Table of Contents

 

#####  

 

##### **UNITED STATES SECURITIES ANDEXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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

####  

**(Markone)**

 
| **x**  | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**  |
|--------|------------|----------------------------------------------------------------------------------------------------------|
|   |       | ** **                                                                                               |
|   |       | **For  the quarterly period ended September 30, 2008**                                              |
|   |       |                                                                                                     |
| **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 registrant as 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 principal executive offices) (Zip Code)

** **

**(503) 721-6500**

(Registrant’s telephone number, including area code)

 

Indicateby check mark whether the registrant: (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports) and (2) has been subject tosuch filing requirements for the past 90 days.                                                       Yesx  Noo

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, a non-accelerated filer, or a smaller reportingcompany.  See definition of “acceleratedfiler”, “large accelerated filer”, and “smaller reporting company” in Rule 12b-2of the Exchange Act.  (Check one):

 

Large accelerated filer o            Accelerated filer o

Non-accelerated filer o (do not check if a smaller reportingcompany)        Smaller reporting companyx

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).    Yeso  Nox

 

**APPLICABLE ONLY TO CORPORATE ISSUERS:**

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date.

 
| **Class**                                 | ** ** | **Outstanding at October 31, 2008** |
|-------------------------------------------|------------|------------------------------------------|
| Common Stock, par value $0.0001 per share |       | 7,954,928 shares                         |

 

 

 

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Tableof Contents

 

FOG CUTTER CAPITAL GROUP INC.

 

FORM 10-Q

 

I N D E X

 
| ** **                                 | **Page No.**                                                                           |
|--------------------------------------------|---------------------------------------------------------------------------------------------|
| **PART I—FINANCIAL INFORMATION** |                                                                                        |
|                                       |                                                                                        |   |
| Item 1.                                    | Interim  Consolidated Financial Statements (Unaudited):                                     |   |
|                                       |                                                                                        |   |
|                                       | Consolidated Statements of Financial Condition                                              | 3 |
|                                       |                                                                                        |   |
|                                       | Consolidated Statements of Operations                                                       | 4 |
|                                       |                                                                                        |   |
|                                       | Consolidated Statement of Stockholders’ Equity  (Deficit)                              | 5 |
|                                       |                                                                                        |   |
|                                       | Consolidated Statements of Cash Flows                                                       | 6 |
|                                       |                                                                                        |   |
|                                       | Notes to Consolidated Financial Statements                                                  | 7 |
|                                       |                                                                                        |   |
| Item 2.                                    | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 15 |
|                                       |                                                                                        |   |
| Item 3.                                    | Quantitative  and Qualitative Disclosures about Market Risk                                 | 24 |
|                                       |                                                                                        |   |
| Item 4.                                    | Controls  and Procedures                                                                    | 24 |
|                                       |                                                                                        |   |
| **PART II—OTHER  INFORMATION**   |                                                                                        |
|                                       |                                                                                        |   |
| Item 1.                                    | Legal  Proceedings                                                                          | 26 |
|                                       |                                                                                        |   |
| Item 1A.                                   | Risk Factors                                                                                | 26 |
|                                       |                                                                                        |   |
| Item 2.                                    | Unregistered  Sales of Equity Securities and Use of Proceeds                                | 26 |
|                                       |                                                                                        |   |
| Item 3.                                    | Defaults  Upon Senior Securities                                                            | 26 |
|                                       |                                                                                        |   |
| Item 4.                                    | Submission  of Matters to a Vote of Security Holders                                        | 27 |
|                                       |                                                                                        |   |
| Item 5.                                    | Other  Information                                                                          | 27 |
|                                       |                                                                                        |   |
| Item 6.                                    | Exhibits                                                                                    | 27 |
|                                       |                                                                                        |   |
| Signatures                                 | 29                                                                                          |

 

Availableinformation

 

Ourwebsite is www.fogcutter.com.  We makeour annual report on Form 10-K, as well as other reports filed with theSecurities and Exchange Commission, available through our website as soon asreasonably practicable after they are filed. A copy of these reports may also be obtained by writing to us at 1410 SWJefferson Street, Portland, Oregon, 97201, Attn:  Investor Reporting.

 

2

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Tableof Contents

 

**PART I — FINANCIAL INFORMATION**

## **ITEM 1.  INTERIMCONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

FOG CUTTER CAPITAL GROUP INC.

CONSOLIDATED STATEMENTS OFFINANCIAL CONDITION

*(dollars in thousands, except share data)*

 
| ** **                                                                                                                                                                                                                                       | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                       | ** ** | **(unaudited)**              | ** ** | ** **                  | ** ** |
| Assets                                                                                                                                                                                                                                           |       |                         |       |                        |       |
| Current Assets:                                                                                                                                                                                                                                  |       |                         |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                                                                        |       | $                            | 911        |                        | $          | 1,131 |   |
| Accounts receivable                                                                                                                                                                                                                              |       | 1,838                        |       | 1,479                       |       |
| Notes receivable, current portion                                                                                                                                                                                                                |       | 20                           |       | 566                         |       |
| Loans to senior executives                                                                                                                                                                                                                       |       | —                       |       | 1,147                       |       |
| Inventories                                                                                                                                                                                                                                      |       | 3,977                        |       | 2,505                       |       |
| Investments in real estate, held for sale,  net                                                                                                                                                                                                  |       | 2,287                        |       | 19,658                      |       |
| Current assets held for sale                                                                                                                                                                                                                     |       | —                       |       | 86                          |       |
| Other current assets                                                                                                                                                                                                                             |       | 511                          |       | 528                         |       |
| Total current assets                                                                                                                                                                                                                             |       | 9,544                        |       | 27,100                      |       |
|                                                                                                                                                                                                                                             |       |                         |       |                        |       |
| Notes receivable                                                                                                                                                                                                                                 |       | 34                           |       | 46                          |       |
| Property, plant and equipment, net                                                                                                                                                                                                               |       | 8,735                        |       | 10,184                      |       |
| Intangible assets, net                                                                                                                                                                                                                           |       | 4,615                        |       | 4,756                       |       |
| Goodwill                                                                                                                                                                                                                                         |       | 8,528                        |       | 8,528                       |       |
| Other assets held for sale                                                                                                                                                                                                                       |       | —                       |       | 2,147                       |       |
| Other assets                                                                                                                                                                                                                                     |       | 1,657                        |       | 1,008                       |       |
| Total assets                                                                                                                                                                                                                                     |       | $                            | 33,113     |                        | $          | 53,769 |   |
|                                                                                                                                                                                                                                             |       |                         |       |                        |       |
| Liabilities and Stockholders’ Equity  (Deficit)                                                                                                                                                                                             |       |                         |       |                        |       |
| Liabilities:                                                                                                                                                                                                                                     |       |                         |       |                        |       |
| Accounts payable and accrued liabilities                                                                                                                                                                                                         |       | $                            | 17,732     |                        | $          | 12,645 |   |
| Current liabilities associated with assets  held for sale                                                                                                                                                                                        |       | —                       |       | 2,565                       |       |
| Obligations under capital leases on real  estate held for sale                                                                                                                                                                                   |       | —                       |       | 9,994                       |       |
| Borrowings and notes payable, current  portion                                                                                                                                                                                                   |       | 9,566                        |       | 12,256                      |       |
| Obligations under capital leases, current  portion                                                                                                                                                                                               |       | 396                          |       | 141                         |       |
| Total current liabilities                                                                                                                                                                                                                        |       | 27,694                       |       | 37,601                      |       |
|                                                                                                                                                                                                                                             |       |                         |       |                        |       |
| Borrowings and notes payable                                                                                                                                                                                                                     |       | 4,743                        |       | 6,355                       |       |
| Obligations under capital leases                                                                                                                                                                                                                 |       | 1,629                        |       | 1,929                       |       |
| Deferred income                                                                                                                                                                                                                                  |       | 4,562                        |       | 5,187                       |       |
| Total liabilities                                                                                                                                                                                                                                |       | 38,628                       |       | 51,072                      |       |
|                                                                                                                                                                                                                                             |       |                         |       |                        |       |
| Commitments and contingencies                                                                                                                                                                                                                    |       |                         |       |                        |       |
| Minority interests in consolidated  subsidiaries                                                                                                                                                                                                 |       | 777                          |       | 701                         |       |
|                                                                                                                                                                                                                                             |       |                         |       |                        |       |
| Stockholders’ Equity (Deficit):                                                                                                                                                                                                             |       |                         |       |                        |       |
| 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, 2008 and  December 31, 2007;  7,954,928  shares outstanding as of September 30, 2008 and December 31, 2007 |       | 171,851                      |       | 170,956                     |       |
| Accumulated deficit                                                                                                                                                                                                                              |       | (166,132                     | )          | (156,949                    | )          |
| Treasury stock, 3,802,145 common shares as  of September 30, 2008 and December 31, 2007, at cost                                                                                                                                       |       | (12,011                      | )          | (12,011                     | )          |
| Total stockholders’ equity (deficit)                                                                                                                                                                                                        |       | (6,292                       | )          | 1,996                       |       |
| Total liabilities and stockholders’ equity  (deficit)                                                                                                                                                                                       |       | $                            | 33,113     |                        | $          | 53,769 |   |

 

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

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FOG CUTTER CAPITAL GROUP INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

*(dollars in thousands, except share data)*

 
| ** **                                                                                                | ** ** | **Quarter Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|------------------------|------------|---------------------------------|------------|
| ** **                                                                                                | ** ** | **September 30,** | ** ** | **September 30,**          | ** ** |
| ** **                                                                                                | ** ** | **2008**               | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| Revenue:                                                                                                  |       |                   |       |                            |       |   |   |   |   |
| Restaurant and manufacturing sales                                                                        |       | $                      | 11,292     |                            | $          | 10,166 |   | $ | 32,473 |   | $ | 29,756 |   |
| Restaurant franchise and royalty fees                                                                     |       | 1,309                  |       | 599                             |       | 2,613 |   | 1,706 |   |
| Total revenue                                                                                             |       | 12,601                 |       | 10,765                          |       | 35,086 |   | 31,462 |   |
|                                                                                                      |       |                   |       |                            |       |   |   |   |   |
| Operating costs and expenses:                                                                             |       |                   |       |                            |       |   |   |   |   |
| Restaurant and manufacturing cost of sales                                                                |       | 6,736                  |       | 5,717                           |       | 19,281 |   | 17,019 |   |
| Engineering and development                                                                               |       | 285                    |       | 256                             |       | 865 |   | 724 |   |
| Depreciation and amortization                                                                             |       | 502                    |       | 437                             |       | 1,508 |   | 1,353 |   |
| Total operating costs and expenses                                                                        |       | 7,523                  |       | 6,410                           |       | 21,654 |   | 19,096 |   |
|                                                                                                      |       |                   |       |                            |       |   |   |   |   |
| General and administrative expenses:                                                                      |       |                   |       |                            |       |   |   |   |   |
| Compensation and employee benefits                                                                        |       | 2,520                  |       | 2,401                           |       | 9,067 |   | 9,705 |   |
| Professional fees                                                                                         |       | 668                    |       | 743                             |       | 2,378 |   | 2,265 |   |
| Other                                                                                                     |       | 3,664                  |       | 3,696                           |       | 11,719 |   | 11,477 |   |
| Total general and administrative expenses                                                                 |       | 6,852                  |       | 6,840                           |       | 23,164 |   | 23,447 |   |
|                                                                                                      |       |                   |       |                            |       |   |   |   |   |
| Non-operating income (expense):                                                                           |       |                   |       |                            |       |   |   |   |   |
| Interest income                                                                                           |       | 30                     |       | 93                              |       | 101 |   | 133 |   |
| Interest expense                                                                                          |       | (646                   | )          | (402                            | )          | (1,505 | ) | (1,093 | ) |
| Other income (expense), net                                                                               |       | (1,760                 | )          | (1,244                          | )          | (1,780 | ) | (1,093 | ) |
| Total non-operating income (expense)                                                                      |       | (2,376                 | )          | (1,553                          | )          | (3,184 | ) | (2,053 | ) |
|                                                                                                      |       |                   |       |                            |       |   |   |   |   |
| Loss before provision for income taxes,  minority interests, and equity in income of equity investees     |       | (4,150                 | )          | (4,038                          | )          | (12,916 | ) | (13,134 | ) |
|                                                                                                      |       |                   |       |                            |       |   |   |   |   |
| Minority interest in (earnings) losses                                                                    |       | (214                   | )          | 193                             |       | (10 | ) | 677 |   |
| Equity in income of equity investee                                                                       |       | —                 |       | —                          |       | 218 |   | — |   |
| Income tax benefit                                                                                        |       | —                 |       | 4,385                           |       | 52 |   | 4,385 |   |
|                                                                                                      |       |                   |       |                            |       |   |   |   |   |
| Income (loss) from continuing operations                                                                  |       | (4,364                 | )          | 540                             |       | (12,656 | ) | (8,072 | ) |
|                                                                                                      |       |                   |       |                            |       |   |   |   |   |
| Income (loss) from discontinued operations  (including gain on sale of $4,217 in 2008 and $2,492 in 2007) |       | —                 |       | (475                            | )          | 3,473 |   | 1,081 |   |
|                                                                                                      |       |                   |       |                            |       |   |   |   |   |
| Net income (loss)                                                                                         |       | $                      | (4,364     | )                               | $          | 65 |   | $ | (9,183 | ) | $ | (6,991 | ) |
|                                                                                                      |       |                   |       |                            |       |   |   |   |   |
| Basic earnings (loss) per share from  continuing operations                                               |       | $                      | (0.55      | )                               | $          | 0.07 |   | $ | (1.59 | ) | $ | (1.01 | ) |
| Basic earnings (loss) per share from  discontinued operations                                             |       | $                      | —     |                            | $          | (0.06 | ) | $ | 0.44 |   | $ | 0.13 |   |
| Basic earnings (loss) per share                                                                           |       | $                      | (0.55      | )                               | $          | 0.01 |   | $ | (1.15 | ) | $ | (0.88 | ) |
| Basic weighted average shares outstanding                                                                 |       | 7,954,928              |       | 7,957,428                       |       | 7,954,928 |   | 7,957,428 |   |
|                                                                                                      |       |                   |       |                            |       |   |   |   |   |
| Dividends declared per share                                                                              |       | $                      | —     |                            | $          | — |   | $ | — |   | $ | — |   |

 

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

 

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FOG CUTTER CAPITAL GROUP INC.

