**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**W****ashington,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 March 26, 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 SeafoodRestaurants, Inc.**

(Exactname of registrant as specified 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’stelephone number, including area code)

 

                Indicateby check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days.   Yes  ý   No  o

 

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

 

                Therewere 13,782,350 shares of common stock outstanding as of May 10, 2005.

 

 

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**INDEX**

 

 
| **PART I. FINANCIAL INFORMATION**                                                                    |   |   |
|------------------------------------------------------------------------------------------------------|--------|--------|
|                                                                                                 |   |   |
| Item 1 - Financial Statements —(Unaudited)                                                      | 2      |   |
|                                                                                                 |   |   |
| Consolidated Balance Sheets  as of December 25, 2004 and March 26, 2005                              | 2      |   |
|                                                                                                 |   |   |
| Consolidated  Statements of Operations for the Quarter Ended March 27, 2004 and March 26,  2005      | 3      |   |
|                                                                                                 |   |   |
| Consolidated  Statements of Cash Flows for the Quarter Ended March 27, 2004 and March 26,  2005      | 4      |   |
|                                                                                                 |   |   |
| Notes to  Consolidated Financial Statements                                                          | 5      |   |
|                                                                                                 |   |   |
| Item 2 - Management’s Discussion and Analysis of  Financial Condition and Results of Operations | 9      |   |
|                                                                                                 |   |   |
| Item  3 - Quantitative and Qualitative Disclosures About Market Risk                                 | 27     |   |
|                                                                                                 |   |   |
| Item 4 - Controls and  Procedures                                                                    | 27     |   |
|                                                                                                 |   |   |
| **PART II. OTHER INFORMATION**                                                                       |   |   |
|                                                                                                 |   |   |
| Item 1 - Legal Proceedings                                                                           | 27     |   |
|                                                                                                 |   |   |
| Item  2 - Unregistered Sales of Equity Securities and Use of Proceeds                                | 28     |   |
|                                                                                                 |   |   |
| Item 3 -  Defaults Upon Senior Securities                                                            | 28     |   |
|                                                                                                 |   |   |
| Item  4 - Submissions of Matters to a Vote of Security Holders                                       | 28     |   |
|                                                                                                 |   |   |
| Item 5 - Other Information                                                                           | 28     |   |
|                                                                                                 |   |   |
| Item 6  - Exhibits                                                                                   | 28     |   |
|                                                                                                 |   |   |
| Signatures                                                                                           | 29     |   |

 

 

 

1

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**PART I****— FINANCIAL INFORMATION**

** **

**ITEM 1****. FINANCIAL STATEMENTS**

** **

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

**ConsolidatedBalance Sheets****—Unaudited**

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

 
| ** **                                                                                       | ** ** | **December 25,** | ** ** | **March 26,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|------------------|------------|---------------|------------|
| ** **                                                                                       | ** ** | **2004**         | ** ** | **2005**      | ** ** |
| **Assets**                                                                                       |       |             |       |          |       |
| Current assets                                                                                   |       |             |       |          |       |
| Cash and cash equivalents                                                                        |       | $                | 451        |          | $          | 607 |   |
| Trade accounts receivable, net                                                                   |       | 4,641            |       | 4,069         |       |
| Tenant improvement allowance receivables                                                         |       | 347              |       | 2,840         |       |
| Inventories                                                                                      |       | 3,384            |       | 3,532         |       |
| Prepaid expenses and other current assets                                                        |       | 2,846            |       | 2,942         |       |
| Deferred income taxes                                                                            |       | 830              |       | 844           |       |
| Total current assets                                                                             |       | 12,499           |       | 14,834        |       |
| Equipment and leasehold improvements, net                                                        |       | 92,744           |       | 95,971        |       |
| Other assets                                                                                     |       | 53,821           |       | 53,745        |       |
| Goodwill                                                                                         |       | 19,996           |       | 19,996        |       |
| Total assets                                                                                     |       | $                | 179,060    |          | $          | 184,546 |   |
| **Liabilities and Stockholders’ Equity**                                                    |       |             |       |          |       |
| Current liabilities                                                                              |       |             |       |          |       |
| Book overdraft                                                                                   |       | $                | 429        |          | $          | — |   |
| Accounts payable                                                                                 |       | 12,875           |       | 12,048        |       |
| Accrued expenses                                                                                 |       | 15,197           |       | 15,732        |       |
| Capital lease obligations, current portion                                                       |       | 433              |       | 413           |       |
| Total current liabilities                                                                        |       | 28,934           |       | 28,193        |       |
| Revolving credit facility                                                                        |       | 12,000           |       | 14,500        |       |
| Other long-term liabilities                                                                      |       | 11,791           |       | 13,258        |       |
| Capital lease obligations, noncurrent portion                                                    |       | 707              |       | 619           |       |
| Deferred income taxes                                                                            |       | 1,558            |       | 2,259         |       |
| Total liabilities                                                                                |       | 54,990           |       | 58,829        |       |
|                                                                                             |       |             |       |          |       |
| Stockholders’ equity                                                                        |       |             |       |          |       |
| Common stock, $0.001 par value, 120,000 shares authorized, 13,782  shares issued and outstanding |       | 14               |       | 14            |       |
| Additional paid in capital                                                                       |       | 127,917          |       | 127,917       |       |
| Accumulated deficit                                                                              |       | (3,861           | )          | (2,214        | )          |
| Total stockholders’ equity                                                                  |       | 124,070          |       | 125,717       |       |
| Total liabilities and stockholders’ equity                                                  |       | $                | 179,060    |          | $          | 184,546 |   |

 

Theaccompanying notes are an integral part of these unaudited consolidatedfinancial statements.

 

 

2

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

**ConsolidatedStatements of Operations****—Unaudited**

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

 
| ** **                                                                 | ** ** | **Quarter Ended** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------|------------|
| ** **                                                                 | ** ** | **March 27,**     | ** ** | **March 26,** | ** ** |
| ** **                                                                 | ** ** | **2004**          | ** ** | **2005** | ** ** |
| ** **                                                                 | ** ** | **Restated**      | ** ** | ** ** | ** ** |
| Revenues                                                                   |       | $                 | 54,513     |   | $ | 60,385 |   |
|                                                                       |       |              |       |   |   |
| Restaurant operating costs                                                 |       |              |       |   |   |
| Food and beverage                                                          |       | 16,286            |       | 17,760 |   |
| Labor                                                                      |       | 17,810            |       | 19,356 |   |
| Operating                                                                  |       | 7,874             |       | 9,017 |   |
| Occupancy                                                                  |       | 4,848             |       | 5,605 |   |
| Total restaurant operating costs                                           |       | 46,818            |       | 51,738 |   |
| General and administrative expenses                                        |       | 2,549             |       | 3,342 |   |
| Restaurant pre-opening costs                                               |       | 994               |       | 529 |   |
| Depreciation and amortization                                              |       | 2,683             |       | 2,232 |   |
| Management fees and covenants not to compete                               |       | 638               |       | — |   |
| Total costs and expenses                                                   |       | 53,682            |       | 57,841 |   |
| Operating income                                                           |       | 831               |       | 2,544 |   |
| Interest expense                                                           |       | 857               |       | 156 |   |
| Accrued dividends and accretion on mandatorily redeemable preferred  stock |       | 1,012             |       | — |   |
| Income (loss) before income taxes                                          |       | (1,038            | )          | 2,388 |   |
| Income tax expense (benefit)                                               |       | (15               | )          | 741 |   |
| Net income (loss)                                                          |       | $                 | (1,023     | ) | $ | 1,647 |   |
| Net income (loss) per share(1)                                             |       |              |       |   |   |
| Basic and diluted                                                          |       | $                 | (0.13      | ) | $ | 0.12 |   |
| Shares used in computing net income (loss) per share(1)                    |       |              |       |   |   |
| Basic                                                                      |       | 7,782             |       | 13,782 |   |
| Diluted                                                                    |       | 7,782             |       | 13,959 |   |

----

(1)          For the quarterended March 27, 2004, which was prior to the Company’s initial public offering,the presentation gives retroactive effect to the completion of the Company’scorporate reorganization in calculating common shares outstanding.

 

Theaccompanying notes are an integral part of these unaudited consolidatedfinancial statements.

 

 

3

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

**ConsolidatedStatements of Cash Flows****—Unaudited**

**(Inthousands)**

** **
| ** **                                                                               | ** ** | **Quarter Ended** | ** ** |
|------------------------------------------------------------------------------------------|------------|-------------------|------------|
| ** **                                                                               | ** ** | **March 27,**     | ** ** | **March 26,** | ** ** |
| ** **                                                                               | ** ** | **2004**          | ** ** | **2005** | ** ** |
| ** **                                                                               | ** ** | **Restated**      | ** ** | ** ** | ** ** |
| **Operating activities**                                                                 |       |              |       |   |   |
| Net income (loss)                                                                        |       | $                 | (1,023     | ) | $ | 1,647 |   |
| Adjustments to reconcile net income (loss) to net cash provided by  operating activities |       |              |       |   |   |
| Depreciation and amortization                                                            |       | 2,683             |       | 2,232 |   |
| Amortization of unearned compensation                                                    |       | 3                 |       | — |   |
| Deferred income taxes                                                                    |       | (15               | )          | 741 |   |
| Accrued dividends and accretion on mandatorily redeemable preferred  stock               |       | 1,012             |       | — |   |
| Changes in operating assets and liabilities                                              |       |              |       |   |   |
| Trade accounts receivable                                                                |       | (707              | )          | 572 |   |
| Tenant improvement allowance receivables                                                 |       | (1,209            | )          | (2,493 | ) |
| Inventories                                                                              |       | (234              | )          | (148 | ) |
| Prepaid expenses and other current assets                                                |       | (700              | )          | (96 | ) |
| Accounts payable                                                                         |       | (846              | )          | (827 | ) |
| Accrued expenses                                                                         |       | 1,628             |       | 481 |   |
| Other long-term liabilities                                                              |       | 1,315             |       | 1,467 |   |
| Net cash provided by operating activities                                                |       | 1,907             |       | 3,576 |   |
| **Investing activities**                                                                 |       |              |       |   |   |
| Acquisition of equipment and leasehold improvements                                      |       | (11,482           | )          | (5,394 | ) |
| Other assets                                                                             |       | (53               | )          | 11 |   |
| Net cash used in investing activities                                                    |       | (11,535           | )          | (5,383 | ) |
| **Financing activities**                                                                 |       |              |       |   |   |
| Decrease in book overdraft                                                               |       | (2,319            | )          | (429 | ) |
| Borrowings made on revolving credit facility                                             |       | 25,500            |       | 5,500 |   |
| Payments made on revolving credit facility                                               |       | (13,500           | )          | (3,000 | ) |
| Payments on capital lease obligations                                                    |       | (102              | )          | (108 | ) |
| Net cash provided by financing activities                                                |       | 9,579             |       | 1,963 |   |
| Net increase (decrease) in cash and cash equivalents                                     |       | (49               | )          | 156 |   |
| Cash and cash equivalents, beginning of period                                           |       | 2,453             |       | 451 |   |
| Cash and cash equivalents, end of period                                                 |       | $                 | 2,404      |   | $ | 607 |   |
|                                                                                     |       |              |       |   |   |
| **Supplemental disclosure of cash flow information**                                     |       |              |       |   |   |
| Cash paid during the period                                                              |       |              |       |   |   |
| Interest                                                                                 |       | $                 | 646        |   | $ | 229 |   |
| Income taxes                                                                             |       | 16                |       | 54 |   |

