolidatedstatements of cash flows:

 
| ** **                                            | ** ** | **Thirty-nine week period ended** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                            | ** ** | **September 25,**            | ** ** | **September 24,** | ** ** |
| ** **                                            | ** ** | **2004**                          | ** ** | **2005** | ** ** |
| ** **                                            | ** ** | **Restated**                      | ** ** | ** ** | ** ** |
| ** **                                            | ** ** | **(in thousands)**                | ** ** |
| Net cash  provided by operating activities            |       | $                                 | 11,790     |   | $ | 19,438 |   |
| Net cash  used in investing activities                |       | (22,582                           | )          | (17,056 | ) |
| Net cash  provided by (used in) financing activities  |       | 10,912                            |       | (2,389 | ) |
| Net increase  (decrease) in cash and cash equivalents |       | $                                 | 120        |   | $ | (7 | ) |

 

Net cash provided by operating activities was$19.4 million in the thirty-nine week period ended September 24, 2005,compared to $11.8 million in the thirty-nine week period ended September 25,2004. The increase in net cash provided by operating activities was primarilydue to an increase in net income of $13.5 million.

 

Net cash used in investing activities was$17.1 million in the thirty-nine week period ended September 24, 2005,compared to $22.6 million in the thirty-nine week period ended September 25,2004. We use cash for tenant improvements and equipment to open newrestaurants, and to upgrade and add capacity to existing restaurants. Net cashused in investing activities varied in the periods presented based on thenumber of new restaurants opened and the expansion of existing restaurantcapacity during the period. Purchases of property and equipment also includepurchases of information technology systems and expenditures relating to ourcorporate headquarters.

 

Net cash used by financing activities was$2.4 million in the thirty-nine week period ended September 24, 2005.  The net cash used by financing activities wasprimarily a result of payments made on our revolving credit facility of $11.0million, partially offset by borrowings made on our revolving credit facilityof $7.0 million, and a decrease in book overdraft of $1.9 million.    Net cash provided by financing activitieswas $10.9 million in the thirty-nine week period ended September 25,2004.  The net cash provided by financingactivities was primarily due to proceeds from the issuance of common stock of$64.9 million and borrowings made on our revolving credit facility of $62.5million, partially offset by payment made for redemption of senior preferredstock of $28.9 million and payments made on our revolving credit facility of$84.0 million.

 

As of September 24,2005, the outstanding balance on our revolving credit facility was $8.0million. The revolving credit facility agreement also provides for bankguarantee under standby letter of credit arrangements in the normal course ofbusiness operations. As of September 24, 2005 the maximumexposure under these standby letters of credit was $1.5 million. At September 24,2005 there were no amounts drawn upon these letters of credit.  At September 24, 2005 the Company had$40.5 million available under its revolving credit facility.

 

Under our revolving credit facility, we are subject to certainfinancial and non-financial covenants, including an adjusted leverage ratio, aconsolidated cash flow ratio and growth capital expenditures limitation. Wewere in compliance with these covenants as of September 24, 2005.

 

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

 

18

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**Critical Accounting Policies and Estimates**

 

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

 

***Equipment and Leasehold Improvements***

 

Equipment and leasehold improvements arestated at cost less accumulated depreciation and amortization. Equipmentconsists primarily of restaurant equipment, furniture, fixtures and smallwares. Depreciation is generally calculated using the straight-line method overthe estimated useful lives of the related assets. Leasehold improvements areamortized using the straight-line method over the shorter of the lease term asdefined in Statement of Financial Accounting Standards (“SFAS”) No. 13 (“SFAS13”), “Accounting for Leases,” as amended, or the estimated useful life of theasset. As discussed in SFAS 13, the lease term includes any period covered by arenewal option where the renewal is reasonably assured because failure to renewthe lease would impose an economic penalty to the lessee. Repairs andmaintenance are expensed as incurred; renewals and betterments are capitalized.Estimated useful lives are generally as follows: equipment - 5 to 10 years;furniture and fixtures - 5 to 10 years and leasehold improvements - 7 to 30years. Judgments and estimates made by us related to the expected useful livesof these assets are affected by factors such as changes in economic conditionsand changes in operating performance. If these assumptions change in thefuture, we may be required to record impairment charges for these assets.

