##### **SECURITIES AND EXCHANGECOMMISSION**

 

**Washington, D.C. 20549**

 

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

 
| **(Mark one)** |
|----------------|
| ** **     | ** ** |
| **ý**     | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **     | ** ** |
| ** **     | **For the quarterly period ended September 30,  2004** |
| ** **     | ** ** |
| **OR**         |
| ** **     | ** ** |
| **o**          | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

** **

**Commission File No. 0-23911**

 

**FogCutter Capital Group Inc.**

(Exact name of registrantas specified in its charter)

 
| **Maryland**                                                     | **52-2081138**                        |
|------------------------------------------------------------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) | (I.R.S. Employer  Identification No.) |

 

**1410 SW Jefferson Street**

**Portland, OR  97201**

(Address of principalexecutive offices) (Zip Code)

** **

**(503) 721-6500**

(Registrant’s telephonenumber, including area code)

 

Indicate by check mark whether the registrant: (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports) and (2) has been subjectto such filing requirements for the past 90 days.  YesýNoo.

 

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

 

**APPLICABLE ONLY TO CORPORATEISSUERS:**

 

Indicate the number of shares outstanding of each ofthe issuer’s classes of common stock, as of the latest practicable date.

 
| **Class**                                  | **Outstanding  at September 30, 2004** |
|--------------------------------------------|----------------------------------------|
| Common Stock, par value  $0.0001 per share | 8,380,673 shares                       |

 

 

----

 

FOG CUTTER CAPITAL GROUPINC.

 

FORM 10-Q

 

I N D E X

 
| **PART  I–FINANCIAL INFORMATION** | ** **                                                                                  |
|----------------------------------------|---------------------------------------------------------------------------------------------|
| ** **                             | ** **                                                                                  | ** ** |
| Item  1.                               | Interim  Financial Statements (Unaudited):                                                  |   |
|                                   |                                                                                        |   |
|                                   | Consolidated Statements of  Financial Condition                                             |   |
|                                   |                                                                                        |   |
|                                   | Consolidated Statements of  Operations                                                      |   |
|                                   |                                                                                        |   |
|                                   | Consolidated Statement of Changes in  Stockholders’ Equity                             |   |
|                                   |                                                                                        |   |
|                                   | Consolidated  Statements of Cash Flows                                                      |   |
|                                   |                                                                                        |   |
|                                   | Notes  to Consolidated Financial Statements                                                 |   |
|                                   |                                                                                        |   |
| Item  2.                               | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
|                                   |                                                                                        |   |
| Item 3.                                | Quantitative and Qualitative  Disclosures about Market Risk                                 |   |
|                                   |                                                                                        |   |
| Item 4.                                | Controls and Procedures                                                                     |   |
|                                   |                                                                                        |   |
| **PART II–OTHER INFORMATION**     | ** **                                                                                  |
| ** **                             | ** **                                                                                  | ** ** |
| Item 1.                                | Legal Proceedings                                                                           |   |
|                                   |                                                                                        |   |
| Item 2.                                | Changes in Securities  and Use of Proceeds                                                  |   |
|                                   |                                                                                        |   |
| Item 3.                                | Defaults Upon Senior  Securities                                                            |   |
|                                   |                                                                                        |   |
| Item 4.                                | Submission of  Matters to a Vote of Security Holders                                        |   |
|                                   |                                                                                        |   |
| Item 5.                                | Other Information                                                                           |   |
|                                   |                                                                                        |   |
| Item 6.                                | Exhibits and Reports on  Form 8-K                                                           |   |
|                                   |                                                                                        |   |
| Signatures                             |                                                                                        |

 

Available information

 

Our website iswww.fccgi.com.  We make our annual reporton Form 10-K, as well as other reports filed with the Securities and ExchangeCommission, available free of charge through our website as soon as reasonablypracticable after they are filed.  A copyof these reports may also be obtained by writing to us at 1410 SW JeffersonStreet, Portland, Oregon 97201, Attn: Investor Reporting.

 

2

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PART I— FINANCIAL INFORMATION

 

## **ITEM 1**.  INTERIM FINANCIAL STATEMENTS

 

FOG CUTTER CAPITAL GROUPINC.

CONSOLIDATEDSTATEMENTS OF FINANCIAL CONDITION

(dollars in thousands,except share data)

 
| ** **                                                                                                                                                                                                                                                                                | ** ** | **September 30  2004** | ** ** | **December 31  2003** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
|                                                                                                                                                                                                                                                                                      | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| Assets                                                                                                                                                                                                                                                                                    | ** ** | ** **             | ** ** | ** **            | ** ** |
| Cash and cash  equivalents                                                                                                                                                                                                                                                                |       | $                      | 7,103      |                  | $          | 19,607 |   |
| Securities  available for sale, pledged under repurchase agreements, at estimated fair  value                                                                                                                                                                                             |       | —                 |       | 35,010                |       |
| Securities  available for sale, at estimated fair value                                                                                                                                                                                                                                   |       | 10                     |       | 500                   |       |
| Loans held for  investment                                                                                                                                                                                                                                                                |       | 10,417                 |       | 3,744                 |       |
| Investments in  real estate, net                                                                                                                                                                                                                                                          |       | 28,009                 |       | 22,577                |       |
| Loans to senior  executives                                                                                                                                                                                                                                                               |       | 2,975                  |       | 2,964                 |       |
| Investment in  Bourne End                                                                                                                                                                                                                                                                 |       | 1,969                  |       | 2,141                 |       |
| Restaurant  property, plant and equipment, net                                                                                                                                                                                                                                            |       | 6,036                  |       | 5,897                 |       |
| Intangible  assets, net                                                                                                                                                                                                                                                                   |       | 5,456                  |       | 5,640                 |       |
| Goodwill                                                                                                                                                                                                                                                                                  |       | 7,541                  |       | 7,300                 |       |
| Other assets                                                                                                                                                                                                                                                                              |       | 3,960                  |       | 3,596                 |       |
| Total assets                                                                                                                                                                                                                                                                              |       | $                      | 73,476     |                  | $          | 108,976 |   |
|                                                                                                                                                                                                                                                                                      |       |                   |       |                  |       |
| Liabilities and  Stockholders’ Equity                                                                                                                                                                                                                                                |       |                   |       |                  |       |
| Liabilities:                                                                                                                                                                                                                                                                              |       |                   |       |                  |       |
| Repurchase  agreements                                                                                                                                                                                                                                                                    |       | $                      | —     |                  | $          | 25,318 |   |
| Borrowings and  notes payable                                                                                                                                                                                                                                                             |       | 7,699                  |       | 7,804                 |       |
| Obligations  under capital leases                                                                                                                                                                                                                                                         |       | 12,684                 |       | 12,942                |       |
| Obligation under  leave of absence agreement                                                                                                                                                                                                                                              |       | 2,358                  |       | —                |       |
| Dividends  payable                                                                                                                                                                                                                                                                        |       | 41                     |       | 1,216                 |       |
| Deferred income                                                                                                                                                                                                                                                                           |       | 4,426                  |       | 3,700                 |       |
| Deferred income  taxes                                                                                                                                                                                                                                                                    |       | 5,880                  |       | 6,980                 |       |
| Accrued expenses  and other liabilities                                                                                                                                                                                                                                                   |       | 6,018                  |       | 5,635                 |       |
| Total  liabilities                                                                                                                                                                                                                                                                        |       | 39,106                 |       | 63,595                |       |
|                                                                                                                                                                                                                                                                                      |       |                   |       |                  |       |
| Commitments and  contingencies                                                                                                                                                                                                                                                            |       |                   |       |                  |       |
|                                                                                                                                                                                                                                                                                      |       |                   |       |                  |       |
| Stockholders’  Equity:                                                                                                                                                                                                                                                               |       |                   |       |                  |       |
| Preferred stock,  $.0001 par value; 25,000,000 shares authorized; no shares issued and  outstanding                                                                                                                                                                                       |       | —                 |       | —                |       |
| Common stock,  $.0001 par value; 200,000,000 shares authorized; 11,757,073 shares issued as  of September 30, 2004 and 11,716,600 shares issued as of December 31, 2003;  8,380,673 shares outstanding as of September 30, 2004 and 8,670,700 shares  outstanding as of December 31, 2003 |       | 168,191                |       | 168,018               |       |
| Accumulated  deficit                                                                                                                                                                                                                                                                      |       | (123,776               | )          | (115,588              | )          |
| Option to  purchase common stock                                                                                                                                                                                                                                                          |       | (592                   | )          | —                |       |
| Accumulated  other comprehensive income                                                                                                                                                                                                                                                   |       | 274                    |       | 968                   |       |
| Treasury stock;  3,376,400 common shares as of September 30, 2004, and 3,045,900 common shares  as of December 31, 2003, at cost                                                                                                                                                          |       | (9,727                 | )          | (8,017                | )          |
| Total  stockholders’ equity                                                                                                                                                                                                                                                          |       | 34,370                 |       | 45,381                |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                                                                                          |       | $                      | 73,476     |                  | $          | 108,976 |   |
|                                                                                                                                                                                                                                                                                           |            |                        |            |                       |            |  |  |  |  |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

3

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FOG CUTTER CAPITAL GROUPINC.

CONSOLIDATEDSTATEMENTS OF OPERATIONS

(Unaudited)

(dollars in thousands,except share data)

 
| ** **                                    | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine months Ended  September 30,** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|--------------------------------------|------------|
| ** **                                    | ** ** | **2004**                         | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net Interest  Income:                         |       |                             |       |                                 |       |   |   |   |   |
| Loans                                         |       | $                                | 456        |                                 | $          | 534 |   | $ | 1,431 |   | $ | 850 |   |
| Loans to senior  executives                   |       | 51                               |       | 54                                   |       | 138 |   | 162 |   |
| Securities                                    |       | 11                               |       | 509                                  |       | 616 |   | 1,983 |   |
| Other  investments                            |       | 14                               |       | 36                                   |       | 85 |   | 127 |   |
| Total interest  income                        |       | 532                              |       | 1,133                                |       | 2,270 |   | 3,122 |   |
| Interest expense                              |       | —                           |       | 160                                  |       | 112 |   | 578 |   |
| Net interest  income                          |       | 532                              |       | 973                                  |       | 2,158 |   | 2,544 |   |
|                                          |       |                             |       |                                 |       |   |   |   |   |
| Real Estate  Operations:                      |       |                             |       |                                 |       |   |   |   |   |
| Operating income                              |       | 1,106                            |       | 1,034                                |       | 3,083 |   | 2,965 |   |
| Gain on sale of  real estate                  |       | 154                              |       | —                               |       | 159 |   | 279 |   |
| Operating  expense                            |       | (454                             | )          | (498                                 | )          | (1,330 | ) | (1,564 | ) |
| Interest expense                              |       | (281                             | )          | (320                                 | )          | (843 | ) | (1,040 | ) |
| Depreciation                                  |       | (166                             | )          | (155                                 | )          | (489 | ) | (461 | ) |
| Total real  estate operations                 |       | 359                              |       | 61                                   |       | 580 |   | 179 |   |
|                                          |       |                             |       |                                 |       |   |   |   |   |
| Restaurant  Operations:                       |       |                             |       |                                 |       |   |   |   |   |
| Operating  revenue                            |       | 5,673                            |       | 2,472                                |       | 16,424 |   | 2,472 |   |
| Cost of goods  sold                           |       | (3,274                           | )          | (1,515                               | )          | (9,812 | ) | (1,515 | ) |
| Franchise and  royalty fee                    |       | 349                              |       | 152                                  |       | 998 |   | 152 |   |
| General and  administrative cost              |       | (2,530                           | )          | (901                                 | )          | (7,946 | ) | (901 | ) |
| Interest expense                              |       | (97                              | )          | (112                                 | )          | (442 | ) | (112 | ) |
| Depreciation and  amortization                |       | (377                             | )          | (141                                 | )          | (1,121 | ) | (141 | ) |
| Total restaurant  operations                  |       | (256                             | )          | (45                                  | )          | (1,899 | ) | (45 | ) |
|                                          |       |                             |       |                                 |       |   |   |   |   |
| Other Operating  Income:                      |       |                             |       |                                 |       |   |   |   |   |
| Gain on sale of  loans and securities         |       | —                           |       | 1,289                                |       | 2,099 |   | 10,672 |   |
| Gain on sale of  prepaid servicing credit     |       | —                           |       | —                               |       | 1,530 |   | — |   |
| Equity in income  of equity investees         |       | 2,719                            |       | 500                                  |       | 4,231 |   | 1,370 |   |
| Loan brokerage  fees                          |       | 1,839                            |       | 1,244                                |       | 4,213 |   | 3,497 |   |
| Other revenue                                 |       | 476                              |       | 725                                  |       | 1,349 |   | 1,318 |   |
| Total other  operating income                 |       | 5,034                            |       | 3,758                                |       | 13,422 |   | 16,857 |   |
|                                          |       |                             |       |                                 |       |   |   |   |   |
| Operating  Expenses:                          |       |                             |       |                                 |       |   |   |   |   |
| Compensation and  employee benefits           |       | 2,443                            |       | 2,283                                |       | 7,966 |   | 8,101 |   |
| Leave of absence  expense                     |       | —                           |       | —                               |       | 4,750 |   | — |   |
| Professional  fees                            |       | 794                              |       | 444                                  |       | 1,963 |   | 1,539 |   |
| Fees paid to  related parties                 |       | 141                              |       | 121                                  |       | 365 |   | 391 |   |
| Other                                         |       | 1,400                            |       | 795                                  |       | 4,099 |   | 2,444 |   |
| Total operating  expenses                     |       | 4,778                            |       | 3,643                                |       | 19,143 |   | 12,475 |   |
|                                          |       |                             |       |                                 |       |   |   |   |   |
| Net income  before provision for income taxes |       | 891                              |       | 1,104                                |       | (4,882 | ) | 7,060 |   |
| Provision for  income taxes                   |       | —                           |       | 550                                  |       | — |   | 2,260 |   |
| Net Income                                    |       | $                                | 891        |                                 | $          | 554 |   | $ | (4,882 | ) | $ | 4,800 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

4

----

 
| ** **                                   | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine months Ended  September 30,** | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|--------------------------------------|------------|
| ** **                                   | ** ** | **2004**                         | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Basic net income  (loss) per share           |       | $                                | 0.11       |                                 | $          | 0.06 |   | $ | (0.57 | ) | $ | 0.56 |   |
|                                         |       |                             |       |                                 |       |   |   |   |   |
| Basic weighted  average shares outstanding   |       | 8,380,173                        |       | 8,670,575                            |       | 8,490,376 |   | 8,585,550 |   |
|                                         |       |                             |       |                                 |       |   |   |   |   |
| Diluted net  income (loss) per share         |       | $                                | 0.11       |                                 | $          | 0.06 |   | $ | (0.57 | ) | $ | 0.50 |   |
|                                         |       |                             |       |                                 |       |   |   |   |   |
| Diluted weighted  average shares outstanding |       | 8,385,146                        |       | 9,746,241                            |       | 8,490,376 |   | 9,661,216 |   |
|                                         |       |                             |       |                                 |       |   |   |   |   |
| Dividends  declared per share                |       | $                                | 0.13       |                                 | $          | 0.13 |   | $ | 0.39 |   | $ | 0.39 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

5

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**FOGCUTTER CAPITAL GROUP INC.**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’EQUITY**

 

(Unaudited)

 

(dollarsin thousands)

 
| ** **                                                                                                    | ** ** | ** **       | ** ** | ** **         | ** ** | ** **              | ** ** | ** **      | ** ** | **Accumulated**   | ** ** | ** **  | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|------------------|------------|--------------------|------------|-------------------------|------------|-----------------|------------|-------------------|------------|-------------|------------|
| ** **                                                                                                    | ** ** | ** **       | ** ** | ** **         | ** ** | ** **              | ** ** | ** **      | ** ** |
|                                                                                                          |       |             |       |               |       |                    |       |            |       | **Common Stock**  |       |        |       | **Other** |   |   |   |
|                                                                                                          |       | **Common Stock** |       | **Treasury Stock** |       | **Subject  to Options** |       | **Accumulated** |       | **Comprehensive** |       |        |       |
|                                                                                                          |       | **Shares (1)**   | ** ** | **Amount**         | ** ** | **Shares**              | ** ** | **Amount**      |       | **Amount**        |       | **Deficit** |       | **Income** |   | **Total** |   |
| Balance at  January 1, 2004                                                                                   |       | 8,670,700        |       | $                  | 168,018    |                    | 3,045,900  |            | $          | (8,017            | )          | $           | —     |   | $ | (115,588 | ) | $ | 968 |   | $ | 45,381 |   |
| Comprehensive  income (loss):                                                                                 |       |             |       |               |       |                    |       |            |       |              |       |        |       |   |   |   |   |
| Net loss                                                                                                      |       | —           |       | —             |       | —                  |       | —          |       | —            |       | (4,882      | )          | — |   | (4,882 | ) |
| Other  comprehensive income:                                                                                  |       |             |       |               |       |                    |       |            |       |              |       |        |       |   |   |   |   |
| Foreign currency  translation                                                                                 |       | —           |       | —             |       | —                  |       | —          |       | —            |       | —      |       | 97 |   | 97 |   |
| Unrealized  holding gains on securities available for sale                                                    |       | —           |       | —             |       | —                  |       | —          |       | —            |       | —      |       | 1,362 |   | 1,362 |   |
| Reclassification  adjustment for gains on securities and foreign currency translation included  in net income |       | —           |       | —             |       | —                  |       | —          |       | —            |       | —      |       | (2,153 | ) | (2,153 | ) |
| Total  comprehensive loss                                                                                     |       | —           |       | —             |       | —                  |       | —          |       | —            |       | —      |       | — |   | (5,576 | ) |
| Purchase of  treasury stock                                                                                   |       | (330,500         | )          | —             |       | 330,500                 |       | (1,710          | )          | —            |       | —      |       | — |   | (1,710 | ) |
| Common stock  issued pursuant to exercise of stock options                                                    |       | 40,473           |       | 173                |       | —                  |       | —          |       | —            |       | —      |       | — |   | 173 |   |
| Dividends  declared                                                                                           |       | —           |       | —             |       | —                  |       | —          |       | —            |       | (3,306      | )          | — |   | (3,306 | ) |
| Purchase of call  options                                                                                     |       | —           |       | —             |       | —                  |       | —          |       | (592              | )          | —      |       | — |   | (592 | ) |
| Balance at  September 30, 2004                                                                                |       | 8,380,673        |       | $                  | 168,191    |                    | 3,376,400  |            | $          | (9,727            | )          | $           | (592       | ) | $ | (123,776 | ) | $ | 274 |   | $ | 34,370 |   |

 

----

(1)          Issued and outstanding

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

6

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FOG CUTTER CAPITAL GROUPINC.