 

Theaccompanying notes are an integral part of these unaudited consolidatedfinancial statements.

 

 

4

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

**Notesto Consolidated Financial Statements****—Unaudited**

 

**1.   The Business andOrganization**

 

                McCormick& Schmick’s Seafood Restaurants, Inc. is a leading national seafoodrestaurant operator in the affordable upscale dining segment. McCormick &Schmick’s Seafood Restaurants, 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.

 

                Thefinancial statements for the period covered by this report are those ofMcCormick & Schmick’s Seafood Restaurants, Inc. for periods beginning afterJuly 19, 2004 and those of the LLC for periods ended on or before July 19,2004. Except with respect to information regarding the membership units in theLLC and the common stock issued upon the reorganization, there was no impact tothe financial statements as a result of converting from a limited liabilitycompany to a corporation. Before July 20, 2004, the Company’s operations wereconducted by subsidiaries of the LLC, which were taxable corporations.Accordingly, the financial statements of the Company have historically includeda provision for income taxes and related deferred income taxes. Throughout thisreport, McCormick & Schmick’s Seafood Restaurants, Inc. and the LLC arereferred to collectively as “the Company.”

 

**2.   Basis of Presentation**

** **

                Asof March 26, 2005 the Company owned and operated 51 restaurants in 23 statesthroughout the United States of America. The Company also provides management services to two additionalrestaurants.

 

                Theaccompanying unaudited consolidated financial statements have been prepared inaccordance with U.S. generally accepted accounting principles for interimfinancial information and with the instructions to Form 10-Q and Article 10 ofRegulation S-X. Accordingly, they do not include all of the information andfootnotes required by U.S. generally accepted accounting principles forcomplete financial statements. In the opinion of management, all adjustments(consisting of normal recurring accruals) considered necessary for a fair presentationhave been included. Operating results for the quarter ended March 26, 2005 arenot necessarily indicative of the results that may be expected for the fiscal yearending December 31, 2005.

 

                Theconsolidated balance sheet at December 25, 2004 has been derived from theaudited consolidated financial statements at that date, but does not includeall of the information and footnotes required by U.S. generally acceptedaccounting principles for complete financial statements. For furtherinformation, refer to the consolidated financial statements and notes theretoincluded in the Company’s Annual Report on Form 10-K for the fiscal year endedDecember 25, 2004.

 

                Certainprior period amounts have been reclassified to conform to current periodpresentation.

 

**3.   Restatement of FinancialInformation**

 

                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 Chief Accountant ofthe Securities and Exchange Commission to the American Institute of Certified Public Accountants regarding properaccounting for certain operating lease matters under generally acceptedaccounting principles. Based on our review, we determined that we incorrectlyaccounted for certain operating lease transactions under generally acceptedaccounting principles.  Accordingly, theCompany has adjusted its consolidated financial statements for fiscal years andquarters ended prior to December 25, 2004. These restatement adjustments increased net loss by

 

 

5

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$274,000 and increased basic and diluted netloss per share by ($0.03) for the quarter ended March 27, 2004.  The restatement adjustments are non-cash andhad no impact on revenues or cash and cash equivalents.

 

**Lease Term**

** **

                Historically,the Company amortized its leasehold improvements on leased properties over theshorter of the combined initial term and all option periods of the lease(generally ranging from 20 to 30 years) or the useful life of the asset. Inaddition, the Company recognized rent expense on the straight-line basis fromthe opening date of the restaurant through the initial term of the lease. TheCompany concluded that its calculation of straight line rent expense should bebased on the lease term as defined in Statement of Financial AccountingStandards (“SFAS”) No. 13, Accounting for Leases, as amended, which in mostcases exceeds the initial term of the lease. As a result, it restated itsfinancial statements to recognize rent expense on the straight-line basis overthe lease term, including option periods which are reasonably assured ofrenewal primarily due to the presence of certain economic penalties. Forpurposes of calculating straight-line rents, the lease term commences on thedate the lessee obtains control over the property, which is generally when thelessor’s property is substantially complete and is ready for tenantimprovements. In addition, the Company amortizes leasehold improvements overthe shorter of the lease term or the useful life of the assets. As a result ofthese changes, the Company’s deferred rent credit liability included in otherlong-term liabilities, pre-opening costs and rent expense in the accompanyingfinancial statements have increased on a restated basis.

 

**Tenant Improvement Allowances**

** **

                TheCompany historically netted all tenant improvement allowances against thecapitalized cost of leasehold improvements. It determined that certain tenantimprovement allowances should be considered lease incentives and recorded as adeferred rent credit and amortized as a reduction to rent expense over thelease term. This change increases capitalized leasehold improvements and thedeferred rent credit liability included in other long-term liabilities whichresults in increases in amortization expense and decreases in rent expense.

** **

**4.   Summary of SelectedAccounting Policies**

 

**Principles of Consolidation**

 

                Theconsolidated financial statements include the assets, liabilities and resultsof operations of McCormick & Schmick’s Seafood Restaurants, Inc. and itssubsidiaries: McCormick & Schmick Acquisition Corp II, McCormick &Schmick Acquisition Corp., McCormick & Schmick Restaurant Corp., McCormick& Schmick Maryland Liquor, Inc., McCormick & Schmick Acquisition ITexas, Inc., McCormick & Schmick Acquisition II Texas, Inc., McCormick& Schmick Acquisition III Texas, Inc., McCormick & Schmick AcquisitionTexas, LP, McCormick & Schmick’s Atlanta II, LLC, McCormick & Schmick’sHackensack, LLC, McCormick & Schmick Orlando, LLC, McCormick & SchmickDallas LP, McCormick & Schmick Dallas Liquor, Inc., McCormick & SchmickAustin LP, and McCormick & Schmick Austin Liquor, Inc. All intercompanybalances and transactions have been eliminated upon consolidation.

 

**Management Estimates**

** **

                Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenue and expensesduring the reporting period. The Company bases its estimates on historicalexperience and on various assumptions that are believed to be reasonable underthe circumstances at the time. Actual results could differ from those estimatesunder different assumptions or conditions.

 

 

6

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**Revenue Recognition**

 

                Revenuesare recognized at the point of delivery of products and services. A deferredliability is recognized for gift certificates that have been sold but not yetredeemed at their anticipated redemption value. The anticipated redemptionvalue includes the cash value of gift certificates outstanding forapproximately eighteen months from the date of sale. The anticipated redemptionvalue is adjusted thereafter based on the Company’s historical redemptionrates. The Company recognizes revenue and reduces the related deferredliability when the gift certificates are redeemed.

 

**Equity-Based Compensation Plan**

 

                TheCompany accounts for its equity-based compensation plan using theintrinsic-value method prescribed by Accounting Principles Board Opinion No.25, Accounting for Stock Issued to Employees, as amended, (“APB 25”).  Accordingly, the Company computedcompensation cost for employee equity units granted as the amount by which theestimated fair value of the Company’s equity units on the date of grant exceedsthe amount the employee must pay to acquire the related equity units. Theamount of compensation cost is charged to income over the vesting period.

 

                UnderSFAS No. 123, Accounting for Stock-Based Compensation, (“SFAS 123”), as amendedby SFAS No. 148, Accounting for Stock-Based Compensation-Transition andDisclosure, as amended, (“SFAS 148”), companies who choose to account forequity-based compensation plans using the intrinsic-value method are requiredto determine the fair value of employee equity grants using the fair valuemethod and to disclose the impact of fair value accounting in a note to thefinancial statements. Prior to the Company’s initial public offering, there wasno difference between the accounting for the equity-based compensation plandescribed under APB 25 and SFAS 123. Accordingly, prior to the initial publicoffering, there was no difference between reported net income and pro forma netincome determined under SFAS 123.

 

                InDecember 2004, the Financial Accounting Standards Board (‘‘FASB’’) issued SFASNo. 123(R), ‘‘Share-Based Payment’’(“SFAS 123(R)”), which is a revision of SFAS123 and supercedes APB 25. SFAS  123(R)requires all share-based payments to employees, including grants of employeestock options, to be valued at fair value on the date of grant, and to beexpensed over the applicable vesting period. On April 14, 2005, the Securitiesand Exchange Commission adopted a new rule that amends the compliance dates forSFAS 123(R). SFAS 123(R) is effective for public companies for fiscal yearsbeginning after June 15, 2005. Under the new rule, the Company is required to adoptSFAS 123(R) beginning January 1, 2006. Pro forma disclosure of share-basedpayments effect to the statement of operations is not permissible under SFAS123(R).  SFAS 123(R) is effective for allstock-based awards granted on or after January 1, 2006. In addition, companiesmust also recognize compensation expense related to any awards that are notfully vested as of January 1, 2006. Compensation expense for the unvestedawards will be measured based on the fair value of the awards previouslycalculated in developing the pro forma disclosures in accordance with theprovisions of SFAS 123. The Company is currently evaluating the effect that theadoption of SFAS 123(R) will have on its financial position and results ofoperations. The adoption of SFAS 123(R) is expected to increase compensationexpense.