 

***Impairment of Long-Lived Assets***

 

We review property and equipment (whichincludes leasehold improvements) for impairment when events or circumstancesindicate these assets might be impaired. We test impairment using historicalcash flow and other relevant facts and circumstances as the primary basis forour estimates of future cash flows. The analysis is performed at the restaurantlevel for indicators of permanent impairment. In determining future cash flows,significant estimates are made by us with respect to future operating resultsof each restaurant over its remaining lease term. If assets are determined tobe impaired, the impairment charge is measured by calculating the amount bywhich the asset-carrying amount exceeds its fair value. The determination ofasset fair value is also subject to significant judgment. This process requiresthe use of estimates and assumptions, which are subject to a high degree ofjudgment. If these assumptions change in the future, we may be required torecord impairment charges for these assets. In our most recent impairmentevaluation for long-lived assets, no additional impairment charge would haveresulted even if there were a permanent 5% reduction in revenues in ourrestaurants.

 

***Goodwill and Other Indefinite Lived Assets***

 

Goodwill and other indefinite lived assetsresulted from our acquisition in 2001 by Castle Harlan Partners III, L.P. andBruckmann, Rosser, Sherrill & Co. II, L.P. Goodwill and otherintangible assets with indefinite lives are not subject to amortization.However, such assets must be tested for impairment whenever events or changesin circumstances indicate that the carrying amount may not be recoverable andat least annually. We completed our most recent impairment test on balances asof December 25, 2004, and determined that there were no impairment lossesrelated to goodwill and other indefinite lived assets.  In assessing the recoverability of goodwilland other indefinite lived assets, market values and projections regardingestimated future cash flows and other factors are used to determine the fairvalue of the respective assets. The estimated future cash flows were projectedusing significant assumptions, including future revenues and expenses. If theseestimates or related projections change in the future, we may be required torecord impairment charges for these assets. In our most recent impairmentevaluation for goodwill and other indefinite lived assets, no impairment chargewould have resulted even if a permanent 5% reduction in revenues were to occur.

 

***Insurance Liability***

 

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

 

***Income Taxes***

 

We have accounted for, and currently accountfor, income taxes in accordance with SFAS No. 109 (“SFAS 109”), “Accountingfor Income Taxes.” SFAS 109 establishes financial accounting and reporting standardsfor the effects of income taxes that result from an enterprise’s activitiesduring the current and preceding years. It requires an asset and liabilityapproach for financial accounting and reporting of income taxes. We recognizedeferred tax liabilities and assets for the future consequences of events thathave been recognized in our consolidated financial statements or tax returns.If the future consequences of differences between financial reporting bases andtax bases of our assets and liabilities result in a net deferred tax asset, anevaluation is made of the 

 

19

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probability of being able torealize the future benefits indicated by the asset. A valuation allowancerelated to a deferred tax asset is recorded when it is more likely than notthat some portion or all of the deferred tax asset will not be realized. Therealization of a net deferred tax asset will generally depend on whether wewill have sufficient taxable income of an appropriate character within thecarry-forward period permitted by the tax law. Without sufficient taxableincome to offset the deductible amounts and carry-forwards, the related taxbenefits will expire unused. We have evaluated both positive and negativeevidence in determining whether it is more likely than not that all or someportion of the deferred tax asset will not be realized. Measurement of deferreditems is based on enacted tax laws. No deferred tax asset valuation allowancehas been recorded as of September 24, 2005.

 

***Operating Leases***

 

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

 

**Factors That May Affect Our Business andthe Price of Our Stock**

 

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

 

We are subject to a variety of claims arisingin the ordinary course of our business brought by or on behalf of our customersor employees, including personal injury claims, contract claims, andemployment-related claims. In recent years, a number of restaurant companieshave been subject to lawsuits, including class action lawsuits, allegingviolations of federal and state law regarding workplace, employment and similarmatters. A number of these lawsuits have resulted in the payment of substantialdamages by the defendants. Similar lawsuits have been instituted against usfrom time to time. Regardless of whether any claims against us are valid orwhether we are ultimately determined to be liable, claims may be expensive todefend and may divert time and money away from our operations and hurt ourperformance. A judgment significantly in excess of our insurance coverage forany claims could materially adversely affect our financial condition or resultsof operations, and adverse publicity resulting from these allegations maymaterially adversely affect our business. We may incur substantial damages andexpenses resulting from lawsuits, which could have a material adverse effect onour business.