CONSOLIDATEDSTATEMENTS OF CASH FLOWS

(Unaudited)

(dollars in thousands)

 
| ** **                                                                            | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------------|------------|
| ** **                                                                            | ** ** | **2004**                         | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                |       |                             |       |                                 |       |   |   |   |   |
| Net income  (loss)                                                                    |       | $                                | 891        |                                 | $          | 554 |   | $ | (4,882 | ) | $ | 4,800 |   |
| Adjustments to  reconcile net income to net cash used in operating activities:        |       |                             |       |                                 |       |   |   |   |   |
| Depreciation and  amortization                                                        |       | 509                              |       | 241                                  |       | 1,611 |   | 613 |   |
| Gain on foreign  currency translation                                                 |       | (31                              | )          | (491                                 | )          | (51 | ) | (728 | ) |
| Gain on sale of  securities and loans                                                 |       | —                           |       | (1,289                               | )          | (2,099 | ) | (10,672 | ) |
| Gain on sale of  real estate                                                          |       | (154                             | )          | —                               |       | (159 | ) | — |   |
| Gain on sale of  prepaid servicing credit                                             |       | —                           |       | —                               |       | (1,530 | ) | — |   |
| Equity in income  of equity investees                                                 |       | (2,719                           | )          | (500                                 | )          | (4,231 | ) | (1,370 | ) |
| Other                                                                                 |       | (237                             | )          | 32                                   |       | (882 | ) | (253 | ) |
| Change in:                                                                            |       |                             |       |                                 |       |   |   |   |   |
| Deferred income                                                                       |       | 417                              |       | 980                                  |       | 726 |   | 980 |   |
| Accrued interest  receivable                                                          |       | 16                               |       | (19                                  | )          | 64 |   | 57 |   |
| Other assets                                                                          |       | 1,657                            |       | (325                                 | )          | 456 |   | 333 |   |
| Accounts payable  and accrued liabilities                                             |       | (436                             | )          | (266                                 | )          | 2,616 |   | 946 |   |
| Net cash used in  operating activities                                                |       | (87                              | )          | (1,083                               | )          | (8,361 | ) | (5,294 | ) |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                |       |                             |       |                                 |       |   |   |   |   |
| Repayments of  securities available for sale                                          |       | —                           |       | 7,178                                |       | 6,818 |   | 14,486 |   |
| Investment in  real estate                                                            |       | (799                             | )          | (1,987                               | )          | (2,433 | ) | (1,987 | ) |
| Investment in  variable interest entity                                               |       | (1,601                           | )          | —                               |       | (2,229 | ) | — |   |
| Proceeds from  sale of securities available for sale                                  |       | —                           |       | 1,844                                |       | 29,090 |   | 13,835 |   |
| Purchase of  loans and discounted loans                                               |       | (935                             | )          | —                               |       | (8,008 | ) | (1,486 | ) |
| Principal  repayments on loans and discounted loans                                   |       | 115                              |       | 289                                  |       | 1,169 |   | 782 |   |
| Proceeds from  sale of real estate                                                    |       | 362                              |       | —                               |       | 536 |   | — |   |
| Proceeds from  sale of prepaid servicing credit                                       |       | —                           |       | —                               |       | 1,530 |   | — |   |
| Investment in  and loans to equity investees                                          |       | —                           |       | —                               |       | — |   | (3,000 | ) |
| Payments made in  connection with the acquisition of subsidiary, net of cash acquired |       | —                           |       | (4,965                               | )          | — |   | (4,965 | ) |
| Proceeds from  investments in and loans to equity investees                           |       | 4,429                            |       | 3,042                                |       | 4,429 |   | 5,942 |   |
| Purchase of  restaurant property plant and equipment                                  |       | (293                             | )          | —                               |       | (1,077 | ) | — |   |
| Other                                                                                 |       | (9                               | )          | 54                                   |       | 18 |   | (194 | ) |
| Net cash  provided by investing activities                                            |       | 1,269                            |       | 5,455                                |       | 29,843 |   | 23,413 |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                |       |                             |       |                                 |       |   |   |   |   |
| Repayments under  capital leases                                                      |       | (117                             | )          | (2,891                               | )          | (378 | ) | (3,184 | ) |
| Repayments on  borrowings                                                             |       | (1,324                           | )          | (953                                 | )          | (27,136 | ) | (9,173 | ) |
| Payment of  obligation to purchase treasury stock                                     |       | —                           |       | —                               |       | — |   | (1,399 | ) |
| Proceeds from  issuance of common stock                                               |       | 9                                |       | 2                                    |       | 173 |   | 877 |   |
| Investment in  option to purchase stock                                               |       | —                           |       | —                               |       | (592 | ) | — |   |
| Investment in  treasury stock                                                         |       | —                           |       | —                               |       | (1,710 | ) | — |   |
| Dividend  payments on common stock                                                    |       | (1,080                           | )          | (1,127                               | )          | (4,480 | ) | (4,610 | ) |
| Other                                                                                 |       | 197                              |       | —                               |       | 121 |   | — |   |
| Net cash used in  financing activities                                                |       | (2,315                           | )          | (4,969                               | )          | (34,002 | ) | (17,489 | ) |
| EFFECT OF  EXCHANGE RATE CHANGES ON CASH                                              |       | (1                               | )          | 2                                    |       | 16 |   | (3 | ) |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                                 |       | (1,134                           | )          | (595                                 | )          | (12,504 | ) | 627 |   |
| CASH AND CASH  EQUIVALENTS AT BEGINNING OF PERIOD                                     |       | 8,237                            |       | 15,727                               |       | 19,607 |   | 14,505 |   |
| CASH AND CASH  EQUIVALENTS AT END OF PERIOD                                           |       | $                                | 7,103      |                                 | $          | 15,132 |   | $ | 7,103 |   | $ | 15,132 |   |
| SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION:                                   |       |                             |       |                                 |       |   |   |   |   |
| Cash paid for  interest                                                               |       | $                                | 380        |                                 | $          | 523 |   | $ | 1,355 |   | $ | 1,722 |   |
| Notes payable  issued to settle obligation to purchase treasury stock                 |       | $                                | —     |                                 | $          | 331 |   | $ | — |   | $ | 3,131 |   |
| Cash paid for  income taxes                                                           |       | $                                | 71         |                                 | $          | 232 |   | $ | 203 |   | $ | 361 |   |
| Non-cash assets  acquired                                                             |       | $                                | —     |                                 | $          | 19,502 |   | $ | — |   | $ | 19,502 |   |
| Non-cash  liabilities assumed                                                         |       | $                                | —     |                                 | $          | 14,537 |   | $ | — |   | $ | 14,537 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

7

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FOG CUTTER CAPITAL GROUPINC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

**NOTE 1****-BASIS OF PRESENTATION**

 

The accompanying interimconsolidated financial statements of Fog Cutter Capital Group Inc. andSubsidiaries (“FCCG” or the “Company”) are unaudited and have been prepared inconformity with the requirements of Regulation S-X promulgated under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”), particularlyRule 10-01 thereof, which governs the presentation of interim financialstatements.  Accordingly, they do notinclude all of the information and footnotes required by accounting principlesgenerally accepted in the United States for complete financial statements.  The accompanying interim consolidatedfinancial statements should be read in conjunction with the Company’s 2003Annual Report on Form 10-K/A.  A summaryof the Company’s significant accounting policies is set forth in Note 2 to theconsolidated financial statements in the 2003 Annual Report on Form 10-K/A.

 

In the Company’s opinion, all adjustments, comprisedof normal recurring accruals necessary for the fair presentation of the interimfinancial statements, have been included in the accompanying consolidatedfinancial statements.  Operating resultsfor the nine months ended September 30, 2004 are not necessarily indicative ofthe results that may be expected for the year ending December 31, 2004.

 

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States requires theCompany to make estimates and assumptions that affect the reported amounts ofassets and liabilities and disclosures of contingent assets and liabilities atthe date of the financial statements and the reported amounts of revenues andexpenses during the reporting period. Actual results could differ from those estimates.  Certain items in the previously reportedconsolidated financial statements were reclassified to conform to the September30, 2004 presentation, none of which affected previously reported results ofoperations.

 

At September 30, 2004, certain Company officers anddirectors had, directly or indirectly, majority voting control of the Company.

 

**NOTE 2****-SIGNIFICANT TRANSACTIONS**

 

FatburgerHoldings, Inc.

 

On August 15, 2003, theCompany acquired a controlling interest in Fatburger Holdings, Inc. (“Fatburger”),and began reporting the operations of Fatburger on a consolidated basis as ofthat date.  Fatburger operates orfranchises 60 hamburger restaurants located in California, Nevada, Arizona, NewJersey, Colorado, Florida and Washington. Franchisees currently own and operate 35 of the Fatburger locations and Fatburgerhas agreements for approximately 240 new franchise restaurants.  The terms of the original acquisition by theCompany were amended on January 12, 2004 and May 12, 2004.  Initially, the Company made a $5.4 millioninvestment and acquired approximately 83% of the voting control ofFatburger.  However, all but 15% of theownership investment was redeemable by Fatburger.  On May 12, 2004, the Company contributed anadditional $3.0 million, bringing its total investment to $8.4 million.  As a result of this transaction, the Company’svoting control of Fatburger was reduced to approximately 71%, but the Companyretained a non-redeemable, fully diluted 47% ownership interest inFatburger.  The Company’s investmentconsists of the purchase of convertible preferred stock (the “Series APreferred”) and redeemable preferred stock (the “Series D Preferred”).

 

The Series APreferred is convertible into a 50% ownership interest of the common stock ofFatburger on a fully diluted basis.  TheCompany owns approximately 93% of the issued and outstanding Series APreferred, and currently holds voting rights equal to 71% of the voting controlof Fatburger.  The Series A Preferred isnot redeemable and does not pay dividends.

 

The Series DPreferred has a liquidation preference and is redeemable by Fatburger for $10.1million plus accrued but unpaid dividends. Dividends accrue at a rate of 20% of the redemption value,

 

8

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compoundedannually.  The Series D Preferred does nothave any voting rights.  The Company ownsall of the issued and outstanding Series D Preferred.

 

Mortgage-Backed Securities

 

During the nine monthsended September 30, 2004, the Company sold four mortgage-backed securities for$29.1 million in cash.  As a result ofthese transactions, the Company recognized gains on the sale of securities of $2.1million in the accompanying consolidated statement of operations.  As of September 30, 2004, the Company’sinvestment in mortgage-backed securities had decreased to less than $0.1million.

 

Loans

 

During the nine monthsended September 30, 2004, the Company purchased or funded four loans secured byreal estate for a total of $8.0 million. The current yield to the Company on these loans is approximately 17.6%.

 

Dividends

 

TheCompany has declared and paid a $0.13 per share dividend for each quarter of2004.  The first quarter dividend waspaid on March 1, 2004 to stockholders of record on February 20, 2004.  The second quarter dividend was paid on June1, 2004 to stockholders of record on May 21, 2004.  The third quarter dividend was paid onSeptember 1, 2004 to stockholders of record on August 18, 2004.  On October 20, 2004, the Company announcedthe declaration of a $0.13 per share fourth quarter dividend, payable on November15, 2004 to stockholders of record on November 1, 2004.

 

Call Option

 

On April 26, 2004, the Company purchased a three yearcall option (the “Call Option”) from Andrew A. Wiederhorn.  At the time, Mr. Wiederhorn was the Company’sChairman and Chief Executive Officer. Currently, Mr. Wiederhorn is a director and Chief Strategic Officerunder a leave of absence agreement.  TheCall Option gives the Company the right, but not the obligation, to purchase423,245 of the Company’s outstanding common stock (the “Option Shares”) fromMr. Wiederhorn for a purchase price of $3.99 per share.   The option may be exercised at any timeduring the three year option period.  TheCompany paid $750,000 ($1.77 per option share) for the Call Option.   Thepremium paid for the Call Option, together with the strike price, represented apremium to the Company’s book value per share and market price per share at thetime the option was purchased.  Inpurchasing the Call Option, the Company and its directors considered thefollowing factors:  (1) the potentiallynegative impact on the Company’s share price if the Option Shares were disposedof publicly; (2) the Company’s favorable liquidity position; (3) the potentialreduction in the risk that shares are transferred in a transaction which wouldhave an adverse impact on its NOL position; and (4) the reduction in the futureexpenditure of cash dividends by the Company once the Company exercises theCall Option.  The Board of Directorsreviewed and approved the transaction to confirm that the transaction was inthe best interest of the Company and its other stockholders.  As a result of the purchase of the CallOption, the Company recorded a direct reduction to stockholders’ equity of $592,000and compensation expense of $158,000.

 

Treasury Stock Purchase

 

On April 28, 2004, the Company purchased 330,500shares of its common stock from Clarence B. Coleman, who at the time was agreater than 10% shareholder.  Thepurchase price was $5.40 per share ($1.8 million) and the shares were added totreasury stock.  At the time, thepurchase price represented a small premiumto the Company’s book value per share and market price per share.  The Company and its directors considered thefollowing factors:  (1) the potentiallynegative impact on the Company’s share price if the shares were disposed ofpublicly; (2) the Company’s favorable liquidity position; (3) the potentialreduction in the risk that shares are transferred in a transaction which wouldhave an adverse impact on its NOL position; and (4) the reduction in the futureexpenditure of cash dividends by the Company. The Board of Directors reviewed and approved the transaction to confirmthat the transaction was in the best interest of the Company

 

9

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and its other stockholders.  As a result of this transaction, the Companyrecorded treasury stock of $1.7 million and a charge to earnings of $0.1million.

 

Leave of Absence Agreement

 

As the Company has previouslydisclosed, the Company’s former Chairman and Chief Executive Officer, AndrewWiederhorn, and former President, Lawrence Mendelsohn, received letters fromthe United States Attorney’s Office for the District of Oregon (“USAODO”) inMarch 2001 advising them that they were targets of a grand jury investigation(the “CCL Investigation”) into the failure of Capital Consultants, L.L.C (“CCL”).

 

In August 2002, Mr.Mendelsohn resigned as President and Director of the Company. In November 2003,Mr. Mendelsohn entered into an agreement with the USAODO pursuant to which heplead guilty to filing a false 1998 personal tax return and agreed to cooperatein the CCL Investigation.

 

On June 3, 2004, the Company announcedthat Chief Executive Officer and Chairman of the Board Andrew Wiederhorn hadentered into a settlement with the USAODO regarding its investigation into CCL(the “Settlement”) and would take a leave of absence from his corporatepositions at FCCG.  Under the Settlement’sterms, Mr. Wiederhorn pled guilty on June 3, 2004 to two federal counts and wassentenced to 18-months incarceration and fined $2.0 million.  The charges to which Mr. Wiederhorn has pledguilty pursuant to the Settlement are not based upon any acts or omission tothe Company or of Mr. Wiederhorn in his capacity as an officer or director ofthe Company.

 

On June 2, 2004, the Company and Mr. Wiederhornentered into a leave of absence agreement. In entering into Mr. Wiederhorn’s leave of absence agreement, the Boardof Directors considered the nature of the statutes to which Mr. Wiederhorn pledand the fact that he relied on the advice of expert legal counsel and anational accounting firm.  The Board alsobelieved it was important to assure Mr. Wiederhorn’s return to activeinvolvement with the Company because of his expertise and knowledge and topreserve a significant business relationship and the value of the Company’sinvestments.

 

Mr. Wiederhorn iscurrently a director and Chief Strategic Officer of the Company.  Under the terms of the leave of absenceagreement, Mr. Wiederhorn will continue to receive his regular salary and bonuspursuant to and as set forth in his employment agreement.  In addition, for the reasons stated in theagreement, the Company made a leave of absence payment to Mr. Wiederhorn in theamount of $2.0 million on June, 2, 2004.

 

Mr. Wiederhorn began hisleave of absence on August 2, 2004 and is expected to remain in that status fora period of 14 to 18 months.  Theaccompanying consolidated financial statements reflect a charge to earnings of$4.8 million for the nine month period ending September 30, 2004.  This is comprised of the $2.0 million paymentmade on June 2, 2004 and the accrual of the expected salary and bonus relatingto the leave of absence period.

 

Change in Auditor

 

On July 16, 2004, Ernst & Young LLPadvised the Company that the firm would resign as the Company’s auditors uponcompletion of its review of the interim financial information for the secondquarter of 2004 and filing of the Company’s quarterly report on Form 10-Q forthe quarter ending June 30, 2004.  Theresignation was not the result of disagreements with Ernst & Young LLP onany matter of accounting principles or practices, financial statementdisclosure, or auditing scope or procedure. On September 7, 2004, the Companyappointed UHY LLP as its independent auditor. The decision to appoint UHY LLP was approved by the Audit Committee andthe Board of Directors.

 

10

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Nasdaq Delisting

 

EffectiveOctober 14, 2004, theCompany’s Common Stock began trading in the over-the-counter (“OTC”)market on the OTC “pink sheets.”  Prior tothat, the Company’s Common Stock was quoted on the Nasdaq National Market.  On July 20, 2004, the Company was notified by Nasdaqof a staff determination to delist the Company’s Common Stock effective July29, 2004.  The Company challenged thestaff determination and requested an oral hearing by a Listing QualificationsPanel to review the staff’s conclusions. A hearing was held on September 9, 2004 and, on October 12,2004, the Company was notified by Nasdaq that the Listing Qualifications Panel upheldthe staff determination and the Company’s Common Stock was delisted from theNasdaq National Market on October 14, 2004.  The Companyhas requested a review of the Listing Qualifications Panel’s decision by Nasdaq’sListing and Hearing Review Council.  There can be no assurance that the Company’s appeal will besuccessful.

 

BourneEnd

 

On August 6, 2004, an equity investee of the Company, Bourne End sold itsSouthend Shopping Center for approximately 28.0 million Great Britain pounds (“GBP”).  The Company’s share of the net gain on thistransaction was $2.8 million.

 

George Elkins Mortgage Banking Company

 

On August 11, 2004 the Company received a notice fromthe Class B Holders of Fog Cap GEMB Holdings LLC (“Holdings”), a 51% ownedsubsidiary of the Company which owns trade names and certain assets relating tothe operation of George Elkins Mortgage Banking Company.  The notice was to inform the Company that theClass B Holders believe that a Change in Control Transaction (as defined in theHoldings Operating Agreement) has occurred as a result of the leave of absenceof Mr. Wiederhorn.  The notice alsoindicates that unless the Change in Control Transaction is corrected within 120days, the Class B Holders intend to exercise their rights to purchase the ClassA Interests held by the Company in accordance with the formula outlined in theOperating Agreement.

 

The Companydisputes the claim that a Change in Control Transaction has occurred as aresult of the leave of absence of Mr. Wiederhorn.  The Company believes that the market value ofits investment is greater than the amount of the buyback formula and intends tovigorously defend against these claims.  However,if the Company is unsuccessful in defending this position, an analysis of theeconomic effect of the buyback formula indicates that the Company would notincur a loss on the transaction.  As aresult, no reserves are required due to the receipt of the notice.

 

**NOTE 3 –COMMITMENTS, CONTINGENCIES & OFF-BALANCE SHEET RISK**

 

CCL Investigation

 

The Company’s former ChiefExecutive Officer and current Chief Strategic Officer, Andrew Wiederhorn, andformer President, Lawrence Mendelsohn, pursuant to the terms of theirrespective employment agreements, may have been entitled to indemnity from theCompany for litigation expenses and personal losses in connection with the CCLinvestigations and any related litigation. Messrs. Wiederhorn and Mendelsohn had notified the Company that,although they believed they were entitled to primary indemnification from othersources, they were reserving their rights to seek indemnity from the Company.  The Company did not agree to any indemnityrequests.  Mr. Wiederhorn released theCompany from any and all claims he may have had relating to the CCL matter aspartial consideration for the leave of absence agreement in June 2004.   The USAODO has settled the CCL matter as itrelates to both Mr. Wiederhorn and Mr. Mendelsohn.  As a result, the Company believes that thecontingencies relating to the potential indemnification of these officers orformer officers have now been resolved.

 

Strouds Acquisition Corporation

 

On October 6, 2003, the Official Committee of Unsecured Creditorsof Strouds Acquisition Corporation (“Strouds”) filed a lawsuit in the UnitedStates Bankruptcy Court which named the Company,

 

11

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among others, as adefendant.  The lawsuit was amended onNovember 10, 2003 and limited the complaint against the Company solely in itscapacity as collateral agent for certain secured creditors of StroudsAcquisition Corporation.  The lawsuit, asit pertained to the Company, sought reimbursement of the proceeds from approximately$3.0 million in funds received in October 2003, which the Company was holdingas collateral agent for other secured creditors.  These funds were not included in the assetsof the Company, but were being held in trust. On July 1, 2004, the lawsuit was settled and the Company distributed thetrust funds, net of legal reimbursements of $0.3 million, in accordance withthe settlement agreement.  The Companyreceived a general release from the parties and considers the matter closed.

 

Shareholder Derivative Complaint

 

On July 6, 2004,Jeff Allen McCoon, derivatively on behalf of the Company, filed a lawsuit inthe Circuit Court for the State of Oregon (Multnomah County) which named the Company andall of its directorsas defendants.  The lawsuit alleges thatmembers of the Company’s Board of Directors breached their duties to theCompany by entering into the leave of absence agreement with AndrewWiederhorn.  The lawsuit generally seeks restitution of payments madeunder the leave of absence agreement plus attorney fees and costs.  Theindividual defendants have indemnity agreements with the Company and haveasserted the right to indemnification from the Company under those indemnityagreements. This case is in the very early pleading stages and motions arepending against the complaint. The Company may incur expenses under theindemnity agreements and also may derive benefits if the plaintiff’s claims aresuccessful. At this stage of the case, it is too early to predict the outcomewith any certainty. The complaint is not specific as to the amount of damagesit is seeking against the individual defendants, but it appears to seek atleast the return of $2 million paid to Mr. Wiederhorn under the Leave ofAbsence Agreement.