 

 

7

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                Thetable below shows the effects on net income and net income per share hadcompensation cost been measured with the fair value method pursuant to SFAS123:

 

| ** **                                           | ** ** | **Quarter Ended**                          | ** ** |
|------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                           | ** ** | **March 26, 2005**                         | ** ** |
| ** **                                           | ** ** | **(in thousands, except  per share data)** | ** ** |
| Net income, as reported                              |       | $                                          | 1,647      |   |
| Compensation cost based on the fair value method     |       | (216                                       | )          |
| Pro forma net income                                 |       | $                                          | 1,431      |   |
|                                                 |       |                                       |       |
| Basic and fully diluted net income per share         |       |                                       |       |
| As reported                                          |       | $                                          | 0.12       |   |
| Pro forma                                            |       | $                                          | 0.10       |   |
| Shares used in computing net income per common share |       |                                       |       |
| Basic                                                |       | 13,782                                     |       |
| Fully diluted                                        |       | 13,959                                     |       |

 

                Thepreceding proforma results were calculated with the use of the Black-Scholesoption pricing model. The following assumptions were used:

 

(1)          risk-free interest rate of3.9%;

 

(2)          dividend yield of 0%;

 

(3)          expected life of 5.5 years;

 

(4)          and volatility of 24.3%.

 

                Resultsmay vary depending on the assumptions applied within the model.

 

                Thereis no difference between reported net loss and net loss per share and proformanet loss and net loss per share determined under SFAS 123 for the quarter endedMarch 27, 2004.

 

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

** **

                Basicincome (loss) per share is computed based on the weighted-average number ofcommon shares outstanding during the period since the Company’s initial publicoffering. For periods prior to the initial public offering the 7,179,357 sharesof common stock of the Company issued to the former unit holders of the LLC andthe 602,292 shares issuable upon the exercise of certain warrants (because thewarrants have a nominal exercise price) are assumed to be outstanding for allperiods presented. Diluted earnings per share are computed using the weightedaverage number of shares of common stock and potentially dilutive securitiesassumed to be outstanding during the year. Potentially dilutive shares fromstock options and other common stock equivalents are excluded from thecomputation when their effect is antidilutive.

 

                Optionsto purchase 865,300 shares of common stock were outstanding at March 26, 2005.The diluted weighted-average shares for the quarter ended March 26, 2005include 176,695 shares subject to stock options. There were no stock optionsprior to the initial public offering.

 

**Operating Leases**

** **

                TheCompany has entered into operating leases, which have accelerating minimum baserent terms and contingent rent terms if individual restaurant sales exceedcertain levels. The Company records the minimum base rents on a straight-linebasis over the life of the lease term, including option periods which arereasonably assured of renewal due to the presence of certain economicpenalties. For purposes of calculating straight-line rents, the lease termcommences on the date the lessee obtains control of the property, which isnormally when the property is ready for normal tenant improvements(build-out-period), when no rent payments are typically due

 

 

8

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under the terms of the lease. For certainleases the Company only has the right to exercise its option for renewal ifcertain sales targets are achieved at or near the renewal date. These renewaloption periods have been included in the lease term when the Company determinesat lease inception or at the acquisition date of the restaurant, if later, thatthe sales targets are nonsubstantive and achievement of such sales targets isvirtually certain. The difference between rent expense calculated on a straightline basis and rent paid is recorded as deferred rent liability. The Companyreceives certain tenant improvement allowances which are considered leaseincentives and are amortized as reduction of rent expense over the lease term.  Accordingly, the Company has recorded adeferred rent liability for the straightlining of rents and lease incentives,which is included in other long-term liabilities of $10.8 million and $12.3million as of December 25, 2004 and March 26, 2005, respectively.  Non-cash rents were $0.5 million in both thefirst quarter of 2005 and the first quarter of 2004.

** **

**5.   Long-Term Debt**

 

                OnJuly 23, 2004, the Company repaid the outstanding balance on its revolvingcredit facility in the amount of $51.5 million with net proceeds from itsinitial public offering and $18.1 million in loans under a new revolving creditfacility agreement, which provides among other things for $50.0 million inrevolving credit loans. Loans under the facility are collateralized by a firstpriority security interest in all of the Company’s assets and mature on July23, 2009.

 

                Theoutstanding balance on the Company’s revolving credit facility was $14.5million and $12.0 million as of March 26, 2005 and December 25, 2004,respectively. The interest rate on the credit facility is based on thefinancial institution’s prime rate plus a margin of 0.25% to 0.75% or theEurodollar rate plus a margin of 1.75% to 2.25%, with margins determined bycertain financial ratios. Under the revolving credit facility, the Companyis  subject to certain financial andnon-financial covenants, including an adjusted leverage ratio, a consolidatedcash flow ratio, and a growth capital expenditures limitation. The Company wasin compliance with these covenants as of March 26, 2005.

 

**6.   Related PartyTransactions**

** **

                Priorto the Company’s initial public offering, it paid annual management fees of$1.1 million to each of Bruckman, Rosser, Sherrill & Co., L.L.C. (“BRS”)and Castle Harlan, Inc. (“Castle Harlan”), affiliates of which had significantownership interests in the Company. These management agreements were terminated in conjunction with theCompany’s initial public offering in July 2004, at which time, affiliates ofeach of BRS and Castle Harlan had significant ownership interests in theCompany. Management fees recognized as expenses totaled $550,000 in the firstquarter of 2004.  Pursuant to covenantsnot to compete agreements with the Company’s co-founders, William P. McCormickand Douglas L. Schmick, the Company expensed $87,500 in the first quarter of2004. These covenants not to compete agreements were terminated in connectionwith the Company’s initial public offering.

 

                TheCompany leases properties from landlords controlled by certain stockholders ofthe Company. Total rent paid to these landlords was $202,000 and $127,000 forthe first quarter of 2005 and the first quarter of 2004, respectively.

 

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

** **

**FORWARD LOOKING STATEMENTS**

** **

                ThisQuarterly Report, including Items 1 and 2 of Part I, contains forward-lookingstatements that are subject to substantial risks and uncertainties. Thesestatements relate to future events or our future financial performance. We haveattempted to identify forward-looking statements by terminology including “anticipate,”“believe,” “can,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,”“potential,” “predict,” “should” or “will” or the negative of these terms orother comparable terminology. The expectations reflected in theseforward-looking statements may prove to be incorrect.

 

                Importantfactors that could cause actual results to differ materially from ourexpectations include those discussed below under “Factors That May Affect OurBusiness and the Price of Our Stock.”  Wedo not

 

 

9

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undertake any duty to update forward-lookingstatements after the date they are made or to conform them to actual results orto changes in circumstances or expectations.

 

**Restatement of FinancialInformation**

 

                Likemany other restaurant companies and retailers, we have conducted a review ofour 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 Chief Accountant ofthe Securities and Exchange Commission to the American Institute of CertifiedPublic Accountants regarding proper accounting for certain operating leasematters under generally accepted accounting principles. Accordingly, we haveadjusted our consolidated financial statements for fiscal years and quartersended prior to December 25, 2004.  Theserestatement adjustments increased net loss by $274,000 and increased basic anddiluted net loss per share by ($0.03) for the quarter ended March 27,2004.  The restatement adjustments arenon-cash and had no impact on revenues or cash and cash equivalents.

** **

*Lease term*

 

                Historically,we amortized our leasehold improvements on leased properties over the shorterof the combined initial term and all option periods of the lease (generallyranging from 20 to 30 years) or the useful life of the asset. In addition, werecognized rent expense on the straight-line basis from the opening date of therestaurant through the initial term of the lease. We have concluded that ourcalculation of straight-line rent expense should be based on the lease term asdefined in Statement of Financial Accounting Standards (“SFAS”) No. 13,Accounting for Leases, as amended, (“SFAS 13”), which in most cases exceeds theinitial term of the lease. As a result, we have restated our financialstatements to recognize rent expense on the straight-line basis over 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 over the property, which is generally when the lessor’s property issubstantially complete and ready for tenant improvements. In addition, we nowamortize leasehold improvements over the shorter of the lease term or theuseful life of the assets. As a result of these changes, deferred rent creditliability included in other long-term liabilities, pre-opening costs and rentexpense in the accompanying financial statements have increased on a restatedbasis.

 

*Tenant improvement allowances*

* *

                Wehistorically netted all tenant improvement allowances against the capitalizedcost of leasehold improvements. We have determined that certain tenantimprovement allowances should be considered lease incentives and recorded as adeferred rent credit and amortized as a reduction to rent expense over thelease term. This change increases capitalized leasehold improvements and thedeferred rent credit liability, which results in increases in amortizationexpense and decreases in rent expense.

 

**Reorganization in Connection withInitial Public Offering**

** **

                Inconnection with our initial public offering in July 2004, we convertedMcCormick & Schmick Holdings LLC, a Delaware limited liability company,into McCormick & Schmick’s Seafood Restaurants, Inc., a Delawarecorporation. Because our operations are conducted by wholly owned subsidiaries,the conversion did not affect our financial statements, except with respect toinformation regarding the membership units in McCormick & Schmick HoldingsLLC. Except where specifically noted, references in this Quarterly Report on Form10 Q to “we” or to “the Company” means McCormick & Schmick Holdings LLC forperiods before July 20, 2004 and McCormick & Schmick’s Seafood Restaurants,Inc. for periods on and after July 20, 2004.