 

***Our ability to expand our restaurant base is influenced by factorsbeyond our control and therefore we may not be able to achieve our plannedgrowth.***

 

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

 

•   hiring, training and retaining skilledmanagement, chefs and other qualified personnel to open, manage and operate newrestaurants;

 

•   locating and securing a sufficient number ofsuitable new restaurant sites in new and existing markets on acceptable leaseterms;

 

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

 

•   obtaining adequate financing for theconstruction of new restaurants;

 

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

 

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

 

•   general economic conditions.

 

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

 

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

 

Our growth strategy includes openingrestaurants in markets where we have little or no operating experience and inwhich potential customers may not be familiar with our restaurants. The successof these new restaurants may be affected by different competitive conditions,consumer tastes and discretionary spending patterns, and our ability togenerate market awareness and acceptance of the McCormick & Schmick’sbrand. As a result, we may incur costs related to the opening, operation andpromotion of these new restaurants that are greater than those incurred inother areas. Even though we may incur substantial additional costs with thesenew restaurants, they may attract fewer customers than our more establishedrestaurants in existing markets. Sales at restaurants that we open in newmarkets may take longer to reach our average annual sales, if at all. As aresult, the results of operations at our new restaurants may be inferior tothose of our existing restaurants. We may not be able to profitably openrestaurants in new markets.

 

***Our growth may strain our infrastructure and resources, which couldslow our development of new restaurants and adversely affect our ability tomanage our existing restaurants.***

 

We opened nine company-owned restaurants andbegan operating an additional restaurant under a management contract in 2004.We plan to open seven company-owned restaurants in 2005, five of which wereopen at September 24, 2005. Our expansion and our future growth may strainour restaurant management systems and resources, financial controls andinformation systems. Those demands on our infrastructure and resources may alsoadversely affect our ability to manage our existing restaurants. If we fail tocontinue to improve our infrastructure or to manage other factors necessary forus to meet our expansion objectives, our operating results could be materiallyand adversely affected.

 

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

 

Changes in our operating plans, accelerationof our expansion plans, lower than anticipated sales, increased expenses orother events described in this section may require us to seek additionaldebt or equity financing. Financing may not be available on acceptable termsand our failure to raise capital when needed could negatively impact our growthand our financial condition and results of operations. Additional equityfinancing may be dilutive to the holders of our common stock, and debtfinancing, if available, may involve significant cash payment obligations andcovenants that restrict our ability to operate our business. See “Management’sDiscussion and Analysis of Financial Condition and Results ofOperations—Liquidity and Capital Resources.”

 

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

 

Our profitability depends significantly onour ability to anticipate and react to changes in seafood costs. We rely onlocal, regional and national suppliers to provide our seafood. Increases indistribution costs or sale prices or failure to perform by these supplierscould cause our food costs to increase. We could also experience significantshort-term disruptions in our supply if a significant supplier failed to meetits obligations. The supply of seafood is more volatile than other types offood. The type, variety, quality and price of seafood is subject to factors beyondour control, including weather, governmental regulation, availability andseasonality, each of which may affect our food costs or cause a disruption inour supply. Changes in the price or availability of certain types of seafoodcould affect our ability to offer a broad menu and price offering to customersand could materially adversely affect our profitability.

 

Our operating results may fluctuatesignificantly and could fall below the expectations of securities analysts andinvestors due to seasonality and other factors, resulting in a decline in ourstock price.