 

Other 

 

The Company is involvedin various other legal proceedings occurring in the ordinary course of businesswhich the Company believes will not have a material adverse effect on theconsolidated financial condition or operations of the Company.

 

The Company may utilize awide variety of off-balance sheet financial techniques to manage its risk.  In hedging the interest rate and/or exchangerate exposure of a foreign currency denominated asset or liability, the Companymay enter into hedge transactions to counter movements in interest rates andforeign currencies.  These hedges may bein the form of currency and interest rate swaps, options, and forwards, orcombinations thereof.

 

At September 30, 2004,the Company had no outstanding derivative instruments held for trading orhedging purposes.

 

The Company has operating leases for office and retailspace which expire through 2012.  Theleases provide for varying minimum annual rental payments including rentincreases and free rent periods.

 

Future minimum rental payments, by year and in theaggregate, under noncancelable operating leases with initial or remaining termsof one year or more, consisted approximately of the following at September 30,2004 (dollars in thousands): 

 
| 2004                          |   | $     | 722    |   |
|-------------------------------|--------|-------|--------|--------|
| 2005                          |   | 2,787 |   |
| 2006                          |   | 2,329 |   |
| 2007                          |   | 1,808 |   |
| 2008                          |   | 1,273 |   |
| Thereafter                    |   | 3,308 |   |
| Total minimum  lease payments |   | $     | 12,227 |   |

 

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In order to facilitate the development of franchiselocations, as of September 30, 2004, Fatburger had guaranteed the annual minimumlease payments of three restaurant sites owned and operated byfranchisees.  The amount of theguarantees total approximately $1.9 million plus certain contingent rentalpayments as defined in the respective leases. These leases expire at various times through 2008.

 

The Company did not have any other off balance sheetarrangements in place as of September 30, 2004.

 

**NOTE 4 -GOODWILL AND OTHER INTANGIBLE ASSETS**

 

Primarily due to the acquisition of Fatburger, theCompany has goodwill in the amount of $7.5 million and other intangible assetsin the amount of $5.5 million. In accordance with the Financial AccountingStandards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No.142, “Goodwill and Other Intangible Assets”, goodwill is not amortized, but issubject to an annual impairment test, which is being performed as of August 15,2004.  Since the acquisition of Fatburgerby the Company, Fatburger has experienced operating losses and has funded itsoperations and expansion with limited liquidity.  The Company believes that these conditionsare temporary in nature, however, should these conditions not be corrected, theCompany may be required to recognize impairment losses on its recordedgoodwill.  As of September 30, 2004, theCompany was not aware of any events or changes in circumstances that wouldrequire the impairment of the recorded goodwill.

 

Summarized information for the Company’s acquiredintangible assets as of September 30, 2004 is as follows (dollars inthousands):

 

Amortized intangibleassets:

 
| Franchise  Agreements              |   | $      | 983    |   |
|------------------------------------|--------|--------|--------|--------|
| Other                              |   | 503    |   |
| Total amortized  intangible assets |   | $      | 1,486  |   |
|                               |   |   |   |
| Unamortized  intangible assets:    |   |   |   |
|                               |   |   |   |
| Trademarks                         |   | $      | 3,970  |   |
|                                    |        |        |        |        |  |  |

 

Trademarks, which haveindefinite lives, are not subject to amortization.  All other intangible assets are amortizedusing the straight-line method over the estimated useful lives of the assets offive to fifteen years.  Estimatedamortization expense for the remainder of 2004 and the five succeeding years isas follows (dollars in thousands):

 
| 2004 |   | $   | 60     |   |
|------|--------|-----|--------|--------|
| 2005 |   | 241 |   |
| 2006 |   | 239 |   |
| 2007 |   | 236 |   |
| 2008 |   | 236 |   |
| 2009 |   | 236 |   |

 

The recorded values of goodwill and other intangibleassets may become impaired in the future. The determination of the value ofsuch intangible assets requires management to make estimates and assumptionsthat affect the consolidated financial statements.  Potential impairments to intangible assetsare assessed when there is evidence that events or changes in circumstancesindicate that the carrying amount of an asset may not be recovered.  This assessment is based on the operationalperformance of acquired businesses, market conditions and other factorsincluding future events.   Any resultingimpairment loss could have an adverse impact on the results of operations ofthe Company.

 

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**NOTE 5 –RECENTLY ISSUED ACCOUNTING STANDARDS**

 

In December 2003, the Accounting StandardsExecutive Committee (“AcSEC”) issued Statement of Position 03-3 (“SOP 03-3”), “*Accounting for CertainLoans or Debt Securities Acquired in a Transfer.*” SOP 03-3 requiresthat the excess of contractual cash flows over cash flows expected to becollected not be recognized as an adjustment of yield, loss accrual, orvaluation allowance. Subsequent increases in cash flows expected to becollected generally should be recognized prospectively through adjustment ofthe loan’s yield over its remaining life and decreases in cash flows expectedto be collected should be recognized as impairment. SOP 03-3 is effective forloans acquired in fiscal years beginning after December 15, 2004 and isnot expected to have a material effect on the Company’s consolidated financialposition or results of operations

 

In March 2004, the FASB issued an exposure draft, “*Share-Based Payment - An Amendment to FASB StatementsNo. 123 and 95,”* which changes the requirements of stock optionaccounting. The exposure draft requires expense recognition of stock optionsand certain employee stock purchase plans in the statement of operations. Afinal standard is expected to be effective relative to the Company during theyear ending December 31, 2005. Such stock option expensing would require theCompany to value its employee stock option grants pursuant to an optionvaluation formula and then amortize that value against its earnings over thevesting period in effect for those options. The Company currently accounts forstock-based awards to employees in accordance with Accounting Principles BoardOpinion No. 25, “*Accounting for Stock Issuedto Employees*,” and have adopted the disclosure-only alternative ofFASB Statement No. 123, “*Accounting forStock-Based Compensation*.” If the Company is required to expenseemployee stock options in the future, the change in accounting treatment mayadversely affect the Company’s future reported results of operations.

 

**NOTE 6 – STOCK OPTIONS AND RIGHTS**

 

The Company has adopted a non-qualified stock optionplan (the “Option Plan”) which provides for options to purchase shares of theCompany’s common stock.  The maximumnumber of shares of common stock that may be issued pursuant to options grantedunder the Option Plan is 3,500,000 shares.

 

The Companyapplies Accounting Principles Board Opinion No. 25, *“Accountingfor Stock Issued to Employees,”*and related interpretations inaccounting for the Option Plan. Accordingly, no compensation expense has beenrecognized in the Consolidated Statements of Operations for grants under theOption Plan.  Had compensation expensefor the Company’s Option Plan been determined based on the fair value at thegrant date consistent with the methods of FASB Statement No. 123 “*Accounting for Stock Based Compensation,*” the Company’s netincome and income per share for the nine months ended September 30, 2004 and2003 would have been decreased to the pro forma amounts indicated below:

 

| ** **                                                                | ** ** | **Nine months ended September 30,**           | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                | ** ** | **2004**                                      | ** ** | **2003** | ** ** |
| ** **                                                                | ** ** | **(dollars in thousands, except share data)** | ** ** |
| Net income  (loss):                                                       |       |                                          |       |   |   |
| As reported                                                               |       | $                                             | (4,882     | ) | $ | 4,800 |   |
| Pro forma  compensation expense from stock based compensation, net of tax |       | (278                                          | )          | (29 | ) |
| Pro forma net  income (loss)                                              |       | $                                             | (5,160     | ) | $ | 4,771 |   |
| Net income  (loss) per common and common share equivalent:                |       |                                          |       |   |   |
| Basic income per  share:                                                  |       |                                          |       |   |   |
| As reported                                                               |       | $                                             | (0.58      | ) | $ | 0.56 |   |
| Pro forma                                                                 |       | $                                             | (0.61      | ) | $ | 0.55 |   |
| Diluted income  per share:                                                |       |                                          |       |   |   |
| As reported                                                               |       | $                                             | (0.58      | ) | $ | 0.50 |   |
| Pro forma                                                                 |       | $                                             | (0.61      | ) | $ | 0.49 |   |

 

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There were no options granted with exercise pricesbelow the market value of the stock at the grant date. Fair values for 2004were estimated using the Black-Scholes option-pricing model with the followingweighted average assumptions used: 10% dividend yield, expected volatility of 86%,risk-free interest rate of 2.5% and expected lives of five years.

 

**NOTE 7 – VARIABLE INTEREST ENTITIES**

 

During the nine months ended September 30, 2004, theCompany funded $2.3 million to two related Spanish entities formed to purchase,reposition and sell two apartment buildings in Barcelona, Spain.  Under the terms of the loan, the Companyreceives a preferred 30% return on its investment plus an 80% share inadditional profits generated by the investment. The investment meets the definition of a Variable Interest Entity (“VIE”)  under FASB Interpretation 46 (“FIN 46”) andthe Company is the primary beneficiary of the VIE.  As a result, the assets and liabilities ofthe VIE have been consolidated into the accompanying consolidated financialstatements as of September 30, 2004.

 

The VIE purchased the apartment buildings for $4.2million.  The purchase was funded withbank loans totaling $1.4 million, the Company’s $2.3 million investment and a $0.4million contribution from the project managers. Neither the creditors nor the other beneficial interest holders have recourseto the Company with regard to this investment and, as a result, the maximumlimit of the Company’s exposure to loss on this investment is $2.3 million.

 

As of September 30, 2004, the following assets andliabilities of the VIE were included in the accompanying consolidated statementsof financial condition:

 
| Investment in  real estate, net        |   | $         | 4,198,000 |   |
|----------------------------------------|--------|-----------|-----------|--------|
| Other assets                           |   | 21,000    |      |
| Borrowings and  notes payable          |   | 1,467,000 |      |
| Accrued expense  and other liabilities |   | 129,000   |      |
| Minority  interest                     |   | 406,000   |      |

 

**NOTE 8 – OPERATING SEGMENTS**

 

The Company’s operating segments consist of (i)restaurant operations conducted through Fatburger Holdings, Inc. (“Fatburger”),(ii) commercial real estate mortgage brokerage activities conducted throughGeorge Elkins Mortgage Banking Company (“George Elkins”) and (iii) real estate,merchant banking and financing activities. The following is a summary of each of the operating segments:

 

Restaurant Operations

 

Fatburger operatesor franchises 60 hamburger restaurants located in California, Nevada, Arizona, NewJersey, Florida, Colorado and Washington. The Company provided an investment and financing package for Fatburgerwhich involved the acquisition of the 93% of the entire class of the Series APreferred and the entire class of the Series D Preferred stock ofFatburger.  Currently, the Company ownsapproximately 71% of the voting control of Fatburger.  Fatburger has plans to open additionalrestaurants including expansion into Oregon, Louisiana, Georgia, New York,Ohio, Texas, Missouri, Kansas, Pennsylvania, West Virginia, Virginia, NorthCarolina, South Carolina, Washington D.C., British Columbia, Minnesota andMichigan.   Franchisees currently own andoperate about 35 of the Fatburger locations.

 

**Revenue from the operation ofFatburger company-owned restaurants is recognized when sales occur.  Franchise fee revenue from the sale ofindividual Fatburger franchises is recognized only when all material servicesor conditions relating to the sales have been substantially performed orsatisfied.  The completion of trainingand the opening of a location by the franchisee constitute substantialperformance on the part of Fatburger. Nonrefundable deposits collected in relation to the sale of franchisesare recorded as deferred franchise fees until the completion of training andthe opening of the restaurant, at which time the franchise fee revenue isrecognized.  In addition to franchise feerevenue, Fatburger collects a royalty**

 

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**ranging from 5% to 6% of gross sales from restaurantsoperated by franchisees.  Fatburgerrecognizes royalty fees as the related sales are made by the franchisees.  Costs relating to continuing franchisesupport are expensed as incurred.**

 

During the ninemonths ended September 30, 2004, thirty-one individual Fatburger franchiseswere sold.  Five new restaurants wereopened during the period, including two company-owned locations.  Royalty revenues were approximately $0.3million and $0.9 million, respectively, for the three and nine month periodsended September 30, 2004.

 

Commercial Real Estate Mortgage Brokerage Operations

 

In May 2002, theCompany purchased a 51% ownership interest in George Elkins, a Californiamortgage banking operation, which, in 2003, provided brokerage services relatedto the production of over $600 million in commercial real estate mortgages.George Elkins is headquartered in Los Angeles, with satellite offices locatedthroughout the southern California area. As of September 30, 2004, the mortgagebrokerage operation also manages a commercial loan servicing portfolio inexcess of $700 million for various investors. The Company earned mortgage servicing fees of $0.5 million during both thenine month periods ended September 30, 2004 and September 30, 2003, which areincluded in other revenue in the accompanying consolidated statements ofoperations.

 

Real Estate, Merchant Banking and Financing Operations

 

The Company invests in or finances real estate,mortgage-backed securities and other real estate related or finance relatedassets.  The merchant banking andfinancing operations focus on the acquisition of controlling interests inbusinesses in the process of restructuring. This can take the form of assisting in a management buy-out, refinancingcorporate debt or acquiring the “non-core” assets of a business.

 

16

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Segment data for the ninemonths ended September 30, 2004, and 2003 are as follows (dollars inthousands):

 
| ** **                                | ** ** | **Merchant Banking,  Real Estate and Finance** | ** ** | **Mortgage Brokerage** | ** ** | **Restaurant** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|------------------------------------------------|------------|------------------------|------------|----------------|------------|-----------|------------|
| ** **                                | ** ** | **2004**                                       | ** ** | **2003**               | ** ** | **2004**       | ** ** | **2003**  | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net Interest  Income:                     |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Loans                                     |       | $                                              | 1,431      |                   | $          | 850            |       | $         | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | 1,431 |   | $ | 850 |   |
| Loans to senior  executives               |       | 138                                            |       | 162                    |       | —         |       | —    |       | — |   | — |   | 138 |   | 162 |   |
| Securities                                |       | 616                                            |       | 1,983                  |       | —         |       | —    |       | — |   | — |   | 616 |   | 1,983 |   |
| Other  investments                        |       | 83                                             |       | 125                    |       | 2              |       | 2         |       | — |   | — |   | 85 |   | 127 |   |
| Total interest  income                    |       | 2,268                                          |       | 3,120                  |       | 2              |       | 2         |       | — |   | — |   | 2,270 |   | 3,122 |   |
| Interest expense                          |       | 112                                            |       | 578                    |       | —         |       | —    |       | — |   | — |   | 112 |   | 578 |   |
| Net interest  income                      |       | 2,156                                          |       | 2,542                  |       | 2              |       | 2         |       | — |   | — |   | 2,158 |   | 2,544 |   |
|                                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Real estate  operations:                  |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Operating  revenue                        |       | 3,083                                          |       | 2,965                  |       | —         |       | —    |       | — |   | — |   | 3,083 |   | 2,965 |   |
| Operating  expense                        |       | (1,330                                         | )          | (1,564                 | )          | —         |       | —    |       | — |   | — |   | (1,330 | ) | (1,564 | ) |
| Gain on sale of  real estate              |       | 159                                            |       | 279                    |       | —         |       | —    |       | — |   | — |   | 159 |   | 279 |   |
| Interest expense                          |       | (843                                           | )          | (1,040                 | )          | —         |       | —    |       | — |   | — |   | (843 | ) | (1,040 | ) |
| Depreciation                              |       | (489                                           | )          | (461                   | )          | —         |       | —    |       | — |   | — |   | (489 | ) | (461 | ) |
| Total real  estate operations             |       | 580                                            |       | 179                    |       | —         |       | —    |       | — |   | — |   | 580 |   | 179 |   |
|                                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Restaurant  operations:                   |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Operating income                          |       | —                                         |       | —                 |       | —         |       | —    |       | 16,424 |   | 2,472 |   | 16,424 |   | 2,472 |   |
| Cost of goods  sold                       |       | —                                         |       | —                 |       | —         |       | —    |       | (9,812 | ) | (1,515 | ) | (9,812 | ) | (1,515 | ) |
| Franchise and  royalty fees               |       | —                                         |       | —                 |       | —         |       | —    |       | 998 |   | 152 |   | 998 |   | 152 |   |
| General and  administrative costs         |       | —                                         |       | —                 |       | —         |       | —    |       | (7,946 | ) | (901 | ) | (7,946 | ) | (901 | ) |
| Interest Expense                          |       | —                                         |       | —                 |       | —         |       | —    |       | (442 | ) | (112 | ) | (442 | ) | (112 | ) |
| Depreciation and  amortization            |       | —                                         |       | —                 |       | —         |       | —    |       | (1,121 | ) | (141 | ) | (1,121 | ) | (141 | ) |
| Total restaurant  operations              |       | —                                         |       | —                 |       | —         |       | —    |       | (1,899 | ) | (45 | ) | (1,899 | ) | (45 | ) |
|                                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Other operating  income:                  |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Market  valuations loss / impairment      |       | —                                         |       | —                 |       | —         |       | —    |       | — |   | — |   | — |   | — |   |
| Gain on sale of  prepaid servicing credit |       | 1,530                                          |       | —                 |       | —         |       | —    |       | — |   | — |   | 1,530 |   | — |   |
| Equity in income  of equity investees     |       | 4,231                                          |       | 1,370                  |       | —         |       | —    |       | — |   | — |   | 4,231 |   | 1,370 |   |
| Gain on sale of  loans and securities     |       | 2,099                                          |       | 10,672                 |       | —         |       | —    |       | — |   | — |   | 2,099 |   | 10,672 |   |
| Loan origination  fees                    |       | —                                         |       | —                 |       | 4,213          |       | 3,497     |       | — |   | — |   | 4,213 |   | 3,497 |   |
| Other revenue                             |       | 1,088                                          |       | 951                    |       | 261            |       | 367       |       | — |   | — |   | 1,349 |   | 1,318 |   |
| Total other  operating income             |       | 8,948                                          |       | 12,993                 |       | 4,474          |       | 3,864     |       | — |   | — |   | 13,422 |   | 16,857 |   |
|                                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Operating  expenses:                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Compensation and  employee benefits       |       | 4,185                                          |       | 4,908                  |       | 3,781          |       | 3,193     |       | — |   | — |   | 7,966 |   | 8,101 |   |
| Leave of absence  expense                 |       | 4,750                                          |       | —                 |       | —         |       | —    |       | — |   | — |   | 4,750 |   | — |   |
| Professional  fees                        |       | 1,934                                          |       | 1,415                  |       | 29             |       | 124       |       | — |   | — |   | 1,963 |   | 1,539 |   |
| Fees paid to  related parties             |       | 365                                            |       | —                 |       | —         |       | —    |       | — |   | — |   | 365 |   | — |   |
| Other                                     |       | 3,442                                          |       | 2,198                  |       | 657            |       | 637       |       | — |   | — |   | 4,099 |   | 2,835 |   |
| Total operating  expenses                 |       | 14,676                                         |       | 8,521                  |       | 4,467          |       | 3,954     |       | — |   | — |   | 19,143 |   | 12,475 |   |
|                                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Net income  (loss) before provisions      |       | (2,992                                         | )          | 7,193                  |       | 9              |       | (88       | )          | (1,899 | ) | (45 | ) | (4,882 | ) | 7,060 |   |
| Provision for  income taxes               |       | —                                         |       | 2,152                  |       | —         |       | —    |       | — |   | 108 |   | — |   | 2,260 |   |
| Net income  (loss)                        |       | $                                              | (2,992     | )                      | $          | 5,041          |       | $         | 9          |   | $ | (88 | ) | $ | (1,899 | ) | $ | (153 | ) | $ | (4,882 | ) | $ | 4,800 |   |
| Segment assets                            |       | $                                              | 51,204     |                   | $          | 91,557         |       | $         | 1,778      |   | $ | 2,989 |   | $ | 20,494 |   | $ | 20,260 |   | $ | 73,476 |   | $ | 114,806 |   |

 