 

 

10

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**Overview**

 

                Ourcompany was founded in 1972 with William P. McCormick’s acquisition of Jake’sFamous Crawfish in Portland, Oregon. We grew our family of restaurants slowlythrough the next two decades and in 1994, when we owned 14 restaurants, amajority interest in our company was purchased by Castle Harlan Partners II,L.P., a private investment firm. Avado Brands purchased us in 1997. We operatedas a division of Avado Brands and added 18 new restaurants in just under fourand a half years. In August 2001, Avado Brands sold our company to CastleHarlan Partners III, L.P. and Bruckmann, Rosser, Sherrill & Co. II, L.P. ,private equity investment firms that actively invest in restaurant companies.We have expanded our restaurant base to 53 restaurants, including tworestaurants operated under management contracts.

 

                Wehave grown our business by offering our customers a daily-printed menu with abroad selection of affordable, quality fresh seafood in an upscale environment,serviced by knowledgeable and professional management and staff. Our revenuesare generated by sales at our restaurants, including banquets.

 

                Wemeasure performance using key operating indicators such as comparablerestaurant sales, food and beverage costs, labor costs, restaurant operatingexpenses, and total occupancy costs, with a focus on those costs and expensesas a percentage of revenues.  We alsotrack trends in average weekly revenues at both the restaurant level and on aconsolidated basis as an indicator of our performance. The key operatingmeasure used by management in evaluating our operating results is operatingincome. Operating income is calculated by deducting restaurant operating costs,general and administrative expenses, restaurant pre-opening costs, depreciationand amortization and other corporate costs from revenues. We monitor generaland administrative expenses as a percentage of revenues, which we target to beapproximately 5% of revenues. Restaurant pre-opening costs are analyzed basedon the number and timing of restaurant openings and by comparison to budgetedamounts, with an overall target of approximately $0.3 to $0.4 million perrestaurant opening, which may include up to $0.1 million in non-cash rentexpense during the construction period.

 

                Themost significant restaurant operating costs are food and beverage costs andlabor and related employee benefits. We believe our national and regionalpresence allows us to achieve better quality and pricing on key products thanmost of our competitors. We closely monitor food and beverage costs andregularly review our selection of preferred vendors on the basis of several keymetrics, including pricing. In addition, because we print our menu daily, weare able to adapt the seafood items we offer to changes in vendor pricing tooptimize our revenue mix and mitigate the impact of cost increases in anyparticular seafood item by substituting a lower-cost alternative on our menu orby adjusting the price. With respect to labor costs, we believe the combinationof future growth in revenues and the resulting greater leverage of our vicepresidents of operations and regional managers will allow us to better leveragepayroll expenses over time. Our employee benefits include health insurance, thecost of which continues to increase faster than the general rate of inflation.We continually monitor this cost and review strategies to effectively controlincreases but we are subject to the overall trend of increases in healthcarecosts.

 

                Generaland administrative expenses are controlled in absolute amounts and monitored asa percentage of revenues. As we have continued our growth, we have incurredsubstantial training costs and made significant investments in infrastructure,including our information systems. As we continue to grow and are able toleverage investments made in our people and systems, we expect these expensesto decrease as a percentage of revenues over time.

 

                Identificationof appropriate new restaurant sites is essential to our growth strategy. Weevaluate and invest in new restaurants based on site-specific projected returnson investment. We believe our store model and flexible real estate strategyprovide us with continued opportunities to find attractive real estatelocations on favorable terms.

 

**Strategic Focus and OperatingOutlook**

 

                Ourprimary business focus for over 33 years has been to consistently offer a broadselection of high quality, fresh seafood, which we believe commands strongloyalty from our customers. We have successfully expanded our McCormick & Schmick’sseafood restaurant concept throughout the United States and have competed

 

11

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effectively with both national and regionalrestaurant chains as well as with local operators. We opened three, three andnine new company-owned restaurants in 2002, 2003 and 2004, respectively, andentered into management contracts for one restaurant in 2002 and one restaurantin 2004, growing from 35 to 52 restaurants during this three year period.

 

                Ourobjective is to continue to prudently grow McCormick & Schmick’s seafoodrestaurants in existing and new markets. Our 2005 plan includes the opening ofseven new restaurants. In addition to new unit growth, we are committed toimproving comparable restaurant sales over the levels achieved in 2004 bydriving increased customer counts as well as restaurant level operatingmargins.

 

**Financial Performance Overview**

** **

                Thefollowing are highlights of our financial performance for the first quarterended March 26, 2005:

 

•                  Comparable restaurant salesin the first quarter of 2005 increased 1.2% compared to an increase of 5.8%over the comparable restaurant sales in the first quarter of 2004.

 

•                  Revenues increased 10.8% inthe first quarter of 2005 compared to the first quarter of 2004, to $60.4million. The increase was primarily due to revenues generated by the fivecompany-owned restaurants opened in the last three quarters of 2004 and thefirst quarter of 2005 coupled with our 1.2% positive comparable restaurantsales.

 

•                  Net income increased $2.7million in the first quarter of 2005 compared to the first quarter of 2004, to$1.6 million due to the following:

 

•                  Operating income increased$1.7 million in the first quarter of 2005 compared to the first quarter of2004, to $2.5 million primarily due to the higher revenues.

 

•                  General and administrativeexpenses increased $0.8 million primarily due to additional expenses related tobeing a public company.

 

•                  Restaurant pre-opening costsdecreased $0.5 million due to the decreased number of restaurant openings orrestaurants under construction in the first quarter of 2005.

 

•                  In connection with theinitial public offering, we eliminated certain stockholder managementagreements and covenants not to compete agreements resulting in the eliminationof management fees and covenants not to compete expense.  The impact of these items resulted in a $0.6million increase to operating income.

 

•                  With the proceeds from ourinitial public offering, we redeemed all of our preferred stock, and substantiallydecreased our average outstanding debt balance, resulting in the elimination ofaccrued dividends and accretion on our mandatorily redeemable preferred stockcoupled with a reduction in interest expense. The impact of these two items resulted in a $1.5 million increase to netincome.

 

 

12

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                Thefollowing table sets forth our operating results and our operating resultsexpressed as a percentage of revenues for the quarterly periods ended March 27,2004 and March 26, 2005.

 
| ** **                                                                 | ** ** | **Quarter Ended**  | ** ** |
|----------------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                 | ** ** | **March 27, 2004** | ** ** | **March 26, 2005** | ** ** |
| ** **                                                                 | ** ** | **Restated**       | ** ** | ** ** | ** ** |
| ** **                                                                 | ** ** | **(in thousands)** | ** ** |
| ** **                                                                 | ** ** | ** **         | ** ** |
| Revenues                                                                   |       | $                  | 54,513     |   | 100 | % | $ | 60,385 |   | 100 | % |
|                                                                       |       |               |       |   |   |   |   |   |   |
| Restaurant operating costs                                                 |       |               |       |   |   |   |   |   |   |
| Food and beverage                                                          |       | 16,286             |       | 29.9 | % | 17,760 |   | 29.4 | % |
| Labor                                                                      |       | 17,810             |       | 32.7 | % | 19,356 |   | 32.1 | % |
| Operating                                                                  |       | 7,874              |       | 14.4 | % | 9,017 |   | 14.9 | % |
| Occupancy                                                                  |       | 4,848              |       | 8.9 | % | 5,605 |   | 9.3 | % |
| Total restaurant operating costs                                           |       | 46,818             |       | 85.9 | % | 51,738 |   | 85.7 | % |
| General and administrative expenses                                        |       | 2,549              |       | 4.7 | % | 3,342 |   | 5.5 | % |
| Restaurant pre-opening costs                                               |       | 994                |       | 1.8 | % | 529 |   | 0.9 | % |
| Depreciation and amortization                                              |       | 2,683              |       | 4.9 | % | 2,232 |   | 3.7 | % |
| Management fees and covenants not to compete                               |       | 638                |       | 1.2 | % | — |   | — |   |
| Total costs and expenses                                                   |       | 53,682             |       | 98.5 | % | 57,841 |   | 95.8 | % |
| Operating income                                                           |       | 831                |       | 1.5 | % | 2,544 |   | 4.2 | % |
| Interest expense                                                           |       | 857                |       | 1.6 | % | 156 |   | 0.3 | % |
| Accrued dividends and accretion on mandatorily redeemable preferred  stock |       | 1,012              |       | 1.9 | % | — |   | — |   |
| Income (loss) before income taxes                                          |       | (1,038             | )          | (1.9 | )% | 2,388 |   | 4.0 | % |
| Income tax expense (benefit)                                               |       | (15                | )          | — |   | 741 |   | 1.2 | % |
| Net income (loss)                                                          |       | $                  | (1,023     | ) | (1.9 | )% | $ | 1,647 |   | 2.7 | % |

 

***Revenues and Restaurant Operating Costs***

*** ***

                Thefollowing table sets forth revenues and restaurant operating costs, includingfood and beverage, labor, operating and occupancy costs from our unauditedconsolidated statements of operations:

 
| ** **                       | ** ** | **Quarter Ended**  | ** ** | **Change**    | ** ** |
|----------------------------------|------------|--------------------|------------|---------------|------------|
| ** **                       | ** ** | **March 27,**      | ** ** | **March 26,** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                       | ** ** | **2004**           | ** ** | **2005**      | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                       | ** ** | **Restated**       | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                       | ** ** | **(in thousands)** | ** ** | ** **    | ** ** | ** ** | ** ** |
| ** **                       | ** ** | ** **         | ** ** | ** **    | ** ** | ** ** | ** ** |
| Revenues                         |       | $                  | 54,513     |          | $          | 60,385 |   | $ | 5,872 |   | 10.8 | % |
|                             |       |               |       |          |       |   |   |   |   |
| Restaurant operating costs       |       |               |       |          |       |   |   |   |   |
| Food and beverage                |       | $                  | 16,286     |          | $          | 17,760 |   | $ | 1,474 |   | 9.1 | % |
| Labor                            |       | 17,810             |       | 19,356        |       | 1,546 |   | 8.7 | % |
| Operating                        |       | 7,874              |       | 9,017         |       | 1,143 |   | 14.5 | % |
| Occupancy                        |       | 4,848              |       | 5,605         |       | 757 |   | 15.6 | % |
| Total restaurant operating costs |       | $                  | 46,818     |          | $          | 51,738 |   | $ | 4,920 |   | 10.5 | % |

 

                *Revenues*.   Revenues increased by $5.9 million, or10.8%, to $60.4 million in the first quarter of 2005 from $54.5 million in thefirst quarter of 2004.  This increase wasprimarily attributable to revenues of $4.0 million generated by fivecompany-owned restaurants opened in the last three quarters of 2004 and thefirst quarter of 2005 and an increase in comparable restaurant sales of  $0.6 million, or 1.2%. Comparable restaurantsales were positive

 

 

13

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1.2%, primarily as a result of higherpricing.