 

Our operating results may fluctuatesignificantly because of several factors, including:

 

•   our ability toachieve and manage our planned expansion;

 

•   our ability toachieve market acceptance, particularly in new markets;

 

•   our ability toraise capital in the future;

 

•   changes in theavailability and costs of food;

 

•   the loss of keymanagement personnel;

 

•   the concentrationof our restaurants in specific geographic areas;

 

•   our ability toprotect our name and logo and other proprietary information;

 

•   changes inconsumer preferences or discretionary spending;

 

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

 

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•   health concernsabout seafood or other foods;

 

•   our ability toattract, motivate and retain qualified employees;

 

•   increases in laborcosts;

 

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

 

•   the impact oflitigation;

 

•   the effect ofcompetition in the restaurant industry; and

 

•   economic trendsgenerally.

 

Our business also is subject to seasonalfluctuations. Historically, sales in most of our restaurants have been higherduring the second and fourth quarter of each year. As a result, our quarterlyand annual operating results and restaurant sales may fluctuate significantlyas a result of seasonality and the factors discussed above. Accordingly,results for any one fiscal quarter are not necessarily indicative of results tobe expected for any other quarter or for any year and comparable restaurantsales for any particular future period may decrease. Our operating results may alsofall below the expectations of securities analysts and investors. In thatevent, the price of our common stock would likely decrease.

 

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

 

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

 

***If we lose theservices of any of our key management personnel, our business could suffer.***

 

We depend on the services ofour key management personnel, including Saed Mohseni, our chief executiveofficer, and Douglas L. Schmick, our president. If we lose the services of anymembers of our senior management or key personnel for any reason, we may beunable to replace them with qualified personnel, which could have a materialadverse effect on our business and growth. We do not carry key person lifeinsurance on any of our executive officers.

 

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

 

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

 

In addition, given our geographicconcentrations, negative publicity regarding any of our restaurants in theseareas could have a material adverse effect on our business and operations, ascould other regional occurrences such as local strikes, oil spills, terroristattacks, energy shortages or increases in energy prices, droughts orearthquakes or other natural disasters.

 

***Our success depends on our ability to protect our proprietaryinformation. Failure to protect our trademarks, service marks or trade secretscould adversely affect our business.***

 

Our business prospects depend in part on ourability to develop favorable consumer recognition of the McCormick & Schmick’sname. Although McCormick & Schmick’s, M&S Grill and other of ourservice marks are federally registered trademarks with the United States Patentand Trademark Office, our trademarks could be imitated in ways that we cannotprevent. In addition, we rely on trade secrets, proprietary know-how, conceptsand recipes. Our methods of protecting this information may not be adequate,however, and others could independently develop similar know-how or obtainaccess to our trade secrets, know-how, concepts and recipes. Moreover, we mayface claims of misappropriation or infringement of third parties’ rights thatcould interfere with our use of 

 

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our proprietary know-how,concepts, recipes or trade secrets. Defending these claims may be costly and,if unsuccessful, may prevent us from continuing to use this proprietaryinformation in the future, and may result in a judgment or monetary damages.

 

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

 

***Our current insurance policies may notprovide adequate levels of coverage against all claims.***

 

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

 

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

 

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

 

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

 

We may seek to selectively acquire existingrestaurants and integrate them into our business operations. Achieving theexpected benefits of any restaurants that we acquire will depend in large parton our ability to successfully integrate the operations of the acquiredrestaurants and personnel in a timely and efficient manner. The risks involvedin such restaurant acquisitions and integration include:

 

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

 

•   possibledisruption to our business as a result of the diversion of management’sattention from its normal operational responsibilities and duties; and

 

•   the consolidationof the corporate, information technology, accounting and administrativeinfrastructure and resources of the acquired restaurants into our business.

 

Future acquisitions of existing restaurants,which may be accomplished through a cash purchase transaction or the issuanceof our equity securities, or a combination of both, could result in dilutiveissuances of our equity securities, the incurrence of debt and contingentliabilities and impairment charges related to goodwill and other intangibleassets, any of which could harm our business and financial condition.