CONSOLIDATED STATEMENT OFSTOCKHOLDERS’ EQUITY (DEFICIT)

(Unaudited)

*(dollars in thousands, except share data)*

 
| ** **                         | ** ** | **Common Stock**   | ** ** | **Treasury Stock** | ** ** | **Accumulated  Deficit** | ** ** | ** ** | ** ** |
|------------------------------------|------------|-------------------------|------------|-------------------------|------------|--------------------------|------------|------------|------------|
| ** **                         | ** ** | **Shares ****(1)** | ** ** | **Amount**              | ** ** | **Shares**               | ** ** | **Amount** | ** ** | ** ** | **Total** | ** ** |
| Balance at January 1, 2008    |       | 7,954,928               |       | $                       | 170,956    |                     | 3,802,145  |       | $          | (12,011 | ) | $ | (156,949 | ) | $ | 1,996 |   |
| Comprehensive income (loss):       |       |                    |       |                    |       |                     |       |       |       |   |   |   |   |
| Net loss                           |       | —                  |       | —                  |       | —                   |       | —     |       | (9,183 | ) | (9,183 | ) |
| Stock options expensed in net loss |       | —                  |       | 895                     |       | —                   |       | —     |       | — |   | 895 |   |
| Balance at September 30, 2008 |       | 7,954,928               |       | $                       | 171,851    |                     | 3,802,145  |       | $          | (12,011 | ) | $ | (166,132 | ) | $ | (6,292 | ) |

 

----

(1)  Issued and outstanding

 

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

 

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FOG CUTTER CAPITAL GROUP INC.

CONSOLIDATED STATEMENTS OFCASH FLOWS

(Unaudited)

*(dollars in thousands)*

 
|                                                                            |   | **Quarter Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------------------------|--------|------------------------|------------|---------------------------------|------------|
|                                                                            |   | **September 30,** | ** ** | **September 30,**          | ** ** |
|                                                                            |   | **2008**               | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| Cash flows from operating activities:                                           |   |                   |       |                            |       |   |   |   |   |
| Net income (loss)                                                               |   | $                      | (4,364     | )                               | $          | 65 |   | $ | (9,183 | ) | $ | (6,991 | ) |
| Income (loss) from discontinued operations                                      |   | —                 |       | 475                             |       | (3,473 | ) | (1,081 | ) |
| Income (loss) from continuing operations                                        |   | (4,364                 | )          | 540                             |       | (12,656 | ) | (8,072 | ) |
| Adjustments to reconcile net income (loss)  to net operating cash flows:        |   |                   |       |                            |       |   |   |   |   |
| Equity in income of equity investees                                            |   | —                 |       | —                          |       | (218 | ) | — |   |
| Depreciation and amortization                                                   |   | 617                    |       | 565                             |       | 1,845 |   | 1,748 |   |
| Foreign currency (gain) loss                                                    |   | 696                    |       | (546                            | )          | 160 |   | (799 | ) |
| Loss (gain) on sale of real estate                                              |   | 563                    |       | (13                             | )          | 563 |   | (13 | ) |
| Share based compensation                                                        |   | 269                    |       | 526                             |       | 895 |   | 1,431 |   |
| Market value impairment reserve                                                 |   | 37                     |       | 1,800                           |       | 636 |   | 2,909 |   |
| Loss on disposal of fixed assets                                                |   | 735                    |       | —                          |       | 735 |   | — |   |
| Other                                                                           |   | 259                    |       | (186                            | )          | 130 |   | (590 | ) |
| Change in:                                                                      |   |                   |       |                            |       |   |   |   |   |
| Other assets                                                                    |   | (563                   | )          | (319                            | )          | (1,871 | ) | (1,099 | ) |
| Deferred income                                                                 |   | (645                   | )          | 135                             |       | (626 | ) | 865 |   |
| Deferred income taxes                                                           |   | —                 |       | (4,441                          | )          | — |   | (4,452 | ) |
| Accounts payable and accrued liabilities                                        |   | 383                    |       | 1,197                           |       | 2,365 |   | 3,423 |   |
| Net cash used in operating activities                                           |   | (2,013                 | )          | (742                            | )          | (8,042 | ) | (4,649 | ) |
|                                                                            |   |                   |       |                            |       |   |   |   |   |
| Cash flows from investing activities:                                           |   |                   |       |                            |       |   |   |   |   |
| Principal repayments on notes receivable,  including loans to senior executives |   | 523                    |       | 254                             |       | 1,728 |   | 263 |   |
| Investment in real estate                                                       |   | (1                     | )          | (39                             | )          | (28 | ) | (127 | ) |
| Investments in property, plant, and  equipment                                  |   | (306                   | )          | (243                            | )          | (1,320 | ) | (1,951 | ) |
| Proceeds on sale of real estate                                                 |   | 4,522                  |       | 376                             |       | 4,522 |   | 376 |   |
| Other                                                                           |   | —                 |       | (18                             | )          | 218 |   | (52 | ) |
| Net cash provided by (used in) investing  activities                            |   | 4,738                  |       | 330                             |       | 5,120 |   | (1,491 | ) |
|                                                                            |   |                   |       |                            |       |   |   |   |   |
| Cash flows from financing activities:                                           |   |                   |       |                            |       |   |   |   |   |
| Proceeds from borrowings                                                        |   | 1,237                  |       | 87                              |       | 3,987 |   | 2,202 |   |
| Repayments on borrowings                                                        |   | (3,495                 | )          | (139                            | )          | (8,403 | ) | (294 | ) |
| Repayments under capital leases                                                 |   | (55                    | )          | (21                             | )          | (67 | ) | (4 | ) |
| Investments by minority interests, net                                          |   | 11                     |       | —                          |       | 361 |   | 1,100 |   |
| Other, net                                                                      |   | —                 |       | —                          |       | — |   | — |   |
| Net cash provided by (used in) financing  activities                            |   | (2,302                 | )          | (73                             | )          | (4,122 | ) | 3,004 |   |
|                                                                            |   |                   |       |                            |       |   |   |   |   |
| Effect of exchange rate change on cash                                          |   | —                 |       | —                          |       | (21 | ) | (2 | ) |
| Net change in cash and cash equivalents  from continuing operations             |   | 423                    |       | (485                            | )          | (7,065 | ) | (3,138 | ) |
|                                                                            |   |                   |       |                            |       |   |   |   |   |
| Net change in cash and cash equivalents  from discontinued operations:          |   |                   |       |                            |       |   |   |   |   |
| Net cash provided by (used in) operating  activities                            |   | —                 |       | 81                              |       | (955 | ) | (187 | ) |
| Net cash provided by (used in) investing  activities                            |   | —                 |       | (32                             | )          | 7,879 |   | 2,827 |   |
| Net cash used in financing activities                                           |   | —                 |       | (114                            | )          | (79 | ) | (614 | ) |
| Net change in cash and cash equivalents                                         |   | 423                    |       | (550                            | )          | (220 | ) | (1,112 | ) |
| Cash and cash equivalents at beginning of  period                               |   | 488                    |       | 1,262                           |       | 1,131 |   | 1,824 |   |
| Cash and cash equivalents at end of period                                      |   | $                      | 911        |                            | $          | 712 |   | $ | 911 |   | $ | 712 |   |
|                                                                            |   |                   |       |                            |       |   |   |   |   |
| Supplemental disclosures of cash flow  information:                             |   |                   |       |                            |       |   |   |   |   |
| Cash paid for interest                                                          |   | $                      | 675        |                            | $          | 883 |   | $ | 2,099 |   | $ | 2,430 |   |
|                                                                            |   |                   |       |                            |       |   |   |   |   |
| Non-cash financing and investing  activities:                                   |   |                   |       |                            |       |   |   |   |   |
| Assets acquired through capital lease                                           |   | $                      | —     |                            | $          | — |   | $ | — |   | $ | 52 |   |
| Acquisition of net assets of franchisee  using notes payable                    |   | $                      | —     |                            | $          | 500 |   | $ | — |   | $ | 500 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

**NOTE 1 – BASIS OF PRESENTATION AND ACCOUNTING POLICIES**

 

Theaccompanying interim consolidated financial statements of Fog Cutter CapitalGroup Inc. and Subsidiaries (“FCCG” or the “Company”) are unaudited and havebeen prepared in conformity with the requirements of Regulation S-X promulgatedunder the Securities Exchange Act of 1934, as amended (the “Exchange Act”),particularly Rule 10-01 thereof, which governs the presentation of interimfinancial statements.  Accordingly, theydo not include all of the information and footnotes required by accountingprinciples generally accepted in the United States for complete financialstatements.  The accompanying interimconsolidated financial statements should be read in conjunction with theCompany’s Annual Report as of and for the year ended December 31, 2007 on Form 10-K(“2007 Form 10-K”) and Form 10-K/A, as previously filed with the SECon March 31, 2008 and April 25, 2008, respectively.  Except as described below, there have been nochanges to the Company’s significant accounting policies as described in Notes2 and 3 to the consolidated financial statements in its 2007 Form 10-K.

 

Inthe Company’s opinion, all adjustments, comprised of normal recurring accrualsnecessary for the fair presentation of the interim financial statements, havebeen included in the accompanying consolidated financial statements.  Operating results for the nine months ended September 30,2008 are not necessarily indicative of the results that may be expected for theyear ending December 31, 2008.

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States requires the Company to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosures of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period.  Actual results coulddiffer from those estimates.  The Company’soperations and activities have become more focused on restaurant activities andless focused on finance and real estate. As a result, certain reclassifications of the balances and modificationsto the presentation of the financial statements have been made, including thereclassification of certain investments in real estate as held for sale.  None of these changes in presentation affectedpreviously reported results of operations.

 

AtSeptember 30, 2008, certain Company officers and directors had, directlyor indirectly, majority voting control of the Company.

 

**NOTE 2 – SIGNIFICANT TRANSACTIONS**

 

Thefollowing significant events affected our operations for the three months andthe nine months ended September 30, 2008:

 

*Restaurant openings and closures*

 

During the nine months ended September 30, 2008, FatburgerHoldings Inc. (“Fatburger”), the Company’s restaurant operations subsidiary,opened six additional franchise locations. In addition, three locations have been converted from franchise-owned tocompany-owned restaurants.  Two franchiselocations and six underperforming company-owned locations have been closed.During the three months ended September 30, 2008, there were no newrestaurants opened, however, Fatburger acquired the net assets of one franchiselocation and converted it to a company-owned location. In order to improveoverall operations, five underperforming company-owned restaurants and onefranchise location were closed during the three month period.

 

*Discontinued operations*

 

InFebruary 2008, the Company sold a wholly-owned subsidiary Fog Cap RetailInvestors LLC (“FCRI”), which held the Company’s leased real estate portfolio.  The sales price for the FCRI membershipinterests was $8.5 million and was paid in cash.  A portion of the proceeds were used to repay$4.2 million of existing debt.  TheCompany recorded a $4.2 million gain on sale as a result of the transaction.  The Company also entered into an optionagreement with the buyer that gives the Company the right, but not theobligation, to re-acquire all of the membership interests in FCRI.  The option period is for two years beginning February 15,2008.  Under certain circumstances after December 31,2008, the buyer may accelerate the termination of the option period upon thirtydays notice.  The exercise priceincreases over the option period from approximately $9.7 million currently to$11.3 million after January 31, 2010. The option commitment fee was $850,000 and is payable by the Company ininstallments over the option period.  TheCompany has determined that the option exercise prices are significantly higherthan the expected value during the option period.  Therefore, theoption has been assigned no value as it is not anticipated that it will providea future economic benefit to the Company. The $850,000 option commitment fee reduced the amount of the gain onsale.

 

InJune 2008, the Company exercised its rights under a loan securityagreement on loans to a consolidated subsidiary, Centrisoft Corporation (“Centrisoft”).  Pursuant to the security agreement, thecollateral assets of Centrisoft were transferred to the Company in satisfactionof the loans.  Centrisoft has sinceceased operations.  As of June 30, 2008, the Company no longerincluded Centrisoft as a consolidated subsidiary.  The Company will continue to service existingcustomers of Centrisoft using the assets acquired through the security agreementand will seek to sell the Centrisoft technology and assets to a third party.

 

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*Sale of real estate and repayment of notes payable*

 

InSeptember 2008, the Company sold one investment property in Barcelona,Spain held through a Variable Interest Entity (“VIE”).  The Company received cash proceeds ofapproximately $4.5 million and recorded a loss on the sale of approximately$0.6 million.  Approximately $3.2 millionof the cash proceeds were used to partially repay two outstanding notespayable.

 

*Borrowings on notes payable*

 

InMay 2008, the Company borrowed $2.0 million through a note payable securedby certain assets of the Company.  Thenote bears interest at a fixed rate of 2% per month, one half of which is duemonthly in arrears, the other half being due at the note’ scheduled maturitydate.  The note is due on or before December 31,2008.  In September 2008, theCompany amended this note payable to borrow an additional $1.0 million.

 

*Income from equity investee*

 

InDecember 2000, the Company organized and led a group of investors topurchase all of the outstanding capital stock of Bourne End Properties Plc (“BourneEnd”), a specialist investor in retail property.  The Company invested in 26% of Bourne End,which at the time of the acquisition had approximately GBP 169.6 million ofassets and GBP 123.1 million of debt. The real estate assets consisted of 1.7 million square feet in fifteenshopping centers located in the United Kingdom. Bourne End sold all of these properties between the date of theacquisition and 2006 and distributed the net proceeds to the investors.  Since the sale of the last property in 2006,Bourne End has been proceeding toward final liquidation.  In the first quarter of 2008, Bourne Endrevised its estimates of accrued liabilities associated with its finalliquidation, and the Company was notified that it had been allocated anadditional $0.2 million in income, which was subsequently distributed in cashin the second quarter of 2008.

