##### **SECURITIES AND EXCHANGE COMMISSION**

##### ** **

**Washington,D.C. 20549**

 

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

#### ** **

| **(Mark one)** |
|----------------|
|           |
| **ý**     |   | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|           |   |   |
|           |   | **For the quarterly period ended  March 31, 2004** |
|           |   |   |
| **OR**         |
|           |   |   |
| **o**          |   | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Commission File No. 0-23911**

 

**Fog CutterCapital Group Inc.**

(Exact name of registrant as specified in itscharter)

 

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

 

**1410SW Jefferson Street**

**Portland,OR  97201**

(Address of principal executive offices) (ZipCode)

 

**(503)721-6500**

(Registrant’s telephone number, includingarea code)

 

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

 

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

 

**APPLICABLEONLY TO CORPORATE ISSUERS:**

 

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

 

| **Class**                                 |   | **Outstanding  at March 31, 2004** |
|-------------------------------------------|--------|-----------------------------------------|
| Common Stock, par value $0.0001 per share |   | 8,677,200 shares                        |

 

 

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FOG CUTTER CAPITAL GROUP INC.

 

FORM 10-Q

 

I N D E X

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

 

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

 

2

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## **PARTI** — FINANCIAL INFORMATION

 

## **ITEM1**.  INTERIMFINANCIAL STATEMENTS

## ** **

FOG CUTTER CAPITAL GROUP INC.

CONSOLIDATEDSTATEMENTS OF FINANCIAL CONDITION

*(dollars in thousands, except share data)*

 
|                                                                                                                                                                                                                                                                                                         |   | **March 31  2004** |    | **December 31  2003** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|---------|----------------------------|--------|
|                                                                                                                                                                                                                                                                                                         |   | **(Unaudited)**         |    |                       |   |
| Assets                                                                                                                                                                                                                                                                                                       |   |                    |    |                       |   |
| Cash and cash equivalents                                                                                                                                                                                                                                                                                    |   | $                       | 11,638  |                       | $      | 19,607 |   |
| Securities available for sale, pledged  under repurchase agreements, at estimated fair value                                                                                                                                                                                                                 |   | 32,182                  |    | 35,010                     |   |
| Securities available for sale, at estimated  fair value                                                                                                                                                                                                                                                      |   | 75                      |    | 500                        |   |
| Loans held for investment                                                                                                                                                                                                                                                                                    |   | 7,635                   |    | 3,744                      |   |
| Investments in real estate, net                                                                                                                                                                                                                                                                              |   | 23,313                  |    | 22,577                     |   |
| Loans to senior executives                                                                                                                                                                                                                                                                                   |   | 2,957                   |    | 2,964                      |   |
| Investment in Bourne End                                                                                                                                                                                                                                                                                     |   | 2,232                   |    | 2,141                      |   |
| Restaurant property, plant and equipment,  net                                                                                                                                                                                                                                                               |   | 6,170                   |    | 5,897                      |   |
| Intangible assets, net                                                                                                                                                                                                                                                                                       |   | 5,572                   |    | 5,640                      |   |
| Goodwill                                                                                                                                                                                                                                                                                                     |   | 7,300                   |    | 7,300                      |   |
| Other assets                                                                                                                                                                                                                                                                                                 |   | 3,883                   |    | 3,596                      |   |
| Total assets                                                                                                                                                                                                                                                                                                 |   | $                       | 102,957 |                       | $      | 108,976 |   |
|                                                                                                                                                                                                                                                                                                         |   |                    |    |                       |   |
| Liabilities and Stockholders’ Equity                                                                                                                                                                                                                                                                    |   |                    |    |                       |   |
| Liabilities:                                                                                                                                                                                                                                                                                                 |   |                    |    |                       |   |
| Repurchase agreements                                                                                                                                                                                                                                                                                        |   | $                       | 24,327  |                       | $      | 25,318 |   |
| Borrowings and notes payable                                                                                                                                                                                                                                                                                 |   | 7,556                   |    | 7,804                      |   |
| Obligations under capital leases                                                                                                                                                                                                                                                                             |   | 12,799                  |    | 12,942                     |   |
| Dividend payable                                                                                                                                                                                                                                                                                             |   | 97                      |    | 1,216                      |   |
| Deferred income                                                                                                                                                                                                                                                                                              |   | 3,860                   |    | 3,700                      |   |
| Deferred income taxes                                                                                                                                                                                                                                                                                        |   | 6,405                   |    | 6,980                      |   |
| Accrued expenses and other liabilities                                                                                                                                                                                                                                                                       |   | 5,462                   |    | 5,635                      |   |
| Total liabilities                                                                                                                                                                                                                                                                                            |   | 60,506                  |    | 63,595                     |   |
|                                                                                                                                                                                                                                                                                                         |   |                    |    |                       |   |
| Commitments and contingencies                                                                                                                                                                                                                                                                                |   |                    |    |                       |   |
|                                                                                                                                                                                                                                                                                                         |   |                    |    |                       |   |
| Stockholders’ Equity:                                                                                                                                                                                                                                                                                   |   |                    |    |                       |   |
| Preferred stock, $.0001 par value;  25,000,000 shares authorized; no shares issued  and outstanding                                                                                                                                                                                                     |   | —                  |    | —                     |   |
| Common stock, $.0001 par value; 200,000,000  shares authorized; 11,723,100 shares issued as of March 31, 2004 and  11,716,600 shares issued as of   December 31, 2003; 8,677,200 shares outstanding as of  March 31, 2004 and 8,670,700 shares outstanding as of December 31,  2003 |   | 168,042                 |    | 168,018                    |   |
| Accumulated deficit                                                                                                                                                                                                                                                                                          |   | (118,351                | )       | (115,588                   | )      |
| Accumulated other comprehensive income                                                                                                                                                                                                                                                                       |   | 777                     |    | 968                        |   |
| Treasury stock; 3,045,900 common shares as  of March 31, 2004, and 3,045,900 common shares as of December 31,  2003, at cost                                                                                                                                                                       |   | (8,017                  | )       | (8,017                     | )      |
| Total stockholders’ equity                                                                                                                                                                                                                                                                              |   | 42,451                  |    | 45,381                     |   |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                                                                              |   | $                       | 102,957 |                       | $      | 108,976 |   |

 

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

 

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FOG CUTTER CAPITAL GROUP INC.

CONSOLIDATEDSTATEMENTS OF OPERATIONS

(Unaudited)

*(dollars in thousands, except share data)*

 
|                                                 |   | **Quarter  Ended March 31,** |   |
|------------------------------------------------------|--------|-----------------------------------|--------|
|                                                 |   | **2004**                          |   | **2003** |   |
| Net Interest Income:                                 |   |                              |   |   |   |
| Loans                                                |   | $                                 | 390    |   | $ | 136 |   |
| Securities                                           |   | 313                               |   | 775 |   |
| Loans to senior executives                           |   | 36                                |   | 54 |   |
| Other investments                                    |   | 47                                |   | 55 |   |
| Total interest income                                |   | 786                               |   | 1,020 |   |
| Interest expense                                     |   | (71                               | )      | (208 | ) |
| Net interest income                                  |   | 715                               |   | 812 |   |
|                                                 |   |                              |   |   |   |
| Real Estate Operations:                              |   |                              |   |   |   |
| Operating income                                     |   | 954                               |   | 972 |   |
| Operating expense                                    |   | (456                              | )      | (538 | ) |
| Interest expense                                     |   | (281                              | )      | (360 | ) |
| Depreciation                                         |   | (159                              | )      | (153 | ) |
| Total real estate operations                         |   | 58                                |   | (79 | ) |
|                                                 |   |                              |   |   |   |
| Restaurant Operations:                               |   |                              |   |   |   |
| Operating revenue                                    |   | 5,284                             |   | — |   |
| Cost of goods sold                                   |   | (3,077                            | )      | — |   |
| Franchise and royalty fee                            |   | 272                               |   | — |   |
| General and administrative cost                      |   | (2,715                            | )      | — |   |
| Interest expense                                     |   | (165                              | )      | — |   |
| Depreciation and amortization                        |   | (352                              | )      | — |   |
| Total restaurant operations                          |   | (753                              | )      | — |   |
|                                                 |   |                              |   |   |   |
| Other Operating (Loss) Income:                       |   |                              |   |   |   |
| Equity in income (losses) of equity  investees       |   | 22                                |   | (1,008 | ) |
| Gain on sale of loans and securities                 |   | 1,086                             |   | 4,788 |   |
| Loan origination income                              |   | 1,126                             |   | 800 |   |
| Other                                                |   | 211                               |   | 191 |   |
| Total other operating (loss) income                  |   | 2,445                             |   | 4,771 |   |
|                                                 |   |                              |   |   |   |
| Operating Expenses:                                  |   |                              |   |   |   |
| Compensation and employee benefits                   |   | 2,761                             |   | 2,203 |   |
| Professional fees                                    |   | 241                               |   | 499 |   |
| Other                                                |   | 1,098                             |   | 900 |   |
| Total operating expenses                             |   | 4,100                             |   | 3,602 |   |
|                                                 |   |                              |   |   |   |
| Net income (loss) before provision for  income taxes |   | (1,635                            | )      | 1,902 |   |
| Provision for income taxes                           |   | —                            |   | 242 |   |
| Net income (loss)                                    |   | $                                 | (1,635 | ) | $ | 1,660 |   |
|                                                 |   |                              |   |   |   |
| Basic income (loss) per share                        |   | $                                 | (0.19  | ) | $ | 0.20 |   |
| Basic weighted average shares outstanding            |   | 8,673,950                         |   | 8,478,450 |   |
| Diluted net income (loss) per share                  |   | $                                 | (0.19  | ) | $ | 0.19 |   |
| Diluted weighted average shares outstanding          |   | 8,673,950                         |   | 8,767,617 |   |
| Dividends declared per share                         |   | $                                 | 0.13   |   | $ | 0.13 |   |

 

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

 

4

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FOG CUTTER CAPITAL GROUP INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’EQUITY

(Dollars inthousands)

 
|                                                                                                         |   | **Common Stock** |   | **Treasury Stock** |    | **Accumulated  Deficit** |      | **Accumulated Other  Comprehensive  Income** |   | **Total** |   |
|--------------------------------------------------------------------------------------------------------------|--------|------------------|--------|--------------------|---------|--------------------------|-----------|----------------------------------------------|--------|-----------|--------|
| **Shares (1)**                                                                                               |   | **Amount**       |   | **Shares**         |    | **Amount**               |
| Balance at January 1,  2004                                                                        |   | 8,670,700        |   | $                  | 168,018 |                     | 3,045,900 |                                         | $      | (8,017    | )      | $ | (115,588 | ) | $ | 968 |   | $ | 45,381 |   |
| Comprehensive income (loss):                                                                                 |   |             |   |               |    |                     |      |                                         |   |      |   |   |   |   |   |
| Net income (loss)                                                                                            |   | —           |   | —             |    | —                   |      | —                                       |   | (1,635    | )      | — |   | (1,635 | ) |
| Other comprehensive income:                                                                                  |   |             |   |               |    |                     |      |                                         |   |      |   |   |   |   |   |
| Foreign currency translation                                                                                 |   | —           |   | —             |    | —                   |      | —                                       |   | —    |   | 94 |   | 94 |   |
| Unrealized holding gains on securities  available for sale                                              |   | —           |   | —             |    | —                   |      | —                                       |   | —    |   | 820 |   | 820 |   |
| Reclassification adjustment for gains on  securities and foreign currency translation included in net income |   | —           |   | —             |    | —                   |      | —                                       |   | —    |   | (1,105 | ) | (1,105 | ) |
| Total comprehensive income (loss)                                                                            |   | —           |   | —             |    | —                   |      | —                                       |   | —    |   | — |   | (1,826 | ) |
| Common stock issued pursuant to exercise of stock  options                                                   |   | 6,500            |   | 24                 |    | —                   |      | —                                       |   | —    |   | — |   | 24 |   |
| Dividends declared                                                                                           |   | —           |   | —             |    | —                   |      | —                                       |   | (1,128    | )      | — |   | (1,128 | ) |
| Balance at March 31, 2004                                                                               |   | 8,677,200        |   | $                  | 168,042 |                     | 3,045,900 |                                         | $      | (8,017    | )      | $ | (118,351 | ) | $ | 777 |   | $ | 42,451 |   |

 

----

(1)          Issued and outstanding

 

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

 

5

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FOG CUTTER CAPITAL GROUP INC.