 

                *Food and Beverage Costs*.   Food and beverage costsincreased by $1.5 million, or 9.1%, to $17.8 million in the first quarter of2005 from $16.3 million in the first quarter of 2004. This increase wasprimarily due to the five company-owned restaurants opened in the last threequarters of 2004 and the first quarter of 2005. Food and beverage costs as apercentage of revenues decreased to 29.4% in the first quarter of 2005 comparedto 29.9% in the first quarter of 2004, primarily related to pricing increasesand increased product handling efficiency for the restaurants opened in 2004.

 

*                LaborCosts*.   Labor costs increased by $1.5 million, or 8.7%, to $19.4million in the first quarter of 2005 from $17.8 million in the first quarter of2004. This increase was primarily due to the five company-owned restaurantsopened in the last three quarters of 2004 and the first quarter of 2005. Laborcosts as a percentage of revenue decreased to 32.1 % in the first quarterof  2005 compared to 32.7% in the firstquarter of 2004 because of lower management costs as a percentage of revenues.

 

                *Operating Costs*.   Operating costs increased by $1.1million, or 14.5%, to $9.0 million in the first quarter of 2005 from $7.9million in the first quarter of 2004. This increase was primarily due to thefive company-owned restaurants opened in the last three quarters of 2004 and thefirst quarter of 2005. Operating costs as a percentage of revenues increased to14.9% in the first quarter of 2005 from 14.4% in the first quarter of 2004. Thepercentage increase in operating costs was primarily due to higher marketingand utility costs.

 

                *Occupancy Costs*.   Occupancy costs increased by $0.8million, or 15.6%, to $5.6 million in the first quarter of 2005 from $4.8million in the first quarter of 2004, primarily due to the occupancy costs ofthe five company-owned restaurants opened in the last three quarters of 2004and the first quarter of 2005. Occupancy costs as a percentage of revenuesincreased to 9.3% in the first quarter of 2005 from 8.9% in the first quarterof 2004, primarily due to occupancy costs as a percentage of revenues for therestaurants opened in the last three quarters of 2004 and the first quarter of2005 being higher than occupancy costs as a percentage of revenues for thecomparable restaurants. Non-cash rents were $0.5 million in both the firstquarter of 2005 and the first quarter of 2004.

 

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

 

                Thefollowing table sets forth general and administrative, restaurant pre-opening,depreciation and amortization and management fees and covenants not to competecosts from our unaudited consolidated statements of operations:

 
| ** **                                   | ** ** | **Quarter Ended**  | ** ** | **Change**    | ** ** |
|----------------------------------------------|------------|--------------------|------------|---------------|------------|
| ** **                                   | ** ** | **March 27,**      | ** ** | **March 26,** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **2004**           | ** ** | **2005**      | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                   | ** ** | **Restated**       | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **(in thousands)** | ** ** | ** **    | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | ** **         | ** ** | ** **    | ** ** | ** ** | ** ** |
| General and administrative expenses          |       | $                  | 2,549      |          | $          | 3,342 |   | $ | 793 |   | 31.1 | % |
| Restaurant pre-opening costs                 |       | 994                |       | 529           |       | (465 | ) | (46.8% | ) |
| Depreciation and amortization                |       | 2,683              |       | 2,232         |       | (451 | ) | (16.8% | ) |
| Management fees and covenants not to compete |       | 638                |       | —        |       | (638 | ) | (100.0% | ) |
|                                              |            |                    |            |               |            |  |  |  |  |  |  |  |

 

*                Generaland Administrative Expenses*.   General andadministrative expenses increased by $0.8 million, or 31.1%, to $3.3 million inthe first quarter of 2005 from $2.5 million in the first quarter of 2004.General and administrative expenses as a percentage of revenues were 5.5% inthe first quarter of 2005 and 4.7% in the first quarter of 2004. The increasein general and administrative expenses as a percentage of revenues wasprimarily due to costs associated with being a public company.

 

 

14

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                *Restaurant Pre-Opening Costs*.    Restaurant pre-openingcosts decreased by $0.5 million, or 47.0%, to $0.5 million in the first quarterof 2005 from $1.0 million in the first quarter of 2004, primarily due to thedecreased number of restaurant openings or restaurants under construction inthe first quarter of 2005 compared to the first quarter of 2004.

 

                *Depreciation and Amortization*.   Depreciation andamortization decreased by $0.5 million, or 16.8%, to $2.2 million in the firstquarter of 2005 from $2.7 million in the first quarter of 2004. The decreasewas primarily due to three-year lived assets acquired in August of 2001 whichbecame fully depreciated in 2004.

 

*                ManagementFees and Covenants Not to Compete*.    Prior to ourinitial public offering, we paid annual management fees of $1.1 million to eachof BRS and Castle Harlan. These management agreements were terminated inconjunction with our initial public offering at which time affiliates of eachof BRS and Castle Harlan had significant ownership interests in the Company.Management fees recognized as expenses totaled $550,000 in the first quarter of2004.  Pursuant to covenants not tocompete agreements with our co-founders, William P. McCormick and Douglas L.Schmick, we expensed $87,500 in the first quarter of 2004. These covenants notto compete agreements were terminated in connection with our initial publicoffering.

 

***Other Expenses***

 

                Thefollowing table sets forth interest expense, minority interest, write off ofdeferred loan costs, and income tax expense (benefit)  from our unaudited consolidated statements ofoperations.

 
| ** **                                                                 | ** ** | **Quarter Ended**  | ** ** | **Change**    | ** ** |
|----------------------------------------------------------------------------|------------|--------------------|------------|---------------|------------|
| ** **                                                                 | ** ** | **March 27,**      | ** ** | **March 26,** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                 | ** ** | **2004**           | ** ** | **2005**      | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                                                 | ** ** | **Restated**       | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                 | ** ** | **(in thousands)** | ** ** | ** **    | ** ** | ** ** | ** ** |
| ** **                                                                 | ** ** | ** **         | ** ** | ** **    | ** ** | ** ** | ** ** |
| Interest expense                                                           |       | $                  | 857        |          | $          | 156 |   | $ | (701 | ) | (81.8 | )% |
| Accrued dividends and accretion on mandatorily redeemable preferred  stock |       | $                  | 1,012      |          | $          | — |   | $ | (1,012 | ) | (100.0 | )% |
| Income (loss) before income taxes                                          |       | $                  | (1,038     | )             | $          | 2,388 |   | $ | 3,426 |   | * |   |
| Income tax expense (benefit)                                               |       | (15                | )          | 741           |       | 756 |   | * |   |
| Net income (loss)                                                          |       | $                  | (1,023     | )             | $          | 1,647 |   | $ | 2,671 |   | * |   |

----

*                 Percentage change is notmeaningful.

 

*                InterestExpense*.   Interest expense decreased by $0.7 million, or 81.8%, to $0.2million in the first quarter of 2005, from $0.9 million in the first quarter of2004.  This was primarily due to adecrease of approximately $40.0 million in the average outstanding debt balanceas a result of the payoff of our prior credit facility.

 

*                AccruedDividends and Accretion on Mandatorily 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.

 

*                IncomeTax (Benefit) Expense*.   Income tax expense was $0.7 millionin the first quarter of 2005, which reflects an effective tax rate ofapproximately 31% and the benefit of FICA tip credits.  In the first quarter of 2004 income taxbenefit was $15,000.

 

*                NetIncome (Loss).  *Net income increased $2.7 million in thefirst quarter of 2005 compared to the first quarter of 2004, to $1.6 milliondue to the following:

 

•          Operating income increased$1.7 million in the first quarter of 2005 compared to the first quarter of2004, to $2.5 million primarily due to the higher revenues.

 

•          General and administrativeexpenses increased $0.8 million primarily due to additional expenses related tobeing a public company.

 

 

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•          Restaurant pre-opening costsdecreased $0.5 million due to the decreased number of restaurant openings orrestaurants under construction in the first quarter of 2005.

 

•                  In connection with theinitial public offering, we terminated certain management agreements andcovenants not to compete agreements resulting in the elimination of managementfees and covenants not to compete expense. The impact of these items resulted in a $0.6 million increase tooperating income.

 

•          With the proceeds from ourinitial public offering, we redeemed all of our preferred stock, andsubstantially decreased our average outstanding debt balance, resulting in theelimination of accrued dividends and accretion on our mandatorily redeemablepreferred stock coupled with a reduction in interest expense.  The impact of these two items resulted in a$1.5 million increase to net income.

 

**Liquidity and Capital Resources**

** **

                Ourprimary cash needs have been for new restaurant construction, working capitaland general corporate purposes, including payments under credit facilities. Ourmain sources of cash have been issuance of common stock, net cash provided byoperating activities and borrowings under credit facilities.

 

                OnJuly 20, 2004, we completed our initial public offering.  In connection with the initial publicoffering we:

 

•          Issued 7,179,357 shares of commonstock in the merger to the holders of McCormick & Schmick Holdings LLC’sunits, not including 602,992 shares issuable upon the exercise of warrants at anominal price to The Bell Atlantic Master Trust.

 

•          Sold 6,000,000 shares at$12.00 per share, raising approximately $65.1 million after underwritingdiscounts and transaction costs.

 

•          Repaid $51.5 million ofindebtedness on our then existing credit facility with the proceeds raised inthe initial public offering and from $18.1 million in loans under a newrevolving credit facility, which provides, among other things, for $50.0million in revolving credit loans.

 

•          Paid $28.9 million to TheBell Atlantic Master Trust to redeem all of the 13% senior exchangeablepreferred stock of a wholly owned subsidiary.