17

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Segmentdata for the three months ended September 30, 2004, and 2003 are as follows(dollars in thousands):

 
| ** **                                | ** ** | **Merchant Banking,  Real Estate and Finance** | ** ** | **Mortgage Brokerage** | ** ** | **Restaurant** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|------------------------------------------------|------------|------------------------|------------|----------------|------------|-----------|------------|
| ** **                                | ** ** | **2004**                                       | ** ** | **2003**               | ** ** | **2004**       | ** ** | **2003**  | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net Interest  Income:                     |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Loans                                     |       | $                                              | 456        |                   | $          | 534            |       | $         | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | 456 |   | $ | 588 |   |
| Loans to senior  executives               |       | 51                                             |       | 54                     |       | —         |       | —    |       | — |   | — |   | 51 |   | — |   |
| Securities                                |       | 11                                             |       | 509                    |       | —         |       | —    |       | — |   | — |   | 11 |   | 509 |   |
| Other  investments                        |       | 13                                             |       | 35                     |       | 1              |       | 1         |       | — |   | — |   | 14 |   | 36 |   |
| Total interest  income                    |       | 531                                            |       | 1,132                  |       | 1              |       | 1         |       | — |   | — |   | 532 |   | 1,133 |   |
| Interest expense                          |       | —                                         |       | 160                    |       | —         |       | —    |       | — |   | — |   | — |   | 160 |   |
| Net interest  income                      |       | 531                                            |       | 972                    |       | 1              |       | 1         |       | — |   | — |   | 532 |   | 973 |   |
|                                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Real estate  operations:                  |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Operating income                          |       | 1,106                                          |       | 1,034                  |       | —         |       | —    |       | — |   | — |   | 1,106 |   | 1,034 |   |
| Gain on sale of  real estate              |       | 154                                            |       | —                 |       | —         |       | —    |       | — |   | — |   | 154 |   | — |   |
| Operating  expense                        |       | (454                                           | )          | (498                   | )          | —         |       | —    |       | — |   | — |   | (454 | ) | (498 | ) |
| Interest expense                          |       | (281                                           | )          | (320                   | )          | —         |       | —    |       | — |   | — |   | (281 | ) | (320 | ) |
| Depreciation                              |       | (166                                           | )          | (155                   | )          | —         |       | —    |       | — |   | — |   | (166 | ) | (155 | ) |
| Total real  estate operations             |       | 359                                            |       | 61                     |       | —         |       | —    |       | — |   | — |   | 359 |   | 61 |   |
|                                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Restaurant  operations:                   |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Operating  revenue                        |       | —                                         |       | —                 |       | —         |       | —    |       | 5,673 |   | 2,472 |   | 5,673 |   | 2,472 |   |
| Cost of goods  sold                       |       | —                                         |       | —                 |       | —         |       | —    |       | (3,274 | ) | (1,515 | ) | (3,274 | ) | (1,515 | ) |
| Franchise and  royalty fees               |       | —                                         |       | —                 |       | —         |       | —    |       | 349 |   | 152 |   | 349 |   | 152 |   |
| General and  administrative costs         |       | —                                         |       | —                 |       | —         |       | —    |       | (2,530 | ) | (901 | ) | (2,530 | ) | (901 | ) |
| Interest Expense                          |       | —                                         |       | —                 |       | —         |       | —    |       | (97 | ) | (112 | ) | (97 | ) | (112 | ) |
| Depreciation and  amortization            |       | —                                         |       | —                 |       | —         |       | —    |       | (377 | ) | (141 | ) | (377 | ) | (141 | ) |
| Total restaurant  operations              |       | —                                         |       | —                 |       | —         |       | —    |       | (256 | ) | (45 | ) | (256 | ) | (45 | ) |
|                                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Other operating  income:                  |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Market  valuations loss / impairment      |       | —                                         |       | —                 |       | —         |       | —    |       | — |   | — |   | — |   | — |   |
| Gain on sale of  prepaid servicing credit |       | —                                         |       | —                 |       | —         |       | —    |       | — |   | — |   | — |   | — |   |
| Equity in income  of equity investees     |       | 2,719                                          |       | 500                    |       | —         |       | —    |       | — |   | — |   | 2,719 |   | 500 |   |
| Gain on sale of  loans and securities     |       | —                                         |       | 1,289                  |       | —         |       | —    |       | — |   | — |   | — |   | 1,289 |   |
| Loan origination  fees                    |       | —                                         |       | —                 |       | 1,839          |       | 1,244     |       | — |   | — |   | 1,839 |   | 1,244 |   |
| Other revenue                             |       | 462                                            |       | 602                    |       | 14             |       | 123       |       | — |   | — |   | 476 |   | 725 |   |
| Total other  operating income             |       | 3,181                                          |       | 2,391                  |       | 1,853          |       | 1,367     |       | — |   | — |   | 5,034 |   | 3,758 |   |
|                                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Operating  expenses:                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Compensation and  employee benefits       |       | 907                                            |       | 1,203                  |       | 1,536          |       | 1,080     |       | — |   | — |   | 2,443 |   | 2,283 |   |
| Leave of absence  expense                 |       | —                                         |       | —                 |       | —         |       | —    |       | — |   | — |   | — |   | — |   |
| Professional  fees                        |       | 779                                            |       | 365                    |       | 15             |       | 79        |       | — |   | — |   | 794 |   | 444 |   |
| Fees paid to  related parties             |       | 141                                            |       | 121                    |       | —         |       | —    |       | — |   | — |   | 141 |   | 121 |   |
| Other                                     |       | 1,168                                          |       | 542                    |       | 232            |       | 253       |       | — |   | — |   | 1,400 |   | 795 |   |
| Total operating  expenses                 |       | 2,995                                          |       | 2,231                  |       | 1,783          |       | 1,412     |       | — |   | — |   | 4778 |   | 3,643 |   |
|                                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Net income  (loss) before provisions      |       | 1,076                                          |       | 1,193                  |       | 71             |       | (44       | )          | (256 | ) | (45 | ) | 891 |   | 1,104 |   |
| Provision for  income taxes               |       | —                                         |       | 442                    |       | —         |       | —    |       | — |   | 108 |   | — |   | 550 |   |
| Net income  (loss)                        |       | $                                              | 1,076      |                   | $          | 751            |       | $         | 71         |   | $ | (44 | ) | $ | (256 | ) | $ | (153 | ) | $ | 891 |   | $ | 554 |   |
| Segment assets                            |       | $                                              | 51,204     |                   | $          | 91,557         |       | $         | 1,778      |   | $ | 2,989 |   | $ | 20,494 |   | $ | 20,260 |   | $ | 73,476 |   | $ | 114,806 |   |

 

18

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**NOTE 9– INCOME TAXES**

 

As of September 30, 2004,the Company had, for U.S. Federal tax purposes, a net operating loss (“NOL”)carry forward of approximately $76.1 million, including $11.5 million relatingto Fatburger. The Company’s NOL begins to expire in 2018. Fatburger’s NOLbegins to expire in 2004 and is generally subject to an annual limitation underthe Internal Revenue Code of 1986, Section 382, *Limitationon Net Operating Loss Carryovers and Certain Built-In Losses Following Changein Control*.  In addition, tothe extent the Fatburger NOL is utilized, the recognition of the related taxbenefits would first reduce goodwill related to the Fatburger acquisition, thenother non-current intangible assets related to that acquisition, and thenincome tax expense in accordance with Statement on Financial AccountingStandards No. 109, *Accounting for IncomeTaxes.*

 

United States taxregulations impose limitations on the use of NOL carry forwards followingcertain changes in ownership.  If such achange were to occur with respect to the Company, the limitation couldsignificantly reduce the amount of benefits that would be available to offsetfuture taxable income each year, starting with the year of ownershipchange.  To reduce the likelihood of suchownership changes, the Company established a Shareholder Rights Plan dated asof October 18, 2002, which discourages, under certain circumstances, ownershipchanges which would trigger the NOL limitations.

 

During the nine months ended September 30, 2004, aprovision for income taxes was not required due to the tax net operating lossgenerated during the period.  During the ninemonths ended September 30, 2003, the Company recognized a provision for incometaxes of $2.3 million.

 

**NOTE 10 – SUBSEQUENT EVENTS**

 

Dividends

 

On October 20, 2004, the Board of Directors declared a$0.13 per share dividend for the fourth quarter of 2004.  The dividend is payable on November 15, 2004to shareholders of record on November 1, 2004.

 

Sale of Real Estate

 

Subsequent to September 30, 2004, the Company soldfour stand-alone retail locations for a sales price of $2.3 million.  The proceeds from these sales consisted of$1.0 million in cash and a note receivable of $1.3 million.  Additionally, during October 2004, theCompany received the final $1.1 million payment on a note receivable relatingto the sale of real estate during 2000.

 

The Company is currently under contract to sell fouradditional free-standing retail locations for a combined sales price of $2.3million.

 

19

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**ITEM 2****.  MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*Thefollowing discussion and analysis should be read in conjunction with theInterim Consolidated Financial Statements of Fog Cutter Capital Group Inc. andthe notes thereto included elsewhere in this filing.  References in this filing to “Fog CutterCapital Group Inc.,” “we,” “our,” and “us” refer to Fog Cutter Capital GroupInc. and its subsidiaries unless the context indicates otherwise.*

* *

## **GENERAL**

 

Fog Cutter Capital Group Inc. (“FCCG” or the “Company”)focuses on the acquisition of assets where its expertise in intensive assetmanagement and financial structuring can create value.

 

Our business strategy consists of developing,strengthening and expanding our restaurant and commercial real estate mortgagebrokerage operations and continuing to identify and acquire real estateinvestments with favorable risk-adjusted returns. We also seek to identify andacquire controlling interests in other operating businesses in which we feel wecan add value.

 

We make acquisitions where our expertise in intensiveasset management, credit analysis and financial structuring can create valueand provide an appropriate risk-adjusted rate of return. We maintain a flexibleapproach with respect to the nature of our business, seeking to take advantageof opportunities as they arise or are developed.

 

During 2003 and 2004, we redeployed a large portion ofthe capital generated through our sale of mortgage-backed securities and fromcash distributions from our Bourne End subsidiary.  We used a portion of this capital to acquirevoting control of Fatburger Holdings Inc. in August 2003 and further increasedour investment in Fatburger in May 2004. The expansion and success of Fatburger is currently one of our primaryfocuses.  Since our acquisition,Fatburger has opened 10 additional restaurant locations and currently hasagreements for approximately 240 new franchise restaurants.

 

We have also been investing in special situation realestate loans, and funded four loans totaling $8.0 million during the ninemonths ended September 30, 2004.  Ourspecial situation loans are generally secured by real estate and are typicallyshort-term, with maturities ranging from 6 to 24 months. Due to the uniquecircumstances relating to these loans, the interest rate charged the borroweris significantly higher than conventional real estate lending.

 

Due to the varied nature of our operations, managementdoes not utilize a standard array of key performance indicators in evaluatingthe progress of the Company.  Management’sevaluation, instead, focuses on an asset-by-asset analysis within the Company’soperating segments.

 

**CriticalAccounting Policies**

** **

**Management’sDiscussion and Analysis of Financial Condition and Results of Operationsdiscusses our consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the UnitedStates.  The preparation of thesefinancial statements requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and the disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.  Management bases its estimates and judgmentson historical experience and on various other factors that are believed to bereasonable under the circumstances. Actual results may differ from these estimates under differentassumptions or conditions.  Managementbelieves the following critical accounting policies, affect its moresignificant judgments and estimates used in the preparation of its financialstatements.**

 

20

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***Accounting For Equity Investees***

** **

The equity method of accounting is used for investmentsin associated companies which are not unilaterally controlled by the Companyand in which the Company’s interest is generally between 20% and 50% of theoutstanding voting rights.  The Company’sshare of earnings or losses of associated companies, in which at least 20% ofthe voting securities is owned, is included in the consolidated statement ofoperations.

** **

***Sale Recognition***

** **

**Duringthe nine months ended September 30, 2004, we completed the sale ofsubstantially all of our mortgage-backed securities and may sell other assets,from time to time, in the future.  Ouraccounting policy calls for the recognition of sales of financial instruments,including mortgage-backed securities and loans, only when we have irrevocablysurrendered control over these assets. We do not retain any recourse or performance obligations with respect toour sales of assets.  Our sales were cashsales, and the cash proceeds were not contingent upon any future event.**

** **

***FatburgerRestaurant and Franchise Revenue***

** **

**Revenue from the operation ofFatburger company-owned restaurants is recognized when sales occur.  Franchise fee revenue from the sale ofindividual Fatburger franchises is recognized only when all material servicesor conditions relating to the sales have been substantially performed orsatisfied.  The completion of trainingand the opening of a location by the franchisee constitute substantialperformance on the part of Fatburger. Nonrefundable deposits collected in relation to the sale of franchisesare recorded as deferred franchise fees until the completion of training andthe opening of the restaurant, at which time the franchise fee revenue isrecognized.  In addition to franchise feerevenue, Fatburger collects a royalty ranging from 5% to 6% of gross sales fromrestaurants operated by franchisees. Fatburger recognizes royalty fees as the related sales are made by thefranchisees.  Costs relating tocontinuing franchise support are expensed as incurred.**

** **

**Fatburger operates on a 52-weekcalendar and its fiscal year ends on the Sunday closest to December 31.  Consistent with the industry, Fatburgermeasures its stores’ performance based upon 7 day work weeks.  Using the 52-week cycle ensures consistentweekly reporting for operations and ensures that each week has the same days,since certain days are more profitable than others.  Accordingly, the accompanying consolidatedfinancial statements reflect a Fatburger quarter end of September 26, 2004.**

** **

***Goodwilland Other Intangible Assets***

** **

**Goodwill** represents the excess of the purchase price andother acquisition related costs over the estimated fair value of the nettangible and intangible assets acquired. The Company does not amortize goodwill. Intangible assets are stated at cost and include trademarks, operatingmanuals, franchise agreements and leasehold interests.  Trademarks, which have indefinite lives, arenot subject to amortization.  All otherintangible assets are amortized over their estimated useful lives, which rangefrom five to fifteen years.  The Companyassesses potential impairments to intangible assets at least annually, or whenthere is evidence that events or changes in circumstances indicate that thecarrying amount of an asset may not be recovered. Judgments regarding theexistence of impairment indicators and future cash flows related to intangibleassets are based on operational performance of the acquired businesses, marketconditions and other factors.

 

***Long-lived Assets***

 

The Company evaluates its real estate properties,including properties under capital leases, and other similar long-lived assetsat least annually, or whenever events or changes in circumstances indicate thatthe carrying amounts may not be recoverable. The Company first evaluates these assets for indicators of impairmentsuch as significant decreases in the estimated market price of a real estateasset, a significant adverse change in the extent or manner in which a realestate assets is being used or in its physical

 

21

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condition, or cash flow combined with a history of operating cash flowlosses or a projection or forecast that demonstrates continuing lossesassociated with the use of the long-lived asset.  When any such indicators of impairment arenoted, the Company compares the carrying amount of these assets to the futureestimated undiscounted net cash flows expected to result from the use andeventual disposition of the assets.  Ifthe undiscounted cash flows are less than the carrying amount, the Companyrecords an impairment charge equal to the excess of carrying value over theasset’s estimated fair value. Fair value is estimated in consideration of thirdparty value opinions and comparative similar asset prices, whenever available,or internally developed discounted cash flow analyses.

 

Any long-lived assets which the Company expects tosell or dispose of in the near term are stated at the lower of their carryingamounts or their fair value less the cost to sell, and are evaluated forimpairment throughout the sales process.

 

**RESULTS OF OPERATIONS**3⁄4NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO NINE MONTHS ENDED SEPTEMBER30, 2003

 

NET INCOME.  Ournet loss for the nine months ended September 30, 2004, was $4.9 million, or $0.57per share, compared with a net income of $4.8 million, or $.56 per share, forthe nine months ended September 30, 2003. The net loss for the 2004 period is primarily attributable to operatingexpenses of $19.1 million and losses from restaurant operations of $1.9million, partially offset by net interest income of $2.2 million, gain on saleof loans and securities of $2.1 million, loan brokerage fees of $4.2 million, equityin earnings of equity investees of $4.2 million, and gain on sale of a prepaidservicing credit of $1.5 million.

 

Operating expenses were higher than normal during the ninemonths ended September 30, 2004 primarily due to a $2.0 million leave ofabsence payment to Andrew Wiederhorn and the accrual of $2.4 million of futureexpenses associated with the leave of absence.

 

The net income for the 2003 period is primarilyattributable to net interest income of $2.5 million, gain on sale of loans andsecurities of $10.7 million, and loan brokerage fees of $3.5 million, partiallyoffset by other operating expenses of $12.5 million and provision for incometaxes of $2.3 million.

 

The following sections describe the results ofoperations of our operating segments for the nine months ended September 30,2004:

 

**Restaurant Segment Operations**

 

In August 2003,the Company completed an investment and financing package for Fatburger whichinvolved the acquisition of Series A-1 Preferred and Series D Preferred stockof Fatburger.  As a result of our greaterthan 50% voting control, we began reporting the operations of Fatburger on aconsolidated basis beginning August 15, 2003.

 

During the ninemonths ending September 30, 2004, we recognized a net loss from our restaurantsegment of $1.9 million.  This wasprimarily the result of a gross margin (sales net of cost of goods sold) of $6.6million and franchise and royalty revenue of $1.0 million, offset by generaland administrative costs of $7.9 million, interest expense of $0.4 million, anddepreciation and amortization of $1.1 million. The Company’s strategy with respect to Fatburger is to increase thenumber of franchises, thus increasing the franchise fees and future royaltyincome to the operation.

 

During theapproximately two months from acquisition through September 30, 2003, werecognized a net loss from our restaurant segment of $0.2 million.  This was primarily the result of a grossmargin (sales net of cost of goods sold) of $1.0 million and franchise and royalty revenue of $0.2 million, offsetby general and administrative costs of $0.9 million, interest expense of $0.1million, depreciation and amortization of $0.1 million and a provision forincome taxes of $0.1 million.

 

22

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**Commercial Real Estate Mortgage Brokerage SegmentOperations**

 

In May 2002, theCompany purchased a 51% ownership interest in George Elkins Mortgage BankingCompany (“George Elkins”), a California mortgage banking operation, which, in2003, provided brokerage services related to the production of over $600million in commercial real estate mortgages. George Elkins is headquartered in Los Angeles, with satellite officeslocated throughout the southern California area.  The mortgage banking operation also manages acommercial loan servicing portfolio in excess of $700 million for variousinvestors. The Company began reporting the operations of George Elkins on aconsolidated basis beginning May 15, 2002.

 

We had break even operations from the commercial realestate brokerage segment for the nine months ended September 30, 2004, comparedto a loss of $0.1 million during the 2003 period.  During the 2004 period, we recognized loanbrokerage fees of $4.2 million, loan servicing and other revenue of $0.3million, which was offset by compensation expense of $3.8 million and otheroperating expense of $0.7 million.  Duringthe 2003 period, we recognized loan brokerage fees of $3.5 million, loan servicingand other revenue of $0.4 million, which were offset by compensation expense of$3.2 million and other operating expense of $0.8 million.