CONSOLIDATEDSTATEMENTS OF CASH FLOWS

(Unaudited)

*(dollars in thousands)*

 
|                                                                     |   | **Quarter  Ended March 31,** |   |
|--------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                     |   | **2004**                          |   | **2003** |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                    |   |                              |   |   |   |
| Net income (loss)                                                        |   | $                                 | (1,635 | ) | $ | 1,660 |   |
| Adjustments to reconcile net income (loss)  to net operating cash flows: |   |                              |   |   |   |
| Equity in (income) losses of equity  investees                           |   | (22                               | )      | 1,008 |   |
| Depreciation and amortization                                            |   | 527                               |   | 192 |   |
| (Gain) loss on foreign currency translation                              |   | (15                               | )      | 2 |   |
| Gain on sale of securities and loans                                     |   | (1,086                            | )      | (4,788 | ) |
| Other                                                                    |   | (363                              | )      | — |   |
| Change in:                                                               |   |                              |   |   |   |
| Deferred income Deferred income                                          |   | 160                               |   | — |   |
| Accrued interest receivable                                              |   | (7                                | )      | (13 | ) |
| Other assets                                                             |   | 144                               |   | 502 |   |
| Accounts payable and accrued liabilities                                 |   | (20                               | )      | (1,443 | ) |
| Net cash used in operating activities                                    |   | (2,317                            | )      | (2,880 | ) |
|                                                                     |   |                              |   |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                    |   |                              |   |   |   |
| Principal payments on securities available  for sale                     |   | 2,247                             |   | 2,139 |   |
| Proceeds from sale of securities available  for sale                     |   | 1,300                             |   | 5,560 |   |
| Proceeds from sale of real estate                                        |   | 172                               |   | — |   |
| Investment in loans and discounted loans                                 |   | (4,223                            | )      | (64 | ) |
| Principal repayments on loans and  discounted loans                      |   | 40                                |   | 127 |   |
| Proceeds from sale of loans                                              |   | 30                                |   | — |   |
| Investments in real estate                                               |   | (1,061                            | )      | — |   |
| Investments in and loans to equity  investees                            |   | —                            |   | (3,000 | ) |
| Investments in restaurant, property, plant  and equipment                |   | (557                              | )      | — |   |
| Other                                                                    |   | 6                                 |   | (23 | ) |
| Net cash provided by (used in) investing  activities                     |   | (2,046                            | )      | 4,739 |   |
|                                                                     |   |                              |   |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                    |   |                              |   |   |   |
| Proceeds from borrowings                                                 |   | 2                                 |   | — |   |
| Repayments on borrowings                                                 |   | (1,263                            | )      | (673 | ) |
| Repayments under capital leases                                          |   | (143                              | )      | (147 | ) |
| Payment of obligation to purchase treasury  stock                        |   | —                            |   | (1,399 | ) |
| Dividend payments on common stock                                        |   | (2,247                            | )      | (2,356 | ) |
| Other                                                                    |   | 24                                |   | 35 |   |
| Net cash (used in) provided by financing  activities                     |   | (3,627                            | )      | (4,540 | ) |
|                                                                     |   |                              |   |   |   |
| EFFECT OF EXCHANGE RATE CHANGE ON CASH                                   |   | 21                                |   | (17 | ) |
| NET (DECREASE) INCREASE IN CASH AND CASH  EQUVALENTS                     |   | (7,969                            | )      | (2,698 | ) |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF  PERIOD                        |   | 19,607                            |   | 14,505 |   |
| CASH AND CASH EQUIVALENTS AT END OF PERIOD                               |   | $                                 | 11,638 |   | $ | 11,807 |   |
|                                                                     |   |                              |   |   |   |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW  INFORMATION                       |   |                              |   |   |   |
| Cash paid for interest                                                   |   | 508                               |   | 566 |   |
| Cash paid for taxes                                                      |   | 4                                 |   | 104 |   |
|                                                                     |   |                              |   |   |   |
| NONCASH FINANCING AND INVESTING ACTIVITIES                               |   |                              |   |   |   |
| Notes payable issued to settle obligation  to purchase treasury stock    |   | —                            |   | 2,800 |   |
| Treasury stock acquired in exchange for  assets                          |   | —                            |   | — |   |

 

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

 

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FOG CUTTER CAPITAL GROUP INC.

NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

 

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

 

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 2003 Annual Report on Form 10-K. A summary of the Company’s significant accounting policies is set forthin Note 2 to the consolidated financial statements in the 2003 Annual Report onForm 10-K.

 

In the Company’s opinion, all adjustments, comprised of normalrecurring accruals necessary for the fair presentation of the interim financialstatements, have been included in the accompanying consolidated financialstatements.  Operating results for thethree months ended March 31, 2004 are not necessarily indicative of theresults that may be expected for the year ending December 31, 2004.

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States requires the Company to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosures of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period.  Actualresults could differ from those estimates. Certain items in the previously reported consolidated financialstatements were reclassified to conform to the March 31, 2004presentation, none of which affected previously reported results of operations.

 

At March 31, 2004, certain Company officers and directors had,directly or indirectly, majority voting control of the Company.

 

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

 

Fatburger Holdings, Inc.

 

On August 15, 2003, the Company acquired a controlling interest inFatburger Holdings, Inc. (“Fatburger”), and began reporting the operations ofFatburger on a consolidated basis as of that date.  Fatburger operates or franchises 55 hamburger restaurants locatedin California, Nevada, Arizona, Colorado, Florida and Washington.  Franchisees currently own and operate abouthalf of the Fatburger locations.  Sincethe acquisition, Fatburger has opened five new restaurants, three of which areoperated by franchisees.  Fatburger hasagreements for approximately 250 new franchise restaurants.  Based upon the outstanding shares currentlyeligible to vote, the Company acquired approximately 83% of the voting controlof Fatburger as part of a $5.4 million investment and financing package.  The Company’s investment consists of thepurchase of convertible preferred stock (the “Series A-1 Preferred”) andredeemable convertible preferred stock (the “Series D Preferred”).

 

On March 10, 2004, with the approval of the Company, Fatburgeramended the redemption terms of the Series D Preferred.  Under the amended terms, Fatburger mayextend the redemption date of the Series D Preferred to May 15, 2006 by makinga cash payment to the Company of at least $2,500,000 on or before May 15, 2004,which will first be applied against any and all cumulative accrued and unpaiddividends, then to an extension fee of $225,000 and then to redeem the numberof outstanding shares of Series D Preferred at the stated redemption price pershare.  In addition, Fatburger mayextend the redemption date by one additional year to May 15, 2007 by making anadditional payment to the Company of at least $1,250,000 on or before May 15,2006, which will first be applied against any cumulative accrued and unpaiddividends and then to redeem the number of outstanding shares of Series DPreferred at

 

7

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the stated redemption price per share. The Company owns all of the issued and outstanding Series D Preferred,which currently has voting rights equal to approximately 63% of the votingcontrol of Fatburger.  In the eventFatburger fails to redeem the Series D Preferred by the scheduled redemptiondate, the Company will be issued additional stock to bring its total ownershipand control of Fatburger to 90%.

 

The Series A-1 Preferred is convertible into a 20%ownership interest of the common stock of Fatburger on a fully dilutedbasis.  If Fatburger extends thescheduled redemption period of the Series D Preferred, the conversion featureof the Series A-1 Preferred increases to fully diluted 35% ownership interestin the common stock of Fatburger.  TheCompany owns all of the issued and outstanding Series A-1 Preferred, whichcurrently has voting rights equal to 20% of the voting control of Fatburger.

 

On March 10, 2004, the Company granted a $1 million unsecured lineof credit to Fatburger.  The line ofcredit matures May 15, 2004 and bears interest at the rate of 10% per annum.  As of March 31, 2004, the Company hadadvanced $0.9 million under the line of credit.

 

Mortgage-Backed Securities

 

During the three months ended March 31, 2004, the Company sold twomortgage-backed securities for $1.3 million in cash.  As a result of these transactions, the Company recognized gainson the sale of securities of $1.1 million in the accompanying consolidatedstatement of operations.

 

Loans

 

During the three months ended March 31, 2004, the Companypurchased two loans secured by real estate for a total of $4.2 million.  The current yield to the Company on theseloans is 13.4%.

 

Dividends

 

The Company declared and paid a $0.13 pershare dividend for the three months ended March 31, 2004.  The first quarter dividend was paid onMarch 1, 2004, to stockholders of record on February 20, 2004.

 

**NOTE 3 – VALUATION OF MORTGAGE-BACKED SECURITIES**

 

At March 31, 2004, approximately $31.3million (97% of the portfolio) of the Company’s mortgage-backed securitiesconsisted of a “AAA” rated FNMA certificate for which market quotes wereobtained.

 

The Companyevaluates, on an ongoing basis, the carrying value of its securities portfolio,which is accounted for as available-for-sale. To the extent differences between the book basis of the securities andtheir current market values are deemed to be temporary in nature, such unrealizedgains or losses are reflected directly in equity as “other comprehensive incomeor loss.”  Declines in fair value areconsidered other-than-temporary when: (i) the carrying value of the beneficialinterests exceeds the fair value of such beneficial interests using currentassumptions, and (ii) the timing and/or extent of cash flows expected to bereceived on the beneficial interests has adversely changed from the previousvaluation date.  To the extent declinesin fair value are considered other-than-temporary, a write-down is recorded inthe consolidated statement of operations. During the three months ended March 31, 2004 and 2003, no marketvaluation losses and impairments were recorded.