 

•          Paid $2.8 million inconnection with the termination of the management agreements and covenants notto compete agreements.

 

                Thefollowing table summarizes our sources and uses of cash and cash equivalentsfrom our unaudited consolidated statements of cash flows:

 

| ** **                                           | ** ** | **Quarter Ended**  | ** ** |
|------------------------------------------------------|------------|--------------------|------------|
| ** **                                           | ** ** | **March 27,**      | ** ** | **March 26,** | ** ** |
| ** **                                           | ** ** | **2004**           | ** ** | **2005** | ** ** |
| ** **                                           | ** ** | **Restated**       | ** ** | ** ** | ** ** |
| ** **                                           | ** ** | **(in thousands)** | ** ** |
| ** **                                           | ** ** | ** **         | ** ** |
| Net cash provided by operating activities            |       | $                  | 1,907      |   | $ | 3,576 |   |
| Net cash used in investing activities                |       | (11,535            | )          | (5,383 | ) |
| Net cash provided by financing activities            |       | 9,579              |       | 1,963 |   |
| Net increase (decrease) in cash and cash equivalents |       | $                  | (49        | ) | $ | 156 |   |

 

                Netcash provided by operating activities was $3.6 million in the first quarter of2005, compared to $1.9 million in the first quarter of 2004. The increase innet cash provided by operating activities was primarily due to

 

 

16

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generating net income in the first quarter of2005, an increase in net income (loss) of $2.7 million, partially offset by adecrease in accrued expenses of $1.1 million.

 

                Netcash used in investing activities was $5.4 million in the first quarter of2005, compared to $11.5 million in the first quarter of 2004. We use cash fortenant improvements and equipment to open new restaurants, and to upgrade andadd capacity to existing restaurants. Net cash used in investing activitiesvaried in the periods presented based on the number of new restaurants openedand the expansion of existing restaurant capacity during the period. Purchasesof property and equipment also include purchases of information technologysystems and expenditures relating to our corporate headquarters.

 

                Netcash provided by financing activities was $2.0 million in the first quarter of2005 compared to $9.6 million in the first quarter of 2004.  The decrease in net cash provided byfinancing activities was primarily due to a decrease in borrowings under ourrevolving credit facilities of $20.0 million partially offset by a decrease inpayments made on our revolving credit facilities of $10.5 million.

 

                Asof March 26, 2005, the outstanding balance on our revolving credit facility was$14.5 million. The interest rate on the credit facility is based on thefinancial institution’s prime rate plus a margin of 0.25% to 0.75% or theEurodollar rate plus a margin of 1.75% to 2.25%, with margins determined bycertain financial ratios. Under our revolving credit facility, we are subjectto certain financial and non-financial covenants, including an adjustedleverage ratio, a consolidated cash flow ratio and growth capital expenditureslimitation. We were in compliance with these covenants as of March 26, 2005.

 

                Webelieve the net cash provided by operating activities and funds available fromour revolving credit facility will be sufficient to satisfy our working capitaland capital expenditure requirements, including restaurant construction,pre-opening costs and potential initial operating losses related to newrestaurant openings for at least the next 12 months.

 

**Critical Accounting Policies andEstimates**

** **

                Oursignificant accounting policies are those that we believe are both important tothe portrayal of our financial condition and results and require our mostdifficult, subjective or complex judgments, often as a result of the need tomake estimates about the effect of matters that are inherently uncertain. Webelieve our critical accounting policies and estimates used in the preparationof our consolidated financial statements are the following:

 

***Equipment and LeaseholdImprovements***

*** ***

                Equipmentand leasehold improvements are stated at cost less accumulated depreciation andamortization. Equipment consists primarily of restaurant equipment, furniture,fixtures and small wares. Depreciation is generally calculated using thestraight-line method over the estimated useful lives of the related assets.Leasehold improvements are amortized using the straight-line method over theshorter of the lease term as defined in SFAS 13 or the estimated useful life ofthe asset. As discussed in SFAS 13, the lease term includes any period coveredby a renewal option where the renewal is reasonably assured because failure torenew the 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 30 years.Judgments and estimates made by us related to the expected useful lives ofthese assets are affected by factors such as changes in economic conditions andchanges in operating performance. If these assumptions change in the future, wemay be required to record impairment charges for these assets.

 

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

 

                Wereview property and equipment (which includes leasehold improvements) forimpairment when events or circumstances indicate these assets might beimpaired. We test impairment using historical cash flow and other relevantfacts and circumstances as the primary basis for our estimates of future cashflows. The analysis is performed at the restaurant level for indicators ofpermanent impairment. In determining future cash flows,

 

 

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significant estimates are made by us withrespect to future operating results of each restaurant over its remaining leaseterm. If assets are determined to be impaired, the impairment charge ismeasured by calculating the amount by which the asset-carrying amount exceedsits fair value. The determination of asset fair value is also subject tosignificant judgment. This process requires the use of estimates andassumptions, which are subject to a high degree of judgment. If theseassumptions change in the future, we may be required to record impairmentcharges for these assets. In our most recent impairment evaluation forlong-lived assets, no additional impairment charge would have resulted even ifthere were a permanent 5% reduction in revenues in our restaurants.

 

***Goodwill and Other IndefiniteLived Assets***

 

                Goodwilland other indefinite lived assets resulted from our acquisition in 2001.Goodwill and other intangible assets with indefinite lives are not subject toamortization. However, such assets must be tested for impairment wheneverevents or changes in circumstances indicate that the carrying amount may not berecoverable and at least annually. We completed our most recent impairment teston balances as of December 25, 2004, and determined that there were no impairmentlosses related 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***

 

                Wemaintain various insurance policies for workers’ compensation, employee health,general liability, and property damage. Pursuant to those policies, we areresponsible for losses up to certain limits and are required to estimate aliability that represents our ultimate exposure for aggregate losses belowthose limits. This liability is based on management’s estimates of the ultimatecosts to be incurred to settle known claims and claims not reported as of thebalance sheet date. Our estimated liability is not discounted and is based on anumber of assumptions and factors, including historical trends, actuarialassumptions, and economic conditions.  Ifactual trends differ from our estimates, our financial results could be impacted.

 

***Income Taxes***

 

                Wehave accounted for, and currently account for, income taxes in accordance withSFAS No. 109, Accounting for Income Taxes. This Statement establishes financialaccounting and reporting standards for the effects of income taxes that resultfrom an enterprise’s activities during the current and preceding years. Itrequires an asset and liability approach for financial accounting and reportingof income taxes. We recognize deferred tax liabilities and assets for thefuture consequences of events that have been recognized in our consolidatedfinancial statements or tax returns. In the event the future consequences ofdifferences between financial reporting bases and tax bases of our assets andliabilities result in a net deferred tax asset, an evaluation is made of theprobability of being able to realize the future benefits indicated by suchasset. A valuation allowance related to a deferred tax asset is recorded whenit is more likely than not that some portion or all of the deferred tax assetwill not be realized. The realization of such net deferred tax asset willgenerally depend on whether we will have sufficient taxable income of anappropriate character within the carry forward period permitted by the tax law.Without sufficient taxable income to offset the deductible amounts and carryforwards, the related tax benefits will expire unused. We have evaluated bothpositive and negative evidence in making a determination as to whether it ismore likely than not that all or some portion of the deferred tax asset willnot be realized. Measurement of deferred items is based on enacted tax laws. Nodeferred tax asset valuation allowance has been recorded as of March 26, 2005.

 

 

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***Operating Leases***

 

                Rentexpense for our operating leases, which generally have escalating rentals overthe term of the lease, is recorded on the straight-line basis over the leaseterm as defined in SFAS 13. The lease term commences on the date which isnormally when the property is ready for normal tenant improvements (build-outperiod), when no rent payments are typically due under the terms of the lease.The difference between rent expense and rent paid is recorded as deferred rentliability and is included in the consolidated balance sheets.

 

**Factors That May Affect OurBusiness and the Price of Our Stock**

 

***Our ability to expand our restaurant base isinfluenced by factors beyond our control and therefore we may not be able toachieve our planned growth.***

 

                Ourgrowth strategy depends in large part on our ability to open new restaurantsand to operate these restaurants profitably. Delays or failures in opening newrestaurants could impair our ability to meet our growth objectives. We have inthe past experienced delays in restaurant openings and may experience similardelays in the future. Our ability to expand our business successfully willdepend upon numerous factors, including:

 

•          hiring, training and retaining skilled management,chefs and other qualified personnel to open, manage and operate new restaurants;

 

•          locating and securing a sufficient number of suitablenew restaurant sites in new and existing markets on acceptable lease terms;

 

•          managing the amount of time and construction anddevelopment costs associated with the opening of new restaurants;

 

•          obtaining adequate financing for the construction ofnew restaurants;

 

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

 

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

 

•          general economic conditions.

 

                Someof these factors are beyond our control. We may not be able to achieve ourexpansion goals and our new restaurants may not be able to achieve operatingresults similar to those of our existing restaurants.

 

***Unexpected expenses and low market acceptance couldadversely affect the profitability of restaurants that we open in new markets.***

 

                Ourgrowth strategy includes opening restaurants in markets where we have little orno meaningful operating experience and in which potential customers may not befamiliar with our restaurants. The success of these new restaurants may beaffected by different competitive conditions, consumer tastes and discretionaryspending patterns, and our ability to generate market awareness and acceptanceof the McCormick & Schmick’s brand. As a result, we may incur costs relatedto the opening, operation and promotion of these new restaurants that aregreater than those incurred in other areas. Even though we may incursubstantial additional costs with these new restaurants, they may attract fewercustomers than our more established restaurants in existing markets. Sales atrestaurants that we open in new markets may take longer to reach our averageannual sales, if at all. As a result, the results of operations at our newrestaurants may be inferior to those of our existing restaurants. We may not besuccessful in profitably opening restaurants in new markets.