 

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

 

*Warlick complaints*

 

OnOctober 16, 2006, Fatburger Holdings, Inc., Fatburger Corporation andFatburger North America, Inc. filed suit against Keith A. Warlick (“Warlick”)the former Chief Executive Officer of Fatburger Holdings, Inc. andFatburger Corporation. Warlick’s employment with Fatburger was terminated on September 21,2006 by resolution of the board of directors of Fatburger Holdings, Inc.The Fatburger companies initiated the lawsuit to recover damages from Warlickarising from wrongful acts and conduct during and after his employment, and areasserting claims for:  breach ofcontract, breach of duty of loyalty, breach of fiduciary duty, conversion –embezzlement; fraud/commencement; intentional interference with contractualrelations, and equitable indemnity. Warlick filed an answer to the lawsuit denying the allegations andincluded a Cross-complaint against Fatburger Holdings, Inc., FatburgerCorporation, Fatburger North America, Inc., Fog Cutter Capital Group, Inc.,and Andrew Wiederhorn (“Cross-Defendants”), for breach of contract, employmentdiscrimination based on race and retaliation, wrongful termination anddefamation – slander without any specification of damages.  On a motion filed by the Cross-Defendants,the Court dismissed Warlick’s cross-claim for employment discrimination basedon race and retaliation.  In furtherresponse, Warlick initiated a second lawsuit against the Company, variousFatburger companies, and members of the Fatburger board of directors, which isset out below. The defendants to the Cross-complaint filed by Warlick disputethe allegations of the cross-complaint and intend to vigorously defend againstthe cross-complaint.

 

OnFebruary 6, 2007, Warlick, his wife, and a limited liability companycontrolled by Warlick, each of whom is a minority shareholder of FatburgerHoldings, Inc., filed a complaint against various Fatburger entities, theCompany, Andrew Wiederhorn, and members of the Fatburger board of directors.The complaint alleges fraud, negligent misrepresentation against Wiederhorn andthe Company, and breach of contract and breach of fiduciary duty against allthe defendants, related to business transactions which the plaintiff’s allegewere not in the best interests of Fatburger Holdings, Inc., or theplaintiff minority shareholders. The defendants dispute the allegations of thelawsuit and intend to vigorously defend against the claims.

 

*Other litigation*

 

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

 

*Liquidity*

 

As of September 30, 2008, borrowings related to the Company’sproperty holdings in Barcelona, Spain of $0.9 million were reflected as currentliabilities in the accompanying Consolidated Statements of Financial Conditiondue to management’s intention to sell these properties and repay the relateddebt at the time of sale.  The sale ofreal estate and other investments is considered to be a normal, recurring partof operations and management expects these transactions to generate adequatecash flow to meet the Company’s liquidity needs for the 2008 fiscal year.

 

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*Debt Covenants*

 

AtDecember 31, 2007, Fatburger was not in compliance with all obligationsunder the agreements evidencing its indebtedness, as defined in the applicableagreements, due to its failure to meet the prescribed fixed charge coverageratio and the prescribed debt-coverage ratio in three notes payable.  As it has in the past, the lendersubsequently issued a waiver of the covenant violations at December 31,2007.  The next measurement date forcompliance with this covenant is December 31, 2008.

 

Asof September 30, 2008, Fatburger had past due loan payments totalingapproximately $82,000, however, this amount was brought current subsequent tothe quarter end.  In addition, theBarcelona Spain VIE was delinquent in loan payments totaling approximately $16,000.

 

*Restricted cash balance*

 

AtSeptember 30, 2008, $0.2 million of the Company’s cash balance wasrestricted to secure certain obligations.

 

*Dividends*

 

The Company does not have a fixed dividend policy, and may declare andpay new dividends on common stock, subject to financial condition, results ofoperations, capital requirements and other factors deemed relevant by the Boardof Directors.  One factor the Board ofDirectors may consider is the impact of dividends on the Company’sliquidity.  No dividends were declared inthe three or nine months ended September 30, 2008.

 

*Fatburger operations*

 

TheCompany expects that Fatburger will require capital resources and have negativecash flow in the near term while it pursues a growth strategy through developingadditional franchisee and company-owned restaurants.  Fatburger development involves substantialrisks that the Company intends to manage; however, it cannot be assured thatpresent or future development will perform in accordance with the Company’sexpectations or that any restaurants will generate the Company’s expectedreturns on investment.  The currentcredit crisis in the United States and internationally has had the effect ofreducing the availability and increasing the cost of financing available toFatburger and its franchisees.  Continueduncertainty in the credit markets may affect the Company’s ability to expandFatburger or to manage that growth, which could have a material adverse effecton the Company’s operations and financial condition.  In addition, if Fatburger or its franchiseesare unsuccessful in obtaining capital sufficient to fund this expansion, thetiming of restaurant openings may be delayed and Fatburger’s results may benegatively impacted.

 

*Other*

 

Inorder to facilitate the development of franchise locations, as of September 30,2008, Fatburger had guaranteed the annual minimum lease payments of onerestaurant site owned and operated by a franchisee.  The guarantee is approximately $0.7 millionplus certain contingent rental payments as defined in the lease.  The lease expires in July 2015.  As of September 30, 2008, management wasnot aware of any event or demand that was likely to trigger the guarantee byFatburger.

 

Managementmay utilize a wide variety of financial techniques to assist in the managementof currency risk, including currency swaps, options, and forwards, orcombinations thereof.  No such currencyhedging techniques were used in the nine months ended September 30, 2008.

 

Therewere no other off-balance sheet arrangements used in the three and nine monthsended September 30, 2008.

 

**NOTE 4 – STOCK OPTIONS AND RIGHTS**

 

TheCompany has a stock option plan (the “Option Plan”) that provides for optionsto purchase shares of the Company’s common stock.  The maximum number of shares of common stockthat may be issued pursuant to options granted under the Option Plan is3,500,000.  Newly elected independentdirectors automatically receive 5,000 options on the day they join the Board ofDirectors.  Additionally, each independentdirector receives, on the last day of each quarter, an automatic grant ofnon-qualified options to purchase 1,500 shares of common stock at 110% of thefair market value on that day.  Automaticgrants vest one third on each of the first three anniversaries of the grantdate and expire on the tenth anniversary of the grant date.  The Company granted a total of 4,500 optionsand 13,500 options to its independent directors in the three months and ninemonths ending September 30, 2008, respectively.  The resignation of certain Managers (asdefined by the Option Plan) resulted in the forfeiture of 96,833 unvestedoptions in the nine months ended September 30, 2008.

 

Therewere no options granted with exercise prices below the market value of thestock at the grant date.  Fair values forthe third quarter of 2008 were estimated using the Black-Scholes option-pricingmodel with the following weighted average assumptions used: 0% dividend yield,expected volatility of 109%, risk-free interest rate of 4.6% and expected livesof ten years.

 

Asummary of our stock options activity for the nine months ended September 30,2008 is presented below:

 

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| ** **                             | ** ** | **Shares** | ** ** | **Weighted Average  Exercise  Price** | ** ** |
|----------------------------------------|------------|------------|------------|--------------------------------------------|------------|
| Outstanding at January 1, 2008    |       | 3,246,333  |       | $                                          | 1.57       |   |
| Granted                                |       | 13,500     |       | $                                          | 0.68       |   |
| Exercised                              |       | —     |       | $                                          | —     |   |
| Cancelled/forfeited                    |       | (96,833    | )          | $                                          | 3.31       |   |
| Outstanding at September 30, 2008 |       | 3,163,000  |       | $                                          | 1.51       |   |

 

Asummary of our stock options activity for the three months ended September 30,2008 is presented below:

 
| ** **                             | ** ** | **Shares** | ** ** | **Weighted Average  Exercise  Price** | ** ** |
|----------------------------------------|------------|------------|------------|--------------------------------------------|------------|
| Outstanding at June 30, 2008      |       | 3,158,500  |       | $                                          | 1.52       |   |
| Granted                                |       | 4,500      |       | $                                          | 0.44       |   |
| Exercised                              |       | —     |       | $                                          | —     |   |
| Cancelled/forfeited                    |       | —     |       | $                                          | —     |   |
| Outstanding at September 30, 2008 |       | 3,163,000  |       | $                                          | 1.51       |   |

 

Asummary of our stock options outstanding as of September 30, 2008 ispresented below:

 
| **Range of  Exercise Prices** | ** ** | **Shares** | ** ** | **Weighted Average  Remaining  Life** | ** ** | **Weighted Average  Exercise  Price** | ** ** |
|-----------------------------------------|------------|------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| $0.01 – 1.00                       |       | 13,500     |       | 9.7                                        |       | $                                          | 0.68       |   |
| $1.01 – 2.00                       |       | 2,622,000  |       | 8.2                                        |       | $                                          | 1.32       |   |
| $2.01 – 4.00                       |       | 527,500    |       | 8.7                                        |       | $                                          | 2.48       |   |
| Total                                   |       | 3,163,000  |       | 8.3                                        |       | $                                          | 1.51       |   |

 

**NOTE 5 – VARIABLE INTEREST ENTITIES**

 

Asof September 30, 2008, the Company has loaned $1.5 million to a relatedSpanish entity formed to purchase, reposition and sell an apartment building inBarcelona, Spain.  Under the terms of theloans, the investment meets the definition of a Variable Interest Entity (“VIE”)under FASB Interpretation No. 46 (“FIN 46”) and the Company is the primarybeneficiary of the VIE.  As a result, theassets, liabilities, and results of operations of the VIE have beenconsolidated into the accompanying consolidated financial statements.  Neither the creditors nor the otherbeneficial interest holders have recourse to the Company with regard to thisinvestment.

 

TheVIE currently owns one apartment building, consisting of 8 residential unitsand 2 commercial units with a carrying value of approximately $2.3 million,including capital improvements and carrying costs.  The property met the criteria to beclassified as “held for sale” and was classified as such on the Statement ofFinancial Condition at September 30, 2008.

 

InSeptember 2008, the VIE sold one similar property.  The Company received cash proceeds ofapproximately $4.5 million and recorded a loss on the sale of approximately$0.6 million.  Prior to the sale, theCompany had recorded market value impairments totaling $0.6 million on thisproperty in the nine months ended September 30, 2008.  The fair value of the remaining property wasestimated using significant observable inputs other than quoted prices (Level 2inputs per SFAS 157), including prior sale offers on the property, current salenegotiations for the property, and market prices for similar properties in theBarcelona, Spain market.

 

Assetsand liabilities of the VIE included in the accompanying consolidated statementsof financial condition as of September 30, 2008 are summarized as follows:

 
| Investment in real estate, held for sale,  net                                             |   | $       | 2,287,000 |   |
|--------------------------------------------------------------------------------------------|--------|---------|-----------|--------|
| Other assets                                                                               |   | 97,000  |      |
| Borrowings and notes payable (included in  current liabilities at September 30, 2008) |   | 919,000 |      |
| Accrued expenses and other liabilities                                                     |   | 132,000 |      |
| Minority interest                                                                          |   | 106,000 |      |

 

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**NOTE 6 – LOANS TO SENIOR EXECUTIVES**

 

Priorto the passage of the Sarbanes-Oxley Act of 2002, the Company’s employmentagreement with its Chief Executive Officer, Andrew Wiederhorn, allowed him toborrow a specified maximum amount from the Company to purchase shares of commonstock.  The loans were full recourse tothe borrower and bore interest at the prime rate.  The total amount of loans receivable from Mr. Wiederhorn,including compounded interest, was $1.1 million at December 31, 2007.  The loans matured on February 21, 2007,and were repaid in full, including interest, on February 21, 2008.

 

**NOTE 7 – INVENTORIES**

 

Inventoriesrelate primarily to the Company’s manufacturing subsidiary, DAC International (“DAC”),and consist of the following:

 
| ** **        | ** ** | **September 30,  2008**         | ** ** | **December 31, 2007** | ** ** |
|-------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **        | ** ** | **(dollars in thousands)** | ** ** |
| Raw materials     |       | $                                    | 2,818      |                            | $          | 1,565 |   |
| Work in progress  |       | 805                                  |       | 772                             |       |
| Finished goods    |       | 354                                  |       | 168                             |       |
| Total inventories |       | $                                    | 3,977      |                            | $          | 2,505 |   |

 

**NOTE 8 – ACCOUNTS PAYABLE AND ACCRUED LIABILITIES**

 

Accountspayable and accrued liabilities consisted of the following:

 
| ** **                                    | ** ** | **September 30,  2008**         | ** ** | **December 31, 2007** | ** ** |
|-----------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                    | ** ** | **(dollars in thousands)** | ** ** |
| Accounts payable                              |       | $                                    | 7,649      |                            | $          | 8,872 |   |
| Sales deposits                                |       | 2,339                                |       | 1,478                           |       |
| Accrued wages, bonus and commissions          |       | 1,657                                |       | 708                             |       |
| Other                                         |       | 6,087                                |       | 1,587                           |       |
| Total accrued expenses and other  liabilities |       | $                                    | 17,732     |                            |       | $ | 12,645 |   |
|                                               |            |                                      |            |                                 |            |  |  |  |  |

 

AtSeptember 30, 2008, other accrued liabilities include the accrual ofmanagement fees ($1.7 million) and option commitment fee ($0.5 million), bothassociated with the sale of FCRI.

 

**NOTE 9 – OPERATING SEGMENTS**

 

Operatingsegments consist of (i) restaurant operations conducted through Fatburger,(ii) manufacturing activities conducted through DAC International, and (iii) realestate and financing activities.  Eachsegment operates with its own management and personnel.  The Company allocates certain corporateexpenses to Fatburger through a management fee to reflect management’sincreased involvement in the restaurant operations and to more closelyrepresent the true costs of restaurant operations in the appropriate segmentreporting.  The management fee iseliminated upon consolidation.  Thefollowing is a summary of each of the operating segments:

 

*Restaurant operations*

 

As of September 30, 2008, the Company owned approximately 82% ofthe voting control of Fatburger, which operates or franchises 90 hamburgerrestaurants located primarily in California and Nevada, as well as 11 otherstates, Canada, and China.  Franchiseescurrently own and operate 54 of the Fatburger locations.  Six new franchise restaurants were openedduring the nine months ended September 30, 2008.  In the nine months ended September 30,2008, Fatburger acquired the net assets of three franchise locations andconverted them to company-owned locations, and two franchise locations and sixunderperforming company-owned locations were closed.  During the three months ended September 30,2008, there were no new restaurants opened, however, Fatburger acquired the netassets of one franchise location and converted it to a company-owned location.In order to improve overall operations, five underperforming company-ownedrestaurants and one franchise location were closed during the three monthperiod.