 

**NOTE 4 – COMMITMENTS, CONTINGENCIES & OFF-BALANCE SHEET RISK**

 

CCL Investigation

 

As the Company has previously disclosed, the Company’s Chief ExecutiveOfficer, Andrew Wiederhorn, and former President, Lawrence Mendelsohn, receivedletters from the United States

 

8

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Attorney’s Office for the District of Oregon (“USAODO”) inMarch 2001 advising them that they were targets of a grand juryinvestigation (the “CCL Investigation”) into the failure of CapitalConsultants, L.L.C (“CCL”).  CCL was alender to Wilshire Credit Corporation (“WCC”) and related and affiliatedcompanies. WCC was a mortgage loan servicing company owned by Mr. Wiederhornand Mr. Mendelsohn that provided mortgage loan servicing for Wilshire FinancialServices Group Inc., a public company for which Mr. Wiederhorn acted as CEO andMr. Mendelsohn acted as President and which was principally engaged in banking,loan pool purchasing, and investing in mortgage-backed securities.  As a result of the liquidity crisis in thefinancial markets in the fall of 1998, Wilshire Financial Services Group Inc.experienced significant losses and filed for bankruptcy, which in turn had asignificant impact on its affiliates, including  WCC, which could not repay the amounts borrowed from CCL.  At the time, Wilshire Financial ServicesGroup Inc. owned approximately 8.6% of the Company’s common stock and managedthe Company’s investments under a management agreement.

 

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

 

The Company believes that the CCL Investigation isnearing conclusion as to Mr. Wiederhorn. Although the Company believes that theCCL Investigation is unrelated to Mr. Wiederhorn’s activities as CEO of theCompany or the Company’s activities, in the event an indictment is returnedagainst him or he pleads guilty to one or more offenses pursuant to anagreement with the USAODO, one or more potential negative consequences to theCompany could result, including, among other things (i) the strong possibilitythat Mr. Wiederhorn would be unable to continue as a director and officer of theCompany, including the risk that incarceration would be required and that theCompany would need to make sure an appropriate management team was in place,(ii) concerns on the part of shareholders, clients and employees that couldadversely affect the Company’s stock price, and (iii) inquiries by regulatoryagencies, such as the NASD and the SEC.

 

Messrs. Wiederhorn andMendelsohn, pursuant to the terms of their respective employment agreements,may be entitled to indemnity from the Company for litigation expenses andpersonal losses in connection with these investigations and any relatedlitigation.  Messrs. Wiederhorn andMendelsohn have notified the Company that they are reserving their rights toseek indemnity from the Company, however, they may be entitled to primaryindemnification from other sources. At this time, it is not possible todetermine the extent of liability, if any, the Company may face with regard tothese potential indemnity claims. The Company has not agreed to any indemnityrequests.

 

Strouds Acquisition Corporation

 

On October 6, 2003, the Official Committee of UnsecuredCreditors of Strouds Acquisition Corporation filed a lawsuit in the UnitedStates Bankruptcy Court (LA 03-23620-ER) which names the Company, among others,as a defendant.  The lawsuit was amendedon November 10, 2003 and limits the complaint against the Company solelyin its capacity as collateral agent for certain secured creditors of StroudsAcquisition Corporation.  The lawsuit,as it pertains to the Company, seeks reimbursement of the proceeds fromapproximately $3.0 million in funds received in October 2003, which theCompany is holding as collateral agent for other secured creditors.  The $3.0 million being held as collateralagent will continue to be held in trust, less reimbursements to the Company,from time-to-time, of the Company’s related legal costs, until the bankruptcycourt resolves the dispute regarding its distribution.  These funds are not included in the assetsof the Company in the accompanying statements of financial position.  As of March 31 2004, the Company hadbeen reimbursed for legal fees in the amount of $0.3 million from thecollateral agent funds. The Committee of Unsecured Creditors is seeking therefund of those fees.  The Companybelieves that it will prevail in this matter and has not established a reservefor reimbursement.

 

9

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Other 

 

The Company is involved in various other legal proceedings occurring inthe ordinary course of business which the Company believes will not have amaterial adverse effect on the consolidated financial condition or operationsof the Company.

 

The Company may utilize a wide variety of off-balance sheet financialtechniques to manage its interest rate risk. In hedging the interest rate and/or exchange rate exposure of a foreigncurrency denominated asset or liability, the Company may enter into hedgetransactions to counter movements in the different currencies, as well asinterest rates in those currencies.  Thesehedges may be in the form of currency and interest rate swaps, options, andforwards, or combinations thereof.

 

At March 31, 2004, the Company had no outstanding derivativeinstruments held for trading or hedging purposes.

 

The Company has operating leases for office and retail space whichexpire through  2012.  The leases provide for varying minimumannual rental payments including rent increases and free rent periods.

 

Future minimum rental payments, by year and in the aggregate, undernoncancelable operating leases with initial or remaining terms of one year ormore, consisted approximately of the following at March 31, 2004, (dollarsin thousands):

 
| 2004                         |   | $     | 2,118  |   |
|------------------------------|--------|-------|--------|--------|
| 2005                         |   | 2,638 |   |
| 2006                         |   | 2,218 |   |
| 2007                         |   | 1,772 |   |
| 2008                         |   | 1,362 |   |
| Thereafter                   |   | 4,879 |   |
| Total minimum lease payments |   | $     | 14,987 |   |

 

In order to facilitate the development of franchise locations, as ofMarch 31, 2004, Fatburger had guaranteed the annual minimum lease paymentsof two restaurant sites owned and operated by franchisees.  The amount of the guarantees approximate$0.4 million plus certain contingent rental payments as defined in therespective leases.  These leases expireat various times through 2008.

 

The Company did not have any other off balance sheet arrangements inplace as of March 31, 2004.

 

**NOTE 5 - GOODWILL AND OTHER INTANGIBLE ASSETS**

 

Primarily dueto the acquisition of Fatburger, the Company has goodwill in the amount of $7.3million and other intangible assets in the amount of $5.6 million. Inaccordance with SFAS No. 142, “Goodwill and Other Intangible Assets”, goodwillis not amortized, but is subject to an annual impairment test, which will beperformed on August 15, 2004. Since the acquisition of Fatburger by the Company, Fatburger hasexperienced operating losses and has funded its operations and expansion withlimited liquidity.  The Company believesthat these conditions are temporary in nature, however, should these conditionsnot be corrected, the Company may be required to recognize impairment losses onits recorded goodwill.  As ofMarch 31, 2004, the Company was not aware of any events or changes incircumstances that would require the impairment of the recorded goodwill.

 

10

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Summarizedinformation for the Company’s acquired intangible assets as of March 31,2004 is as follows (dollars in thousands):

 
| Amortized intangible assets:      |   |   |   |
|-----------------------------------|--------|--------|--------|
|                              |   |   |   |
| Franchise Agreements              |   | $      | 1,064  |   |
| Other                             |   | 537    |   |
| Total amortized intangible assets |   | $      | 1,601  |   |
|                              |   |   |   |
| Unamortized intangible assets:    |   |   |   |
|                              |   |   |   |
| Trademarks                        |   | $      | 3,971  |   |

 

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

 
| 2004 |   | $   | 161    |   |
|------|--------|-----|--------|--------|
| 2005 |   | 214 |   |
| 2006 |   | 214 |   |
| 2007 |   | 214 |   |
| 2008 |   | 214 |   |
| 2009 |   | 214 |   |

 

The recordedvalues of goodwill and other intangible assets may become impaired in thefuture. The determination of the value of such intangible assets requiresmanagement to make estimates and assumptions that affect the consolidatedfinancial statements.  Potentialimpairments to intangible assets are assessed when there is evidence thatevents or changes in circumstances indicate that the carrying amount of anasset may not be recovered.  Thisassessment is based on the operational performance of acquired businesses,market conditions and other factors including future events.   Any resulting impairment loss could have anadverse impact on the results of operations of the Company.

 

**NOTE 6 – RECENTLY ISSUED ACCOUNTING STANDARDS**

 

In December 2003, the Accounting Standards Executive Committee(“AcSEC”) issued Statement of Position 03-3 (“SOP 03-3”), “ *Accounting for Certain Loans or Debt SecuritiesAcquired in a Transfer*.” SOP 03-3 requires that the excess ofcontractual cash flows over cash flows expected to be collected not berecognized as an adjustment of yield, loss accrual, or valuation allowance.Subsequent increases in cash flows expected to be collected generally should berecognized prospectively through adjustment of the loan’s yield over itsremaining life and decreases in cash flows expected to be collected should berecognized as impairment. SOP 03-3 is effective for loans acquired in fiscalyears beginning after December 15, 2004 and is not expected to have amaterial effect on the Company’s consolidated financial position or results ofoperations

 

**NOTE 7 – STOCKOPTIONS AND RIGHTS**

 

The Company has adopted a non-qualified stock option plan (the “OptionPlan”) which provides for options to purchase shares of the Company’s commonstock.  The maximum number of shares ofcommon stock that may be issued pursuant to options granted under the OptionPlan is 3,500,000 shares.

 

The Company applies Accounting Principles Board Opinion No. 25, *“Accountingfor Stock Issued to Employees,”*and related interpretations inaccounting for the Option Plan. Accordingly, no compensation expense has beenrecognized in the Consolidated Statements of Operations for grants under theOption Plan.  Had compensation expensefor the Company’s Option Plan been determined based on the

 

11

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fair value at the grant date consistent with the methods of SFAS No.123 “*Accountingfor Stock Based Compensation*”, the Company’s net income and incomeper share for the three months ended March 31, 2004 and 2002 would havebeen decreased to the pro forma amounts indicated below:

 
|                                                                      |   | **Three  months ended March 31,**         |   |
|---------------------------------------------------------------------------|--------|------------------------------------------------|--------|
|                                                                      |   | **2004**                                       |   | **2003** |   |
|                                                                      |   | **(dollars  in thousands, except share data)** |   |
| Net (loss) income:                                                        |   |                                           |   |   |   |
| As reported                                                               |   | $                                              | (1,635 | ) | $ | 1,660 |   |
| Pro forma compensation expense from stock  based compensation, net of tax |   | (6                                             | )      | (14 | ) |
| Pro forma net (loss) income                                               |   | $                                              | (1,641 | ) | $ | 1,646 |   |
| Net (loss) income per common and common  share equivalent:                |   |                                           |   |   |   |
| Basic income per share:                                                   |   |                                           |   |   |   |
| As reported                                                               |   | $                                              | (0.19  | ) | $ | 0.20 |   |
| Pro forma                                                                 |   | $                                              | (0.19  | ) | $ | 0.19 |   |
| Diluted income per share:                                                 |   |                                           |   |   |   |
| As reported                                                               |   | $                                              | (0.19  | ) | $ | 0.19 |   |
| Pro forma                                                                 |   | $                                              | (0.19  | ) | $ | 0.19 |   |

 

There were no options granted with exercise prices below the marketvalue of the stock at the grant date. Fair values for 2004 were estimated usingthe Black-Scholes option-pricing model with the following weighted averageassumptions used: 10% dividend yield, expected volatility of 46%, risk-freeinterest rate of 2.8% and expected lives of five years.