 

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

 

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

 

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

 

***Health concerns relating to the consumption of seafood or other foodscould affect consumer preferences and could negatively impact our results ofoperations.***

 

We may lose customers based on healthconcerns about the consumption of seafood or negative publicity concerning foodquality, illness and injury generally, such as negative publicity concerningthe accumulation of mercury or other carcinogens in seafood, e-coli, “mad cow”or “foot-and-mouth” disease, publication of government or industry findingsabout food products served by us or other health concerns or operating issuesstemming from one of our restaurants. In addition, our operational controls andtraining may not be fully effective in preventing all food-borne illnesses.Some food-borne illness incidents could be caused by food suppliers andtransporters and would be outside of our control. Any negative publicity,health concerns or specific outbreaks of food-borne

 

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illnesses attributed to one ormore of our restaurants, or the perception of an outbreak, could result in adecrease in guest traffic to our restaurants and could have a material adverseeffect on our business.

 

***Changes in consumer preferences or discretionary consumer spendingcould negatively impact our results of operations.***

 

The restaurant industry is characterized bythe introduction of new concepts and is subject to rapidly changing consumerpreferences, tastes and purchasing habits. Our continued success depends inpart upon the popularity of seafood and the style of dining we offer. Shifts inconsumer preferences away from this cuisine or dining style could materiallyand adversely affect our operating results. Our success will depend in part onour ability to anticipate and respond to changing consumer preferences, tastesand purchasing habits, and to other factors affecting the restaurant industry,including new market entrants and demographic changes. If we change our conceptand menu to respond to changes in consumer tastes or dining patterns, we maylose customers who do not like the new concept or menu, and may not be able toattract a sufficient new customer base to produce the revenue needed to makethe restaurant profitable. Our success also depends to a significant extent onnumerous factors affecting discretionary consumer spending, including economicconditions, disposable consumer income and consumer confidence. Adverse changesin these factors could reduce guest traffic or impose practical limits onpricing, either of which could harm our results of operations.

 

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

 

Our success depends in part upon our abilityto attract, motivate and retain a sufficient number of qualified employees,including regional operational managers and regional chefs, restaurant generalmanagers and executive chefs, necessary to continue our operations and keeppace with our growth. Qualified individuals are in short supply and competitionfor these employees is intense. If we are unable to recruit and retainsufficient qualified individuals, our business and our growth could beadversely affected. Additionally, competition for qualified employees couldrequire us to pay higher wages, which could result in higher labor costs. Ifour labor costs increase, our results of operations will be negativelyaffected.

 

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

 

Our restaurants are subject to variousfederal, state and local government regulations, including those relating toemployees, the preparation and sale of food and the sale of alcoholicbeverages. These regulations affect our restaurant operations and our abilityto open new restaurants.

 

Each of our restaurants must obtain licensesfrom regulatory authorities to sell liquor, beer and wine, and each restaurantmust obtain a food service license from local health authorities. Each liquorlicense must be renewed annually and may be revoked at any time for cause,including violation by us or our employees of any laws and regulations relatingto the minimum drinking age, advertising, wholesale purchasing and inventorycontrol. In California, where we operate 10 restaurants, the number ofalcoholic beverage licenses available is limited and licenses are traded atmarket prices.

 

The failure to maintain our food and liquorlicenses and other required licenses, permits and approvals could adverselyaffect our operating results. Difficulties or failure in obtaining the requiredlicenses and approvals could delay or result in our decision to cancel theopening of new restaurants.

 

We are subject to “dram shop” statutes insome states. These statutes generally allow a person injured by an intoxicatedperson to recover damages from an establishment that wrongfully servedalcoholic beverages to the intoxicated person. A judgment substantially inexcess of our insurance coverage could harm our operating results and financialcondition.

 

Various federal and state labor laws governour relationship with our employees and affect operating costs. These lawsinclude minimum wage requirements, overtime pay, unemployment tax rates,workers’ compensation rates, and citizenship requirements. Additionalgovernment-imposed increases in minimum wages, overtime pay, paid leaves ofabsence and mandated health benefits, increased tax reporting and tax paymentrequirements for employees who receive gratuities, or a reduction in the numberof states that allow tips to be credited toward minimum wage requirements couldharm our operating results and financial condition.