 

**Merchant Banking, Real Estate and Finance SegmentOperations**

 

NET INTEREST INCOME. Our net interest income for the nine months ended September 30, 2004 was$2.2 million, compared with $2.5 million for the nine months ended September30, 2003.  These results reflect areduction in interest income on securities of $1.4 million as the result of thesale or repayment of mortgage-backed securities.  This decrease was offset by an increase ininterest income on loans (reflecting our increased investment in specialty realestate lending) of $0.6 million and a decrease in interest expense of $0.5million as a result of our repayment of debt related to the mortgage-backedsecurities.  The following tables setforth information regarding the total amount of income from interest-earningassets and expense from interest-bearing liabilities and the resulting averageyields and rates:

 
| ** **                                                       | ** **   | **For the Nine Months Ended September 30, 2004** | ** **   |
|------------------------------------------------------------------|--------------|--------------------------------------------------|--------------|
| ** **                                                       | ** **   | **Average  Balance**                             | ** **   | **Interest  Income (Expense)** | ** ** | **Annualized  Yield/Rate** | ** ** |
| *** ***                                                     | *** *** | **(dollars in thousands)**                       | *** *** |
| Interest-Earning  Assets:                                        |         |                                             |         |   |   |   |   |
|                                                             |         |                                             |         |   |   |   |   |
| Loan portfolios  (1)                                             |         | $                                                | 10,718       |   | $ | 1,569 |   | 19.5 | % |
| Mortgage-backed  securities available for sale                   |         | 16,677                                           |         | 616 |   | 4.9 | % |
| Other  investments                                               |         | 11,503                                           |         | 83 |   | 1.0 | % |
| Total  interest-earning assets                                   |         | $                                                | 38,898       |   | $ | 2,268 |   | 7.8 | % |
|                                                             |         |                                             |         |   |   |   |   |
| Interest-Bearing  Liabilities:                                   |         |                                             |         |   |   |   |   |
|                                                             |         |                                             |         |   |   |   |   |
| Borrowings (2)                                                   |         | $                                                | 12,335       |   | $ | (112 | ) | 1.2 | % |
| Total  interest-bearing liabilities                              |         | $                                                | 12,335       |   | $ | (112 | ) | 1.2 | % |
|                                                             |         |                                             |         |   |   |   |   |
| Net interest  income before provision for loan losses/spread (3) |         |                                             |         | $ | 2,156 |   | 6.6 | % |
| Net interest  margin (4)                                         |         |                                             |         |   |   | 7.4 | % |

 

----

(1)          Includes loans to seniorexecutives.

(2)   Excludesborrowings related to investments in real estate.

(3)          Net interest spreadrepresents the difference between the average rate on interest-earning assetsand the average cost of interest-bearing liabilities.

(4)   Netinterest margin represents net interest income divided by averageinterest-earning assets.

 

23

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| ** **                                                       | ** **   | **For the Nine Months Ended September 30, 2003** | ** **   |
|------------------------------------------------------------------|--------------|--------------------------------------------------|--------------|
| ** **                                                       | ** **   | **Average  Balance**                             | ** **   | **Interest  Income (Expense)** | ** ** | **Annualized  Yield/Rate** | ** ** |
| *** ***                                                     | *** *** | **(dollars in thousands)**                       | *** *** |
| Interest-Earning  Assets:                                        |         |                                             |         |   |   |   |   |
|                                                             |         |                                             |         |   |   |   |   |
| Loan portfolios  (1)                                             |         | $                                                | 6,314        |   | $ | 1,012 |   | 21.4 | % |
| Mortgage-backed  securities available for sale                   |         | 53,750                                           |         | 1,983 |   | 4.9 | % |
| Other investments                                                |         | 14,309                                           |         | 125 |   | 1.2 | % |
| Total  interest-earning assets                                   |         | $                                                | 74,373       |   | $ | 3,120 |   | 5.6 | % |
|                                                             |         |                                             |         |   |   |   |   |
| Interest-Bearing  Liabilities:                                   |         |                                             |         |   |   |   |   |
|                                                             |         |                                             |         |   |   |   |   |
| Borrowings (2)                                                   |         | $                                                | 31,762       |   | $ | (578 | ) | 2.4 | % |
| Total  interest-bearing liabilities                              |         | $                                                | 31,762       |   | $ | (578 | ) | 2.4 | % |
|                                                             |         |                                             |         |   |   |   |   |
| Net interest  income before provision for loan losses/spread (3) |         |                                             |         | $ | 2,542 |   | 3.2 | % |
| Net interest  margin (4)                                         |         |                                             |         |   |   | 4.6 | % |

 

----

(1)          Includes loans to seniorexecutives.

(2)   Excludesborrowings related to investments in real estate.

(3)          Net interest spreadrepresents the difference between the average rate on interest-earning assetsand the average cost of interest-bearing liabilities.

(4)   Netinterest margin represents net interest income divided by averageinterest-earning assets.

 

REAL ESTATE OPERATIONS.  Our real estate operations represent activityfrom our direct investment in commercial property, as well as the operations ofour leasehold interest in freestanding retail buildings.  During the nine months ended September 30,2004, we realized a net income from real estate operations of $0.6 million,compared with a net income from real estate operations of $0.2 million for the ninemonths ended September 30, 2003.

 

In October 2002, theCompany assumed leasehold interests in 109 free-standing retail stores locatedthroughout the United States.  We havesold or terminated 8 of the leasehold interests and purchased and retained the directfee ownership interest in 20 of the retail buildings.  As a result, as of September 30, 2004 weowned 20 properties directly with a carrying value of $7.4 million.  Of the remaining leases, 36 were on terms andconditions that required capitalization of the obligation.  As of September 30, 2004, we had real estatesubject to capital leases of $13.4 million and a related capital leaseobligation of $12.3 million. The remaining 45 leases are classified asoperating leases.  All of our subleasesare accounted for as operating leases.

 

The properties are subletto a broad tenant mix including convenience stores, shoe stores, video rentaloutlets, auto parts dealers, carpet retailers and other small businesses.  The retail properties cover approximately 460,000square feet of retail space located in 24 states. The stores are free-standing,retail locations ranging from 4,500-7,000 square feet each.  The initial term of the leasehold interestshas an average expiration of approximately 6 years.  However, the Company is entitled to exerciseextension options which will allow the Company to control the properties for anadditional 15 to 30 years.  As of September30, 2004, there were vacancies in 10 of the retail buildings.

 

OTHER OPERATINGINCOME.  Our other operating income wasapproximately $8.9 million for the nine months ended September 30, 2004.  This compares to other operating income of $13.0million for the nine months ended September 30 2003.  The primary components of our net otheroperating income include the following:

 

24

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*Equity In Earnings Of Equity Investees*.  We recognized our share of the earnings ofequity investees in the amount of $4.2 million during the nine months ended September 30,2004.  This compares to earnings of $1.4million during the 2003 period.  In December 2000,we arranged and participated in the purchase of all of the outstanding capitalstock of Bourne End Properties Ltd. (“Bourne End”) through a 26% owned Jersey,Channel Islands Company known as BEP Acquisitions (“BEP”).  Bourne End is a specialist investor in retailproperty located in the United Kingdom. We account for this investment using the equity method, therebyrecording our share of income and expense generated by BEP.  Equity in earnings of equity investees duringthe 2004 and 2003 periods are primarily the result of our investment in BourneEnd.

 

*PrepaidLoan Servicing Credit. *Duringthe nine months ended September 30, 2004, we sold our Wilshire CreditCorporation (“WCC”) prepaid loan servicing credit (the “Loan Servicing Credit”)for $1.5 million in cash.  The LoanServicing Credit was originally acquired by us in 1998, when we were anaffiliate of WCC.  The Loan ServicingCredit may be used, subject to certain limitations, to pay for loan portfolioservicing activities performed by WCC.  Asa result of the sale, we recognized a gain in the amount of $1.5 million.

 

*Gain OnThe Sale Of Loans And Securities. *Duringthe nine months ended September 30, 2004 and 2003, we sold loans andsecurities to unrelated third parties for approximately $29.1 million and $13.8million, respectively, resulting in gains of approximately $2.1 million and $10.7million, respectively.

 

OPERATINGEXPENSES.  During the nine months ended September 30,2004, operating expenses from our merchant banking, real estate and financesegment were comprised of compensation and employee benefits of $4.2 million, leaveof absence expense of $4.8 million, professional fees of $1.9 million and othercosts of $3.8 million.  The leave ofabsence expense consists of the $2.0 million leave of absence payment that waspaid to Mr. Wiederhorn on June 2, 2004 and an accrual of $2.8 millionwhich is expected to be paid during the period of the leave of absence.

 

Duringthe nine months ended September 30, 2003, operating expenses from our merchantbanking, real estate and finance segment were comprised of compensation andemployee benefits of $4.9 million, professional fees of $1.4 million and othercosts of $2.2 million.

 

**RESULTSOF OPERATIONS****3⁄4 QUARTER ENDED SEPTEMBER 30,2004 COMPARED TO QUARTER ENDED SEPTEMBER 30, 2003**

 

NETINCOME.  Our net income for the quarterended September 30, 2004 was $0.9 million, or $0.11 per share, comparedwith net income of $0.6 million, or $0.06 per share, for the quarter ended September 30,2003.  The net income for the 2004 periodis primarily attributable to net interest income of $0.5 million; equity inearnings of equity investees of $2.7 million, and loan brokerage fees of $1.8million, partially offset by operating expenses of $4.8 million.

 

Thenet income for the 2003 period is primarily attributable to net interest incomeof $1.0 million; gain on sale of loans and securities of $1.3 million, equityin earnings of equity investees of $0.5 million, and loan brokerage fees of$1.2 million, partially offset by other operating expenses of $3.6 million and$0.6 million in provision for income taxes.

 

Thefollowing sections describe the results of operations of our operating segmentsfor the three months ended September 30, 2004:

 

25

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**RestaurantSegment Operations**

 

As a result of our voting control, we began reportingthe operations of Fatburger on a consolidated basis beginning August 15,2003.

 

During the three months ending September 30, 2004,we recognized a net loss from our restaurant segment of $0.3 million.  This was primarily the result of a grossmargin (sales net of cost of goods sold) of $2.4 million and franchise and royalty revenue of $0.3 million, offsetby general and administrative costs of $2.5 million, interest expense of $0.1million, and depreciation and amortization of $0.4 million.

 

During the approximately two months from acquisitionthrough September 30, 2003, we recognized a net loss from our restaurantsegment of $0.2 million.  This wasprimarily the result of a gross margin (sales net of cost of goods sold)of  $1.0 million and franchise androyalty revenue of $0.2 million, offset by general and administrative costs of$0.9 million, interest expense of $0.1 million, depreciation and amortizationof $0.1 million and a provision for income taxes of $0.1 million.

 

**CommercialReal Estate Mortgage Brokerage Segment Operations**

 

Thecommercial real estate brokerage segment produced net income of $0.1 million forthe three months ended September 30, 2004, compared to a loss of less than$0.1 million during the comparable 2003 period. During the 2004 period, we recognized loan brokerage fees of $1.8million, which was offset by compensation expense of $1.5 million and otheroperating expense of $0.2 million. During the 2003 period, we recognized loan brokerage fees of $1.2million, loan servicing and other revenue of $0.1 million, which was offset bycompensation expense of $1.1 million and other operating expense of $0.3million.

 

**MerchantBanking, Real Estate and Finance Segment Operations**

 

NETINTEREST INCOME.  Our net interest incomefor the quarter ended September 30, 2004 was $0.5 million, compared with $1.0million for the quarter ended September 30, 2003.  The decrease is primarily attributable to areduction in interest income on securities of $0.5 million as the result of thesale or repayment of mortgage-backed securities.  a decrease in interest expense of $0.2 millionas a result of our repayment of debt related to the mortgage-backedsecurities.  The following tables setforth information regarding the total amount of income from interest-earningassets and expense from interest-bearing liabilities and the resulting averageyields and rates:

 
| ** **                                                       | ** ** | **For the Quarter Ended  September 30, 2004** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                       | ** ** | **Average  Balance**                               | ** ** | **Interest  Income (Expense)** | ** ** | **Annualized  Yield/Rate** | ** ** |
| ** **                                                       | ** ** | **(dollars in thousands)**                         | ** ** |
| Interest-Earning Assets:                                         |       |                                               |       |   |   |   |   |
|                                                             |       |                                               |       |   |   |   |   |
| Loan portfolios (1)                                              |       | $                                                  | 13,017     |   | $ | 507 |   | 15.6 | % |
| Mortgage-backed securities available for sale                    |       | 29                                                 |       | 11 |   | 151.7 | % |
| Other investments                                                |       | 7,241                                              |       | 13 |   | 0.7 | % |
| Total interest-earning assets                                    |       | $                                                  | 20,287     |   | $ | 531 |   | 10.5 | % |
|                                                             |       |                                               |       |   |   |   |   |
| Interest-Bearing Liabilities:                                    |       |                                               |       |   |   |   |   |
|                                                             |       |                                               |       |   |   |   |   |
| Borrowings (2)                                                   |       | $                                                  | —     |   | $ | — |   | — |   |
| Total interest-bearing liabilities                               |       | $                                                  | —     |   | $ | — |   | — |   |
|                                                             |       |                                               |       |   |   |   |   |
| Net interest income before provision for loan  losses/spread (3) |       |                                               |       | $ | 531 |   | 10.5 | % |
| Net interest margin (4)                                          |       |                                               |       |   |   | 10.5 | % |

 

26

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----

(1)   Includes loans tosenior executives.

(2)   Excludesborrowings related to investments in real estate.

(3)   Net interestspread represents the difference between the average rate on interest-earningassets and the average cost of interest-bearing liabilities.

(4)   Net interestmargin represents net interest income divided by average interest-earningassets.

 
| ** **                                                       | ** ** | **For the Quarter Ended September 30,  2003** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                       | ** ** | **Average  Balance**                               | ** ** | **Interest  Income (Expense)** | ** ** | **Annualized  Yield/Rate** | ** ** |
| ** **                                                       | ** ** | **(dollars in thousands)**                         | ** ** |
| Interest-Earning Assets:                                         |       |                                               |       |   |   |   |   |
|                                                             |       |                                               |       |   |   |   |   |
| Loan portfolios (1)                                              |       | $                                                  | 6,562      |   | $ | 588 |   | 35.8 | % |
| Mortgage-backed securities available for sale                    |       | 45,453                                             |       | 509 |   | 4.5 | % |
| Other investments                                                |       | 15,153                                             |       | 35 |   | 1.00 | % |
| Total interest-earning assets                                    |       | $                                                  | 67,168     |   | $ | 1,132 |   | 6.8 | % |
|                                                             |       |                                               |       |   |   |   |   |
| Interest-Bearing Liabilities:                                    |       |                                               |       |   |   |   |   |
|                                                             |       |                                               |       |   |   |   |   |
| Borrowings (2)                                                   |       | $                                                  | 26,966     |   | $ | (160 | ) | 2.4 | % |
| Total interest-bearing liabilities                               |       | $                                                  | 26,966     |   | $ | (160 | ) | 2.4 | % |
|                                                             |       |                                               |       |   |   |   |   |
| Net interest income before provision for loan  losses/spread (3) |       |                                               |       | $ | 972 |   | 4.4 | % |
| Net interest margin (4)                                          |       |                                               |       |   |   | 5.8 | % |

 

----

(1)   Includes loans to seniorexecutives.

(2)   Excludesborrowings related to investments in real estate.

(3)   Net interestspread represents the difference between the average rate on interest-earningassets and the average cost of interest-bearing liabilities.

(4)   Net interest marginrepresents net interest income divided by average interest-earning

 

REALESTATE OPERATIONS.  Our real estateoperations represent activity from our investment in various office buildings,retail stores, and other commercial property. During the quarter ended September 30, 2004, we realized net incomeof $0.5 million from real estate operations, compared with net income of $0.1million for the quarter ended September 30, 2003.

 

OTHEROPERATING INCOME.  Our other operatingincome was approximately $3.2 million for the three months ended September 30,2004.  This compares to other operatingincome of $2.4 million for the three months ended September 30, 2003.  The primary components of our other operatingincome include the following:

 

*Equity in Earnings of Equity Investees*.  We recognized our share of the earnings ofequity investees in the amount of $2.7 million during the three months ended September 30,2004.  This compares to earnings of $0.5million during the comparable 2003 period. Equity in earnings of equity investees during the 2004 and 2003 periodsare primarily the result of our investment in Bourne End.

 

*Gain onthe Sale of Loans and Securities. *Therewere no sales of loans or securities during the three months ended September 30,2004.  During the three months ended September 30,2003, we sold loans and securities to unrelated third parties for approximately$1.8 million resulting in gains of approximately $1.3 million.

 

27

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OPERATINGEXPENSES.  During the three months ended September 30,2004, operating expenses from our merchant banking, real estate and financialsegment were comprised of compensation and employee benefits of $0.9 million,professional fees of $0.8 million and other costs of $1.3 million.

 

 During the three months ended September 30,2003, operating expenses were comprised of compensation and employee benefitsof $1.2 million, professional fees of $0.4 million and other costs of $0.7million.

 

**CHANGESIN FINANCIAL CONDITION**

 

GENERAL.  Total assets decreased from approximately$109.0 million at December 31, 2003 to approximately $73.5 million at September 30,2004.  Total liabilities decreased fromapproximately $63.6 million at December 31, 2003 to approximately $39.1million at September 30, 2004.  Thedecline in total assets and liabilities was primarily the result of sales ofour mortgage-backed securities and repayment of the related borrowings.  Stockholders’ equity decreased byapproximately $11.0 million resulting primarily from our net loss of $4.9million, dividends declared of $3.3 million, the purchase of treasury stock of$1.7 million and purchase of a call option of $0.6 million.

 

SECURITIESAVAILABLE FOR SALE.  The balance ofmortgage-backed securities available for sale decreased from $35.5 million at December 31,2003 to less than $0.1 million at September 30, 2004.  The decrease was primarily the result of the sale of mortgage-backed securities with acarrying value of $29.1 million and cash repayments of securities of $6.9million, partially offset by increases in market value of $1.4 million.

 

LOANPORTFOLIO.  We invest in specialsituation loans, generally secured by real estate.  These loans are typically short-term, withmaturities ranging from 6 to 24 months. Due to the unique circumstances relating to the loans, the interest ratecharged the borrower is significantly higher than conventional real estatelending.  As of September 30, 2004,our special situation loan portfolio consisted of seven individual loans with acombined carrying value of $10.4 million. Six of the seven loans are secured by real estate consisting ofmulti-family, commercial or single-family properties located in California,Texas, Maine, and Nevada.  One loan issecured by all of the stock and assets of a commercial manufacturingbusiness.  The loans have a weightedaverage interest rate, excluding fees, of 14.5% and a weighted average maturityof six months.

 

Duringthe nine months ended September 30, 2004, our loan portfolio increased byapproximately $6.7 million.  This wasprimarily the result of the acquisition of four new loans with a carrying valuetotaling $7.7 million.  As of September 30,2004, two of the Company’s loans totaling $2.0 million had been restructured toprovide additional time for repayment by the borrowers in exchange for variousextension fees or other new terms.  As aresult, these loans were considered impaired for accounting purposes, however,no impairment reserves were required on these loans due to management’sexpectation that the carrying amounts will be collected.

 

INVESTMENTSIN REAL ESTATE.  Investments in realestate increased by $5.4 million during the nine months ended September 30,2004.  The increase was primarily due tothe purchase of the fee interest in two freestanding retail buildings for $0.4million, the purchase of two apartment buildings in Barcelona, Spain for $4.2million and capital improvements of $1.7 million, partially offset by the saleof two properties for $0.4 million and depreciation of $0.5 million.

 

LOANSTO SENIOR EXECUTIVES.  Prior to thepassage of the Sarbanes-Oxley Act of 2002, we had an employment agreement withMr. Wiederhorn which allowed him to borrow a specified maximum amount from usto purchase shares of the Company’s Common Stock in the open market.  The resulting loans are full recourse,secured loans bearing interest at the prime rate.  At September 30, 2004, in addition tothe $2 million loan to Mr. Wiederhorn described below, we had outstanding loansto Mr. Wiederhorn, including accrued interest, of approximately $1.0 million.  The Company is not obligated to makeadditional advances on loans under the current employment agreement.  The loans to Mr. Wiederhorn are furtherdescribed as follows:

 

28

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On February 21,2002, we loaned Mr. Wiederhorn $175,000 to finance the purchase of CommonStock.  This loan is full recourse to Mr.Wiederhorn and is secured by all of Mr. Wiederhorn’s rights under hisemployment agreement.  We are entitled tonet amounts payable under the employment agreement against any amounts payableby Mr. Wiederhorn upon any default or at maturity of the loan.  At Mr. Wiederhorn’s direction (in accordancewith the terms of his employment agreement), on February 21, 2002, weloaned a limited partnership controlled by Mr. Wiederhorn’s spouse (the “LP”)$687,000 to finance the purchase of Common Stock.  The loan is secured by the membershipinterests of two limited liability companies owned by the LP.  The limited liability companies each own aparcel of real property in Oregon and have no liabilities.  At the time of the loan, the real propertyhad an appraised value of $725,000.  Theloan is also guaranteed by Mr. Wiederhorn. The Common Stock purchased with the proceeds of these loans does notserve as security for the loans.  Theloans are due on February 21, 2007, and bear interest at the prime rate,as published in the Wall Street Journal, which interest is added to theprincipal annually.