 

**NOTE 8 – OPERATINGSEGMENTS**

 

As a result of the acquisition of Fatburger during August 2003,the Company began to report the results of operating segments.    The operating segments consistof (i) restaurant operations conducted through Fatburger Holdings, Inc.(“Fatburger”), (ii) commercial real estate mortgage brokerage activitiesconducted through George Elkins Mortgage Banking Company (“George Elkins”) and(iii) real estate, merchant banking and financing activities.  The following is a summary of each of theoperating segments:

 

Restaurant Operations

 

Fatburger operates or franchises 55 hamburgerrestaurants located in California, Nevada, Arizona, Florida, Colorado andWashington.  In August 2003, theCompany provided an investment and financing package for Fatburger whichinvolved our acquisition of the entire class of the Series A-1 Preferred andthe Series D Preferred stock of Fatburger. Currently, the Company owns approximately 83% of the voting control ofFatburger.  Fatburger has plans to openadditional restaurants including expansion into Oregon, Louisiana, Georgia, NewYork, Ohio, New Jersey, Texas, Missouri, Kansas, Pennsylvania, West Virginia,Virginia, North Carolina, South Carolina, Washington D.C., British Columbia,Minnesota and Michigan.   Franchiseescurrently own and operate about half of the Fatburger locations.

 

Commercial Real Estate Mortgage Brokerage Operations

 

In May 2002, the Company purchased a 51% ownershipinterest in George Elkins, a California mortgage banking operation, which, in2002, provided brokerage services related to the production of over $600million per year in commercial real estate mortgages. George Elkins isheadquartered in Los Angeles, with satellite offices located throughout thesouthern California area.  The mortgagebrokerage operation also manages a commercial loan servicing portfolio inexcess of $700 million for various investors. The Company earned mortgage servicing fees of $0.2 million during thethree months ended March 31, 2004, which are included in other revenue inthe accompanying consolidated statements of operations.

 

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Real Estate, Merchant Banking and Financing Operations

 

The Company invests in or finances real estate, mortgage-backedsecurities and other real estate related or finance related assets.  The merchant banking and financingoperations focus on the acquisition of controlling interests in businesses inthe process of restructuring.  This cantake the form of assisting in a management buy-out, refinancing corporate debtor acquiring the “non-core” assets of a business.

 

Segment data for the three months ended March 31,2004, and 2003 are as follows (dollars in thousands):

 
|                                                 |   | **Merchant  Banking,  Real Estate and Finance** |   | **Mortgage  Brokerage** |   | **Restaurant** |   | **Total** |   |
|------------------------------------------------------|--------|-------------------------------------------------|--------|-------------------------|--------|----------------|--------|-----------|--------|
|                                                 |   | **2004**                                        |   | **2003**                |   | **2004**       |   | **2003**  |   | **2004** |   | **2003** |   | **2004** |   | **2003** |   |
| Net Interest Income:                                 |   |                                            |   |                    |   |           |   |      |   |   |   |   |   |   |   |   |   |
| Loans                                                |   | $                                               | 426    |                    | $      | 190            |   | $         | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 426 |   | $ | 190 |   |
| Securities                                           |   | 313                                             |   | 775                     |   | —         |   | —    |   | — |   | — |   | 313 |   | 775 |   |
| Other investments                                    |   | 47                                              |   | 55                      |   | —         |   | —    |   | — |   | — |   | 47 |   | 55 |   |
| Total interest income                                |   | 786                                             |   | 1,020                   |   | —         |   | —    |   | — |   | — |   | 786 |   | 1,020 |   |
| Interest expense                                     |   | 71                                              |   | 208                     |   | —         |   | —    |   | — |   | — |   | 71 |   | 208 |   |
| Net interest income                                  |   | 715                                             |   | 812                     |   | —         |   | —    |   | — |   | — |   | 715 |   | 812 |   |
|                                                 |   |                                            |   |                    |   |           |   |      |   |   |   |   |   |   |   |   |   |
| Real estate operations:                              |   |                                            |   |                    |   |           |   |      |   |   |   |   |   |   |   |   |   |
| Operating revenue                                    |   | 951                                             |   | 972                     |   | —         |   | —    |   | — |   | — |   | 951 |   | 972 |   |
| Operating expense                                    |   | (456                                            | )      | (538                    | )      | —         |   | —    |   | — |   | — |   | (456 | ) | (538 | ) |
| Gain on sale of real estate                          |   | 3                                               |   | —                  |   | —         |   | —    |   | — |   | — |   | 3 |   | — |   |
| Interest expense                                     |   | (281                                            | )      | (360                    | )      | —         |   | —    |   | — |   | — |   | (281 | ) | (360 | ) |
| Depreciation                                         |   | (159                                            | )      | (153                    | )      | —         |   | —    |   | — |   | — |   | (159 | ) | (153 | ) |
| Total real estate operations                         |   | 58                                              |   | (79                     | )      | —         |   | —    |   | — |   | — |   | 58 |   | (79 | ) |
|                                                 |   |                                            |   |                    |   |           |   |      |   |   |   |   |   |   |   |   |   |
| Restaurant operations:                               |   |                                            |   |                    |   |           |   |      |   |   |   |   |   |   |   |   |   |
| Operating income                                     |   | —                                          |   | —                  |   | —         |   | —    |   | 5,284 |   | — |   | 5,284 |   | — |   |
| Cost of goods sold                                   |   | —                                          |   | —                  |   | —         |   | —    |   | (3,077 | ) | — |   | (3,077 | ) | — |   |
| Franchise and advertising fees                       |   | —                                          |   | —                  |   | —         |   | —    |   | 272 |   | — |   | 272 |   | — |   |
| General and administrative costs                     |   | —                                          |   | —                  |   | —         |   | —    |   | (2,715 | ) | — |   | (2,715 | ) | — |   |
| Interest Expense                                     |   | —                                          |   | —                  |   | —         |   | —    |   | (165 | ) | — |   | (165 | ) | — |   |
| Depreciation and amortization                        |   | —                                          |   | —                  |   | —         |   | —    |   | (352 | ) | — |   | (352 | ) | — |   |
| Total restaurant operations                          |   | —                                          |   | —                  |   | —         |   | —    |   | (753 | ) | — |   | (753 | ) | — |   |
|                                                 |   |                                            |   |                    |   |           |   |      |   |   |   |   |   |   |   |   |   |
| Other operating income:                              |   |                                            |   |                    |   |           |   |      |   |   |   |   |   |   |   |   |   |
| Equity in losses of equity investees                 |   | 22                                              |   | (1,008                  | )      | —         |   | —    |   | — |   | — |   | 22 |   | (1,008 | ) |
| Gain on sale of loans and securities                 |   | 1,086                                           |   | 4,788                   |   | —         |   | —    |   | — |   | — |   | 1,086 |   | 4,788 |   |
| Loan brokerage fees                                  |   | —                                          |   | —                  |   | 1,126          |   | 800       |   | — |   | — |   | 1,126 |   | 800 |   |
| Other revenue (loss)                                 |   | 58                                              |   | (4                      | )      | 153            |   | 195       |   | — |   | — |   | 211 |   | 191 |   |
| Total other operating income                         |   | 1,166                                           |   | 3,776                   |   | 1,279          |   | 995       |   | — |   | — |   | 2,445 |   | 4,771 |   |
|                                                 |   |                                            |   |                    |   |           |   |      |   |   |   |   |   |   |   |   |   |
| Operating expenses:                                  |   |                                            |   |                    |   |           |   |      |   |   |   |   |   |   |   |   |   |
| Compensation and employee benefits                   |   | 1,650                                           |   | 1,439                   |   | 1,111          |   | 764       |   | — |   | — |   | 2,761 |   | 2,203 |   |
| Professional fees                                    |   | 234                                             |   | 462                     |   | 7              |   | 37        |   | — |   | — |   | 241 |   | 499 |   |
| Other                                                |   | 872                                             |   | 729                     |   | 226            |   | 171       |   | — |   | — |   | 1,098 |   | 900 |   |
| Total operating expenses                             |   | 2,756                                           |   | 2,630                   |   | 1,344          |   | 972       |   | — |   | — |   | 4,100 |   | 3,602 |   |
|                                                 |   |                                            |   |                    |   |           |   |      |   |   |   |   |   |   |   |   |   |
| Net income (loss) before provision for  income taxes |   | (817                                            | )      | 1,879                   |   | (65            | )      | 23        |   | (753 | ) | — |   | (1,635 | ) | 1,902 |   |
| Provision for income taxes                           |   | —                                          |   | 242                     |   | —         |   | —    |   | — |   | — |   | — |   | 242 |   |
| Net income (loss)                                    |   | $                                               | (817   | )                       | $      | 1,637          |   | $         | (65    | ) | $ | 23 |   | $ | (753 | ) | $ | — |   | $ | (1,635 | ) | $ | 1,660 |   |
| Segment assets                                       |   | $                                               | 81,282 |                    | $      | 106,077        |   | $         | 2,083  |   | $ | 2,899 |   | $ | 19,592 |   | $ | — |   | $ | 102,957 |   | $ | 108,976 |   |

 

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**NOTE 9– INCOME TAXES**

 

As of March 31, 2004, the Company had, for U.S. Federal taxpurposes, a net operating loss (“NOL”) carry forward of approximately $80.9million, including $12.9 million relating to Fatburger. The Company’s NOLbegins to expire in 2018. Fatburger’s NOL begins to expire in 2004 and isgenerally subject to an annual limitation under the Internal Revenue Code of1986, Section 382, Limitation on Net Operating Loss Carryovers and CertainBuilt-In Losses Following Change in Control. In addition, to the extent the Fatburger NOL is utilized, therecognition of the related tax benefits would first reduce goodwill related toFatburger acquisition, then other non-current intangible assets related to thatacquisition, and then income tax expense in accordance with Statement onFinancial Accounting Standards No. 109, Accounting for Income Taxes.

 

United States tax regulations impose limitations on the use of NOLcarry forwards following certain changes in ownership.  If such a change were to occur with respectto the Company, the limitation could significantly reduce the amount ofbenefits that would be available to offset future taxable income each year,starting with the year of ownership change. To reduce the likelihood of such ownership changes, the Companyestablished a Shareholder Rights Plan dated as of October 18, 2002, whichdiscourages, under certain circumstances, ownership changes which would triggerthe NOL limitations.

 

During the three months ended March 31, 2004, a provision forincome taxes was not required.  Duringthe three months ended March 31, 2003, the Company recognized a provisionfor income taxes of $0.2 million.

 

**NOTE 10 – SUBSEQUENTEVENTS**

 

On April 26, 2004, the Company purchased a three year call option(the “Call Option”) from its Chairman and Chief Executive Officer, Andrew A.Wiederhorn.  The Call Option gives theCompany the right, but not the obligation, to purchase 423,245 of the Company’soutstanding common stock (the “Option Shares”) from Mr. Wiederhorn for apurchase price of $3.99 per share.   Theoption may be exercised at any time during the three year option period.  The Company paid $750,000 ($1.77 per optionshare) for the Call Option.   TheCompany and its directors believe that the Call Option gives the Company auseful option to acquire a large block of stock over an extended period at anexercise price well below the current market price and the aggregate price tothe Company on exercise of $5.76 per share would be a small premium to theCompany’s current book value per share and current market price per share.  The Company and its directors considered thefollowing factors:  (1) the potentiallynegative impact on the Company’s share price if the Option Shares were disposedof publicly; (2) the Company’s favorable liquidity position; (3) the potentialreduction in the risk that shares are transferred in a transaction which wouldhave an adverse impact on its NOL position; and (4) the reduction in the futureexpenditure of cash dividends by the Company once the Company exercises theCall Option.  The Board of Directorsreviewed and approved the transaction to confirm that the transaction was inthe best interest of the Company and its other stockholders.