 

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| ** **                                     | ** ** | **Three months ended September  30,** | ** ** | **Nine months ended September  30,** | ** ** |
|------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                     | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                     | ** ** | **(dollars in thousands)**                 | ** ** |
|                                           |       |                                                 |       |                                                |       |   |   |   |   |
| Company-owned restaurant sales                 |       | $                                                    | 7,755      |                                                | $          | 7,226 |   | $ | 23,643 |   | $ | 21,975 |   |
| Royalty revenue                                |       | 562                                                  |       | 528                                                 |       | 1,697 |   | 1,574 |   |
| Franchise fee revenue                          |       | 748                                                  |       | 71                                                  |       | 916 |   | 132 |   |
| Total revenue                                  |       | 9,065                                                |       | 7,825                                               |       | 26,256 |   | 23,681 |   |
|                                           |       |                                                 |       |                                                |       |   |   |   |   |
| Cost of sales                                  |       | (4,577                                               | )          | (4,075                                              | )          | (14,060 | ) | (12,682 | ) |
| Depreciation and amortization                  |       | (527                                                 | )          | (497                                                | )          | (1,601 | ) | (1,529 | ) |
| Other general & administrative  costs |       | (3,889                                               | )          | (3,899                                              | )          | (12,162 | ) | (11,449 | ) |
| Interest expense                               |       | (166                                                 | )          | (195                                                | )          | (524 | ) | (576 | ) |
| Loss on disposal of fixed assets               |       | (735                                                 | )          | —                                              |       | (735 | ) | — |   |
| Management allocation                          |       | (527                                                 | )          | (536                                                | )          | (1,579 | ) | (1,608 | ) |
| Market value impairment reserves               |       | (37                                                  | )          | —                                              |       | (37 | ) | — |   |
| Minority interest in (earnings) losses         |       | (214                                                 | )          | 193                                                 |       | (10 | ) | 677 |   |
| Segment loss                                   |       | $                                                    | (1,607     | )                                                   | $          | (1,184 | ) | $ | (4,452 | ) | $ | (3,486 | ) |
|                                           |       |                                                 |       |                                                |       |   |   |   |   |
| Capital expenditures                           |       | $                                                    | 371        |                                                | $          | 441 |   | $ | 639 |   | $ | 948 |   |
| Segment assets                                 |       |                                                 |       |                                                |       | $ | 20,471 |   | $ | 22,165 |   |
| Minority interests                             |       |                                                 |       |                                                |       | $ | 671 |   | $ | 501 |   |

 

*Manufacturing operations*

 

TheCompany conducts manufacturing activities through its wholly-owned subsidiary,DAC International.  DAC is a supplier ofcomputer controlled lathes and milling machinery for the production ofeyeglass, contact, and intraocular lenses.

 
| ** **                                     | ** ** | **Three months ended September  30,** | ** ** | **Nine months ended September  30,** | ** ** |
|------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                     | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                     | ** ** | **(dollars in thousands)**                 | ** ** |
|                                           |       |                                                 |       |                                                |       |   |   |   |   |
| Manufacturing sales                            |       | $                                                    | 3,536      |                                                | $          | 2,940 |   | $ | 8,831 |   | $ | 7,781 |   |
| Cost of sales                                  |       | (2,159                                               | )          | (1,634                                              | )          | (5,221 | ) | (4,329 | ) |
| Engineering and development                    |       | (285                                                 | )          | (256                                                | )          | (865 | ) | (724 | ) |
| Depreciation and amortization                  |       | (42                                                  | )          | (20                                                 | )          | (100 | ) | (67 | ) |
| Other general & administrative  costs |       | (707                                                 | )          | (612                                                | )          | (2,293 | ) | (1,878 | ) |
| Interest expense                               |       | (12                                                  | )          | (13                                                 | )          | (33 | ) | (28 | ) |
| Other non-operating income                     |       | 259                                                  |       | 3                                                   |       | 285 |   | 20 |   |
| Segment income                                 |       | $                                                    | 590        |                                                | $          | 408 |   | $ | 604 |   | $ | 775 |   |
|                                           |       |                                                 |       |                                                |       |   |   |   |   |
| Capital expenditures                           |       | $                                                    | (40        | )                                                   | $          | 3 |   | $ | 381 |   | $ | 71 |   |
| Segment assets                                 |       |                                                 |       |                                                |       | $ | 7,289 |   | $ | 6,151 |   |

 

*Real estate and financing operations*

 

TheCompany owns various interests in real estate and notes receivable.  At September 30, 2008, real estate iscomprised of ownership of one apartment building located in Barcelona, Spainand one note receivable with a carrying value of less than $0.1 million, whichis secured by real estate.

 
| ** **                                     | ** ** | **Three months ended September  30,** | ** ** | **Nine months ended September  30,** | ** ** |
|------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                     | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                     | ** ** | **(dollars in thousands)**                 | ** ** |
|                                           |       |                                                 |       |                                                |       |   |   |   |   |
| Rental income                                  |       | $                                                    | —     |                                                | $          | — |   | $ | — |   | $ | — |   |
| Operating expenses                             |       | —                                               |       | (8                                                  | )          | — |   | (9 | ) |
| Depreciation and amortization                  |       | —                                               |       | —                                              |       | — |   | (5 | ) |
| Other general & administrative  costs |       | (1                                                   | )          | (15                                                 | )          | (14 | ) | (60 | ) |
| Interest income                                |       | 27                                                   |       | 91                                                  |       | 90 |   | 131 |   |
| Interest expense                               |       | (489                                                 | )          | (486                                                | )          | (1,468 | ) | (1,316 | ) |
| Other non-operating income (loss)              |       | (680                                                 | )          | 1,252                                               |       | (121 | ) | 1,785 |   |
| Gain (loss) on sale of real estate             |       | (563                                                 | )          | 13                                                  |       | (563 | ) | 13 |   |
| Market value impairment reserves               |       | —                                               |       | (2,511                                              | )          | (599 | ) | (2,909 | ) |
| Equity in income of equity investees           |       | —                                               |       | —                                              |       | 218 |   | — |   |
| Segment loss                                   |       | $                                                    | (1,706     | )                                                   | $          | (1,664 | ) | $ | (2,457 | ) | $ | (2,370 | ) |
|                                           |       |                                                 |       |                                                |       |   |   |   |   |
| Capital expenditures                           |       | $                                                    | —     |                                                | $          | 39 |   | $ | — |   | $ | 127 |   |
| Segment assets                                 |       |                                                 |       |                                                |       | $ | 5,353 |   | $ | 12,901 |   |
| Minority interests                             |       |                                                 |       |                                                |       | $ | 106 |   | $ | 392 |   |

 

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Othernon-operating income (loss) for the nine months ended September 30, 2008is primarily composed of foreign currency losses of $0.2 million.  This compares to foreign currency gains of$0.8 million, commission and other non-operating revenue of $0.3 million, and aforfeited deposit on the sale of one Barcelona property of $0.7 million for thenine months ended September 30, 2007.

 

Forthe three month period ending September 30, 2008 other non-operating income(loss) is primarily composed of foreign currency losses of $.07 million.  This compares to foreign currency gains of$0.5 million and a forfeited deposit on the sale of one Barcelona property of$0.7 million for the three months ended September 30, 2007.

 

*Reconciliation to total net income (loss)*

 
| ** **                                 | ** ** | **Three months ended September  30,** | ** ** | **Nine months ended September  30,** | ** ** |
|--------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                 | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                 | ** ** | **(dollars in thousands)**                 | ** ** |
|                                       |       |                                                 |       |                                                |       |   |   |   |   |
| Segment loss from operations               |       | $                                                    | (1,988     | )                                                   | $          | (2,440 | ) | $ | (5,570 | ) | $ | (5,081 | ) |
| Corporate expenses                         |       | (2,189                                               | )          | (2,233                                              | )          | (8,502 | ) | (9,810 | ) |
| Elimination of intercompany charges        |       | 548                                                  |       | 828                                                 |       | 2,099 |   | 2,434 |   |
| Income tax benefit                         |       | —                                               |       | 4,385                                               |       | 52 |   | 4,385 |   |
| Income (loss) from discontinued operations |       | —                                               |       | (475                                                | )          | 3,473 |   | 1,081 |   |
| Net income (loss)                          |       | $                                                    | (3,629     | )                                                   | $          | 65 |   | $ | (8,448 | ) | $ | (6,991 | ) |

 

**NOTE 10 – DISCONTINUED OPERATIONS**

 

*Leased real estate portfolio*

 

In February 2008, the Company sold FCRI, a wholly-owned subsidiarythat held the Company’s leased real estate portfolio.  At the time of sale, this portfolio wascomprised of leasehold interests in 72 freestanding retail buildings locatedthroughout the United States.  Prior tothe sale, the leased real estate portfolio was part of the Real Estate and FinancingOperations segment.  The followingrepresents the results of operations during the time of the Company’s ownershipof FCRI:

 
| ** **                                           | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                           | ** ** | **2008**                                            | ** ** | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                           | ** ** | **(dollars in thousands)**                | ** ** |
| Operating revenue                                    |       | $                                                   | —     |                                               | $          | 972 |   | $ | 610 |   | $ | 2,851 |   |
| Operating expenses                                   |       | —                                              |       | (305                                               | )          | (240 | ) | (1,013 | ) |
| Depreciation and amortization                        |       | —                                              |       | (111                                               | )          | (39 | ) | (330 | ) |
| Operating margin                                     |       | —                                              |       | 556                                                |       | 331 |   | 1,508 |   |
|                                                 |       |                                                |       |                                               |       |   |   |   |   |
| General and administrative expenses                  |       | —                                              |       | (229                                               | )          | (7 | ) | (293 | ) |
| Interest expense                                     |       | —                                              |       | (240                                               | )          | (157 | ) | (702 | ) |
| Other non-operating income                           |       | —                                              |       | 7                                                  |       | 8 |   | 20 |   |
| Gain on sale of discontinued real estate  operations |       | —                                              |       | —                                             |       | 4,217 |   | — |   |
| Income from discontinued real estate  operations     |       | $                                                   | —     |                                               | $          | 94 |   | $ | 4,392 |   | $ | 533 |   |
|                                                 |       |                                                |       |                                               |       |   |   |   |   |
| Capital expenditures                                 |       | $                                                   | —     |                                               | $          | 32 |   | $ | 20 |   | $ | 98 |   |
| Segment assets                                       |       |                                                |       |                                               |       | — |   | $ | 11,438 |   |

 

*Software development and sales operations*

 

InJune 2008, the Company exercised its rights under a loan securityagreement on loans to Centrisoft, a consolidated subsidiary.  Pursuant to the security agreement, thecollateral assets of Centrisoft were transferred to the Company in satisfactionof the loans.  Centrisoft has sinceceased operations.  As of September 30, 2008, the Company no longerincludes Centrisoft as a consolidated subsidiary.  The Company will continue to service existingcustomers of Centrisoft using the assets acquired through the securityagreement and will seek to sell the

 

13

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Centrisofttechnology and assets to a third party. Prior to discontinuation of operations, Centrisoft was a reportablesegment of the Company’s operations that developed and sold networkproductivity and security software.  Thefollowing represents the results of operations during the time of the Company’sownership of Centrisoft:

 
| ** **                                     | ** ** | **Three months ended September  30,** | ** ** | **Nine months ended September 30,** | ** ** |
|------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                     | ** ** | **2008**                                             | ** ** | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                     | ** ** | **(dollars in thousands)**                 | ** ** |
|                                           |       |                                                 |       |                                               |       |   |   |   |   |
| Software sales                                 |       | $                                                    | —     |                                               | $          | 46 |   | $ | 128 |   | $ | 60 |   |
| Engineering and development                    |       | —                                               |       | (105                                               | )          | (158 | ) | (367 | ) |
| Depreciation and amortization                  |       | —                                               |       | (110                                               | )          | (182 | ) | (334 | ) |
| Other general & administrative  costs |       | —                                               |       | (107                                               | )          | (215 | ) | (479 | ) |
| Interest expense                               |       | —                                               |       | (294                                               | )          | (492 | ) | (846 | ) |
| Segment loss                                   |       | $                                                    | —     |                                               | $          | (570 | ) | $ | (919 | ) | $ | (1,966 | ) |
|                                           |       |                                                 |       |                                               |       |   |   |   |   |
| Capital expenditures                           |       | $                                                    | —     |                                               | $          | — |   | $ | — |   | $ | — |   |
| Segment assets                                 |       |                                                 |       |                                               |       | $ | — |   | $ | 3,478 |   |

 

*Mortgage banking operations*

 

Priorto February 2007, the Company held a 51% ownership interest in GeorgeElkins Mortgage Banking Company (“George Elkins”), a California commercialmortgage banking operation.  In December 2006,the Company reached an agreement to sell George Elkins to a third party and thesale closed in February 2007.  Priorto disposal, George Elkins was a reportable segment of the Company’soperations.  The following represents theresults of operations during the time of the Company’s ownership of GeorgeElkins:

 
| ** **                                                | ** ** | **Three months ended September  30,** | ** ** | **Nine months ended September  30,** | ** ** |
|-----------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                | ** ** | **(dollars in thousands)**                 | ** ** |
|                                                      |       |                                                 |       |                                                |       |   |   |   |   |
| Loan brokerage fees                                       |       | $                                                    | —     |                                                | $          | — |   | $ | — |   | $ | 1,673 |   |
| Loan servicing fees                                       |       | —                                               |       | —                                              |       | — |   | 134 |   |
| Total revenue                                             |       | —                                               |       | —                                              |       | — |   | 1,807 |   |
|                                                      |       |                                                 |       |                                                |       |   |   |   |   |
| Depreciation and amortization                             |       | —                                               |       | —                                              |       | — |   | (4 | ) |
| Other general & administrative  costs            |       | —                                               |       | —                                              |       | — |   | (1,811 | ) |
| Interest income                                           |       | —                                               |       | —                                              |       | — |   | 2 |   |
| Other non-operating income                                |       | —                                               |       | —                                              |       | — |   | 15 |   |
| Minority interest in earnings                             |       | —                                               |       | —                                              |       | — |   | 13 |   |
| Gain on sale of discontinued mortgage  banking operations |       | —                                               |       | —                                              |       | — |   | 2,492 |   |
| Income from discontinued mortgage banking  operations     |       | $                                                    | —     |                                                | $          | — |   | $ | — |   | $ | 2,514 |   |
|                                                      |       |                                                 |       |                                                |       |   |   |   |   |
| Capital expenditures                                      |       | $                                                    | —     |                                                | $          | — |   | $ | — |   | $ | — |   |
| Segment assets                                            |       |                                                 |       |                                                |       | $ | — |   | $ | — |   |
| Minority interests                                        |       |                                                 |       |                                                |       | $ | — |   | $ | — |   |

 

**NOTE 11 – SUBSEQUENT EVENTS**

 

*Restaurant openings*

 

Subsequentto September 30, 2008, Fatburger opened three franchise locations and onecompany-owned location.