 

 

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***Our growth may strain our infrastructure andresources, which could slow our development of new restaurants and adverselyaffect our ability to manage our existing restaurants.***

 

                Weopened nine company-owned restaurants and began operating an additionalrestaurant under a management contract in 2004. We plan to open sevencompany-owned restaurants in 2005. Our 2004 expansion and our future growth maystrain our 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 inthe future may be limited, which could adversely impact our growth.***

 

                Changesin our operating plans, acceleration of our expansion plans, lower thananticipated sales, increased expenses or other events described in this sectionmay require us to seek additional debt or equity financing. Financing may notbe available on acceptable terms, or at all, and our failure to raise capitalwhen needed could negatively impact our growth and our financial condition andresults of operations. Additional equity financing may be dilutive to theholders of our common stock, and debt financing, if available, may involvesignificant cash payment obligations and covenants that restrict our ability tooperate our business. See “Management’s Discussion and Analysis of FinancialCondition and Results of Operations—Liquidity and Capital Resources.”

 

***Our operations are susceptible to changes in foodavailability and costs, which could adversely affect our operating results.***

 

                Ourprofitability depends significantly on our ability to anticipate and react tochanges in seafood costs. We rely on local, regional and national suppliers toprovide our seafood. Increases in distribution costs or sale prices or failureto perform by these suppliers could cause our food costs to increase. We couldalso experience significant short-term disruptions in our supply if asignificant supplier failed to meet its obligations. The supply of seafood ismore volatile than other types of food. The type, variety, quality and price ofseafood is subject to factors beyond our control, including weather,governmental regulation, availability and seasonality, each of which may affectour food costs or cause a disruption in our supply. Changes in the price oravailability of certain types of seafood could affect our ability to offer abroad menu and price offering to customers and could materially adverselyaffect our profitability.

 

                Ouroperating results may fluctuate significantly and could fall below theexpectations of securities analysts and investors due to seasonality and otherfactors, resulting in a decline in our stock price.

 

                Ouroperating results may fluctuate significantly because of several factors,including:

 

•          our ability to achieve andmanage our planned expansion;

 

•          our ability to achievemarket acceptance, particularly in new markets;

 

•          our ability to raise capitalin the future;

 

•          changes in the availabilityand costs of food;

 

•          the loss of key managementpersonnel;

 

•          the concentration of ourrestaurants in specific geographic areas;

 

•          our ability to protect ourname and logo and other proprietary information;

 

•          changes in consumerpreferences or discretionary spending;

 

•          fluctuations in the numberof visitors or business travelers to downtown locations;

 

•          health concerns aboutseafood or other food products;

 

•          our ability to attract,motivate and retain qualified employees;

 

 

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•          increases in labor costs;

 

•          the impact of federal, stateor local government regulations relating to our employees or the sale orpreparation of food and the sale of alcoholic beverages;

 

•          the impact of litigation;

 

•          the effect of competition inthe restaurant industry; and

 

•          economic trends generally.

 

                Ourbusiness also is subject to seasonal fluctuations. Historically, sales in mostof our restaurants have been higher during the second and fourth quarter ofeach year. As a result, our quarterly and annual operating results andrestaurant sales may fluctuate significantly as a result of seasonality and thefactors discussed above. Accordingly, results for any one fiscal quarter arenot necessarily indicative of results to be expected for any other quarter orfor any year and comparable restaurant sales for any particular future periodmay decrease. Our operating results may also fall below the expectations ofsecurities analysts and investors. In that event, the price of our common stockwould likely decrease.

 

***A decline in visitors or business travelers todowntown areas where our restaurants are located could negatively affect ourrestaurant sales.***

 

                Manyof our restaurants are located in downtown areas. We depend on both localresidents and business travelers to frequent these locations. We experienced adecline in revenues in our downtown locations in 2001 and 2002, caused in partby decreases in business travel and the general decline in economic conditions.We may experience a similar decline in our revenues in the future. If thenumber of visitors to downtown areas declines due to economic or otherconditions, changes in consumer preferences, changes in discretionary consumerspending or for other reasons, our revenues could decline significantly and ourresults of operations could be adversely affected.

 

***If we lose the services of any of our keymanagement personnel or our co-founders, our business could suffer.***

 

                Wedepend on the services of our key management personnel, including Saed Mohseni,our chief executive officer, and Douglas L. Schmick, our president. Inaddition, we have increasingly relied on personal appearances and interviews by our co-founders,William P. McCormick and Douglas L. Schmick, in our marketing and advertisingefforts. If we lose the services of any members of our senior management, keypersonnel or co-founders for any reason, we may be unable to replace them withqualified personnel, which could have a material adverse effect on our businessand growth. We do not carry key person life insurance on any of our executiveofficers.

 

***Many of our restaurants are concentrated in localor regional areas and, as a result, we are sensitive to economic and othertrends and developments in these areas.***

 

                Weoperate four restaurants in Seattle, Washington, six in the Portland, Oregonarea and 10 in California; our East Coast restaurants are concentrated in andaround Washington, D.C. As a result, adverse economic conditions, weather andlabor markets in any of these areas could have a material adverse effect on ouroverall results of operations. For example, ice storms in northwestern Oregonin January 2004 affected sales at six, or 13%, of our then existingrestaurants.

 

                Inaddition, given our geographic concentrations, negative publicity regarding anyof our restaurants in these areas could have a material adverse effect on ourbusiness and operations, as could other regional occurrences such as localstrikes, oil spills, terrorist attacks, energy shortages or increases in energyprices, droughts or earthquakes or other natural disasters.

 

 

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***Our success depends on our ability to protect ourproprietary information. Failure to protect our trademarks, service marks ortrade secrets could adversely affect our business.***

 

                Ourbusiness prospects depend in part on our ability to develop favorable consumerrecognition of the McCormick & Schmick’s name. Although McCormick &Schmick’s, M&S Grill and other of our service marks are federally registeredtrademarks with the United States Patent and Trademark Office, our trademarkscould be imitated in ways that we cannot prevent. In addition, we rely on tradesecrets, proprietary know-how, concepts and recipes. Our methods of protectingthis information may not be adequate, however, and others could independentlydevelop similar know-how or obtain access to our trade secrets, know-how,concepts and recipes. Moreover, we may face claims of misappropriation orinfringement of third parties’ rights that could interfere with our use of ourproprietary know-how, concepts, recipes or trade secrets. Defending theseclaims may be costly and, if unsuccessful, may prevent us from continuing touse this proprietary information in the future, and may result in a judgment ormonetary damages.

 

                Wedo not maintain confidentiality and non-competition agreements with all of ourexecutives, key personnel or suppliers. If competitors independently develop orotherwise obtain access to our know-how, concepts, recipes or trade secrets,the appeal of our restaurants could be reduced and our business could beharmed.

 

***Our current insurance policiesmay not provide adequate levels of coverage against all claims.***

 

                Webelieve we maintain insurance coverage that is customary for businesses of oursize and type. However, there are types of losses we may incur that cannot beinsured against or that we believe are not commercially reasonable to insure.These losses, if they occur, could have a material and adverse effect on ourbusiness and results of operations.

 

***Expanding our restaurant base by opening newrestaurants in existing markets could reduce the business of our existingrestaurants.***

 

                Ourgrowth strategy includes opening restaurants in markets in which we alreadyhave existing restaurants. We may be unable to attract enough customers to thenew restaurants for them to operate at a profit. Even if we are able to attractenough customers to the new restaurants to operate them at a profit, thosecustomers may be former customers of one of our existing restaurants in thatmarket and the opening of new restaurants in the existing market could reducethe revenue of our existing restaurants in that market.

 

***We may not be able to successfully integrate intoour business the operations of restaurants that we acquire, which may adverselyaffect our business, financial condition and results of operations.***

 

                Wemay seek to selectively acquire existing restaurants and integrate them intoour business operations. Achieving the expected benefits of any restaurantsthat we acquire will depend in large part on our ability to successfullyintegrate the operations of the acquired restaurants and personnel in a timelyand efficient manner. The risks involved in such restaurant acquisitions andintegration include:

 

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

 

•          possible disruption to ourbusiness as a result of the diversion of management’s attention from its normaloperational responsibilities and duties; and

 

•          the consolidation of thecorporate, information technology, accounting and administrative infrastructureand resources of the acquired restaurants into our business.

 

                Futureacquisitions of existing restaurants, which may be accomplished through a cashpurchase transaction or the issuance of our equity securities, or a combinationof both, could result in potentially dilutive issuances of our equitysecurities, the incurrence of debt and contingent liabilities and impairmentcharges related to goodwill and other intangible assets, any of which couldharm our business and financial condition.

 

 

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                Wemay be unable to successfully integrate the operations, or realize theanticipated benefits, of any restaurant that we acquire. If we cannot overcomethe challenges and risks that we face in integrating the operations of newlyacquired restaurants, our business, financial condition and results ofoperations could be adversely affected.

 

***Negative publicity concerning food quality, healthand other issues and costs or liabilities resulting from litigation may have amaterial adverse effect on our results of operations.***

 

                Weare sometimes the subject of complaints or litigation from customers allegingillness, injury or other food quality, health or operational concerns.Litigation or adverse publicity resulting from these allegations may materiallyand adversely affect us or our restaurants, regardless of whether theallegations are valid or whether we are liable. Further, these claims maydivert our financial and management resources from revenue-generatingactivities and business operations.

 

***Health concerns relating to the consumption ofseafood or other food products could affect consumer preferences and couldnegatively impact our results of operations.***

*** ***

                Wemay lose customers based on health concerns about the consumption of seafood ornegative publicity concerning food quality, illness and injury generally, suchas negative publicity concerning the accumulation of mercury or othercarcinogens in seafood, e-coli, “mad cow” or “foot-and-mouth” disease,publication of government or industry findings about food products served by usor other health concerns or operating issues stemming from one of ourrestaurants. In addition, we cannot guarantee that our operational controls andtraining will be fully effective in preventing all food-borne illnesses. Somefood-borne illness incidents could be caused by food suppliers and transportersand would be outside of our control. Any negative publicity, health concerns orspecific outbreaks of food-borne illnesses attributed to one or more of ourrestaurants, or the perception of an outbreak, could result in a decrease inguest traffic to our restaurants and could have a material adverse effect onour business.