 

On April 27, 2004, the Board of Directors declared a $0.13 pershare dividend for the second quarter of 2004. The dividend is payable on June 1, 2004 to shareholders of recordon May 21, 2004.

 

On April 28, 2004, the Company purchased 330,500 shares of itscommon stock from a shareholder.  Thepurchase price was $5.40 per share ($1.8 million) and the shares were added totreasury stock.  The purchase pricerepresents a small premium to the Company’s current book value per share andcurrent market price per share.  TheCompany and its directors considered the following factors:  (1) the potentially negative impact on theCompany’s share price if the shares were disposed of publicly; (2) theCompany’s favorable liquidity position (3) the potential reduction in the riskthat shares are transferred in a transaction which would have an adverse impacton its NOL position; and (4) the reduction in the future expenditure of cashdividends by the Company.  The Board ofDirectors reviewed and approved the transaction to confirm that the transactionwas in the best interest of the Company and its other stockholders.

 

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**ITEM2.  MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

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

* *

## **GENERAL**

 

Fog CutterCapital Group Inc. (“FCCG” or the “Company”) is a Nasdaq-listed corporationwhich focuses on the acquisition of assets where its expertise in intensiveasset management and financial structuring can create value.  Our business strategy consists ofdeveloping, strengthening and expanding our restaurant and commercial realestate mortgage brokerage operations and continuing to identify and acquirereal estate investments with favorable risk-adjusted returns.  We also seek to identify and acquirecontrolling interests in other operating businesses in which we feel we can addvalue.  We make acquisitions where ourexpertise in intensive asset management, credit analysis and financialstructuring can create value and provide an appropriate risk-adjusted rate ofreturn. We maintain a flexible approach with respect to the nature of ourbusiness, seeking to take advantage of opportunities as they arise or aredeveloped.

 

We are continuing theprocess of redeploying the capital generated during 2002 and 2003 through oursale of mortgage-backed securities and from cash distributions from our BourneEnd subsidiary.  We used a portion ofthis capital to acquire voting control of Fatburger Holdings Inc. inAugust 2003.  The expansion and successof Fatburger is currently one of our primary focuses.  Since our acquisition, Fatburger has opened five additionalrestaurant locations and currently has agreements forapproximately 250 new franchise restaurants.

 

We have also beeninvesting in special situation real estate loans, and funded two loans totaling$4.0 million during the three months ended March 31, 2004.  Our special situation loans are generallysecured by real estate and are typically short-term, with maturities rangingfrom 6 to 24 months.  Due to the uniquecircumstances relating to these loans, the interest rate charged the borroweris significantly higher than conventional real estate lending.   Based on current activity levels, we expectthat special situation lending will be a growing part of our business.

 

Due to the varied nature of our operations, management does not utilizea standard array of key performance indicators in evaluating the progress ofthe Company.  Management’s evaluation,instead, focuses on an  asset-by-assetanalysis within the Company’s operating segments.

 

**Critical Accounting Policies**

 

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

 

15

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***AccountingFor Equity Investees***

 

The equity method of accounting is used for investments in associatedcompanies which are not unilaterally controlled by the Company and in which theCompany’s interest is generally between 20% and 50% of the outstanding voting rights.  The Company’s  shareof  earnings  or  losses  of associated companies, in which at least20% of the voting securities is owned, is included in the consolidatedstatement of operations.

 

***Sale Recognition***

 

**Wecontinue to be involved in significant sales of mortgage-backed securities andother assets.  Our accounting policycalls for the recognition of sales of financial instruments, includingmortgage-backed securities and loans, only when we have irrevocably surrenderedcontrol over these assets.  We do notretain any recourse or performance obligations with respect to our sales ofassets.  Our sales of financialinstruments were cash sales, and the cash proceeds were not contingent upon anyfuture event.**

 

**Werecognize gain on sales of real estate under the full accrual method when (1) asale is consummated, (2) the buyer’s initial and continuing investments areadequate to demonstrate a commitment to pay for the property, (3) anyreceivable from the buyer is not subject to future subordination and (4) theusual risks and rewards of ownership of the property have been transferred tothe buyer.  If any of these conditionsare not met, our accounting policy requires that gain on sale be deferred untilall of the conditions have been satisfied.**

 

***Fatburger Restaurant and Franchise Revenue***

 

**Revenuefrom the operation of Fatburger company-owned restaurants are recognized whensales occur.**                          Franchise fee revenue from the sale of individualFatburger franchises is recognized only when all material services orconditions relating to the sales have been substantially performed orsatisfied.  The completion of trainingand the opening of a location by the franchisee constitute substantial performanceon the part of Fatburger.  Nonrefundabledeposits collected in relation to the sale of franchises are recorded asdeferred franchise fees until the completion of training and the opening of therestaurant, at which time the franchise fee revenue is recognized.

 

**Inaddition to franchise fee revenue, Fatburger collects a royalty ranging from 5%to 6% of gross sales from restaurants operated by franchisees.  Fatburger recognizes royalty fees as therelated sales are made by the franchisees. Costs relating to continuing franchise support are expensed as incurred.**

 

***Goodwill and Other Intangible Assets***

 

**Goodwill represents the excess of the purchaseprice and other acquisition related costs over the estimated fair value of thenet tangible and intangible assets acquired. We do not amortize goodwill. Intangible assets are stated at cost and include trademarks, operatingmanuals, franchise agreements and leasehold interests.  Trademarks, which have indefinite lives, arenot subject to amortization.  All otherintangible assets are amortized over their estimated useful lives, which rangefrom five to fifteen years.**

 

We assesspotential impairments to intangible assets at least annually, or when there isevidence that events or changes in circumstances indicate that the carryingamount of an asset may not be recovered. Our judgments regarding the existenceof impairment indicators and future cash flows related to intangible assets arebased on operational performance of our acquired businesses, market conditionsand other factors. Future events could cause us to conclude that impairmentindicators exist and that goodwill or other intangible assets associated withour acquired businesses is impaired. Any resulting impairment loss could havean adverse impact on our results of operations.

 

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**RESULTS OF OPERATIONS****3⁄4 THREE MONTHS ENDED MARCH 31, 2004 COMPAREDTO THREE MONTHS ENDED MARCH 31, 2003**

 

NET INCOME.  Our net loss forthe three months ended March 31, 2004, was $1.6 million, or $0.19 pershare, compared with net income of $1.7 million, or $0.20 per share, for thethree months ended March 31, 2003. The net loss for the quarter ended March 31, 2004 was primarily theresult of losses from our restaurant operations of $0.8 million and otheroperating expenses of $4.1 million, partially offset by gains on sales ofmortgage-backed securities of $1.1 million. The net income for the quarter ended March 31, 2003 was primarilythe result of gains on the sale of securities of $4.8 million, partially offsetby equity in loses of unconsolidated subsidiaries of $1.0 million and byoperating expenses of $3.6 million.

 

The following sections describe the results of operations of ouroperating segments for the three months ended March 31, 2004:

 

**Restaurant SegmentOperations**

 

In August 2003, the Company completed aninvestment and financing package for Fatburger which involved the acquisitionof the entire class of the Series A-1 Preferred and the Series D Preferredstock of Fatburger.  As a result of ourvoting control, we began reporting the operations of Fatburger on aconsolidated basis beginning August 15, 2003.  Fatburger has the option to redeem our Series D Preferred stock,which may result in a reduction in our ownership control.  If Fatburger were to fully redeem the SeriesD Preferred, our ownership percentage would be reduced to 20%.  However, if Fatburger fails to redeem aminimum stipulated amount of Series D Preferred by May 15, 2004, our ownershippercentage in the restaurant operation will increase to 90%.

 

During the three months ending March 31, 2004, werecognized a net loss from our restaurant segment of $0.8 million.  This was primarily the result of net sales(net of cost of goods sold) of  $2.2million and franchise and royalty revenue of $0.3 million, offset by generaland administrative costs of $2.7 million, interest expense of $0.2 million, anddepreciation and amortization of $0.4 million. The Company’s strategy with respect to Fatburger is to increase thenumber of franchises, thus increasing the franchise fees and future royaltyincome to the operation.

 

**Commercial RealEstate Mortgage Brokerage Segment Operations**

 

In May 2002, the Company purchased a 51% ownershipinterest in George Elkins Mortgage Banking Company (“George Elkins”), a Californiamortgage banking operation, which, in 2003, provided brokerage services relatedto the production of over $600 million in commercial real estatemortgages.  George Elkins isheadquartered in Los Angeles, with satellite offices located throughout the southernCalifornia area.  The mortgage bankingoperation also manages a commercial loan servicing portfolio in excess of $700million for various investors. The Company began reporting the operations ofGeorge Elkins on a consolidated basis beginning May 15, 2002.

 

Our net loss from the commercial real estate brokerage segment was $0.1million for the three months ended March 31, 2004, compared to break-evenoperations during the 2003 period. During the 2004 period, we recognized loan brokerage fees of $1.1million, loan servicing and other revenue of $0.2 million, which was offset bycompensation expense of $1.1 million and other operating expense of $0.2million.  During the 2003 period, werecognized loan brokerage fees of $0.8 million, loan servicing and otherrevenue of $0.2 million, which was offset by compensation expense of $0.8million and other operating expense of $0.2 million.

 

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**Merchant Banking,Real Estate and Finance Segment Operations**

 

NET INTEREST INCOME.  Our netinterest income for the three months ended March 31, 2004, was $0.7million, compared with $0.8 million for the three months ended March 31,2003.  The decrease is primarilyattributable to a net reduction of assets (reflecting our sales ofmortgage-backed securities and paydowns of the related debt facilities).  These changes resulted in decreases ininterest income on securities of $0.5 million, partially offset by a decreasein interest expense of $0.1 million and an increase in interest income on loansof $0.2 million.  The following tablesset forth information regarding the total amount of income frominterest-earning assets and expense from interest-bearing liabilities and theresulting average yields and rates:

 
|                                           |   | **For the  Three Months Ended March 31, 2004** |   |
|------------------------------------------------|--------|-----------------------------------------------------|--------|
|                                           |   | **Average  Balance**                                |   | **Interest  Income (Expense)** |   | **Annualized  Yield/Rate** |   |
|                                           |   | **(dollars  in thousands)**                         |   |
| Interest-Earning Assets:                       |   |                                                |   |   |   |   |   |
|                                           |   |                                                |   |   |   |   |   |
| Loan portfolios (1)                            |   | $                                                   | 8,137  |   | $ | 426 |   | 20.9 | % |
| Mortgage-backed securities available for  sale |   | 33,883                                              |   | 313 |   | 3.7 | % |
| Other investments                              |   | 15,758                                              |   | 47 |   | 1.2 | % |
| Total interest-earning assets                  |   | $                                                   | 57,778 |   | 786 |   | 5.4 | % |
|                                           |   |                                                |   |   |   |   |   |
| Interest-Bearing Liabilities:                  |   |                                                |   |   |   |   |   |
|                                           |   |                                                |   |   |   |   |   |
| Borrowings (2)                                 |   | $                                                   | 24,642 |   | (71 | ) | 1.2 | % |
| Total interest-bearing liabilities             |   | $                                                   | 24,642 |   | (71 | ) | 1.2 | % |
|                                           |   |                                                |   |   |   |   |   |
| Net interest income (3)                        |   |                                                |   | $ | 715 |   | 4.2 | % |
| Net interest margin (4)                        |   |                                                |   |   |   | 5.0 | % |

 

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(1)               Includes loans to senior officers.