 

*Personnel reductions*

 

InOctober 2008, the Company eliminated several administrative positions,primarily at the Fatburger subsidiary. These reductions are intended to generate annual savings in compensationand employee benefits of $0.8 million.

 

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

 

*Certain statements contained herein and certain statementscontained in future filings by the Company with the SEC may not be based onhistorical facts and are “Forward-Looking Statements” within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended. Forward-Looking Statements are based on various assumptions and events(some of which are beyond the Company’s control) and may be identified byreference to a future period or periods, or by the use of forward-lookingterminology, such as “may,” “will,” “believe,” “expect,” “anticipate,” “continue,”or similar terms or variations on those terms, or the negative of thoseterms.  Actual results could differmaterially from those set forth in Forward-Looking Statements due to a varietyof factors, including, but not limited to the Risk Factors identified hereinand the following:*

 

·                  *economic factors, particularly in the market areas inwhich the Company operates;*

·                  *the financial and securities markets and theavailability of and costs associated with sources of liquidity;*

·                  *competitive products and pricing;*

·                  *the real estate market, including the residentialreal estate market in Barcelona, Spain;*

·                  *the ability to sell assets to maintain liquidity;*

·                  *fiscal and monetary policies of the U.S. Government;*

·                  *changes in prevailing interest rates;*

·                  *changes in currency exchange rates;*

·                  *acquisitions and the integration of acquiredbusinesses;*

·                  *performance of retail/consumer markets, includingconsumer preferences and concerns about diet;*

·                  *effective expansion of the Company’s restaurants innew and existing markets;*

·                  *profitability and success of franchisee restaurants;*

·                  *availability of quality real estate locations forrestaurant expansion;*

·                  *the market for Centrisoft’s software products;*

·                  *credit risk management; and*

·                  *asset/liability management*

* *

*Except as may be required by law, the Company does notundertake, and specifically disclaims any obligation, to publicly release theresults of any revisions that may be made to any Forward-Looking Statements toreflect the occurrence of anticipated or unanticipated events or circumstancesafter the date of such statements.*

 

*The following discussion and analysis should be read inconjunction with the Consolidated Financial Statements of Fog Cutter CapitalGroup Inc. and the notes thereto included elsewhere in this filing.  References in this filing to “the Company,” “we,”“our,” and “us” refer to Fog Cutter Capital Group Inc. and its subsidiariesunless the context indicates otherwise.*

 

## **Executive Overview**

##  

*Business overview*

 

FogCutter Capital Group Inc. is primarily engaged in the operations of itsFatburger Holdings, Inc. (“Fatburger”) restaurant business.  We acquired the controlling interest inFatburger in August 2003 and currently own 82% voting control.  Fatburger, “The Last Great Hamburger Stand”®,opened its first restaurant in Los Angeles in 1952.  As of September 30, 2008, there were 90Fatburger restaurants located in 13 states and in Canada and China.  The restaurants specialize in fresh,made-to-order hamburgers and other specialty sandwiches.  French fries, homemade-style onion rings,hand-scooped ice cream shakes and soft drinks round out the menu.

 

Weplan to open additional Fatburger restaurants throughout the United States andinternationally, including Canada, China, Saudi Arabia, Indonesia, Kuwait, andthe United Arab Emirates.  We intend tocontinue to open company-owned restaurants in strategic markets and increasethe number of franchised locations in the U.S. and internationally.  Franchisees currently own and operate 54 ofthe Fatburger locations and we have agreements for approximately 208 newfranchise locations.  Many factors affectour ability to open new franchise locations and we expect that it will takeseveral years for our current franchisees to open all of their restaurantlocations.  As is typical for ourindustry, the identification of qualified franchisees and quality locations hasan impact on the rate of growth in the number of our restaurants.

 

Inaddition to our restaurant operation, we also conduct manufacturing activitiesand have made real estate and other real estate-related investments throughvarious controlled subsidiaries.

 

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* *

*Operating segments*

 

Ouroperating segments are:

 

(i)             Restaurant operations – conducted through ourFatburger subsidiary,

(ii)          Manufacturing operations – conducted through our wholly ownedsubsidiary, DAC International (“DAC”), and

(iii)       Real estate and finance operations.

 

Dueto the varied nature of our operations, we do not utilize a standard array ofkey performance indicators in evaluating our results of operations.  Our evaluation instead focuses on aninvestment-by-investment or asset-by-asset analysis within our operatingsegments.

 

*Significant events*

 

Thefollowing significant events affected our operations for the three months andthe nine months ended September 30, 2008:

 

·                  Restaurant openings and closures – During thenine months ended September 30 2008, Fatburger opened six additionalfranchise locations.  Three locationshave been converted from franchise-owned to company-owned restaurants.  In order to improve overall operations, twofranchise locations and six company-owned locations have been closed.  During the three months ended September 30,2008, there were no new restaurants opened, however, Fatburger acquired the netassets of one franchise location and converted it to a company-owned location.In order to improve overall operations, five underperforming company-ownedrestaurants and one franchise location were closed during the three monthperiod.

 

·                  Discontinuedoperations – In February 2008, we sold a wholly-owned subsidiary, Fog CapRetail Investors LLC (“FCRI”), which held our leased real estateportfolio.  The sales price for the FCRImembership interests was $8.5 million and was paid in cash.  A portion of the proceeds were used to repay$4.2 million of existing debt.  Werecorded a gain on sale of $4.2 million as a result of the transaction.  We also entered into an option agreement withthe buyer that gives us the right, but not the obligation, to re-acquire all ofthe membership interests in FCRI.  Theoption period is for two years beginning February 15, 2008.  Under certain circumstances after December 31,2008, the buyer may accelerate the termination of the option period upon thirtydays notice.  The exercise priceincreases over the option period from approximately $9.7 million currently to$11.3 million after January 31, 2010. The option commitment fee was $850,000 and is payable by us ininstallments over the option period. Management has determined that the option exercise prices aresignificantly higher than the expected value during the option period.  Therefore, the option has been assigned novalue as it is not anticipated that it will provide a future economic benefitto us.  The $850,000 option commitmentfee reduced the gain on sale.

 

·                  Discontinuedoperations – In June 2008, we exercised our rights under a securityagreement on loans to a consolidated subsidiary, Centrisoft Corporation (“Centrisoft”).  Pursuant to the security agreement, thecollateral assets of Centrisoft were transferred to us in satisfaction of theloans.  Centrisoft has since ceasedoperations.  As of June 30, 2008, we no longer included Centrisoft asa consolidated subsidiary.  We willcontinue to service existing customers of Centrisoft using the assets acquiredthrough the security agreement and will seek to sell the Centrisoft technologyand assets to a third party.

 

·                  Saleof real estate and repayment of notes payable – In September 2008, we soldone investment property in Barcelona, Spain held through our Variable InterestEntity (“VIE”).  We received cashproceeds of approximately $4.5 million and recorded a loss on the sale ofapproximately $0.6 million. Approximately $3.2 million of the cash proceeds were used to partiallyrepay two outstanding notes payable.

 

·                  Borrowingon notes payable – In May 2008, we borrowed $2.0 million through a notepayable secured by certain assets of the Company.  The note bears interest at a fixed rate of 2%monthly, one half of which is due monthly in arrears, the other half being dueat the note’s scheduled maturity date. The note is due on or before December 31, 2008.  In September 2008, we amended this notepayable to borrow an additional $1.0 million.

 

·                  Incomefrom equity investee – In December 2000, we organized and led a group ofinvestors to purchase all of the outstanding capital stock of Bourne EndProperties Plc (“Bourne End”), a specialist investor in retail property.  We invested in 26% of Bourne End, which atthe time of the acquisition had approximately GBP 169.6 million of assets andGBP 123.1 million of debt.  The realestate assets consisted of 1.7 million square feet in fifteen shopping centerslocated in the United Kingdom.  BourneEnd sold all of these properties between the date of the acquisition and 2006and distributed the net proceeds to the investors.  Since the sale of the last property in 2006,Bourne End has been proceeding toward final liquidation.  In the first quarter of 2008, Bourne Endrevised its estimates of accrued liabilities associated with its finalliquidation, and we were notified that we had been allocated an additional $0.2million in income, which was subsequently distributed in cash in the secondquarter of 2008.

 

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**Results of operations**

 

Wehave incurred net income (losses) from continuing operations as follows:

 
| ** **         | ** ** | **Three months ended September 30,**                        | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------|------------|---------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **         | ** ** | **2008**                                                                        | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **         | ** ** | **(dollars in thousands, except per share data)** | ** ** |
| Net income (loss)  |       | $                                                                               | (4,364     | )                                                       | $          | 540 |   | $ | (12,656 | ) | $ | (8,072 | ) |
| Net loss per share |       | $                                                                               | (0.55      | )                                                       | $          | 0.07 |   | $ | (1.59 | ) | $ | (1.01 | ) |

 

Ournet loss from continuing operations was $12.7 million (or $1.59 per share) forthe nine months ended September 30, 2008 and $4.4 million (or $0.55 pershare) for the three months then ended. This compares to a net loss of $8.1 million (or $1.01 per share) for thenine months ended September 30, 2007 and net income of $0.5 million (or$0.07 per share) for the three months then ended.  The loss is primarily due to operatingexpenses associated with our management infrastructure.  We have put in place a management structurethat we believe will enable us to significantly expand our operations, notablyour Fatburger subsidiary.  However, untilthe growth is realized, the cost of our management structure will be borne byour existing operations.

 

Thefollowing sections describe the results of operations of our operating segmentsfor the three and nine months ended September 30, 2008 and 2007.

 

*Restaurant segment operations*

 

Thefollowing table shows our operating margin for company-owned restaurants for thethree and nine months ended September 30, 2008 and 2007:

 
| ** **                                    | ** ** | **Three months ended September 30,**      | ** ** | **Nine months ended September 30,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                    | ** ** | **2008**                                                      | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                    | ** ** | **(% to Company-owned restaurant sales)** | ** ** |
| Restaurant sales:                             |       |                                                          |       |                                                    |       |   |   |   |   |
| Company-owned restaurant sales                |       | 100.0                                                         | %          | 100.0                                                   | %          | 100.0 | % | 100.0 | % |
| Cost of sales – food, paper, merchandise |       | (26.9                                                         | )%         | (23.7                                                   | )%         | (26.2 | )% | (24.2 | )% |
| Cost of sales – wages and benefits       |       | (32.1                                                         | )%         | (32.7                                                   | )%         | (33.3 | )% | (33.5 | )% |
| Restaurant depreciation and amortization      |       | (6.1                                                          | )%         | (6.0                                                    | )%         | (6.0 | )% | (6.1 | )% |
| Operating margin (restaurant sales only)      |       | 34.9                                                          | %          | 37.6                                                    | %          | 34.5 | % | 36.2 | % |

 

For the nine months ended September 30, 2008, company-ownedrestaurant sales increased 7.2% to $23.6 million from $22.0 million for thesame period in 2007.  For the three monthsended September 30, 2008, company-owned restaurant sales increased 8.3% to$7.8 million from $7.2 million for the same period in 2007.  This increase was primarily the result of theaddition of four company-owned restaurants in the latter part of 2007 and twomore stores in the first quarter of 2008. Same store sales for company-owned restaurants open during all of 2007decreased 3.6% for the first nine months of 2008 but increased 1.4% in thethird quarter compared to the same periods in 2007.  The operating margin as a percentage of salesfor company-owned locations decreased to 34.5% in the first nine months of 2008(34.9% in the third quarter) from 36.2% in 2007 (37.6% in the third quarter)primarily due to rising food and paper costs as a percentage of company ownedrestaurant sales.

 

The following table shows our total operating results from therestaurant segment for the three and nine months ended September 30, 2008and 2007:

 
| ** **                              | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-----------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                              | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                              | ** ** | **(% to total revenue)**                  | ** ** |
| Total restaurant operations:            |       |                                                     |       |                                                    |       |   |   |   |   |
| Company-owned restaurant sales          |       | 85.6                                                     | %          | 92.3                                                    | %          | 90.0 | % | 92.8 | % |
| Royalty revenue                         |       | 6.2                                                      | %          | 6.8                                                     | %          | 6.5 | % | 6.6 | % |
| Franchise fee revenue                   |       | 8.2                                                      | %          | 0.9                                                     | %          | 3.5 | % | 0.6 | % |
| Total revenue                           |       | 100.0                                                    | %          | 100.0                                                   | %          | 100.0 | % | 100.0 | % |
|                                    |       |                                                     |       |                                                    |       |   |   |   |   |
| Cost of sales                           |       | (55.7                                                    | )%         | (57.7                                                   | )%         | (59.0 | )% | (59.3 | )% |
| General & administrative costs |       | (43.5                                                    | )%         | (50.6                                                   | )%         | (47.0 | )% | (49.1 | )% |
| Interest expense                        |       | (1.8                                                     | )%         | (2.5                                                    | )%         | (2.0 | )% | (2.4 | )% |
| Loss on disposition of fixed assets     |       | (8.1                                                     | )%         | —                                                  |       | (2.8 | )% | — |   |
| Management allocation                   |       | (6.2                                                     | )%         | (6.8                                                    | )%         | (6.2 | )% | (6.8 | )% |
| Minority interest in losses             |       | (2.4                                                     | )%         | 2.5                                                     | %          | 0.0 | % | 2.9 | % |
| Segment loss                            |       | (17.7                                                    | )%         | (15.1                                                   | )%         | (17.0 | )% | (14.7 | )% |

 

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Royalty revenue increased to $1.7 million for the first nine months of2008 compared to $1.6 million for the same period in 2007 and increased to $0.6million for the three months ended September 30, 2008 compared to $0.5million for the same period in 2007.  Weadded six franchise locations during the nine months ended September 30,2008 (none in the third quarter).  Thisincrease was partially offset by three locations being converted from franchiseto company-owned restaurants and the closure of two franchise restaurants.  The net increase in franchise locations wasoffset by a decrease of 3.8% in same store sales for franchise restaurants forthe first nine months of 2008 (1.3% decrease in the third quarter) compared tothe same period in 2007.