 

Priorto the passage of the Sarbanes-Oxley Act of 2002, we loaned Mr. Wiederhorn $2.0million.  This loan is full recourse toMr. Wiederhorn and his spouse and is secured by trust deeds on two residenceslocated in Oregon.  The loan is due on August 1,2007 and bears interest at 8.5% per annum, payable monthly.  The Board of Directors (with Mr. Wiederhornabstaining) concluded that the terms of the loan were at least as favorable tothe Company as would be available in an arms length, third party transactionand approved the loan on July 9, 2002.

 

Furtherinformation on these loans to executives is included in our 2003 annual reporton Form 10-K and proxy statements for our 2003 and prior years’ Annual Meetingof Stockholders.  The employmentagreement has been previously filed with the SEC.

 

INVESTMENTIN BOURNE END.  In December 2000, weorganized and led a group of investors to purchase all of the outstandingcapital stock of Bourne End, a specialist investor in retail property.  At the time of the acquisition, Bourne Endhad approximately GBP 169.6 million of assets and GBP 123.1 million ofdebt.  The real estate assets consistedof 1.7 million square feet in fifteen shopping centers located in the UnitedKingdom.  As of September 30, 2004,Bourne End had sold fourteen of the original fifteen shopping centers.  The sales are consistent with the investorgroup’s strategy to reposition each of the centers, including selected newcapital expenditures on existing space and new development on excess oradjoining land, with the ultimate goal of reselling the properties.

 

Bourne End is in the process of selling its lastremaining shopping center, which it hopes to sell within the next 12months.  At that point, Bourne End isexpected to be liquidated and we will receive our share of any remaining assetsor proceeds of Bourne End.

 

Our investment in Bourne End decreased by $0.2 millionto $2.0 million at September 30, 2004. The decrease was primarily the result of our receipt of cashdistributions from Bourne End of $4.4 million, partially offset by the recognitionof $4.2 million our share of the earnings of Bourne End.

 

RESTAURANTPROPERTY, PLANT AND EQUIPMENT, NET.  Ourinvestment in restaurant property, plant and equipment, net of depreciation,increased $0.1 million during the nine months ended September 30, 2004 toa balance of $6.0 million.  The increasewas primarily the result of approximately $1.1 million of additions toequipment, furniture and fixtures relating to new restaurant openings, lessdepreciation expense of approximately $1.0 million, during the period.

 

INTANGIBLEASSETS, NET.  Primarily as a result ofthe acquisition and consolidation of Fatburger, as of September 30, 2004we had intangible assets, net of amortization, of $5.5 million.  This consisted of trademark rights ofapproximately $4.0 million, franchise agreements of approximately $1.0 millionand other miscellaneous intangible assets of $0.5 million.  Intangible assets decreased $0.1 millionduring the nine months ended September 30, 2004 primarily as the result ofamortization expense.

 

GOODWILL.  Primarily as a result of the acquisition andconsolidation of Fatburger, we had recorded goodwill of $7.5 million as of September 30,2004.

 

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OTHERASSETS.  At September 30, 2004, theCompany’s other assets consisted of the following (dollars in thousands):

 
| Capitalized deferred compensation |   | $     | 971    |   |
|-----------------------------------|--------|-------|--------|--------|
| Prepaid expenses                  |   | 370   |   |
| Rent receivable                   |   | 333   |   |
| Investment in operating leases    |   | 329   |   |
| Mortgage servicing rights         |   | 256   |   |
| Other                             |   | 1,701 |   |
| Total                             |   | $     | 3,960  |   |

 

Thecapitalized deferred compensation included in other assets relates to theacquisition of George Elkins.  Inconjunction with the acquisition, certain employees of George Elkins enteredinto long-term employment agreements. These employees received payments totaling $1.9 million which wecapitalized as deferred compensation. The employees are obligated to perform under the employment agreementsand must repay any unearned deferred compensation payments upon earlytermination.  The deferred compensationis earned ratably over the terms of the employment agreements, and we areamortizing the $1.9 million investment over the remaining terms, which rangefrom 8 to 32 months.

 

REPURCHASEAGREEMENTS, BORROWINGS AND NOTES PAYABLE. Our repurchase agreements, borrowings and notes payable decreased $25.6 millionduring the nine months ended September 30, 2004 to an ending balance of $7.5million.  This was primarily the resultof the repayment of repurchase agreements upon the sale of mortgage-backedsecurities.

 

OBLIGATIONSUNDER CAPITAL LEASES.  Obligations undercapital leases decreased approximately $0.3 million during the nine months endedSeptember 30, 2004.  This decreasewas primarily the result of the scheduled amortization of the obligations.

 

DEFERREDINCOME.  Franchise fee revenue from thesales of individual Fatburger franchises is recognized only when all materialservices or conditions relating to the sales have been substantially performedor satisfied.  The completion of trainingand the opening of a location by the franchisee constitute substantialperformance.  Fatburger charges $40,000per location in franchise fees.  One-halfof the fees are collected in cash at the time the franchise rights are grantedand the balance is collected at the time the lease for the location isexecuted. Nonrefundable deposits collected in relation to the sale offranchises are recorded as deferred franchise fees until the completion oftraining and the opening of the restaurant, at which time the franchise feerevenue is recognized.  As of September 30,2004, our deferred income relating to the collection of unearned Fatburgerfranchise fees was $4.4 million, an increase of $0.7 million from December 31,2003.  The increase was primarily theresult of the collection of nonrefundable deposits on new franchises.  As of September 30, 2004, nearly all ofthe deferred income was comprised of the initial $20,000 non-refundable depositreceived per location and the balance of the franchise fee will be collected incash as leases on these locations are signed.

 

DEFERREDINCOME TAXES.  Our deferred income taxesdecreased $1.1 million to $5.9 million at September 30, 2004.  This was primarily the result of a decreasein the accrued taxes associated with unrealized gains on mortgage-backedsecurities.  As of September 30,2004, we had, for U.S. Federal tax purposes, a net operating loss (“NOL”)carryforward of approximately $76.1 million, including $11.5 million relatingto Fatburger.  The NOL carryforward mayreduce the future cash payment of the deferred income tax liability.  Our NOL begins to expire in 2018.  Fatburger’s NOL begins to expire in 2004 andis generally subject to an annual limitation under the Internal Revenue Code of1986, Section 382, Limitation on Net Operating Loss Carryovers and CertainBuilt-In Losses Following Change in Control. In addition, to the extent the Fatburger NOL is utilized, therecognition of the related tax benefits would first reduce goodwill related toFatburger acquisition, then other non-current intangible assets related to thatacquisition, and then income tax expense in accordance with Statement onFinancial Accounting Standards No. 109, Accounting for Income Taxes.

 

30

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UnitedStates tax regulations impose limitations on the use of NOL carry forwardsfollowing certain changes in ownership. If such a change were to occur with respect to the Company, thelimitation could significantly reduce the amount of benefits that would beavailable to offset future taxable income each year, starting with the year ofownership change.  To reduce thelikelihood of such ownership changes, we established a Shareholder Rights Plandated as of October 18, 2002, which discourages, under certaincircumstances, ownership changes which would trigger the NOL limitations.

 

STOCKHOLDERS’EQUITY.  Stockholders’ equity decreasedby approximately $11.0 million resulting primarily from our net loss of $4.9million, purchase of treasury stock of $1.7 million, the purchase of a calloption on the Company’s stock of $0.6 million and dividends declared of $3.3million.

 

In April 2004we purchased 330,500 shares of our common stock from a stockholder.  The purchase price was $5.40 per share andthe shares were placed in treasury.

 

In April 2004we purchased a three year call option (the “Call Option”) from Andrew A.Wiederhorn, the Company’s former Chairman and Chief Executive Officer andcurrent Chief Strategic Officer.  TheCall Option gives us the right, but not the obligation, to purchase 423,245 ofthe Company’s outstanding common stock (the “Option Shares”) from Mr.Wiederhorn for a purchase price of $3.99 per share.  The option may be exercised at any timeduring the three year option period.  We paid$750,000 ($1.77 per option share) for the Call Option.

 

## **LIQUIDITY AND CAPITAL RESOURCES**

 

Liquidityis a measurement of our ability to meet potential cash requirements, includingongoing commitments to repay borrowings, fund restaurant operations and otherbusinesses, engage in loan acquisition and lending activities, and for othergeneral business purposes.  The primarysources of funds for liquidity during the nine months ended September 30,2004, consisted of net cash provided by investing activities, includinginterest and principal payments related to our mortgage-backed securitiesportfolio, the sale of mortgage-backed securities and distributions from BourneEnd.  As of September 30, 2004, wehad cash and cash equivalents of $7.1 million, which we believe will besufficient to meet our current liquidity requirements.

 

Ourborrowings and the availability of further borrowings are substantiallyaffected by, among other things, changes in interest rates, or decreases incredit quality of our underlying assets. Fluctuations in interest rates will continue to impact our net interestincome to the extent our fixed rate assets are funded by variable rate debt orour variable rate assets reprice on a different schedule or in relation toa different index than any floating rate debt which in turn could impactpotential returns to shareholders.  Theimpact of borrowings on the Company has become less significant as it sold its mortgage-backedsecurities portfolio.

 

At September 30,2004, we had total consolidated secured indebtedness of $20.4 million, as wellas $18.7 million of other liabilities. The consolidated secured indebtednessconsisted of (i) $12.7 million outstanding of obligations under capital leasesmaturing between 2010 and 2040 which are primarily secured by real estate, (ii)long-term debt of Fatburger of $6.2 million secured by substantially all of theassets of Fatburger and (iii) borrowings secured by an apartment building inBarcelona, Spain in the amount of $1.5 million. None of this indebtedness had terms which allowed the lender to requestadditional collateral if the value of the underlying collateral declined.

 

If ourexisting liquidity position were to prove insufficient, and we were unable torepay, renew or replace maturing indebtedness on terms reasonably satisfactoryto us, we may be required to sell (potentially on short notice) a portion ofour assets, and could incur losses as a result. Also, Fatburger is involved in a nationwide expansion of franchise locations,which will require significant liquidity. If Fatburger or its franchisees are unsuccessful in obtaining creditlines sufficient to fund this expansion, the timing of restaurant openings maybe delayed.

 

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Historically,we have regularly sold assets as a normal, recurring part of ouroperations.  However, excluding the saleof assets from time to time, we would have been operating with negative cashflow, since many of our assets do not generate current cash flows sufficient tocover current operating expenses.  Webelieve that our existing sources of funds will be adequate for purposes ofmeeting our liquidity needs; however, there can be no assurance that this willbe the case.  Greater demands for liquidityat our operating subsidiaries, including Fatburger and our real estateoperations, or material decreases in monthly cash receipts, generally wouldnegatively impact our liquidity.  On theother hand, improvements in cash flow from our operating subsidiaries or realestate investments, or a decrease in operating expense would positively affectour liquidity.

 

Effective October 14, 2004, our Common Stock began trading in theover-the-counter (“OTC”) market on the OTC “pink sheets.”  Prior to that, our Common Stock was quoted onthe Nasdaq National Market.  On July 20, 2004, we were notifiedby Nasdaq of a staff determination to delist the Company’s Common Stockeffective July 29, 2004.  Wechallenged the staff determination and requested an oral hearing by a ListingQualifications Panel to review the staff’s conclusions.  A hearing was held on September 9, 2004,and, on October 12, 2004, we were notified by Nasdaq that the ListingQualifications Panel upheld the staff determination and the Company’s CommonStock was delisted from the Nasdaq National Market on October 14, 2004. We have requested a review of the Listing Qualifications Panel’sdecision by Nasdaq’s Listing and Hearing Review Council.

 

Trading of our Common Stock in the OTC pink sheets mayreduce the liquidity of the our Common Stock compared to quotation on theNasdaq National Market.  Also, the coverage of the Company by securityanalysts and media could be reduced, which could result in lower prices for theour Common Stock than might otherwise prevail and could also result inincreased spreads between the bid and ask prices for the our Common Stock.  Additionally, certain investors will notpurchase securities that are not quoted on the Nasdaq Stock Market, which couldmaterially impair our ability to raise funds through the issuance of CommonStock or other securities convertible into Common Stock.

 

Inaddition, if the trading price of the our Common Stock is less than $5.00 pershare, trading in our Common Stock could also be subject to the requirements ofRule 15g-9 promulgated under the Securities Exchange Act of 1934, asamended.  Under that Rule, brokers anddealers who recommend such low priced securities to persons other thanestablished customers and accredited investors must satisfy special salespractice requirements, including a requirement that they make an individualizedwritten suitability determination for the purchaser and receive the purchaser’swritten consent prior to any transaction. The Securities Enforcement Remedies and Penny Stock Reform Act of 1990also requires additional disclosure in connection with any trades involving astock defined as a penny stock (generally, according to regulations adopted bythe SEC, any equity security not traded on an exchange or quoted on Nasdaq thathas a market price of less than $5.00 per share, subject to certainexceptions), including the delivery, prior to any penny stock transaction, of adisclosure schedule explaining the penny stock market and the risksassociated therewith.  Such requirementscould severely limit the market liquidity of our Common Stock.  There can be no assurance that our CommonStock will not become treated as penny stock.

 

## **CONTRACTUAL OBLIGATIONS**

 

Since December 31,2004, our expected payments under contractual obligations decreased materiallydue primarily to the repayment of $25.3 million of short-term repurchaseagreements upon the sale of mortgage-backed securities.  Additionally, Fatburger refinancedapproximately $5.4 million in debt, which reduced the interest rate andlengthened the maturity of the debt.  Thefollowing table provides information on the amounts of payments due undercontractual obligations as of September 30, 2004 (dollars in thousands):

 

32

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| ** **                                        | ** ** | **Payments due by Period** | ** ** |
|---------------------------------------------------|------------|----------------------------|------------|
| **Contractual obligations:**                      | ** ** | **Total**                  | ** ** | **Less than 1  year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than 5  years** | ** ** |
| Borrowings and notes payable                      |       | $                          | 7,699      |   | $ | 371 |   | $ | 2,510 |   | $ | 826 |   | $ | 3,992 |   |
| Interest payments on borrowings and notes payable |       | 3,212                      |       | 312 |   | 613 |   | 539 |   | 1,748 |   |
| Obligations under capital leases (1)              |       | 35,085                     |       | 1,683 |   | 3,344 |   | 3,190 |   | 26,868 |   |
| Obligations under operating leases                |       | 12,227                     |       | 2,812 |   | 4,382 |   | 2,043 |   | 2,990 |   |
| Obligations under employment contracts            |       | 2,726                      |       | 2,463 |   | 263 |   | — |   | — |   |
| Purchase obligations (2)                          |       | 447                        |       | 447 |   | — |   | — |   | — |   |
| Total                                             |       | $                          | 61,396     |   | $ | 8,088 |   | $ | 11,112 |   | $ | 6,598 |   | $ | 35,598 |   |

 

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(1)   Theamount of imputed interest to reduce the minimum capital lease payments topresent value is $22.4 million using an effective interest rate of 8.5%.

(2)   Asof September 30, 2004, Fatburger was under contract to purchaseadvertising for $0.4 million.

 

**OFFBALANCE SHEET ARRANGEMENTS**

 

Inorder to facilitate the development of franchise locations, as of September 30,2004, Fatburger had guaranteed the annual minimum lease payments of threerestaurant sites owned and operated by franchisees.  The amount of the guarantees approximate $1.9million plus certain contingent rental payments as defined in the respectiveleases.  These leases expire at varioustimes though 2008.

 

We didnot have any other off balance sheet arrangements in place as of September 30,2004.

 

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## **ITEM 3.  QUANTITATIVE AND**QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Marketrisk is the exposure to loss resulting from changes in interest rates, foreigncurrency exchange rates, commodity prices, and equity prices.  We have some exposure to foreign currencyfluctuations (approximately 15% of the Company’s equity is invested in assetslocated in Europe at September 30, 2004).

 

Withthe sale of substantially all of our mortgage-backed securities, our exposureto interest rate risk has been significantly reduced.  However, we continue to face interest raterisk, primarily in our special situation loan portfolio.  This type of risk is highly sensitive to manyfactors beyond our control, including governmental monetary and tax policies,domestic and international economic and political considerations, and otherfactors.  Changes in the general level ofinterest rates can affect our net interest income by affecting the spreadbetween our interest-earning assets and our interest-bearing liabilities.  Changes in the level of interest rates canalso affect, among other things, the value of our interest-earning assets andour ability to acquire loans.  Our realestate and restaurant operations are primarily funded by fixed rate debt orequity.  As demonstrated in the tablesbelow, we believe that a modest increase in interest rates will not have asignificant effect on our profitability or equity value.

 

It isour objective to attempt to control risks associated with interest ratemovements.  In general, our strategy isto limit our exposure to earnings variations and variations in the value ofassets and liabilities as interest rates change over time.  Our asset and liability management strategyis formulated and monitored regularly to review, among other things, thesensitivity of our assets and liabilities to interest rate changes, the bookand market values of assets and liabilities, unrealized gains and losses,including those attributable to hedging transactions, purchase andsecuritization activity, and maturities of investments and borrowings.

 

The following tablequantifies the potential changes in net interest income and net portfolio valueas of September 30, 2004 should interest rates go up or down (shocked) by100 or 200 basis points, assuming the yield curves of the rate shocks will beparallel to each other and instantaneous. Net portfolio value is calculated asthe sum of the value of off-balance sheet instruments and the present value ofcash in-flows generated from interest-earning assets net of cash out-flows inrespect of interest-bearing liabilities. The cash flows associated with theloan portfolios and securities available for sale are calculated based onprepayment and default rates that vary by asset but not by changes in interestrates. Projected losses, as well as prepayments, are generated based upon theactual experience with the subject pool, as well as similar, more seasonedpools. To the extent available, loan characteristics such as loan-to-valueratio, interest rate, credit history and product types are used to produce theprojected loss and prepayment assumptions that are included in the cash flowprojections of the securities.  Thefollowing table applies the U.S. Treasury yield curve generally for assets andLIBOR for repurchase agreement liabilities and assume a uniform change in bothrates.  The table assumes that changes ininterest rates occur instantaneously. Actual results could differ significantly from those estimated in thetable.

 
| **Projected Percent Change In**   | ** ** |
|-----------------------------------|------------|
| **Change in Interest  Rates (1)** | ** ** | **Net Interest  Income** | ** ** | **Net Portfolio  Value** | ** ** | **Change in Annual   Net  Interest Income** | ** ** | **Change in Net  Portfolio  Value** | ** ** |
| -200 Basis Points                 |       | -5.1 | % | -4.0 | % | $ | (72,000 | ) | $ | (1,369,000 | ) |
| -100 Basis Points                 |       | -4.4 | % | -1.9 | % | $ | (63,000 | ) | $ | (654,000 | ) |
| 0 Basis Points                    |       | 0.0 | % | 0.0 | % | $ | — |   | $ | — |   |
| 100 Basis Points                  |       | 5.7 | % | 1.8 | % | $ | 81,000 |   | $ | 600,000 |   |
| 200 Basis Points                  |       | 11.3 | % | 3.4 | % | $ | 161,000 |   | $ | 1,149,000 |   |

 

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(1)           Assumesthat uniform changes occur instantaneously in both the yield on 10-year U.S.Treasury notes and the interest rate applicable to U.S.  dollar deposits in the London interbank market.

 

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The following table sets forth information as to thetype of funding used to finance the Company’s assets as of September 30,2004.  As indicated in the table, a largepercentage of the Company’s fixed-rate assets are currently not financed andthe Company’s variable-rate assets are generally funded by variable-rateliabilities.