(2)               Excludes borrowings related toinvestments in real estate.

(3)               Net interest spread represents thedifference between the average rate on interest-earning assets and the averagecost of interest-bearing liabilities.

(4)               Net interest margin represents netinterest income divided by average interest-earning assets.

 

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|                                           |   | **For the  Three Months Ended March 31, 2003** |   |
|------------------------------------------------|--------|-----------------------------------------------------|--------|
|                                           |   | **Average  Balance**                                |   | **Interest  Income (Expense)** |   | **Annualized  Yield/Rate** |   |
|                                           |   | **(dollars  in thousands)**                         |   |
| Interest-Earning Assets:                       |   |                                                |   |   |   |   |   |
|                                           |   |                                                |   |   |   |   |   |
| Loan portfolios                                |   | $                                                   | 2,843  |   | $ | 190 |   | 26.7 | % |
| Mortgage-backed securities available for  sale |   | 60,343                                              |   | 775 |   | 5.1 |   |
| Cash deposits and other investments            |   | 15,464                                              |   | 55 |   | 1.4 |   |
| Total interest-earning assets                  |   | $                                                   | 78,650 |   | 1,020 |   | 5.2 | % |
|                                           |   |                                                |   |   |   |   |   |
| Interest-Bearing Liabilities:                  |   |                                                |   |   |   |   |   |
|                                           |   |                                                |   |   |   |   |   |
| Borrowings (1)                                 |   | $                                                   | 35,278 |   | (208 | ) | 2.4 | % |
| Total interest-bearing liabilities             |   | $                                                   | 35,278 |   | (208 | ) | 2.4 | % |
|                                           |   |                                                |   |   |   |   |   |
| Net interest income (2)                        |   |                                                |   | $ | 812 |   | 2.8 | % |
| Net interest margin  (3)                  |   |                                                |   |   |   | 4.1 | % |

 

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(1)               Excludes borrowings related toinvestments in real estate.

(2)               Net interest spread represents thedifference between the average rate on interest-earning assets and the averagecost of interest-bearing liabilities.

(3)               Net interest margin represents netinterest income divided by average interest-earning assets.

 

REAL ESTATE OPERATIONS.  Ourreal estate operations represent activity from our investment in 24 commercialproperties located in Oregon, Texas, Arizona, Oklahoma, Mississippi andCalifornia, as well as the operations of our leasehold interests in 80freestanding retail buildings located throughout the United States.  During the three months ended March 31,2004, we realized net income from real estate operations of approximately $0.1million, compared with a net loss of $0.1 million for the three months endedMarch 31, 2003.  Our strategy withregard to our real estate investments is to position each property to enhancelease values for long-term income or for sale.

 

EQUITY IN EARNINGS OF EQUITY INVESTEES.   At March 31, 2004, our primary equity investee was BourneEnd Properties Plc. (“Bourne End”).  InDecember 2000, we organized and led a group of investors to purchase allof the outstanding capital stock of Bourne End, a specialist investor in retailproperty.  Bourne End was acquiredthrough BEP Property Holdings Limited, which is 26% owned by us, 71% owned byMerrill Lynch (Jersey) Holdings Limited (a subsidiary of Merrill Lynch &Co., Inc.) and 3% owned by the asset manager, Greenbau Estuary Limited.  At the time of the acquisition, Bourne End owned15 shopping centers located in the England and Scotland.  Thirteen of the centers have been sold,which resulted in the recognition of earnings of equity investees for theCompany of $5.0 million during 2003 and $1.1 million for 2002.  Bourne End has two properties remainingwhich are being positioned for sale during 2004.

 

We recognizedincome of less than $0.1 million from equity investees during the three monthsended March 31, 2004, all of which related to Bourne End.  During the three months ended March 31,2003, we recorded $1.0 million in losses relating to equity investees.  Of the 2003 amount, $0.4 million related toour share of the net loss of Bourne End for the period and $0.6 million relatedto Strouds Acquisition Corporation (“Strouds”).   On March 6, 2003, wehad acquired a 49.5% interest in Strouds, a specialty linen retailer.  However, during subsequent periods of 2003,we disposed of our investment in Strouds and recovered all but $0.1 million ofthe loss.

 

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GAIN ON SALE OF LOANS AND SECURITIES. During the three months ended March 31, 2004, we recognized $1.1million in gains on the sale of loans and securities, primarily from the saleof mortgage-backed securities.  Duringthe comparable period of 2003, we recognized gains on the sale of loans andsecurities of $4.8 million, again, primarily from the sale of mortgage-backedsecurities.  Because we have soldsubstantially all of our subordinate mortgage-backed securities portfolio, we expectthat gain on sale of securities will contribute less to future income than ithas in recent years.

 

OPERATING EXPENSES.  During thethree months ended March 31, 2004, we incurred segment operating expensesfrom merchant banking, real estate and finance operations of $2.8 million,compared to $2.6 million during the comparable period in 2003.  Operating expenses for the 2004 periodinclude compensation costs of $1.7 million, professional fees of $0.2 millionand other costs of $0.8 million.

 

**CHANGES IN FINANCIALCONDITION**

 

GENERAL.  Total assets decreasedfrom approximately $109.0 million at December 31, 2003 to approximately$103.0 million at March 31, 2004. Total liabilities decreased from approximately $63.6 million atDecember 31, 2003 to approximately $60.5 million at March 31,2004.  Stockholders’ equity decreased byapproximately $2.9 million resulting primarily from our net loss of $1.6million and dividends declared of $1.1 million.

 

SECURITIES AVAILABLE FOR SALE. The balance of mortgage-backed securities available for sale decreasedfrom $35.5 million at December 31, 2003 to $32.3 million at March 31,2004.   The decrease was primarily theresult of the sale of mortgage-backedsecurities with a carrying value of $1.3 million and cash repayments ofsecurities of $2.2 million, partially offset by increases in market value of$0.3 million.

 

At March 31, 2004, approximately $31.3 million of ourmortgage-backed securities portfolio consisted of a “AAA” rated FNMAcertificate for which market value quotes were obtained.

 

At March 31, 2004, securities available for sale were as follows:

 
|                                                                   |   | **Amortized  Cost (1)**     |   | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Fair Value** |   |
|------------------------------------------------------------------------|--------|-----------------------------|--------|------------------------------|--------|-------------------------------|--------|----------------|--------|
|                                                                   |   | **(dollars  in thousands)** |   |
| Total Mortgage-backed securities, pledged  under repurchase agreements |   | $                           | 31,347 |                         | $      | 882                           |   | $              | (47    | ) | $ | 32,182 |   |
| Other Mortgage-backed securities                                       |   | —                      |   | 75                           |   | —                        |   | 75             |   |
| Total Mortgage-backed securities                                       |   | $                           | 31,347 |                         | $      | 957                           |   | $              | (47    | ) | $ | 32,257 |   |

 

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(1)                                  The amortized cost ofthe securities excludes accrued interest of $0.1 million.

 

LOAN PORTFOLIO.  We invest inspecial situation loans, generally secured by real estate.  These loans are typically short-term, withmaturities ranging from 6 to 24 months. Due to the unique circumstances relating to the loans, the interest ratecharged the borrower is significantly higher than conventional real estatelending.  During the three months endedMarch 31, 2004, our loan portfolio increased by approximately $3.9million.  This was primarily the resultof the acquisition of two new loans with a carrying value totaling $4.0million.  As of March 31, 2004, twoof the Company’s loans totaling $3.0 million had been restructured to provideadditional time for repayment by the borrowers in exchange for variousextension fees or other new terms.  As aresult, these loans were considered impaired for accounting purposes, however,no impairment reserves were required on these loans due to management’sexpectation that all amounts due will be collected.

 

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INVESTMENTS IN REAL ESTATE. Investments in real estate increased by $0.7 million during the threemonths ended March 31, 2004.  Theincrease was primarily due to the purchase of the fee interest in twofreestanding retail buildings for $0.4 million and capital improvements of $0.7million, partially offset by the sale of one property for $0.2 million anddepreciation of $0.2 million.

 

In October 2002, the Company assumed leasehold interests in 109free-standing retail stores located throughout the United States.  As a result of various purchase and saletransactions, including those described above during 2004, as of March 31,2004, we owned the fee interest in 22 of the properties and continued to ownleasehold interests in 80 of the original free-standing retail stores.  The properties are leased or sublet to abroad tenant mix including convenience stores, shoe stores, video rentaloutlets, auto parts dealers, carpet retailers and other small businesses.

 

Of the remaining leases, 36 are on terms and conditions that requirecapitalization of the obligation. Accordingly, as of March 31, 2004, we had capitalized $13.5 millionas investment in real estate as a result of the transaction, and recognized acapital lease obligation of $12.8 million. The remaining 44 leases areclassified as operating leases.  All ofour subleases are accounted for as operating leases.

 

LOANS TO SENIOREXECUTIVES.  Prior to the passage of theSarbanes-Oxley Act of 2002, we had an employment agreement with Mr. Wiederhornwhich allowed him to borrow a specified maximum amount from us to purchaseshares of Common Stock.  The resultingloans are full recourse, secured loans bearing interest at the prime rate.  At March 31, 2004, in addition to the$2 million loan to Mr. Wiederhorn described below, we had outstanding loans toMr. Wiederhorn, including accrued interest, of approximately $1.0 million.  The Company is not obligated to makeadditional advances on loans under the current employment agreement.  The loans to Mr. Wiederhorn are furtherdescribed as follows:

 

On February 21,2002, we loaned Mr. Wiederhorn $175,000 to finance the purchase of CommonStock.  This loan is full recourse toMr. Wiederhorn and is secured by all of Mr. Wiederhorn’s rights under hisemployment agreement.  We are entitledto net amounts payable under the employment agreement against any amountspayable by Mr. Wiederhorn upon any default or at maturity of the loan.  At Mr. Wiederhorn’s direction (in accordancewith the terms of his employment agreement), on February 21, 2002, weloaned a limited partnership controlled by Mr. Wiederhorn’s spouse (the “LP”)$687,000 to finance the purchase of Common Stock.  The loan is secured by the membership interests of two limitedliability companies owned by the LP. The limited liability companies each own a parcel of real property inOregon and have no liabilities.  At thetime of the loan, the real property had an appraised value of $725,000.  The loan is also guaranteed by Mr.Wiederhorn.  The Common Stock purchasedwith the proceeds of these loans does not serve as security for the loans.  The loans are due on February 21, 2007,and bear interest at the prime rate, as published in the Wall Street Journal,which interest is added to the principal annually.