 

System-wide same store sales decreased 3.7% for stores open during allof 2007 during the first nine months of 2008 compared to the same period in2007, and decreased 0.1% in the third quarter of 2008 compared to the sameperiod in 2007.  Our loss from restaurantoperations was 14.2% of total revenue for the nine months ended September 30,2008 (9.6% for the third quarter) compared to 14.7% for the same nine months of2007 (15.1% for the third quarter).

 

Weplan to open additional Fatburger restaurants throughout the United States andinternationally, including Canada, China, Saudi Arabia, Indonesia, Kuwait, andthe United Arab Emirates.  We intend tocontinue to open company-owned restaurants in strategic markets and increasethe number of franchised locations in the U.S. and internationally.  Fatburger has opened a net total of 41restaurant locations since our acquisition in 2003.  As is typical for our industry, theidentification of qualified franchisees and quality locations has an impact onthe rate of growth in the number of our restaurants.  As a result of the recent downturn in theglobal real estate market, Fatburger is initiating discussions with certain ofits landlords in an effort to reduce occupancy expenses.  There can be no assurance that thesediscussions will result in lowered rent for restaurant locations.

 

*Manufacturing segment operations*

 

Thefollowing table summarizes the operating results of our manufacturing segmentfor the three and nine months ended September 30, 2008 and 2007:

 
| ** **                  | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-----------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                  | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                  | ** ** | **(% to total revenue)**                  | ** ** |
| Manufacturing sales         |       | 100.0                                                    | %          | 100.0                                                   | %          | 100.0 | % | 100.0 | % |
| Manufacturing cost of sales |       | (61.0                                                    | )%         | (55.6                                                   | )%         | (59.1 | )% | (55.6 | )% |
| Engineering and development |       | (8.1                                                     | )%         | (8.7                                                    | )%         | (9.8 | )% | (9.3 | )% |
| Operating margin            |       | 30.9                                                     | %          | 35.7                                                    | %          | 31.1 | % | 35.1 | % |
|                        |       |                                                     |       |                                                    |       |   |   |   |   |
| Compensation expense        |       | (12.5                                                    | )%         | (12.6                                                   | )%         | (16.2 | )% | (14.9 | )% |
| Depreciation expense        |       | (1.2                                                     | )%         | (0.7                                                    | )%         | (1.1 | )% | (0.9 | )% |
| Other operating expense     |       | (0.5                                                     | )%         | (8.5                                                    | )%         | (7.0 | )% | (9.3 | )% |
| Segment income              |       | 16.7                                                     | %          | 13.9                                                    | %          | 6.8 | % | 10.0 | % |

 

Totalrevenue for this segment was $8.8 million for the nine months ended September 30,2008 ($3.5 million for the third quarter), compared to $7.8 million for thesame nine months ($2.9 million for the third quarter) in 2007.  Net income for this segment was $0.6 millionfor the nine months ended September 30, 2008 ($0.6 million for the thirdquarter), compared to $0.8 million for the same nine months ($0.4 million forthe third quarter) in 2007.  In order tofocus our efforts on our restaurant segment, we intend to sell our equityposition in DAC for an amount higher than our net investment.  If we were to sell this segment, we expectthat it would decrease our future net revenue. There can be no assurance that we will be able to sell this segment fora profit.

 

*Real estate and finance segment operations*

 

InFebruary 2008, we sold FCRI, our wholly-owned subsidiary that held ourleased real estate portfolio.  The salesprice was $8.5 million and we recorded a gain on sale of $4.2 million.  Results of operations from FCRI (includingthe gain on sale in 2008) have been classified as discontinued operations.  Our remaining real estate investments consistof one apartment building in Barcelona, Spain, which has been classified asheld for sale.

 

*Interest income* – Our interest income for the first nine months of both 2008 and 2007was $0.1 million.

 

*Interest expense* – Interest expense for this segment for the first nine months of 2008was $1.5 million ($0.5 million for the third quarter) compared to $1.3 millionfor the first nine months of 2007 ($0.5 million for the third quarter).

 

*Foreign exchange gains* – Changes in foreign currency exchange ratesresulted in a net loss of approximately $0.2 million in this segment for thenine months ended September 30, 2008 (net loss of $0.7 million in thethird quarter), compared to net gains of $0.8 million for the first

 

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ninemonths of 2007 ($0.5 million in the third quarter).  At September 30, 2008, approximately 5%of our total assets and 3% of our total liabilities were denominated in theeuro.

* *

*Market value impairment reserves* – We recognized a market value impairmentreserve of $0.6 million on one property in Barcelona, Spain in the first halfof 2008.  In the third quarter of 2008,this building was sold for cash proceeds of approximately $4.5 million, and werecognized a loss of $0.6 million on the sale. This compares to an impairment of $2.9 million in the first nine months2007 for the same property.

 

*Other non-operating income –* In the nine months ended September 30,2008, we had equity in income of equity investee of $0.2 million.  In the same nine months of 2007, we hadcommission and other non-operating revenue of $0.3 million, and a forfeiteddeposit on the sale of one Barcelona property of $0.7 million.

 

*Corporate expenses*

 
| ** **                         | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                         | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                         | ** ** | **(dollars in thousands)**                     | ** ** |
| Compensation and employee benefits |       | $                                                        | 1,341      |                                                    | $          | 1,253 |   | $ | 5,377 |   | $ | 6,089 |   |
| Professional fees                  |       | 232                                                      |       | 256                                                     |       | 976 |   | 982 |   |
| Travel and entertainment           |       | 267                                                      |       | 341                                                     |       | 1,116 |   | 1,382 |   |
| Insurance                          |       | 96                                                       |       | 64                                                      |       | 234 |   | 316 |   |
| Directors fees                     |       | 94                                                       |       | 131                                                     |       | 282 |   | 397 |   |
| Occupancy costs                    |       | 34                                                       |       | 29                                                      |       | 104 |   | 106 |   |
| Other expenses                     |       | 125                                                      |       | 159                                                     |       | 413 |   | 538 |   |
| Total operating expenses           |       | $                                                        | 2,189      |                                                    | $          | 2,233 |   | $ | 8,502 |   | $ | 9,810 |   |

 

Forthe nine months ended September 30, 2008, we incurred corporate operatingexpenses of $8.5 million ($2.2 million for the third quarter), compared to $9.8million for the same nine months ($2.2 million for the third quarter) in2007.  This decrease is primarily due toa decrease in compensation expenses and directors fees.  Corporate expenses for the first nine monthsof 2008 include $0.9 million ($0.3 million for the third quarter) for sharebased payments accounted for under FAS 123R, compared to $1.4 million for thesame nine months ($0.5 million for the third quarter) in 2007.

 

*Management allocation and other intercompany charges*

 

In2006, as we focused our efforts on the Fatburger segment we began allocating aportion of our corporate expenses to our restaurant segment to more accuratelyreflect the operating results of that segment. This allocation was $1.6 million for the nine months ended September 30,2008 and 2007 ($0.5 million for the third quarter in each year).  This allocation is eliminated uponconsolidation on the Consolidated Statements of Operations.  Other intercompany charges, includingintercompany interest expense, are eliminated upon consolidation and totaled$0.5 million for the nine months ended September 30, 2008 (less than $0.1million for the third quarter) compared to $0.8 million for the same nine monthof 2007 ($0.3 million for the third quarter).

 

*Income taxes*

 

Duringthe three months and the nine months ended September 30, 2008, noprovision for income taxes was required due to the net operating loss generatedduring the periods.  We recorded a taxbenefit of less than $0.1 million to recognize tax refunds received in thefirst quarter of 2008 on prior taxes paid. During the nine months ended September 30, 2007, we determined thatit was more likely than not that certain NOL carryovers would be available tooffset prior taxable income.  As aresult, we recognized an income tax benefit of $4.4 million and reduced thedeferred tax liability by the same amount. No comparable tax benefit was recognized during the 2008 period.

 

*Discontinued operations*

 

*Leased real estate portfolio –*In February 2008, we sold ourwholly-owned subsidiary, FCRI, which held our leased real estateportfolio.  At the time of sale, thisportfolio was comprised of leasehold interests in 72 freestanding retailbuildings located throughout the United States. Prior to the sale, the leased real estate portfolio was part of our RealEstate and Financing Operations segment. The following represents the results of operations during the time ofour ownership of FCRI:

 
| ** **                                           | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                           | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                           | ** ** | **(dollars in thousands)**                     | ** ** |
| Operating revenue                                    |       | $                                                        | —     |                                                    | $          | 972 |   | $ | 610 |   | $ | 2,851 |   |
| Operating expenses                                   |       | —                                                   |       | (305                                                    | )          | (240 | ) | (1,013 | ) |
| Depreciation and amortization                        |       | —                                                   |       | (111                                                    | )          | (39 | ) | (330 | ) |
| Operating margin                                     |       | —                                                   |       | 556                                                     |       | 331 |   | 1,508 |   |
| General and administrative expenses                  |       | —                                                   |       | (229                                                    | )          | (7 | ) | (293 | ) |
| Interest expense                                     |       | —                                                   |       | (240                                                    | )          | (157 | ) | (702 | ) |
| Other non-operating income                           |       | —                                                   |       | 7                                                       |       | 8 |   | 20 |   |
| Gain on sale of discontinued real estate  operations |       | —                                                   |       | —                                                  |       | 4,217 |   | — |   |
| Income from discontinued real estate  operations     |       | $                                                        | —     |                                                    | $          | 94 |   | $ | 4,392 |   | $ | 533 |   |

 

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*Software development and sales operations –*In June 2008, we exercised our rightsunder a security agreement on loans to Centrisoft, a consolidatedsubsidiary.  Pursuant to the securityagreement, the collateral assets of Centrisoft were transferred to us insatisfaction of the loans.  Centrisofthas since ceased operations.  As of September 30, 2008, we no longerinclude Centrisoft as a consolidated subsidiary.  We will continue to service existingcustomers of Centrisoft using the assets acquired through the securityagreement and will seek to sell the Centrisoft technology and assets to a thirdparty.  Prior to discontinuation ofoperations, Centrisoft was a reportable segment of our operations thatdeveloped and sold network productivity and security software.  The following represents the results ofoperations during the time of the Company’s ownership of Centrisoft:

 
| ** **                  | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-----------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                  | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                  | ** ** | **(dollars in thousands)**                     | ** ** |
| Software sales              |       | $                                                        | —     |                                                    | $          | 46 |   | $ | 128 |   | $ | 60 |   |
| Engineering and development |       | —                                                   |       | (105                                                    | )          | (158 | ) | (367 | ) |
| Compensation expense        |       | —                                                   |       | (38                                                     | )          | (92 | ) | (195 | ) |
| Depreciation expense        |       | —                                                   |       | (110                                                    | )          | (182 | ) | (334 | ) |
| Other operating expense     |       | —                                                   |       | (69                                                     | )          | (123 | ) | (284 | ) |
| Interest expense            |       | —                                                   |       | (294                                                    | )          | (492 | ) | (846 | ) |
| Segment loss                |       | $                                                        | —     |                                                    | $          | (570 | ) | $ | (919 | ) | $ | (1,966 | ) |

 

*Mortgage banking operations –*In December, we and our 49% partners reachedan agreement to sell our ownership interest in George Elkins Mortgage BankingCompany (“George Elkins”), a California commercial mortgage bankingoperation.  The sale closed in February 2007.  Prior to the decision to sell George Elkins,it was a reportable segment of our operations. The following represents the results of operations during the time ofour ownership of George Elkins:

 
| ** **                              | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-----------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                              | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                              | ** ** | **(dollars in thousands)**                     | ** ** |
| Total revenue                           |       | $                                                        | —     |                                                    | $          | — |   | $ | — |   | $ | 1,807 |   |
| Compensation expense                    |       | —                                                   |       | —                                                  |       | — |   | (1,534 | ) |
| Other operating expense                 |       | —                                                   |       | —                                                  |       | — |   | (281 | ) |
| Non-operating income                    |       | —                                                   |       | —                                                  |       | — |   | 17 |   |
| Gain on sale of discontinued operations |       | —                                                   |       | —                                                  |       | — |   | 2,492 |   |
| Minority interest in earnings           |       | —                                                   |       | —                                                  |       | — |   | 13 |   |
| Segment income                          |       | $                                                        | —     |                                                    | $          | — |   | $ | — |   | $ | 2,514 |   |

 

**Changes in financial condition**

 

Ourassets, liabilities and stockholders’ equity (deficit) can be summarized asfollows:

 
| ** **                                | ** ** | **September 30, 2008**     | ** ** | **December 31, 2007** | ** ** |
|-------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                | ** ** | **(dollars in thousands)** | ** ** |
| Total assets                              |       | $                                    | 33,113     |                            | $          | 53,769 |   |
| Total liabilities                         |       | $                                    | 38,628     |                            | 51,072     |   |
| Total minority interests                  |       | $                                    | 777        |                            | 701        |   |
| Total stockholders’ equity (deficit) |       | $                                    | (6,292     | )                               | 1,996      |   |
|                                           |            |                                      |            |                                 |            |  |  |

 

Thedecrease in total assets during the first nine months of 2008 is primarily dueto the disposal of our FCRI subsidiary, which was classified as held for saleat December 31, 2007.  Totalliabilities decreased over the first nine months of 2008 primarily for the samereason.  The cash received from thedisposal of FCRI was used to repay one note payable and to support our operatingactivities.  Stockholders’ equitydecreased during the first nine months of 2008 by approximately $7.5 million,mainly resulting from our net loss of $8.4 million, partially offset by sharebased compensation of $0.9 million. These changes are described in more detail as follows:

 

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*Cash*

 

Ourcash decreased $0.2 million from December 31, 2007 to September 30,2008.  Significant sources and uses ofcash during the nine months ended September 30, 2008 include:

 

·                  $8.1 million of cash used in operations –comprised primarily of our net loss from continuing operations of $11.9 millionadjusted for net non-cash items of $4.0 million;

·                  $5.2 million of cash provided by investingactivities – comprised of $1.7 million received on payments on notesreceivable, $4.5 million proceeds from the sale of real estate, and $0.2million distributed from equity investees, partially offset by $1.3 millioninvested in restaurant assets and other property, plant & equipment;

·                  $4.1 million of cash used in financingactivities – includes payments on borrowings and capital leases of $8.5million, partially offset by proceeds from borrowings of $4.0 million and $0.4million invested by minority interests; and

·                  $6.8 million net cash inflow fromdiscontinued operations.