 

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

 

***Our operations and profitability are susceptible to the effects ofviolence, war and economic trends.***

 

Terrorist attacks and other acts of violenceor war and U.S. military reactions to such attacks may negatively affect ouroperations and an investment in our shares of common stock. The terroristattacks in New York and Washington, D.C. on September

 

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11, 2001 led to a temporaryinterruption in deliveries from some of our suppliers and, we believe,contributed to the decline in average annual comparable restaurant sales in2001 and 2002.

 

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

 

Terrorist attacks could also directly impactour physical facilities or those of our suppliers, and attacks or armedconflicts may make travel and the transportation of our supplies and productsmore difficult and more expensive and ultimately affect our revenues.

 

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

 

The restaurant industry is intenselycompetitive with respect to price, service, location, food quality, ambianceand the overall dining experience. Our competitors include a large and diversegroup of restaurant chains and individual restaurants that range fromindependent local operators to well-capitalized national restaurant companies. Someof our competitors have been in existence for a substantially longer periodthan we have and may be better established in the markets where our restaurantsare or may be located. Some of our competitors may have substantially greaterfinancial, marketing and other resources than we do. If our restaurants areunable to compete successfully with other restaurants in new and existingmarkets, our results of operations will be adversely affected. We also competewith other restaurants for experienced management personnel and hourlyemployees, and with other restaurants and retail establishments for qualityrestaurant sites.

 

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

 

The stock market has experienced significantprice and volume fluctuations. Our common stock has traded at a price lowerthan $12.00, the price at which our shares of common stock were sold in ourinitial public offering. The market price for our shares may continue to fluctuatesignificantly in response to a number of factors, some of which are beyond ourcontrol, including:

 

•   quarterlyvariations in our operating results;

 

•   changes infinancial estimates by securities analysts;

 

•   additions ordepartures of our key personnel; and

 

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

 

Fluctuations or decreases in the tradingprice of our common stock may adversely affect your ability to sell yourshares. In the past, following periods of volatility in the market price of acompany’s securities, securities class action litigation has often beeninstituted. A securities class action suit against us could result insubstantial costs and divert management’s attention and resources that wouldotherwise be used to benefit the future performance of our operations.

 

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

 

Affiliates of Castle Harlan and BRS each ownapproximately 20% of our outstanding common stock.  As a result, these stockholders, actingindividually or together, could exert significant influence over all mattersrequiring stockholder approval, including the election of directors andapproval of significant corporate transactions. In addition, this concentrationof ownership may delay or prevent a change in control of our company and makesome transactions more difficult or impossible without the support of thesestockholders. The interests of these stockholders may not always coincide withour interests as a company or the interest of other stockholders.

 

Accordingly, these stockholders could causeus to enter into transactions or agreements that you would not approve or makedecisions with which you may disagree.

 

**ITEM 3.****  QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

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

 

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Under our revolving credit facility, we areexposed to market risk from changes in interest rates on borrowings, which bearinterest at the financial institution’s prime rate plus a margin of 0.25% to0.75% or the Eurodollar rate plus a margin of 1.75% to 2.25%, with marginsdetermined by certain financial ratios. At our option, we may convert loansunder our revolving credit facility from one type of rate to the other. At September 24,2005, we had $8.0 million of variable rate borrowings. Loans under ourrevolving credit facility mature on July 23, 2009.

 

**ITEM 4.****          CONTROLSAND PROCEDURES**

 

*Disclosure Controls and Procedures. *Our management hasevaluated, under the supervision and with the participation of our chiefexecutive officer and chief financial officer, the effectiveness of ourdisclosure controls and procedures as of the end of the period covered by thisreport pursuant to Rule 13a-15(b) under the Securities Exchange Actof 1934 (the “Exchange Act”).  Based onthat evaluation, our chief executive officer and chief financial officer haveconcluded that, as of the end of the period covered by this report, ourdisclosure controls and procedures are effective in ensuring that informationrequired to be disclosed in our Exchange Act reports is (1) recorded,processed, summarized and reported in a timely manner, and (2) accumulatedand communicated to our management, including our chief executive officer andchief financial officer, as appropriate to allow timely decisions regardingrequired disclosure.

 

*Changes in Internal Control Over FinancialReporting. *Therehave been no changes in our internal control over financial reporting thatoccurred during the period covered by this report that have materially affected,or are reasonably likely to materially affect, our internal control overfinancial reporting.