 

Prior to the passage ofthe Sarbanes-Oxley Act of 2002, we loaned Mr. Wiederhorn $2.0 million.  This loan is full recourse to Mr. Wiederhornand his spouse and is secured by trust deeds on two residences located in Oregon.  The loan is due on August 1, 2007 andbears interest at 8.5% per annum, payable monthly.  The Board of Directors (with Mr. Wiederhorn abstaining) concludedthat the terms of the loan were at least as favorable to the Company as wouldbe available in an arms length, third party transaction and approved the loanon July 9, 2002.

 

Further information onthese loans to executives is included in our 2003 annual report on Form 10-Kand proxy statements for our 2003 and prior years’ Annual Meeting ofStockholders, and the employment agreements have been previously filed with theSEC.

 

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INVESTMENT IN BOURNEEND.   In December 2000, weorganized and led a group of investors to purchase all of the outstandingcapital stock of Bourne End, a specialist investor in retail property.  At the time of the acquisition, Bourne Endhad approximately GBP 169.6 million of assets and GBP 123.1 million ofdebt.  The real estate assets consistedof 1.7 million square feet in fifteen shopping centers located in the UnitedKingdom.  As of March 31, 2004,Bourne End had sold thirteen of the original fifteen shopping centers.  The sales are consistent with the investorgroup’s strategy to reposition each of the centers, including selected newcapital expenditures on existing space and new development on excess oradjoining land, with the ultimate goal of reselling the properties.

 

Bourne End is in the process of improving andselling its two remaining shopping centers, which it hopes to sell within thenext 12 months.  At that point, BourneEnd is expected to be liquidated and we will receive our share of any remainingassets or proceeds of Bourne End.

 

Our investment in Bourne End increased by$0.1 million to $2.2 million at March 31, 2004.  The increase was primarily the result of the recognitionof our share of the earnings of Bourne End.

 

RESTAURANT PROPERTY, PLANT AND EQUIPMENT, NET.  As a result of the acquisition andconsolidation of Fatburger, our investment in restaurant property, plant andequipment, net of depreciation, increased $0.3 million during the three monthsended March 31, 2004 to a balance of $6.2 million.  The increase was primarily the result ofadditions to equipment, furniture and fixtures relating to new store openings.

 

INTANGIBLE ASSETS, NET.  Primarilyas a result of the acquisition and consolidation of Fatburger, as ofMarch 31, 2004 we had intangible assets, net of amortization, of $5.6million.  This consisted of trademarkrights of approximately $4.0 million, franchise agreements of approximately$1.0 million and other miscellaneous intangible assets of $0.5 million.  Intangible assets decreased $0.1 millionduring the three months ended March 31, 2004 primarily as the result ofamortization expense.

 

GOODWILL.  As a result of theacquisition and consolidation of Fatburger, we had recorded goodwill of $7.3million as of March 31, 2004.

 

OTHER ASSETS.  At March 31,2004, the Company’s other assets consisted of the following (dollars inthousands):

 
| Capitalized deferred compensation |   | $     | 1,156  |   |
|-----------------------------------|--------|-------|--------|--------|
| Prepaid expenses                  |   | 778   |   |
| Rent receivable                   |   | 161   |   |
| Investment in operating leases    |   | 392   |   |
| Mortgage servicing rights         |   | 266   |   |
| Other                             |   | 1,130 |   |
| Total                             |   | $     | 3,883  |   |

 

The capitalized deferred compensation included in other assets relatesto the acquisition of George Elkins.  Inconjunction with the acquisition, certain employees of George Elkins enteredinto long-term employment agreements. These employees received payments totaling $1.9 million which wecapitalized as deferred compensation. The employees are obligated to perform under the employment agreementsand must repay any unearned deferred compensation payments upon earlytermination.  The deferred compensationis earned ratably over the terms of the employment agreements, and we areamortizing the $1.9 million investment over the remaining terms, which rangefrom 14 to 38 months.

 

REPURCHASE AGREEMENTS, BORROWINGS AND NOTES PAYABLE.  Our repurchase agreements, borrowings andnotes payable decreased $1.2 million during the three months endedMarch 31, 2004.  This was primarilythe result of the repayment of repurchase agreements secured by mortgage-backedsecurities of  $1.0 million.

 

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OBLIGATIONS UNDER CAPITAL LEASES. Obligations under capital leases decreased approximately $0.1 millionduring the year ended December 31, 2003. This decrease was primarily the result of the scheduled amortization ofthe obligations.

 

DEFERRED INCOME.  Franchise feerevenue from the sales of individual Fatburger franchises is recognized onlywhen all material services or conditions relating to the sales have beensubstantially performed or satisfied. The completion of training and the opening of a location by thefranchisee constitute substantial performance. Nonrefundable deposits collected in relation to the sale of franchisesare recorded as deferred franchise fees until the completion of training andthe opening of the restaurant, at which time the franchise fee revenue isrecognized.  As of March 31, 2004,our deferred income relating to the collection of unearned Fatburger franchisefees was $3.9 million, an increase of $0.2 million from December 31,2003.  The increase was primarily theresult of the collection of nonrefundable deposits on new franchises.

 

DEFERRED INCOME TAXES.  Ourdeferred income taxes decreased $0.6 million to $6.4 million at March 31,2004.  This was primarily the result ofa decrease in the accrued taxes associated with unrealized gains onmortgage-backed securities.  As ofMarch 31, 2004, we had, for U.S. Federal tax purposes, a net operatingloss (“NOL”) carryforward of approximately $80.9 million, including $12.9million relating to Fatburger.  The NOLcarryforward may reduce the future cash payment of the deferred income taxliability.  Our NOL begins to expire in2018.  Fatburger’s NOL begins to expirein 2004 and is generally subject to an annual limitation under the InternalRevenue Code of 1986, Section 382, Limitation on Net Operating LossCarryovers and Certain Built-In Losses Following Change in Control.  In addition, to the extent the Fatburger NOLis utilized, the recognition of the related tax benefits would first reducegoodwill related to Fatburger acquisition, then other non-current intangibleassets related to that acquisition, and then income tax expense in accordancewith Statement on Financial Accounting Standards No. 109, Accounting for IncomeTaxes.

 

United States tax regulations impose limitations on the use of NOLcarry forwards following certain changes in ownership.  If such a change were to occur with respectto the Company, the limitation could significantly reduce the amount ofbenefits that would be available to offset future taxable income each year,starting with the year of ownership change. To reduce the likelihood of such ownership changes, we established aShareholder Rights Plan dated as of October 18, 2002, which discourages,under certain circumstances, ownership changes which would trigger the NOLlimitations.

 

STOCKHOLDERS’ EQUITY. Stockholders’ equity decreased by approximately $2.9 million resultingprimarily from our net loss of $1.6 million and dividends declared of $1.1million.

 

Subsequent to March 31, 2004, the we purchased 330,500 shares ofour common stock from a stockholder. The purchase price was $5.40 per share ($1.8 million) and the shareswere placed in treasury.

 

Also subsequent to March 31, 2004, the Company purchased a three yearcall option (the “Call Option”) from its Chairman and Chief Executive Officer,Andrew A. Wiederhorn.  The Call Optiongives the Company the right, but not the obligation, to purchase 423,245 of theCompany's outstanding common stock (the “Option Shares”) from Mr. Wiederhornfor a purchase price of $3.99 per share. The option may be exercised at any time during the three year optionperiod.  The Company paid $750,000($1.77 per option share) for the Call Option.

 

## **LIQUIDITY ANDCAPITAL RESOURCES**

 

Liquidity is a measurement of our ability to meet potential cashrequirements, including ongoing commitments to repay borrowings, fundrestaurant operations and other businesses, engage in loan acquisition andlending activities, and for other general business purposes.  The primary sources of funds for liquidityduring the three months ended March 31, 2004, consisted of net cash providedby investing activities, including interest and principal payments related toour mortgage-backed securities portfolio and the sale of mortgage-backedsecurities.  As of March 31, 2004,we had cash and cash equivalents of $11.6 million and a $31.3 million “AAA”rated FNMA certificate (which is subject to repurchase agreement debt of $23.9million), which we believe will be sufficient to meet our current liquidityrequirements.

 

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Our borrowings and the availability of further borrowings aresubstantially affected by, among other things, changes in interest rates,changes in market spreads whereby the market value of the collateral securingsuch borrowings may decline substantially, or decreases in credit quality ofunderlying assets.  In the event ofdeclines in market value or credit quality, we may be required to provideadditional collateral for, or repay a portion of outstanding balances of, ourshort-term borrowing facilities. However, our borrowings against securitiesconsist of non-recourse, short-term repurchase agreements held in wholly-ownedsubsidiaries.  As a result, ourpotential risk from collateral calls is limited to the equity in the assetsbeing financed, which at March 31, 2004, totaled $7.9 million.  We consider the potential exposure tocollateral calls to be significantly less than the $7.9 million equity since$7.4 million relates to our equity in a “AAA” rated FNMA security.  As of March 31, 2004, we had nooutstanding collateral calls.  Foradditional information with respect to our monthly mark-to-market of oursecurities available for sale portfolio, see “CHANGES IN FINANCIALCONDITION–SECURITIES AVAILABLE FOR SALE.”

 

Fluctuations in interest rates will continue to impact our net interestincome to the extent our fixed rate assets are funded by variable rate debt orour variable rate assets reprice on a different schedule or in relation toa different index than any floating rate debt which in turn could impactpotential returns to shareholders.  See“Item 7A.  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK.”

 

At March 31, 2004, we had total consolidated secured indebtednessof $44.7 million, as well as $15.8 million of other liabilities. Theconsolidated secured indebtedness consisted of (i) $24.3 million of repurchaseagreements secured by $32.2 million of mortgage-backed securities, (ii) $12.8million outstanding of obligations under capital leases maturing between 2010and 2040 which are primarily secured by real estate and (iii) long-term debt ofFatburger of $7.6 million secured by substantially all of the assets ofFatburger.  Approximately $24.3 millionof this indebtedness had terms which allowed the lender to request additionalcollateral if the value of the underlying collateral declined.  However, due to the non-recourse nature ofour repurchase agreements, our exposure to collateral calls is limited to theequity in the assets being financed.

 

If our existing liquidity position were to prove insufficient, and wewere unable to fund additional collateral requirements or to repay, renew orreplace maturing indebtedness on terms reasonably satisfactory to us, we may berequired to sell (potentially on short notice) a portion of our assets, andcould incur losses as a result.  Also,Fatburger is involved in a nationwide expansion of franchise and Fatburgerowned locations, which will require significant liquidity.  If Fatburger or its franchisees areunsuccessful in obtaining credit lines sufficient to fund this expansion, thetiming of restaurant openings may be delayed.