 

*Net investments in real estate, and related liabilities*

 

Ourinvestments in real estate can be summarized as follows:

 
| ** **                                          | ** ** | **September 30,  2008**         | ** ** | **December 31, 2007** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                          | ** ** | **(dollars in thousands)** | ** ** |
| US based investments – held for sale (1):      |       |                                 |       |                            |       |
| Purchase price / improvements                       |       | $                                    | —     |                            | $          | 13,338 |   |
| Accumulated depreciation and amortization           |       | —                               |       | (2,143                          | )          |
| Net book value                                      |       | —                               |       | 11,195                          |       |
| Foreign-based investments – held for sale (2): |       |                                 |       |                            |       |
| Purchase price / improvements                       |       | 2,287                                |       | 8,463                           |       |
|                                                |       |                                 |       |                            |       |
| Total investments in real estate, net               |       | $                                    | 2,287      |                            | $          | 19,658 |   |

 

----

(1)     Includes 32 commercial properties undercapital lease throughout the United States at December 31, 2007.

(2)     Includes 1 apartment building in Barcelona,Spain at September 30, 2008 and 2 buildings at December 31, 2007.

 

Borrowingsrelated to our investments in real estate were as follows:

 
| ** **                                      | ** ** | **September 30, 2008**     | ** ** | **December 31, 2007** | ** ** |
|-------------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                      | ** ** | **(dollars in thousands)** | ** ** |
| Obligations on real estate under capital  lease |       | 919                                  |       | 3,505                           |       |
| Borrowings on Barcelona properties              |       | $                                    | —     |                            | $          | 9,994 |   |
| Total borrowings related to real estate         |       | $                                    | 919        |                            | $          | 13,499 |   |

 

Investmentsin properties under capital lease (and the related capital lease obligations)decreased to zero at September 30, 2008 due to the sale of our FCRIsubsidiary which held our leased real estate portfolio.  Our investment in apartment buildings inBarcelona, Spain decreased $6.2 million since December 31, 2007 primarilydue to the sale of one building in September 2008.

 

*Net property, plant and equipment*

 

Netproperty, plant and equipment decreased $1.4 million at September 30, 2008compared to December 31, 2007, primarily due to scheduled monthlydepreciation on those assets and the disposal of $0.7 million in fixed assetsassociated with closed Fatburger restaurants. Obligations on property, plant, and equipment under capital leaseremained stable at less than $0.1 million at September 30, 2008 comparedto December 31, 2007.

 

*Goodwill and net intangible assets*

 
| ** **                             | ** ** | **September 30, 2008**     | ** ** | **December 31, 2007** | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **(dollars in thousands)** | ** ** |
| Goodwill – Fatburger              |       | $                                    | 7,063      |                            | $          | 7,063 |   |
| Goodwill – DAC International      |       | 1,465                                |       | 1,465                           |       |
| Total goodwill                         |       | $                                    | 8,528      |                            | 8,528      |   |
|                                   |       |                                 |       |                            |       |
| Net intangible assets – Fatburger |       | $                                    | 4,615      |                            | 4,756      |   |
| Total net intangible assets            |       | $                                    | 4,615      |                            | 4,756      |   |
|                                        |            |                                      |            |                                 |            |  |  |

 

Netintangible assets decreased $0.1 million in the nine months ended September 30,2008 due to monthly amortization.  Netintangible assets at September 30, 2008 consists of trademark rights ofapproximately $4.0 million, franchise agreements of approximately $0.3 million,and other miscellaneous intangible assets of approximately $0.3 million.  We do not believe that there is anyimpairment of goodwill or net intangible assets at September 30, 2008.

 

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*Notes receivable*

 

Asof September 30, 2008, our notes receivable portfolio consists of one notesecured by real estate with a carrying value of less than $0.1 million.  The loan carries an interest rate (excludingfees and points) of 7.0% and matures in April 2010.

 

*Loans to senior executives*

 

Asof December 31, 2007, we had two loans to our Chairman and Chief ExecutiveOfficer, Andrew Wiederhorn, for a total of $1.1 million.  Both loans were made on February 21,2002 (prior to the passage of the Sarbanes-Oxley Act of 2002).  The loans matured on February 21, 2007,and bore interest at the prime rate, as published in the Wall Street Journal,which interest was added to the principal. The loans were repaid in full, including interest, on February 21,2008.

 

*Other assets*

 
| ** **                   | ** ** | **September 30, 2008**     | ** ** | **December 31, 2007** | ** ** |
|------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                   | ** ** | **(dollars in thousands)** | ** ** |
| Trade receivables            |       | $                                    | 1,838      |                            | $          | 1,479 |   |
|                         |       |                                 |       |                            |       |
| Inventories                  |       | $                                    | 3,977      |                            | $          | 2,505 |   |
|                         |       |                                 |       |                            |       |
| Other current assets:        |       |                                 |       |                            |       |
| Prepaid expenses             |       | $                                    | 414        |                            | $          | 526 |   |
| Other                        |       | 97                                   |       | 2                               |       |
| Total other current assets   |       | $                                    | 511        |                            | $          | 528 |   |
|                         |       |                                 |       |                            |       |
| Other assets:                |       |                                 |       |                            |       |
| Software costs               |       | $                                    | 571        |                            | $          | — |   |
| Security deposits            |       | 723                                  |       | 646                             |       |
| Capitalized finance fees     |       | 282                                  |       | 269                             |       |
| Other                        |       | 81                                   |       | 93                              |       |
| Total other assets           |       | $                                    | 1,657      |                            | $          | 1,008 |   |
|                         |       |                                 |       |                            |       |
| Assets held for sale:        |       |                                 |       |                            |       |
| Current assets held for sale |       | $                                    | —     |                            | $          | 86 |   |
| Other assets held for sale   |       | —                               |       | 2,147                           |       |

 

Tradereceivables and inventories at September 30, 2008 relate primarily to theoperations of DAC.  Other assets held forsale at December 31, 2007 relates mainly to Centrisoft, and includes $1.0million of goodwill, $0.9 million of software costs, and $0.2 million ofintangible assets.

 

*Deferred income*

 

Ourdeferred income relating to the collection of unearned Fatburger franchise feesdecreased to $4.6 million at September 30, 2008, compared to $5.2 millionat December 31, 2007.  This wasprimarily the result of the recognition of $0.8 million in franchise feerevenue as we bought out the remaining unused franchise rights of twofranchisees, partially offset by the collection of $0.2 million in deferredfranchise fees.  As of September 30,2008, all of our deferred income was comprised of the non-refundable franchisefee received by Fatburger for each future franchise location.  These initial fees generally represent halfof the total fee per location.  Thebalance of the franchise fee (approximately an additional $4.6 million) will becollected in the future when leases on these specific franchise locations aresigned.

 

*Notes payable*

 

Asof September 30, 2008, our notes payable (excluding borrowings on realestate) totaled $13.4 million, including $6.9 million of debt held at Fatburgerand $0.8 million at DAC.  This comparesto $17.6 million at December 31, 2007. The decrease was primarily due to repayments of notes payable totaling$8.4 million in the nine months ended September 30, 2008, partially offsetby additional borrowings of $4.0 million in the same time frame.

 

*Accounts payable and accrued liabilities*

 

Accountspayable and accrued liabilities totaled $17.7 million at September 30,2008, compared with $12.6 million at December 31, 2007, and consisted ofthe following:

 
| ** **                                                | ** ** | **September 30,  2008**         | ** ** | **December 31, 2007** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                                | ** ** | **(dollars in thousands)** | ** ** |
| Accounts payable                                          |       | $                                    | 7,649      |                            | $          | 8,872 |   |
| Sales deposits                                            |       | 2,339                                |       | 1,478                           |       |
| Accrued wages, bonus and commissions                      |       | 1,657                                |       | 708                             |       |
| Other                                                     |       | 6,087                                |       | 1,587                           |       |
| Total accrued expenses and other  liabilities             |       | $                                    | 17,732     |                            | $          | 12,645 |   |
|                                                      |       |                                 |       |                            |       |
| Current liabilities associated with assets  held for sale |       | $                                    | —     |                            | $          | 2,565 |   |

 

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Theincrease in other payables was primarily the result of the accrual ofmanagement fees and the option commitment fee associated with the sale of FCRI.

 

**Liquidity and Capital Resources**

 

Liquidityis a measurement of our ability to meet potential cash requirements, includingongoing commitments to repay borrowings, fund business operations,acquisitions, and expansion (including growth of company-owned and franchisedrestaurant locations), engage in loan acquisition and lending activities andfor other general business purposes.  Inaddition to our cash on hand, our primary sources of funds for liquidity duringthe first nine months of 2008 consisted of cash provided by proceeds from thesale of discontinued operations, borrowings on notes payable, and therepayments to us from borrowers.  As of September 30,2008, we had cash or cash equivalents of $0.9 million, which, together withprojected borrowings and proceeds from the sales of assets, we believe will besufficient to meet our current liquidity needs.

 

AtSeptember 30, 2008, we had total consolidated secured indebtedness of$16.3 million, as well as $22.3 million of other liabilities.  Our consolidated secured indebtednessconsisted of:

 

·                  notespayable and other debt of Fatburger of $6.9 million secured by the assets ofFatburger;

·                  $2.0million in capital leases maturing on or before 2010 secured by an aircraft andvarious restaurant assets;

·                  notespayable of $0.9 million secured by our Barcelona property;

·                  $4.7million of notes payable secured by various assets of the Company; and

·                  $0.8million of short-term borrowings secured by the assets of DAC International.

 

Weconsider the sale of assets to be a normal, recurring part of our operationsand we are currently generating cash flow as a result of these transactions.  However, excluding the sale of assets fromtime to time, we are currently operating with negative cash flow, since many ofour assets do not currently generate sufficient cash to cover operatingexpenses.  We believe that our existingsources of funds will be adequate to meet our liquidity needs; however, therecan be no assurance that this will be the case.

 

Ifour existing liquidity position were to prove insufficient, and we were unableto repay, renew or replace maturing indebtedness on terms reasonablysatisfactory to us, we may be required to sell (potentially on short notice) aportion of our assets, and could incur losses as a result.  Specific risks to our liquidity positioninclude the following:

 

*Foreign currency exchange rate risk*

 

Ourexposure to foreign currency fluctuations arises mainly from our investment inBarcelona real estate.  As of September 30,2008, approximately 5% of our total assets and 3% of our total liabilities weredenominated in the euro.  We can utilizea wide variety of financial techniques to assist in the management of currencyrisk, including currency swaps, options, and forwards, or combinationsthereof.  No such currency hedgingtechniques were in use as of September 30, 2008.

 

*Interest rate risk*

 

Ourborrowings and the availability of further borrowings are substantiallyaffected by, among other things, changes in interest rates, changes in marketspreads or decreases in credit quality of our assets.  Material increases in interest expense fromvariable-rate funding sources, or material decreases in monthly cash receiptsfrom operations, generally would negatively impact our liquidity.  On the other hand, material decreases ininterest expense from variable-rate funding sources would positively affect ourliquidity.  Fluctuations in interestrates will impact our net income to the extent our operations and our fixedrate assets are funded by variable rate debt. We may also be impacted to the extent that our variable rate assetsre-price on a different schedule or in relation to a different index than anyfloating rate debt.

 

*Debt covenants*

 

AtDecember 31, 2007, Fatburger was not in compliance with all obligationsunder the agreements evidencing its indebtedness, as defined in the applicableagreements, due to its failure to meet the prescribed fixed charge coverageratio and the prescribed debt-coverage ratio in three notes payable.  As it has in the past, the lendersubsequently issued a waiver of the covenant violations at December 31,2007.  The next measurement date forcompliance with this covenant is December 31, 2008.  As of September 30, 2008, Fatburger hadpast due loan payments totaling approximately $ 82,000, however, this amountwas brought current subsequent to the quarter end.  In addition, the Barcelona Spain VIE wasdelinquent in loan payments totaling approximately $16,000.

 

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*Fatburger expansion*

 

Fatburgeris involved in a nationwide expansion of franchise and company-owned locations,which will require significant liquidity. If real estate locations of sufficient quality cannot be located andeither leased or purchased, the timing of restaurant openings may bedelayed.  Additionally, if Fatburger orits franchisees cannot obtain capital sufficient to fund this expansion, thetiming of restaurant openings may be delayed.

 

*Restricted cash balance*

 

AtSeptember 30, 2008, we had $0.2 million of cash restricted to securecertain obligations.

 

*Dividends*

 

Whilewe do not have a fixed dividend policy, we may declare and pay new dividends onour common stock, subject to our financial condition, results of operations,capital requirements and other factors deemed relevant by the Board ofDirectors.  One factor the Board ofDirectors may consider is the impact of dividends on our liquidity.  We have not declared or paid any dividends inthe first nine months of 2008.

 

*Over-the-counter stock listing*

 

EffectiveOctober 14, 2004, our stock began trading in the over-the-counter (“OTC”)market.   Trading of our common stock onthe OTC market reduces the liquidity of our common stock compared to quotationon a national market.  Also, the coverageof the Company by security analysts and media is reduced, which we believeresults in lower prices for our common stock than might otherwise prevail andalso results in increased spreads between the bid and ask prices for our commonstock.  Additionally, certain investorswill not purchase securities that are not quoted on a national market, which webelieve impairs our ability to raise funds through the issuance of common stockor other securities convertible into common stock.