 

Assets and Liabilities

As of September 30, 2004

(dollars in thousands)

 
| ** **                               | ** ** | **Basis Amount** | ** ** | **Coupon Type** | ** ** | **Liability** | ** ** | **Type**   | ** ** |
|------------------------------------------|------------|------------------|------------|-----------------|------------|---------------|------------|------------|------------|
| Interest-Bearing  Assets                 | ** ** | ** **       | ** ** | ** **      | ** ** | ** **    | ** ** | ** ** | ** ** |
| ** **                               | ** ** | ** **       | ** ** | ** **      | ** ** | ** **    | ** ** | ** ** | ** ** |
| Fixed-rate asset, financed floating      |       | $                | —     |            | Fixed      |          | $          | —     |       | LIBOR |   |
| Fixed-rate assets, no financing          |       | 12,427           |       | Fixed           |       | —        |       | None       |       |
| Variable-rate, financed variable         |       | —           |       | 1 TCM (1)       |       | —        |       | LIBOR      |       |
| Variable-rate assets, no financing       |       | 975              |       | Prime           |       | —        |       | None       |       |
| Cash and cash equivalents                |       | 7,103            |       | N/A             |       | —        |       | None       |       |
| Subtotal                                 |       | 20,505           |       |            |       | —        |       |       |       |
|                                     |       |             |       |            |       |          |       |       |       |
| Other Assets                             |       |             |       |            |       |          |       |       |       |
|                                     |       |             |       |            |       |          |       |       |       |
| Investments in real estate               |       | 28,009           |       | N/A             |       | 14,151        |       | Fixed      |       |
| Investment in BEP                        |       | 1,969            |       | N/A             |       | —        |       | None       |       |
| Restaurant property, plant and equipment |       | 6,036            |       | N/A             |       | 6,232         |       | Fixed      |       |
| Intangible assets, net                   |       | 5,456            |       | N/A             |       | —        |       | None       |       |
| Goodwill                                 |       | 7,541            |       | N/A             |       | —        |       | None       |       |
| Other                                    |       | 3,960            |       | N/A             |       | —        |       | None       |       |
| Subtotal                                 |       | 52,971           |       |            |       | 20,383        |       |       |       |
|                                     |       |             |       |            |       |          |       |       |       |
| Liability Only                           |       |             |       |            |       |          |       |       |       |
|                                     |       |             |       |            |       |          |       |       |       |
| Deferred income                          |       | —           |       |            |       | 4,426         |       | None       |       |
| Deferred income taxes                    |       | —           |       |            |       | 5,880         |       | None       |       |
| Other                                    |       | —           |       |            |       | 8,417         |       | None       |       |
| Total                                    |       | $                | 73,476     |            |       |          | $          | 39,106     |       |   |   |

 

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(1)   1 TCM means theone year Treasury Constant Maturity Index.

 

Assetand liability management involves managing the timing and magnitude of therepricing of assets and liabilities.  Itis our objective to attempt to control risks associated with interest ratemovements.  Asset and liabilitymanagement can utilize a wide variety of off-balance sheet financial techniquesto assist it in the management of interest rate risk.  For example, in hedging the interest rate andexchange rate exposure of a foreign currency denominated asset or liability, wemay enter into hedge transactions to counter movements in the differentcurrencies as well as interest rates in those currencies.  These hedges may be in the form of currencyand interest rate swaps, options, and forwards, or combinations thereof.  No such interest rate techniques were in useas of September 30, 2004.

 

Methodsfor evaluating interest rate risk include an analysis of our interest ratesensitivity “gap,” which is defined as the difference between interest-earningassets and interest-bearing liabilities maturing or repricing within a giventime period.  A gap is consideredpositive when the amount of interest-rate sensitive assets exceeds the amountof interest-rate sensitive liabilities. A gap is considered negative when the amount of interest-rate sensitiveliabilities exceeds interest-rate sensitive assets.  During a period of rising interest rates, anegative gap would tend to adversely affect net interest income, while apositive gap would tend to result in an increase in net interest income.  During a period of falling interest rates, anegative gap would tend to result in an increase in net interest income, whilea positive gap would tend to affect net interest income adversely.  Since different types of assets andliabilities with the same or similar maturities may react differently tochanges in overall market rates or conditions, changes in interest rates mayaffect net interest income positively or negatively even if an institution wereperfectly matched in each maturity category.

 

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Thefollowing table sets forth the estimated contractual maturity or repricing ofour interest-earning assets and interest-bearing liabilities at September 30,2004.

 

As of September 30,2004

(dollars in thousands)

 
| ** **                                                                               | ** ** | **Within  3 Months** | ** ** | **4 to 12  Months** | ** ** | **One Year to  3 Years** | ** ** | **More than  3 Years** | ** ** | **TOTAL** | ** ** |
|------------------------------------------------------------------------------------------|------------|----------------------|------------|---------------------|------------|--------------------------|------------|------------------------|------------|-----------|------------|
| Interest-sensitive assets(1):                                                            |       |                 |       |                |       |                     |       |                   |       |      |       |
| Cash and cash equivalents                                                                |       | $                    | 7,103      |                | $          | —                   |       | $                      | —     |      | $          | — |   | $ | 7,103 |   |
| Securities available for sale                                                            |       | —               |       | —              |       | —                   |       | 10                     |       | 10        |       |
| Loans                                                                                    |       | 2,711                |       | 862                 |       | 6,844                    |       | —                 |       | 10,417    |       |
| Loans to senior executives                                                               |       | —               |       | 975                 |       | —                   |       | 2,000                  |       | 2,975     |       |
| Total rate-sensitive assets                                                              |       | $                    | 9,814      |                | $          | 1,837                    |       | $                      | 6,844      |      | $          | 2,010 |   | $ | 20,505 |   |
|                                                                                     |       |                 |       |                |       |                     |       |                   |       |      |       |
| Interest-sensitive liabilities :                                                         |       |                 |       |                |       |                     |       |                   |       |      |       |
| Borrowings and notes payable                                                             |       | $                    | 5,650      |                | $          | 1,467                    |       | $                      | —     |      | 582        |   | $ | 7,699 |   |
| Obligations under capital leases                                                         |       | 126                  |       | 378                 |       | 1,008                    |       | 11,172                 |       | 12,684    |       |
| Total rate-sensitive liabilities                                                         |       | $                    | 5,776      |                | $          | 1,845                    |       | $                      | 1,008      |      | $          | 11,754 |   | $ | 20,383 |   |
| Interest rate sensitivity gap                                                            |       | 4,038                |       | (8                  | )          | 5,836                    |       | (9,744                 | )          |      |       |
| Cumulative interest rate sensitivity gap                                                 |       | 4,038                |       | 4.030               |       | 9,866                    |       | 122                    |       |      |       |
| Cumulative interest rate sensitivity gap as a  percentage of total rate-sensitive assets |       | 20                   | %          | 20                  | %          | 48                       | %          | 1                      | %          |      |       |

 

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(1)   Real estateproperty holdings are not considered interest rate sensitive.

 

**ITEM 4. CONTROLS****AND PROCEDURES**

 

**(A)  Evaluation of disclosurecontrols and procedures**.  Our Chief Executive Officer and our ChiefFinancial Officer, after evaluating the effectiveness of the Company’s “disclosurecontrols and procedures” (as defined in the Securities and Exchange Act of 1934Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by thisreport, have concluded that our disclosure controls and procedures wereadequate and designed to ensure that material information relating to us andour consolidated subsidiaries would be made known to us by others within theseentities.

 

**(B)  Changes in internal control over financialreporting**.  There wereno significant changes in our internal control over financial reporting thatoccurred during our third fiscal quarter of 2004 that have materially affectedor are reasonably likely to materially affect our internal control overfinancial reporting.

 

**(C)  Reportable Conditions – Fatburger.** Prior to our acquisition of Fatburger, theindependent auditors, Ernst & Young LLP, determined that Fatburger hadsignificant deficiencies in internal control which may affect its ability torecord, process, summarize and report financial data.  While not constituting a material weakness,as of September 30, 2004, the deficiencies had not been fully resolved byFatburger.  The issues were as follows:

 

•      A lack of sufficientresources in the accounting department to handle the day-to-day transactionsand record all adjustments for the financial statements.

•      A lack of sufficientcontrols over the information reported to Fatburger from the franchisees, whichmay result in a misstatement of royalty income.

 

Subsequentto our acquisition, Fatburger hired highly qualified individuals to serve aschief financial officer and as corporate controller.  Additional accounting staff positions havealso been filled.  The management ofFatburger is in the process of testing and implementing an integrated point ofsale information system which will provide the basis for controls relating tothe information from all restaurants, including franchisee operatedlocations.  The Company believes thatboth of the reportable conditions will be resolved in the near future.

 

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FORWARD-LOOKINGSTATEMENTS

 

CERTAIN STATEMENTSCONTAINED HEREIN AND CERTAIN STATEMENTS CONTAINED IN FUTURE FILINGS BY THECOMPANY WITH THE SEC MAY NOT BE BASED ON HISTORICAL FACTS AND ARE “FORWARD-LOOKINGSTATEMENTS” WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934,AS AMENDED.  FORWARD-LOOKING STATEMENTSWHICH ARE BASED ON VARIOUS ASSUMPTIONS (SOME OF WHICH ARE BEYOND THE COMPANY’SCONTROL) MAY BE IDENTIFIED BY REFERENCE TO A FUTURE PERIOD OR PERIODS, OR BYTHE USE OF FORWARD-LOOKING TERMINOLOGY, SUCH AS “MAY,” “WILL,” “BELIEVE,” “EXPECT,”“ANTICIPATE,” “CONTINUE,” OR SIMILAR TERMS OR VARIATIONS ON THOSE TERMS, OR THENEGATIVE OF THOSE TERMS.  ACTUAL RESULTSCOULD DIFFER MATERIALLY FROM THOSE SET FORTH IN FORWARD-LOOKING STATEMENTS DUETO A VARIETY OF FACTORS, INCLUDING, BUT NOT LIMITED TO, THOSE RELATED TO THEECONOMIC ENVIRONMENT, PARTICULARLY IN THE MARKET AREAS IN WHICH THE COMPANYOPERATES, THE FINANCIAL AND SECURITIES MARKETS AND THE AVAILABILITY OF ANDCOSTS ASSOCIATED WITH SOURCES OF LIQUIDITY, COMPETITIVE PRODUCTS AND PRICING,THE REAL ESTATE MARKET, FISCAL AND MONETARY POLICIES OF THE U.S. GOVERNMENT,CHANGES IN PREVAILING INTEREST RATES, ACQUISITIONS AND THE INTEGRATION OFACQUIRED BUSINESSES, PERFORMANCE OF RETAIL/CONSUMER MARKETS, DETERIORATION INCONSUMER CREDIT, CREDIT RISK MANAGEMENT, ASSET/LIABILITY MANAGEMENT, THE IMPACTOF ONGOING LITIGATION, AND THE IMPACT OF THE SETTLEMENT OF THE INVESTIGATION OFTHE COMPANY’S CHIEF EXECUTIVE OFFICER. EXCEPT AS MAY BE REQUIRED BY LAW, THE COMPANY DOES NOT UNDERTAKE, ANDSPECIFICALLY DISCLAIMS ANY OBLIGATION, TO PUBLICLY RELEASE THE RESULTS OF ANYREVISIONS WHICH MAY BE MADE TO ANY FORWARD-LOOKING STATEMENTS TO REFLECT THEOCCURRENCE OF ANTICIPATED OR UNANTICIPATED EVENTS OR CIRCUMSTANCES AFTER THEDATE OF SUCH STATEMENTS.

 

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## **PART II — OTHER**INFORMATION

 

**Item 1.**    Legal Proceedings.

 

Capital ConsultantsLLC

 

As theCompany has previously disclosed, the Company’s former Chief Executive Officerand current Chief Strategic Officer, Andrew Wiederhorn, and former President,Lawrence Mendelsohn, received letters from the United States Attorney’s Office forthe District of Oregon (“USAODO”) in March 2001 advising them that theywere targets of a grand jury investigation (the “CCL Investigation”) into thefailure of Capital Consultants, L.L.C (“CCL”). CCL was a lender to Wilshire Credit Corporation (“WCC”) and related andaffiliated companies. WCC was a mortgage loan servicing company owned by Mr.Wiederhorn and Mr. Mendelsohn that provided mortgage loan servicing forWilshire Financial Services Group Inc., a public company for which Mr.Wiederhorn acted as CEO and Mr. Mendelsohn acted as President and which wasprincipally engaged in banking, loan pool purchasing, and investing inmortgage-backed securities.  As a resultof the liquidity crisis in the financial markets in the fall of 1998, WilshireFinancial Services Group Inc. experienced significant losses and filed forbankruptcy, which in turn had a significant impact on its affiliates, includingWCC, which could not repay the amounts borrowed from CCL.  At the time, Wilshire Financial ServicesGroup Inc. owned approximately 8.6% of the Company’s common stock and managedthe Company’s investments under a management agreement.

 

In August 2002,Mr. Mendelsohn resigned as President and Director of the Company. In November 2003,Mr. Mendelsohn entered into an agreement with the USAODO pursuant to which hepled guilty to filing a false 1998 personal tax return and agreed to cooperatein the CCL Investigation.

 

On June 3,2004 the Company announced that Chief Executive Officer and Chairman of theBoard Andrew Wiederhorn had entered into a settlement with the USAODO regardingits investigation into CCL (the “Settlement”) and would take a leave of absencefrom his corporate positions at the Company.

 

Underthe Settlement’s terms, Mr. Wiederhorn pled guilty on June 3, 2004 to twofederal counts and was sentenced to 18 months incarceration and fined $2.0million.  The first count, a violation ofan ERISA provision, involved a federal law that required no criminal intent andfor which his reliance on the advice of counsel was not a defense. The secondcount related to a violation involving a deduction on a personal tax return.  The deduction was structured and approved byMr. Wiederhorn’s tax advisors and did not reduce Mr. Wiederhorn’s tax liabilityor reduce the government’s tax collections. The charges to which Mr. Wiederhorn has pled guilty pursuant to theSettlement are not based upon any acts or omission of the Company or of Mr.Wiederhorn in his capacity as an officer or director of the Company.

 

Inentering into Mr. Wiederhorn’s leave of absence agreement, the Board ofDirectors considered the nature of the statutes to which Mr. Wiederhorn pledand the fact that he relied on the advice of expert legal counsel and anational accounting firm.  The Board alsobelieved it was important to assure Mr. Wiederhorn’s return to activeinvolvement with the Company because of his expertise and knowledge and topreserve a significant business relationship and the value of the Company’sinvestments.

 

Under the terms of the leave of absence agreement, Mr. Wiederhorn willcontinue to receive his regular salary and bonus pursuant to and as set forthin his employment agreement.  Inaddition, in consideration of Mr. Wiederhorn’s good will, cooperation, andcontinuing assistance, and in recognition of Mr. Wiederhorn’s past service tothe Company, to help avoid litigation and for the other reasons stated in theagreement, the Company made a leave of absence payment to Mr. Wiederhorn in theamount of $2.0 million on June 2, 2004.

 

To address the management transition, the Company appointed DonaldBerchtold as Co-Chief Executive Officer in June 2004.  Mr. Berchtold has been Senior Vice Presidentof Administration at Fog Cutter Capital since October 1999 and became adirector in March 2004.  Hecurrently sits on the board of directors of Fatburger and has more than 25years experience in the restaurant business. Mr. Berchtold is the father-in-law of Mr. Wiederhorn.  In order to further assist the transition,David Dale-Johnson and Don Coleman will serve as co-Chairmen of the Board.  Both Mr. Dale-Johnson and Mr. Coleman havebeen

 

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directorsof the Company since October 2001.  Mr. Dale-Johnson was the Director of the RealEstate program at USC’s Marshall School of Business and has significantexpertise in real estate, economics and finance.** **Mr. Coleman hasheld prominent executive operating positions in several major companies and iscurrently the Chief Operating Officer of Eagle Telephonic Inc.  The Company also appointed Mr. Dale-Johnsonas Chief Investment Officer, adding a new, full-time position to the Fog CutterCapital management team.

 

Mr.Wiederhorn began his leave of absence on August 2, 2004 and is expected toremain in that status for a period of 14 to 18 months.  On August 13, 2004, the Board ofDirectors adopted a resolution changing the role of Andrew Wiederhorn fromCo-Chief Executive to Chief Strategic Officer during the leave of absenceperiod.  The Board had discussed thisalternative with Mr. Wiederhorn prior to the effective date of his leave of absence.  The Board determined that during the leave ofabsence period, Mr. Wiederhorn would be in a better position to develop strategies that wouldbe of future benefit to the Company, while his current status wouldsignificantly limit his ability to perform the full functions of Co-ChiefExecutive Officer.  All other provisionsof the Leave of Absence Agreement and employment agreement with Mr. Wiederhornremain in force.  Donald J. Berchtoldwill continue as sole Chief Executive Officer and will serve as the principalexecutive of the Company.

 

Mr.Wiederhorn and Mr. Mendelsohn, pursuant to the terms of their respectiveemployment agreements, may have been entitled to indemnity from the Company forlitigation expenses and personal losses in connection with the CCLinvestigations and any related litigation. Messrs. Wiederhorn and Mendelsohn had notified the Company that,although they believed they were entitled to primary indemnification from othersources, they were reserving their rights to seek indemnity from theCompany.  The Company did not agree toany indemnity requests.  Mr. Wiederhornreleased the Company from any and all claims he may have had relating to theCCL matter as partial consideration for the leave of absence agreement in June 2004.  The USAODO has settled the CCL matter as itrelates to both Mr. Wiederhorn and Mr. Mendelsohn.  As a result, the Company believes that thecontingencies relating to the potential indemnification of these officers orformer officers have now been resolved.

 

Nasdaq Delisting

 

Effective October 14, 2004, the Company’s Common Stock began trading in theover-the-counter market on the OTC “pink sheets.”  Prior to that, the Company’s Common Stock wasquoted on the Nasdaq National Market.  On July 20, 2004, the Company wasnotified by Nasdaq of a staff determination to delist the Company’s CommonStock effective July 29, 2004.  TheCompany challenged the staff determination and requested an oral hearing by aListing Qualifications Panel to review the staff’s conclusions.  A hearing was held on September 9, 2004,and, on October 12, 2004, the Company was notified by Nasdaq that the ListingQualifications Panel upheld the staff determination and the Company’s CommonStock was delisted from the Nasdaq National Market on October 14, 2004. The Company has requested a review of the Listing Qualifications Panel’sdecision by Nasdaq’s Listing and Hearing Review Council.  There can be noassurance that the Company’s appeal will be successful.

 

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Derivative Action

 

On July 6,2004, Jeff Allen McCoon, derivatively on behalf of the Company, filed a lawsuitin the Circuit Court for the State of Oregon (Multnomah County Case No.0407-06900) which named the Company and all of its directors as defendants.  The lawsuit alleges that members of theCompany’s Board of Directors breached their duties to the Company by enteringinto the leave of absence agreement with Andrew Wiederhorn.  The lawsuitgenerally seeks restitution of payments made under the leave of absenceagreement plus attorney fees and costs.  The individual defendants haveindemnity agreements with the Company and have asserted the right to indemnificationfrom the Company under those indemnity agreements. This case is in the veryearly pleading stages and motions are pending against the complaint. TheCompany may incur expenses under the indemnity agreements and also may derivebenefits if the plaintiff’s claims are successful. At this stage of the case,it is too early to predict the outcome with any certainty. The complaint is notspecific as to the amount of damages it is seeking against the individualdefendants, but it appears to seek at least the return of $2 million paid toMr. Wiederhorn under the Leave of Absence Agreement.

 

StroudsAcquisition Corporation

 

On October 6, 2003, the OfficialCommittee of Unsecured Creditors of Strouds Acquisition Corporation (“Strouds”)filed a lawsuit in the United States Bankruptcy Court (LA 03-23620-ER) whichnamed the Company, among others, as a defendant.  The lawsuit was amended on November 10,2003 and limits the complaint against the Company solely in its capacity ascollateral agent for certain secured creditors of Strouds AcquisitionCorporation.  The lawsuit, as it pertainsto the Company, sought reimbursement of the proceeds from approximately $3.0million in funds received in October 2003, which the Company was holdingas collateral agent for other secured creditors.  These funds were not included in the assetsof the Company, but were being held in trust. On July 1, 2004, the lawsuit was settled and the Companydistributed the trust funds, net of legal reimbursements of $0.3 million, inaccordance with the settlement agreement. The Company received a general release from the parties and considersthe matter closed.