 

**PART II. OTHER INFORMATION**

 

**ITEM 1.****          LEGALPROCEEDINGS**

 

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

 

**ITEM 2.****          UNREGISTERED SALES OFEQUITY SECURITIES AND USE OF PROCEEDS**

 

**None**

 

**ITEM 3.****          DEFAULTSUPON SENIOR SECURITIES**

 

**None**

 

**ITEM 4.****          SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

**None**

 

**ITEM 5.****          OTHERINFORMATION**

 

**None**

 

**ITEM 6.****          EXHIBITS**

 

**EXHIBITS.**

 
| 3.1    |   | Certificate of Incorporation of the  Company, as amended (incorporated by reference to Exhibit 3.1 to the  Company’s Registration Statement on Form S-1, File No. 333-114977).                                                                                                                                                                             |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                           |
| 3.2    |   | Bylaws of the Company, as amended  (incorporated by reference to Exhibits 3.2 and 3.2a to our Registration  Statement on Form S-1, File No. 333-114977).                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                           |
| 4.1    |   | Registration Rights Agreement, dated as of August 22,  2001, by and among McCormick & Schmick Holdings LLC, Bruckmann,  Rosser, Sherrill & Co. II, L.P., Castle Harlan Partners III, L.P.  and certain other parties thereto (incorporated by reference to Exhibit 4.2  to our registration statement on Form S-1, file No. 333-114977). |

 

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| 31.1   |   | Certification of the Chief Executive  Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act  of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002. |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                    |
| 31.2   |   | Certification of the Chief Financial  Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act  of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002. |
|   |   |                                                                                                                                                                                                    |
| 32.1   |   | Certification of the Chief Executive  Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906  of the Sarbanes-Oxley Act of 2002.                                      |
|   |   |                                                                                                                                                                                                    |
| 32.2   |   | Certification of the Chief Financial  Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906  of the Sarbanes-Oxley Act of 2002.                                      |

 

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**SIGNATURES**

 

Pursuant tothe requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

 
|         | McCORMICK & SCHMICK’S SEAFOOD  RESTAURANT, INC. |
|--------------|---------------------------------------------------------------|
|         |                                                          |   |
|         | By:                                                           | /s/ SAED MOHSENI |
| ** **   | ** **                                                    | **Saed Mohseni** |
| *** *** | *** ***                                                  | ***Chief Executive Officer*** |
| *** *** | *** ***                                                  | ***(principal executive officer)*** |
|         |                                                          |   |
|         | By:                                                           | /s/ EMANUEL N. HILARIO |
| ** **   | ** **                                                    | **Emanuel N. Hilario** |
| *** *** | *** ***                                                  | ***Chief Financial Officer*** |
| *** *** | *** ***                                                  | ***(principal financial and accounting  officer)*** |

 

 

Date: October 25, 2005

 

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**EXHIBITS.**

 
| 3.1    |   | Certificate of Incorporation of the  Company, as amended (incorporated by reference to Exhibit 3.1 to the  Company’s Registration Statement on Form S-1, File No. 333-114977).                                                                                                                                                                             |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                           |
| 3.2    |   | Bylaws of the Company, as amended  (incorporated by reference to Exhibits 3.2 and 3.2a to our Registration  Statement on Form S-1, File No. 333-114977).                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                           |
| 4.1    |   | Registration Rights Agreement, dated as of August 22,  2001, by and among McCormick & Schmick Holdings LLC, Bruckmann,  Rosser, Sherrill & Co. II, L.P., Castle Harlan Partners III, L.P.  and certain other parties thereto (incorporated by reference to Exhibit 4.2  to our registration statement on Form S-1, file No. 333-114977). |
|   |   |                                                                                                                                                                                                                                                                                                                                                                           |
| 31.1   |   | Certification of the Chief Executive  Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act  of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                           |
| 31.2   |   | Certification of the Chief Financial  Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act  of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                           |
| 32.1   |   | Certification of the Chief Executive  Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906  of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                           |
| 32.2   |   | Certification of the Chief Financial  Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906  of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                             |

 

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