 

**Off Balance Sheet Arrangements**

 

Inorder to facilitate the development of franchise locations, as of September 30,2008, Fatburger had guaranteed the annual minimum lease payments of onerestaurant site owned and operated by a franchisee.  The guarantee is approximately $0.7 millionplus certain contingent rental payments as defined in the lease, which expiresin July 2015.  The lease guaranteeby Fatburger does not provide us with a material source of liquidity, capitalresources or other benefits.  There areno revenues, expenses or cash flows connected with the lease guarantee otherthan the receipt of normal franchise royalties. As of September 30, 2008, we were not aware of any event or demandthat was likely to trigger the guarantee by Fatburger.

 

Wehave various operating leases for office, manufacturing and retail space whichexpire through 2017.  The leases providefor varying minimum annual rental payments including rent increases and freerent periods.  We have future minimumrental payments under non-cancelable operating leases with initial or remainingterms of one year or more of approximately $23.4 million as of September 30,2008.

 

Wedid not have any other off-balance sheet arrangements in place as of September 30,2008.

 

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

##  

Not applicable.

 

**ITEM 4. CONTROLS AND PROCEDURES**

 

*Evaluation of disclosure controls and procedures*

 

OurChief Executive Officer and our Chief Financial Officer, after evaluating theeffectiveness of the Company’s “disclosure controls and procedures” (as definedin the Securities and Exchange Act of 1934 Rules 13a-15(e) and15d-15(e)) as of September 30, 2008, have concluded that our disclosurecontrols and procedures were effective and designed to ensure that materialinformation relating to us and our consolidated subsidiaries is accumulated andcommunicated to our management to allow timely decisions regarding requireddisclosure.

 

TheCompany does not expect that its disclosure controls and procedures willprevent all error and all fraud.  Acontrol procedure, no matter how well conceived and operated, can provide onlyreasonable, not absolute, assurance that the objectives of the controlprocedures are met.  Because of theinherent limitations in all control procedures, no evaluation of controls canprovide absolute assurance that all control issues and instances of fraud, ifany, within the Company have been detected. These inherent limitations include the realities that judgments indecision-making can be faulty, and that breakdowns can occur because of simpleerror or mistake.  Additionally, controlscan be circumvented by the individual acts of some persons, by collusion of twoor more people, or by management override of the control.  The 

 

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Companyconsidered these limitations during the development of its disclosure controlsand procedures, and will continually reevaluate them to ensure they providereasonable assurance that such controls and procedures are effective.

 

*Changes in internal control over financial reporting*

 

Therewere no significant changes in our internal control over financial reporting inconnection with an evaluation that occurred during our third fiscal quarter of2008 that have materially affected or are reasonably likely to materiallyaffect our internal control over financial reporting.

 

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**PART II — OTHER INFORMATION**

 

**ITEM1.  LEGAL PROCEEDINGS**

 

*Warlick complaint*

 

**Fatburger Holdings, Inc., et al. v. Keith A. Warlick/Warlick v. Fatburger, et al, Superior Court of California for the County of LosAngeles, Case No. SC 091436.**** **On October 16, 2006, Fatburger Holdings, Inc., FatburgerCorporation and Fatburger North America, Inc. filed suit against Keith A.Warlick (“Warlick”) the former Chief Executive Officer of Fatburger Holdings, Inc.and Fatburger Corporation. Warlick’s employment with Fatburger was terminatedon September 21, 2006 by resolution of the board of directors of FatburgerHoldings, Inc. The Fatburger companies initiated the lawsuit to recoverdamages from Warlick arising from wrongful acts and conduct during and afterhis employment, and are asserting claims for: breach of contract, breach of duty of loyalty, breach of fiduciary duty,conversion – embezzlement; fraud/commencement; intentional interference withcontractual relations, and equitable indemnity. Warlick filed an answer to the lawsuit denying the allegations andincluded a Cross-complaint against Fatburger Holdings, Inc., FatburgerCorporation, Fatburger North America, Inc., Fog Cutter Capital Group, Inc.,and Andrew Wiederhorn (“Cross-Defendants”), for breach of contract, employmentdiscrimination based on race and retaliation, wrongful termination anddefamation – slander without any specification of damages.  On a motion filed by the Cross-Defendants,the Court dismissed Warlick’s cross-claim for employment discrimination basedon race and retaliation.  In furtherresponse Warlick initiated a second lawsuit against the Company, variousFatburger companies, and members of the Fatburger board of directors, which isset out below. The defendants to the Cross-complaint filed by Warlick disputethe allegations of the cross-complaint and intend to vigorously defend againstthe cross-complaint.

 

**Keith Warlick, et al. v. Fog Cutter Capital Group, et al.,Superior Court of California for the County of Los Angeles, Case No. 58365915.**** **On February 6, 2007, Warlick, his wife, and a limited liabilitycompany controlled by Warlick, each of whom is a minority shareholder ofFatburger Holdings, Inc., filed a complaint against various Fatburgerentities, the Company, Andrew Wiederhorn, and members of the Fatburger board ofdirectors. The complaint alleges fraud, negligent misrepresentation againstWiederhorn and the Company, and breach of contract and breach of fiduciary dutyagainst all the defendants, related to business transactions which theplaintiff’s allege were not in the best interests of Fatburger Holdings, Inc.,or the plaintiff minority shareholders. The defendants dispute the allegationsof the lawsuit and intend to vigorously defend against the claims.

 

**ITEM1A.  RISK FACTORS**

 

***The global economic crisis whichbegan in the third quarter of 2008 may have detrimental impacts on ourbusiness.***

 

Duringthe third quarter 2008, a global economic crisis in the credit markets beganwhich has started to impact the equity markets and may produce a prolongedglobal recession. Although we cannot predict the extent, timing and fullramifications of the crisis, we believe that, at a minimum, the following riskshave been heightened.

 

*Credit availability to the Company* — Continued illiquidity in the creditmarkets may prevent us from being able to repay, renew or replace maturingindebtedness on terms reasonably satisfactory to us and we may be required tosell (potentially on short notice) a portion of our assets, and could incurlosses as a result.   If the Company issuccessful in obtaining new financing, the cost of capital may be significantlyhigher than was previously available.

 

*Credit availability to our franchisees* — We believe that many of ourfranchisees rely on liquidity from operative credit markets. If the marketsremain illiquid, the ability of our franchisees to open additional locationsand our ability to attract new franchisees may be negatively affected.

 

*Potential recession impacts* — A prolonged recession may havenegative impact on our sales as customers seek lower priced alternatives orreduce the frequency of their purchases.

 

*Potential delay in the sale of DAC* — The unrest in the credit markets maydelay our ability to sell DAC in a timely manner, which may affect our abilityto meet our liquidity needs.

 

For a discussion of other risk factors which may affect our business,please refer to Item 1A of the Form 10K for the year ending December 31,2007, as filed with the Securities and Exchange Commission on March 31,2008.

 

**ITEM2.  UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

 

None.

 

**ITEM3.  DEFAULTS UPON SENIOR SECURITIES**

 

Not applicable.

 

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**ITEM4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

None.

 

**ITEM5.  OTHER INFORMATION**

 

None.

 

**ITEM6.  EXHIBITS**

 

3.1                                 Amended and Restated Articles ofIncorporation of the Registrant, incorporated by reference to Exhibit 3.1to the Form 10-Q for the period ended September 30, 1999, aspreviously filed with the SEC on November 22, 1999 (File No. 000-23911).

 

3.2                                 Bylaws of the Registrant, incorporated byreference to Exhibit 3.2 to Amendment No. 3 to the RegistrationStatement (Registration No. 333-39035) on Form S-11, as previouslyfiled with the SEC on March 30, 1998.

 

4.1                                 Common Stock Certificate Specimen,incorporated by reference to Exhibit 4.1 to Amendment No. 3 to theRegistration Statement (Registration No. 333-39035) on Form S-11, aspreviously filed with the SEC on March 30, 1998.

 

4.2                                 Form of Registration Rights Agreement,incorporated by reference to Exhibit 10.8 to Amendment No. 3 to theRegistration Statement (Registration No. 333-39035) on Form S-11, aspreviously filed with the SEC on March 30, 1998.

 

4.3                                 Form of Stock Option Plan, incorporatedby reference to Exhibit 10.3 to Amendment No. 3 to the RegistrationStatement (Registration No. 333-39035) on Form S-11, as previouslyfiled with the SEC on March 30, 1998.

 

4.4                                 Waiver, Release, Delegation and Amendment toStock Option and Voting Agreement among Andrew A. Wiederhorn, Lawrence A.Mendelsohn, Joyce Mendelsohn, Tiffany Wiederhorn, and the Registrant, dated July 31,2002, incorporated by reference to Exhibit 2.1 to the Form 8-K dated August 8,2002, as previously filed with the SEC on August 15, 2002.

 

4.5                                 Summary of Rights to Purchase Shares,incorporated by reference to Exhibit 99.1 to the Form 8-K dated October 18,2002, as previously filed with the SEC on October 18, 2002.

 

4.6                                 Rights Agreement dated as of October 18,2002 between the Registrant and The Bank of New York, incorporated by referenceto Exhibit 1 to Form 8-A, as previously filed with the SEC on October 29,2002.

 

4.7                                 Amendment to the Rights Agreement, dated asof May 1, 2004, by and between the Registrant and The Bank of New York, aspreviously filed with the SEC on March 30, 2005.

 

4.8                                 Long Term Vesting Trust Agreement among theRegistrant and Lawrence Mendelsohn, Andrew Wiederhorn and David Egelhoff, datedOctober 1, 2000, incorporated by reference to Exhibit 4.4 to the Form 10-Kfor the year ended December 31, 2002, as previously filed with the SEC on March 3,2003.

 

4.9                                 Amendment Number 1 to the Long Term Vesting TrustAgreement dated as of September 19, 2002, by and between the Registrantand Andrew Wiederhorn, Don Coleman, and David Dale-Johnson, as previously filedwith the SEC on March 30, 2005.

 

4.10                           Amendment Number 2 to the Long Term VestingTrust Agreement, dated as of May 26, 2004, by and between the Registrantand Andrew Wiederhorn, Don Coleman, and David Dale-Johnson, as previously filedwith the SEC on March 30, 2005.

 

11.1         Computation of Per Share Earnings.

 

31.1                           Certification of Chief Executive Officer,pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2                           Certification of Chief Financial Officer,pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

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

 

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

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, as amended, theregistrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

FOGCUTTER CAPITAL GROUP INC.

 
|   | By:  /s/ Andrew A. Wiederhorn                      |   |   |
|--------|----------------------------------------------------|--------|--------|
|   | Andrew  A. Wiederhorn                              |   |   |
|   | Chief  Executive Officer                           |   |   |
|   |                                               |   |   |
|   |                                               |   |   |
|   | By:  /s/ R. Scott Stevenson                        |   |   |
|   | R.  Scott Stevenson                                |   |   |
|   | Senior  Vice President and Chief Financial Officer |   |   |

 

Date:  November 14, 2008

 

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EXHIBIT INDEX

 

3.1                                 Amended and Restated Articles ofIncorporation of the Registrant, incorporated by reference to Exhibit 3.1to the Form 10-Q for the period ended September 30, 1999, aspreviously filed with the SEC on November 22, 1999 (File No. 000-23911).

 

3.2                                 Bylaws of the Registrant, incorporated byreference to Exhibit 3.2 to Amendment No. 3 to the RegistrationStatement (Registration No. 333-39035) on Form S-11, as previouslyfiled with the SEC on March 30, 1998.

 

4.1                                 Common Stock Certificate Specimen,incorporated by reference to Exhibit 4.1 to Amendment No. 3 to theRegistration Statement (Registration No. 333-39035) on Form S-11, aspreviously filed with the SEC on March 30, 1998.

 

4.2                                 Form of Registration Rights Agreement,incorporated by reference to Exhibit 10.8 to Amendment No. 3 to theRegistration Statement (Registration No. 333-39035) on Form S-11, aspreviously filed with the SEC on March 30, 1998.

 

4.3                                 Form of Stock Option Plan, incorporatedby reference to Exhibit 10.3 to Amendment No. 3 to the RegistrationStatement (Registration No. 333-39035) on Form S-11, as previouslyfiled with the SEC on March 30, 1998.

 

4.4                                 Waiver, Release, Delegation and Amendment toStock Option and Voting Agreement among Andrew A. Wiederhorn, Lawrence A.Mendelsohn, Joyce Mendelsohn, Tiffany Wiederhorn, and the Registrant, dated July 31,2002, incorporated by reference to Exhibit 2.1 to the Form 8-K dated August 8,2002, as previously filed with the SEC on August 15, 2002.

 

4.5                                 Summary of Rights to Purchase Shares,incorporated by reference to Exhibit 99.1 to the Form 8-K dated October 18,2002, as previously filed with the SEC on October 18, 2002.

 

4.6                                 Rights Agreement dated as of October 18,2002 between the Registrant and The Bank of New York, incorporated by referenceto Exhibit 1 to Form 8-A, as previously filed with the SEC on October 29,2002.

 

4.7                                 Amendment to the Rights Agreement, dated asof May 1, 2004, by and between the Registrant and The Bank of New York, aspreviously filed with the SEC on March 30, 2005.

 

4.8                                 Long Term Vesting Trust Agreement among theRegistrant and Lawrence Mendelsohn, Andrew Wiederhorn and David Egelhoff, datedOctober 1, 2000, incorporated by reference to Exhibit 4.4 to the Form 10-Kfor the year ended December 31, 2002, as previously filed with the SEC on March 3,2003.

 

4.9                                 Amendment Number 1 to the Long Term VestingTrust Agreement dated as of September 19, 2002, by and between theRegistrant and Andrew Wiederhorn, Don Coleman, and David Dale-Johnson, aspreviously filed with the SEC on March 30, 2005.

 

4.10                           Amendment Number 2 to the Long Term VestingTrust Agreement, dated as of May 26, 2004, by and between the Registrantand Andrew Wiederhorn, Don Coleman, and David Dale-Johnson, as previously filedwith the SEC on March 30, 2005.

 

11.1                           Computation of Per Share Earnings.

 

31.1                           Certification of Chief Executive Officer,pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2                           Certification of Chief Financial Officer,pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

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

 

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

 

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