 

George ElkinsMortgage Banking Company

 

On August 11,2004 the Company received a notice from the Class B Holders of Fog Cap GEMBHoldings LLC (“Holdings”), a 51% owned subsidiary of the Company which ownstrade names and certain assets relating to the operation of George ElkinsMortgage Banking Company.  The notice wasto inform the Company that the Class B Holders believe that a Change in ControlTransaction (as defined in the Holdings Operating Agreement) has occurred as aresult of the leave of absence of Mr. Wiederhorn.  The notice alsoindicates that unless the Change in Control Transaction is corrected within 120days, the Class B Holders intend to exercise their rights to purchase the ClassA Interests held by the Company in accordance with the formula outlined in theOperating Agreement.

 

TheCompany disputes the claim that a Change in Control Transaction has occurred asa result of the leave of absence agreement with Mr. Wiederhorn.  The Company believes that the market value ofits investment is greater than the amount of the buyback formula and intends tovigorously defend against these claims.  However,if the Company was unsuccessful in defending this position, an analysis of theeconomic effect of the buyback formula indicates that the Company would notincur a loss on the transaction.  As aresult, no reserves are required due to the receipt of the notice.

 

TheCompany is involved in various other legal proceedings occurring in theordinary course of business which the Company believes will not have a materialadverse effect on the consolidated financial condition or operations of theCompany.

 

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**Item 2.**    UnregisteredSales of Equity Securities and Use ofProceeds.

 

None.

 

**Item 3.**    Defaults Upon SeniorSecurities.

 

Notapplicable.

 

**Item 4.**    Submission of Matters to aVote of Security Holders.

 

None

** **

**Item 5.**    Other Information.

 

# **TRANSACTIONS WITH AFFILIATES**

 

**StockPurchase Loans to Officers**

 

Priorto the passage of the Sarbanes-Oxley Act of 2002, we had negotiated employmentagreements with senior executives, which allowed these executives to borrow aspecified maximum amount from us to purchase shares of common stock.  These loans are full recourse, secured loansbearing interest at the prime rate.  At September 30,2004, in addition to the $2 million loan to Mr. Wiederhorn described below, we had outstanding stock purchase loans to Mr.Wiederhorn including accrued interest, of approximately $1.0 million.  The Company is not obligated to makeadditional advances on loans under the employment agreements, and all otherloans to executive officers have been paid in full.  The remaining outstanding loans are describedin the following section and as follows:

 

On February 21,2002, we loaned Mr. Wiederhorn $175,000 to finance the purchase of commonstock.  This loan is fully recourse toMr. Wiederhorn and is secured by all of Mr. Wiederhorn’s rights under hisemployment agreement.  We are entitled tonet amounts payable under the employment agreement against any amounts payableby Mr. Wiederhorn upon any default or at maturity of the loan.  At Mr. Wiederhorn’s direction (in accordancewith the terms of his employment agreement), on February 21, 2002, weloaned a limited partnership controlled by Mr. Wiederhorn’s spouse (the “LP”)$687,000 to finance the purchase of common stock.  The loan is secured by the membershipinterests of two limited liability companies owned by the LP.  The limited liability companies each own aparcel of real property in Oregon and have no liabilities.  At the time of the loan, the real propertyhad an appraised value of $725,000.  Theloan is also guaranteed by Mr. Wiederhorn. The common stock purchased with the proceeds of these loans does notserve as security for the loans.  Theloans are due on February 21, 2007, and bear interest at the prime rate,as published in the Wall Street Journal, which interest is added to theprincipal annually.

 

Furtherinformation on these loans to Mr. Wiederhorn is included in our annual proxystatement for 2003 and prior years and Mr. Wiederhorn’s employment agreementhas been previously filed with the SEC.

 

# **Loan to Executive Officer**

 

Priorto the passage of the Sarbanes-Oxley Act of 2002, we had loaned Mr. Wiederhorn$2.0 million.  This loan is fullyrecourse to Mr. Wiederhorn and is secured by trust deeds on two residenceslocated in Oregon.  The loan is due on August 1,2007 and bears interest at 8.5% per annum, payable monthly.  The Board of Directors (with Mr. Wiederhornabstaining) concluded that the terms of the loan were at least as favorable tothe Company as would be available in an arms length, third party transactionand approved the loan on July 9, 2002.

 

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**FogCutter Long-Term Vesting Trust**

 

In thefourth quarter of 2000, we established a trust which purchased 525,000 sharesof the Company’s common stock from an unrelated shareholder.  Our contribution to the trust ofapproximately $1.3 million was included in compensation expense for the yearended December 31, 2000.  The trustwas established for the benefit of our employees and directors to raise theirownership in the Company, thereby strengthening the mutuality of interestsbetween them and our shareholders.  Whilethese shares are held in trust, they will be voted ratably with ballots cast byall other shareholders.  In December 2002,using the retained earnings on trust assets, the trust purchased an additional100,000 shares of our stock in the open market. In addition, during April 2004, the trust again used its retainedearnings and purchased 69,500 shares of the Company’s stock from a shareholder.

 

AndrewWiederhorn, K. Kenneth Kotler and Don H. Coleman are the trustees for thetrust.  Pursuant to the terms of thetrust, as amended, the trustees will, from time to time, allocate the shares toour employees.  An employee shall nothave any rights with respect to any shares allocated to him unless and untilthe employee completes five years of continuous service with the Company,commencing with the date the employee is first allocated such shares; provided,however, that such service need not be for a continuous period if so determinedby the Company and the Trustees.  Uponthe employee’s completion of the vesting period, the trustees shall promptlydistribute to such employee the shares allocated to such employee;  provided, however, that the trustees may, inlieu of distributing the shares, make a cash payment to the employee equal tothe fair market value of the shares allocated to such employee as of the dateimmediately prior to the date of distribution or distribute any combination ofcash or shares, as determined by the trustees, in their sole discretion.

 

Prior toSeptember 30, 2004, the trustees had allocated 285,500 shares to certainemployees and directors.  Of this amount,50,000 shares previously allocated to a former employee were forfeited.  During July 2004, the trustees allocatedan additional 367,500 shares to certain employees and directors.  As a result, 603,000 shares have beenallocated to employees and directors and 91,500 shares remain unallocated.

 

**BusinessUse of Private Aircraft**

 

Duringthe nine months ended September 30, 2004, the Company paid $0.4 million toPeninsula Capital Partners LLC (“Peninsula Capital”), an entity owned by Mr.Wiederhorn, for the Company’s business use of certain private aircraft.  The Board of Directors is aware of therelationship and approved the fees for the use of the aircraft.  The fee paid is a reimbursement of costs toPeninsula Capital for the Company’s use of the aircraft.

 

**StockPurchase**

 

On April 28,2004, the Company purchased 330,500 shares of its common stock from Clarence B.Coleman, who at the time was a greater than 10% stockholder.  The purchase price was $5.40 per share andthe shares were added to treasury stock. At the time of the purchase, the price represented a small premium tothe Company’s book value per share and market price per share. The Company andits directors considered, among other things, the following factors:  (1) the potentially negative impact on theCompany’s share price if the shares were disposed of publicly; (2) the Company’sfavorable liquidity position; (3) the potential reduction in the risk thatshares are transferred in a transaction which would have an adverse impact onits NOL position; and (4) the reduction in the future expenditure of cashdividends by the Company.  The Board ofDirectors reviewed and approved the transaction to confirm that the transactionwas in the best interest of the Company and its other stockholders.

 

**CallOption**

 

On April 27,2004, the Company purchased an option (the “Call Option”) to acquire 423,245shares of the Company’s Common Stock from Mr. Wiederhorn, the Company’s formerChief Executive Officer and current Chief Strategic Officer during a three yearperiod commencing April 27, 2004, for an exercise price of $3.99 pershare.  The purchase price for the CallOption was $750,000, resulting in an “all-in” cost to the

 

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Company on exercise ofapproximately $5.76 per share.  TheCompany and its directors believe that the Call Option gives the Company auseful option to acquire a large block of stock over an extended period.  The aggregate price to the Company onexercise of $5.76 per share represented a small premium to the Company’s bookvalue per share and market price per share at the time the option was purchased.  The price was determined based on arm’slength negotiations and the Company obtained internal and independent valuationsof the Call Option.  The Company and itsdirectors also considered the following factors:  (1) the potentially negative impact on theCompany’s share price if the Option Shares were disposed of publicly; (2) theCompany’s favorable liquidity position; (3) the potential reduction in the riskthat shares are transferred in a transaction which would have an adverse impacton its NOL position; and (4) the reduction in the future expenditure of cashdividends by the Company once the Company exercises the Call Option.  The Board of Directors reviewed thetransaction to confirm that the transaction was in the best interest of theCompany and its other stockholders.

 

**Leave ofAbsence Agreement**

 

On June 3,2004 the Company announced that former Chief Executive Officer and Chairman ofthe Board, current Chief Strategic Officer, Andrew Wiederhorn had entered intoa settlement with the USAODO regarding its investigation into CCL (the “Settlement”)and would take a leave of absence from his corporate positions at Fog CutterCapital.

 

Underthe Settlement’s terms, Mr. Wiederhorn pled guilty on June 2, 2004 to twofederal counts and was sentenced to 18 months incarceration and fined $2.0million.  The first count, a violation ofan ERISA provision, involved a federal law that required no criminal intent andfor which his reliance on the advice of counsel was not a defense.  The second count related to a violationinvolving a deduction on a personal tax return.  The deduction was structured and approved byMr. Wiederhorn’s tax advisors and did not reduce Mr. Wiederhorn’s tax liabilityor reduce the government’s tax collections. The charges to which Mr. Wiederhorn has pled guilty pursuant to theSettlement are not based upon any acts or omission of the Company or of  Mr. Wiederhorn in his capacity as an officeror director of the Company.

 

OnJune 2, 2004, the Company and Mr. Wiederhorn entered into a leave of absenceagreement.  In entering into Mr.Wiederhorn’s leave of absence agreement, the Board of Directors considered thenature of the statutes to which Mr. Wiederhorn pled and the fact that he reliedon the advice of expert legal counsel and a national accounting firm.  The Board also believed it was important toassure Mr. Wiederhorn’s return to active involvement with the Company becauseof his expertise and knowledge and to preserve a significant businessrelationship and the value of the Company’s investments.

 

Under the terms of the leave of absence agreement, Mr. Wiederhorn willcontinue to receive his regular salary and bonus pursuant to and as set forthin his employment agreement.  Inaddition, in consideration of Mr. Wiederhorn’s good will, cooperation, andcontinuing assistance, and in recognition of Mr. Wiederhorn’s past service tothe Company, to help avoid litigation and for the other reasons stated in theagreement, the Company made a leave of absence payment to Mr. Wiederhorn in theamount of $2.0 million on June 2, 2004.

 

**Item 6.****    Exhibits andReports****on Form 8-K.**

 

(a)   Reports onForm 8-K:

 

A Form8-K was filed with the Securities and Exchange Commission by the Company on July 23,2004 announcing that Ernst & Young LLP would resign as the Company’scertifying accountants following the completion of the Company’s Form 10-Q forthe six months ending June 30, 2004.

 

A Form8-K was filed with the Securities and Exchange Commission by the Company on August 13,2004 announcing the Nasdaq staff determination to de-list the Company from theNasdaq Stock Market.

 

A Form8-K was filed with the Securities and Exchange Commission by the Company on September 8,2004 announcing the appointment of UHY LLP as the Company’s certifying accountants.

 

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A Form 8-K was filed with the Securitiesand Exchange Commission by the Company on September 20, 2004 announcingthe annual meeting of the Company to be held on December 8, 2004.

 

A Form8-K was filed with the Securities and Exchange Commission by the Company on October 13,2004 announcing the decision of the Nasdaq listing panel to de-list the Companyfrom the Nasdaq Stock Market.

 

(b) Exhibits

 

See Exhibit Indeximmediately following the signature page and certifications.

 

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**SIGNATURES**

** **

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|   | FOG CUTTER  CAPITAL GROUP INC. |
|--------|--------------------------------|
|   |                           |
|   |                           | By: /s/ Donald J. Berchtold |   |
|   |                           | Donald J. Berchtold |
|   |                           | Chief Executive Officer |
|   |                           |   |
|   |                           |   |
|   |                           | By: /s/ R. Scott Stevenson |   |
|   |                           | R. Scott Stevenson |
|   |                           | Senior Vice President and Chief Financial Officer |

 

Date:  November 15, 2004

 

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**ExhibitIndex**

 

2.1           Purchaseand Sale Agreement between WREP Islands, Limited and The Aggmore LimitedPartnership, dated November 19, 2001, incorporated by reference to Exhibit2.1 to a Form 8-K dated November 19, 2001, as previously filed with theSEC on December 4, 2001.

 

2.2           LoanOption Agreement, by and between the Registrant and entities listed therein,dated January 1, 2002, incorporated by reference to Exhibit 2.1 to the Form8-K dated March 6, 2002, as previously filed with the SEC on March 8,2002.

 

2.3           PropertyOption Agreement, by and between the Registrant and the entities listedtherein, dated effective March 6, 2002, incorporated by reference toExhibit 2.2 to the Form 8-K dated March 6, 2002, as previously filed withthe SEC on March 8, 2002.

 

2.4           MediumTerm Participation Agreement by and among Fog Cap L.P. and participants listedtherein, dated March 6, 2002, incorporated by reference to Exhibit 2.3 tothe Form 8-K dated March 6, 2002, as previously filed with the SEC on March 8,2002.

 

2.5           InterimFinance and Stock Purchase Agreement, by and between the entities listedtherein and the Registrant, dated as of August 15, 2003, incorporated byreference to Exhibit 2.5 to the Form 10-Q for the period ended September 30,2003, as previously filed with the SEC on November 13, 2003.

 

2.6           FatburgerHoldings Inc. Preferred Stock Purchase Agreement, by and between the entitieslisted therein and the Registrant, dated as of January 12, 2004, incorporated by reference to Exhibit2.6 to the Form 10-K for the year ended December 31, 2003, as previouslyfiled with the SEC on March 19, 2004.

 

2.7           March 2004Supplemental Agreement, by and between Fatburger Holdings, Inc. and the Registrant,dated as of March 10, 2004, incorporated by reference to Exhibit 2.7 to the Form10-K for the year ended December 31, 2003, as previously filed with theSEC on March 19, 2004.

 

3.1           Amendedand Restated Articles of Incorporation of the Registrant, incorporated byreference to Exhibit 3.1 to the Form 10-Q for the period ended September 30,1999, as previously filed with the SEC on November 22, 1999.

 

3.2           Bylaws ofthe Registrant, incorporated by reference to Exhibit 3.2 to Amendment No. 3 tothe Registration Statement (Registration No. 333-39035) on Form S-11, aspreviously filed with the SEC on March 30, 1998.

 

4.1           CommonStock Certificate Specimen, incorporated by reference to Exhibit 4.1 toAmendment No. 3 to the Registration Statement (Registration No. 333-39035) onForm S-11, as previously filed with the SEC on March 30, 1998.

 

4.2           Form ofRegistration Rights Agreement, incorporated by reference to Exhibit 10.8 toAmendment No. 3 to the Registration Statement (Registration No. 333-39035) onForm S-11, as previously filed with the SEC on March 30, 1998.

 

4.3           Form ofStock Option Plan, incorporated by reference to Exhibit 10.3 to Amendment No. 3to the Registration Statement (Registration No. 333-39035) on Form S-11, aspreviously filed with the SEC on March 30, 1998.

 

4.4           Long TermVesting Trust Agreement among the Registrant and Lawrence Mendelsohn, AndrewWiederhorn and David Egelhoff, dated October 1, 2000, incorporated byreference to Exhibit 4.4

 

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to theForm 10-K for the year ended December 31, 2002, as previously filed withthe SEC on March 3, 2003.

 

4.5           Waiver,Release, Delegation and Amendment to Stock Option and Voting Agreement amongAndrew A. Wiederhorn, Lawrence A. Mendelsohn, Joyce Mendelsohn, TiffanyWiederhorn, and the Registrant, dated July 31, 2002, incorporated byreference to Exhibit 2.1 to the Form 8-K dated August 8, 2002, aspreviously filed with the SEC on August 15, 2002.

 

4.6           Summary ofRights to Purchase Shares, incorporated by reference to Exhibit 99.1 to theForm 8-K dated October 18, 2002, as previously filed with the SEC on October 18,2002.

 

4.7           RightsAgreement dated as of October 18, 2002 between the Registrant and The Bankof New York, incorporated by reference to Exhibit 1 to Form 8-A, as previouslyfiled with the SEC on October 29, 2002.

 

10.1         Deed ofTrust, by and among WREP Islands Limited, The Aggmore Limited Partnership andthe Registrant and Fog Cap L.P., dated November 19, 2001, incorporated byreference to Exhibit 2.2 to the Form 8-K dated November 19, 2001, aspreviously filed with the SEC on December 12, 2001.

 

10.2         Stock OptionAgreement, by and among individuals listed on Schedule 4 thereto, AggmoreLimited Partnership acting through its General Partner, Anglo Irish EquityLimited and the Registrant, dated November 19, 2001, incorporated byreference to Exhibit 2.3 to the Form 8-K dated November 19, 2001, aspreviously filed with the SEC on December 4, 2001.

 

10.3         Amended andrestated Employment Agreement between the Registrant and Andrew A. Wiederhorn,incorporated by reference to Exhibit 10.3 to the Form 8-K dated August 13,2003, as previously filed with the SEC on August 13, 2003.

 

10.4         Amended andrestated Employment Agreement, effective as of December 1, 2003, betweenthe Registrant and Robert G. Rosen, incorporated by reference to Exhibit 99.1to the Form 8-K as previously filed with the SEC on February 11, 2004.

 

10.5         EmploymentAgreement between the Registrant and R. Scott Stevenson dated as of September 30,2003, incorporated by reference to Exhibit 10.5 to the Form 8-K dated August 13,2003, as previously filed with the SEC on August 13, 2003.

 

10.6         Leave ofAbsence Agreement between the Registrant and Andrew A. Wiederhorn dated as of June 2,2004, incorporated by reference to Exhibit 10.1 to the Form 8-K dated June 4,2004, as previously filed with the SEC on June 4, 2004.

 

11.1         Computationof Per Share Earnings.

 

31.1         Certificationof Chief Executive Officer, pursuant to Section 302 of the Sarbanes-OxleyAct of 2002.

 

31.2         Certificationof Chief Financial Officer, pursuant to Section 302 of the Sarbanes-OxleyAct of 2002.

 

32.1         Certificationof the Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, asadopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

32.2         Certificationof the Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, asadopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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99.1         Letter,dated October 28, 1998, from Steven Kapiloff to Andrew Wiederhorn,incorporated by reference to Schedule 99.2 to the Form 10-Q for the periodended September 30, 1998, as previously filed with the SEC on November 23,1998.

 

99.2         Letter datedNovember 12, 1999 from Arthur Andersen LLP, incorporated by reference toExhibit 99.1 to the Form 8-K dated November 12, 1999, as previously filedwith the SEC on November 15, 1999.

 

99.3         SettlementAgreement, dated as of December 10, 1999 by and between the Registrant, onbehalf of itself and all of its subsidiaries and affiliates, Andrew A.Wiederhorn, and Lawrence A. Mendelsohn, and Wilshire Financial Services GroupInc., on behalf of itself and all of its subsidiaries and affiliates, otherthan First Bank of Beverly Hills, F.S.B., incorporated by reference to Exhibit99.1 to the Form 8-K dated December 13, 1999, as previously filed with theSEC on December 17, 1999.

 

99.4         Jordan D.Schnitzer Resignation Letter dated March 5, 2002, incorporated byreference to Exhibit 1.1 to the Form 8-K dated March 5, 2002, aspreviously filed with the SEC on March 7, 2002.

 

99.5         SettlementAgreement, incorporated by reference to Exhibit 99.1 to the Form 8-K dated May13, 2002, as previously filed with the SEC on May 14, 2002.

 

99.6         Lawrence A.Mendelsohn Resignation Letter dated August 30, 2002, incorporated byreference to Exhibit 1.1 to the Form 8-K dated August 30, 2002, as previously filed with the SEC on September 3,2002.

 

99.7         Robert G.Rosen Resignation Letter dated March 26, 2004, incorporated by referenceto Exhibit 99.1 to the Form 8-K dated April 1, 2004, as previously filedwith the SEC on April 1, 2004.

 

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