 

***Changes in consumer preferences or discretionaryconsumer spending could negatively impact our results of operations.***

 

                Therestaurant industry is characterized by the continual introduction of newconcepts and is subject to rapidly changing consumer preferences, tastes andpurchasing habits. Our continued success depends in part upon the popularity ofseafood and the style of dining we offer. Shifts in consumer preferences awayfrom this cuisine or dining style could materially and adversely affect ourprofitability and operating results. Our success will depend in part on ourability to anticipate and respond to changing consumer preferences, tastes andpurchasing habits, as well as 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 prefer the new concept or menu, and may not be ableto attract 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 couldslow our growth or harm our business.***

 

                Oursuccess depends in part upon our ability to attract, motivate and retain asufficient number of qualified employees, including regional operationalmanagers and regional chefs, restaurant general managers and executive chefs,necessary to continue our operations and keep pace with our growth. Qualifiedindividuals whom we need to fill these positions are in short supply andcompetition for these employees is intense. If we are unable to recruit andretain sufficient 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.

 

 

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***We may incur costs or liabilities and lose revenue,and our growth strategy may be adversely impacted, as a result of governmentregulation.***

 

                Ourrestaurants are subject to various federal, state and local governmentregulations, including those relating to employees, the preparation and sale offood and the sale of alcoholic beverages. These regulations impact our currentrestaurant operations and our ability to open new restaurants.

 

                Eachof our restaurants must obtain licenses from regulatory authorities allowing itto sell liquor, beer and wine, and each restaurant must obtain a food service licensefrom local health authorities. Each restaurant’s liquor license must be renewedannually and may be revoked at any time for cause, including violation by us orour employees of any laws and regulations relating to the minimum drinking age,advertising, wholesale purchasing and inventory control. In California, wherewe operate 10 restaurants, the number of alcoholic beverage licenses availableis limited and licenses are traded at market prices.

 

                Thefailure to maintain our food and liquor licenses and other required licenses,permits and approvals could adversely affect our operating results.Difficulties or failure in obtaining the required licenses and approvals coulddelay or result in our decision to cancel the opening of new restaurants.

 

                Weare subject to “dram shop” statutes in some states. These statutes generallyallow a person injured by an intoxicated person to recover damages from anestablishment that wrongfully served alcoholic beverages to the intoxicatedperson. A judgment substantially in excess of our insurance coverage could harmour financial condition.

 

                Variousfederal and state labor laws govern our relationship with our employees andaffect operating costs. These laws include minimum wage requirements, overtimepay, unemployment tax rates, workers’ compensation rates, and citizenshiprequirements. Additional government-imposed increases in minimum wages,overtime pay, paid leaves of absence and mandated health benefits, increasedtax reporting and tax payment requirements for employees who receivegratuities, or a reduction in the number of states that allow tips to becredited toward minimum wage requirements could harm our operating results.

 

                TheFederal Americans with Disabilities Act prohibits discrimination on the basisof disability in public accommodations and employment. Although our restaurantsare designed to be accessible to the disabled, we could be required to makemodifications to our restaurants to provide service to, or make reasonableaccommodations for, disabled persons.

 

***Restaurant companies have been the target ofclass-actions and other lawsuits alleging, among other things, violation offederal and state law.***

 

                Weare subject to a variety of claims arising in the ordinary course of ourbusiness brought by or on behalf of our customers or employees, includingpersonal injury claims, contract claims, and employment-related claims. Inrecent years, a number of restaurant companies have been subject to lawsuits,including class action lawsuits, alleging violations of federal and state lawregarding workplace, employment and similar matters. A number of these lawsuitshave resulted in the payment of substantial damages by the defendants. Similarlawsuits have been instituted against us from time to time. Regardless ofwhether any claims against us are valid or whether we are ultimately determinedto be liable, claims may be expensive to defend and may divert time and moneyaway from our operations and hurt our performance. A judgment significantly inexcess of our insurance coverage for any claims could materially adverselyaffect our financial condition or results of operations, and adverse publicityresulting from these allegations may materially adversely affect our business.We offer no assurance that we will not incur substantial damages and expensesresulting from lawsuits, which could have a material adverse effect on ourbusiness.

 

***Our operations and profitability are highlysusceptible to the effects of violence, war and economic trends.***

*** ***

                Terroristattacks and other acts of violence or war and U.S. military reactions to suchattacks may negatively affect our operations and your investment in our sharesof common stock. The terrorist attacks in New York and Washington, D.C. onSeptember 11, 2001 led to a temporary interruption in deliveries from some ofour suppliers and, we believe, contributed to the decline in average annualcomparable restaurant sales in 2001 and 2002.

 

 

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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.

 

                Terroristattacks could also directly impact our physical facilities or those of oursuppliers, and attacks or armed conflicts may make travel and thetransportation of our supplies and products more difficult and more expensiveand ultimately affect our revenues.

 

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

 

                Therestaurant industry is intensely competitive with respect to price, service,location, food quality, ambiance and the overall dining experience. Ourcompetitors include a large and diverse group of restaurant chains andindividual restaurants that range from independent local operators towell-capitalized national restaurant companies. Some of our competitors havebeen in existence for a substantially longer period than we have and may bebetter established in the markets where our restaurants are or may be located.Some of our competitors may have substantially greater financial, marketing andother resources than we do. If our restaurants are unable to competesuccessfully with other restaurants in new and existing markets, our results ofoperations will be adversely affected. We also compete with other restaurantsfor experienced management personnel and hourly employees, and with otherrestaurants and retail establishments for quality restaurant sites.

 

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

 

                Thestock market has experienced significant price and volume fluctuations. Ourcommon stock has traded at a price lower than $12.00, the price at which ourshares of common stock were sold in our initial public offering. The marketprice for our shares may continue to fluctuate significantly in response to anumber of factors, some of which are beyond our control, including:

 

•          quarterly variations in ouroperating results;

 

•          changes in financialestimates by securities analysts;

 

•          additions or departures ofour key personnel; and

 

•          sales of shares of ourcommon stock in the public markets.

 

                Fluctuationsor decreases in the trading price of our common stock may adversely affect yourability to trade your shares. In the past, following periods of volatility inthe market price of a company’s securities, securities class action litigationhas often been instituted. A securities class action suit against us couldresult in substantial costs and divert management’s attention and resourcesthat would otherwise be used to benefit the future performance of ouroperations.

 

***Two significant shareholders each own approximately20% of our outstanding common stock. Their interests may not coincide withyours and they may make decisions with which you may disagree.***

 

                Affiliatesof Castle Harlan and BRS each own approximately 20% of our outstanding commonstock.  As a result, these stockholders,acting individually or together, could exert significant influence over allmatters requiring 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.

 

 

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

 

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**ITEM 3.          QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

                Ourmarket risk exposures are related to our cash and cash equivalents. We investany excess cash in highly liquid short-term investments with maturities of lessthan one year. These investments are not held for trading or other speculativepurposes. Changes in interest rates affect the investment income we earn on ourinvestments and, therefore, impact our cash flows and results of operations.

 

                Underour revolving credit facility, we are exposed to market risk from changes ininterest rates on borrowings, which bear interest at 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. At ouroption, we may convert loans under our revolving credit facility from one typeof rate to the other. At the end of the first quarter of 2005, we had $14.5million of variable rate borrowings. Loans under our revolving credit facilitymature on July 23, 2009.

 

**ITEM 4.          CONTROLS AND PROCEDURES**

 

                *Disclosure Controls and Procedures. *Our management has evaluated, under the supervision and withthe participation of our chief executive officer and chief financial officer,the effectiveness of our disclosure controls and procedures as of the end ofthe period covered by this report pursuant to Rule 13a-15(b) under theSecurities Exchange Act of 1934 (the “Exchange Act”).  Based on that evaluation, our chief executiveofficer and chief financial officer have concluded that, as of the end of theperiod covered by this report, our disclosure controls and procedures areeffective in ensuring that information required to be disclosed in our ExchangeAct reports is (1) recorded, processed, summarized and reported in a timelymanner, and (2) accumulated and communicated to our management, including ourchief executive officer and chief financial officer, as appropriate to allowtimely decisions regarding required disclosure.

 

                *Changes in Internal Control Over Financial Reporting. *In our annual report on Form 10-Kfor the fiscal year ended Decembert 25, 2004, we reported a material weaknessin our internal control over financial reporting related to the way we havehistorically accounted for our real property leases.  To remediate the weakness, we changed ouraccounting policies regarding the review, analysis and recording of new andcurrent leases, including the selection and monitoring of appropriateassumptions and guidelines; there have been no other change in our internalcontrol over financial reporting that occurred during our fiscal quarter endedMarch 26, 2005 that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

**PART II. OTHER INFORMATION**

** **

**ITEM 1.          LEGAL PROCEEDINGS**

 

                Occasionally,we are a defendant in litigation arising in the ordinary course of ourbusiness, including claims resulting from “slip and fall” accidents, employmentrelated claims and claims from guests or employees alleging illness, injury orother food quality, health or operational concerns. None of these types oflitigation, most of which are covered by insurance, has had a material effecton our business, results of operations, financial position or cash flows.

 

 

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**ITEM 2.          UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

** **

**                None**

** **

**ITEM 3.          DEFAULTS UPON SENIOR SECURITIES**

** **

**                None**

** **

**ITEM 4.          SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

** **

**                None**

** **

**ITEM 5.          OTHER INFORMATION**

** **

**                None**

** **

**ITEM 6.  EXHIBITS**

** **

**EXHIBITS.**

** **

**Items identified with an asterisk(*) are management contracts or compensatory plans or arrangements.**

 
| 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) |
|   |   |                                                                                                                                                                                                                                                                                                                                             |
| 10.1*  |   | Summary of Director and  Executive Officer Compensation for Fiscal 2005 (incorporated by reference to  Exhibit 10.9 to our annual report on Form 10-K for the fiscal year ended  December 25, 2004)                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                             |
| 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**

 

                Pursuantto the requirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

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

 

 

29

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