 

We consider the sale of assets to be a normal, recurring part of ouroperations and we are currently generating positive cash flow as a result ofthese transactions.  However, excludingthe sale of assets from time to time, we are currently operating with negativecash flow, since many of our assets do not generate current cash flowssufficient to cover current operating expenses.  We believe that our existing sources of funds will be adequatefor purposes of meeting our liquidity needs, however, there can be no assurancethat this will be the case.  Materialincreases in interest expense from variable-rate funding sources, collateralcalls, greater demands for liquidity at our operating subsidiaries, includingFatburger and our real estate operations, or material decreases in monthly cashreceipts, generally would negatively impact our liquidity.  On the other hand,  improvements in cash flow from our operating subsidiaries or realestate investments, or an increase in market value of our mark-to-marketfinancial assets generally would positively affect our liquidity.

 

**CONTRACTUALOBLIGATIONS**

 

During the three months ended March 31, 2004, there were nomaterial changes to the contractual obligations as reported on Form 10-K forthe year ended December 31, 2003.

 

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**OFF BALANCE SHEETARRANGEMENTS**

 

In order to facilitate the development of franchise locations, as ofMarch 31, 2004 Fatburger had guaranteed the annual minimum lease paymentsof two restaurant sites owned and operated by franchisees.  The amount of the guarantees approximate$0.4 million plus certain contingent rental payments as defined in therespective leases.  These leases expireat various times though 2008.

 

We did not have any other off balance sheet arrangements in place as ofMarch 31, 2004.

 

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

 

Market risk is the exposure to loss resulting from changes in interestrates, foreign currency exchange rates, commodity prices, and equityprices.  We have minor exposure toforeign currency fluctuations (approximately 5% of the Company’s equity isinvested in assets located in the United Kingdom at March 31, 2004).

 

The primary market risk to which we are exposed is interest raterisk.  This type of risk is highlysensitive to many factors beyond our control, including governmental monetaryand tax policies, domestic and international economic and politicalconsiderations, and other factors. Changes in the general level of interest rates can affect our netinterest income by affecting the spread between our interest-earning assets andour interest-bearing liabilities. Changes in the level of interest rates can also affect, among otherthings, the value of our interest-earning assets (including mortgage-backedsecurities) and our ability to acquire loans. We have attempted to mitigate the potential effects of a rising interestrate environment by shifting our mortgage-backed securities portfolio fromfixed rate assets to variable rate assets. Our real estate and restaurant operations are primarily funded by fixedrate debt or equity.  As demonstrated inthe tables below, we believe that a modest increase in interest rates will nothave a significant effect on our profitability or equity value.

 

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

 

The following table quantifies the potential changes in net interestincome and net portfolio value as of March 31, 2004 should interest ratesgo up or down (shocked) by 100 or 200 basis points, assuming the yield curvesof the rate shocks will be parallel to each other and instantaneous. Net portfoliovalue is calculated as the sum of the value of off-balance sheet instrumentsand the present value of cash in-flows generated from interest-earning assetsnet of cash out-flows in respect of interest-bearing liabilities. The cashflows associated with the loan portfolios and securities available for sale arecalculated based on prepayment and default rates that vary by asset but not bychanges in interest rates. Projected losses, as well as prepayments, aregenerated based upon the actual experience with the subject pool, as well assimilar, more seasoned pools. To the extent available, loan characteristicssuch as loan-to-value ratio, interest rate, credit history and product typesare used to produce the projected loss and prepayment assumptions that areincluded in the cash flow projections of the securities.  The following table applies the U.S.Treasury yield curve generally for assets and LIBOR for repurchase agreementliabilities and assume a uniform change in both rates.  The table assumes that changes in interestrates occur  instantaneously.  The table also reflects that we have asignificant exposure to LIBOR rates since our short-term repurchase agreementborrowings are generally based on LIBOR rates. Actual results could differ significantly from those estimated in thetable.

 

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| **Projected  Percent Change In**  |   |
|-----------------------------------|--------|
| **Change in Interest  Rates (1)** |   | **Net  Interest  Income** |   | **Net  Portfolio  Value** |   | **Change in  Annual  Net  Interest Income** |   | **Change in  Net  Portfolio  Value** |   |
| -200 Basis Points                 |   | 0.7 | % | 0.5 | % | $ | 15,000 |   | $ | 193,000 |   |
| -100 Basis Points                 |   | 0.0 | % | 0.3 | % | $ | 1,000 |   | $ | 109,000 |   |
| 0 Basis Points                    |   | 0.0 | % | 0.0 | % | $ | — |   | $ | — |   |
| 100 Basis Points                  |   | -2.6 | % | -0.2 | % | $ | (157,000 | ) | $ | (73,000 | ) |
| 200 Basis Points                  |   | -5.3 | % | -0.5 | % | $ | (115,000 | ) | $ | (209,000 | ) |

 

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

 

Thefollowing table sets forth information as to the type of funding used tofinance the Company’s assets as of March 31, 2004.  As indicated in the table, a largepercentage of the Company’s fixed-rate assets are currently not financed andthe Company’s variable-rate assets are generally funded by variable-rateliabilities.

 

Assets and Liabilities

As of March 31, 2004

(dollars in thousands)

 
|                                     |   | **Basis  Amount** |    | **Coupon  Type** |   | **Liability** |   | **Type** |   |
|------------------------------------------|--------|-------------------|---------|------------------|--------|---------------|--------|----------|--------|
| Interest-Bearing  Assets                 |   |              |    |             |   |          |   |     |   |
|                                     |   |              |    |             |   |          |   |     |   |
| Fixed-rate asset, financed floating      |   | $                 | 1,004   |             | Fixed  |          | $      | 468      |   | LIBOR |   |
| Fixed-rate assets, no financing          |   | 8,099             |    | Fixed            |   | —        |   | None     |   |
| Variable-rate, financed variable         |   | 31,253            |    | 1 TCM (1)        |   | 23,859        |   | LIBOR    |   |
| Variable-rate assets, no financing       |   | 2,493             |    | Prime            |   | —        |   | None     |   |
| Cash and cash equivalents                |   | 11,638            |    | N/A              |   | —        |   | None     |   |
| Subtotal                                 |   | 54,487            |    |             |   | 24,327        |   |     |   |
|                                     |   |              |    |             |   |          |   |     |   |
| Other Assets                             |   |              |    |             |   |          |   |     |   |
|                                     |   |              |    |             |   |          |   |     |   |
| Investments in real estate               |   | 23,313            |    | N/A              |   | 12,799        |   | Fixed    |   |
| Investment in BEP                        |   | 2,232             |    | N/A              |   | —        |   | None     |   |
| Restaurant property, plant and equipment |   | 6,170             |    | N/A              |   | 7,556         |   | Fixed    |   |
| Intangible assets, net                   |   | 5,572             |    | N/A              |   | —        |   | None     |   |
| Goodwill                                 |   | 7,300             |    | N/A              |   | —        |   | None     |   |
| Other                                    |   | 3,883             |    | N/A              |   | —        |   | None     |   |
| Subtotal                                 |   | 48,470            |    |             |   | 20,355        |   |     |   |
|                                     |   |              |    |             |   |          |   |     |   |
| Liability Only                           |   |              |    |             |   |          |   |     |   |
|                                     |   |              |    |             |   |          |   |     |   |
| Deferred income                          |   | —            |    |             |   | 3,860         |   | None     |   |
| Deferred income taxes                    |   | —            |    |             |   | 6,405         |   | None     |   |
| Other                                    |   | —            |    |             |   | 5,559         |   | None     |   |
| Total                                    |   | $                 | 102,957 |             |   |          | $      | 60,506   |   |   |   |

 

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(1)          1 TCM means the one year Treasury ConstantMaturity Index.

 

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Asset and liability management involves managing the timing andmagnitude of the repricing of assets and liabilities.  It is our objective to attempt to control risks associated withinterest rate movements.  Asset andliability management can utilize a wide variety of off-balance sheet financialtechniques to assist it in the management of interest rate risk.  For example, in hedging the interest rateand exchange rate exposure of a foreign currency denominated asset orliability, we may enter into hedge transactions to counter movements in thedifferent currencies as well as interest rates in those currencies.  These hedges may be in the form of currencyand interest rate swaps, options, and forwards, or combinations thereof.  No such interest rate techniques were in useas of March 31, 2004.

 

Methods for evaluating interest rate risk include an analysis of ourinterest rate sensitivity “gap,” which is defined as the difference betweeninterest-earning assets and interest-bearing liabilities maturing or repricingwithin a given time period.  A gap isconsidered positive when the amount of interest-rate sensitive assets exceedsthe amount of interest-rate sensitive liabilities.  A gap is considered negative when the amount of interest-ratesensitive liabilities exceeds interest-rate sensitive assets.  During a period of rising interest rates, anegative gap would tend to adversely affect net interest income, while apositive gap would tend to result in an increase in net interest income.  During a period of falling interest rates, anegative gap would tend to result in an increase in net interest income, whilea positive gap would tend to affect net interest income adversely.  Since different types of assets andliabilities with the same or similar maturities may react differently tochanges in overall market rates or conditions, changes in interest rates mayaffect net interest income positively or negatively even if an institution wereperfectly matched in each maturity category.

 

The following table sets forth the estimated contractual maturity orrepricing of our interest-earning assets and interest-bearing liabilities at March 31, 2004.

 

As of March 31, 2004

(dollars in thousands)

 
|                                                                                            |   | **Within  3 Months** |   | **4 to 12  Months** |   | **One Year  to  3 Years** |   | **More than  3 Years** |   | **TOTAL** |   |
|-------------------------------------------------------------------------------------------------|--------|----------------------|--------|---------------------|--------|---------------------------|--------|------------------------|--------|-----------|--------|
| Interest-sensitive assets(1):                                                                   |   |                 |   |                |   |                      |   |                   |   |      |   |
| Cash and cash equivalents                                                                       |   | $                    | 11,638 |                | $      | —                    |   | $                      | — |      | $      | — |   | $ | 11,638 |   |
| Securities available for sale                                                                   |   | —               |   | —              |   | 31,253                    |   | 1,004                  |   | 32,257    |   |
| Loans                                                                                           |   | 1,550                |   | 4,407               |   | 1,678                     |   | —                 |   | 7,635     |   |
| Loans to senior executives                                                                      |   | —               |   | —              |   | —                    |   | 2,957                  |   | 2,957     |   |
| Total rate-sensitive assets                                                                     |   | $                    | 13,188 |                | $      | 4,407                     |   | $                      | 32,931 |      | $      | 3,961 |   | $ | 54,487 |   |
|                                                                                            |   |                 |   |                |   |                      |   |                   |   |      |   |
| Interest-sensitive liabilities :                                                                |   |                 |   |                |   |                      |   |                   |   |      |   |
| Borrowings and notes payable                                                                    |   | $                    | 24,785 |                | $      | 1,374                     |   | $                      | 3,664  |      | 2,060  |   | $ | 31,883 |   |
| Obligations under capital leases                                                                |   | 26                   |   | 77                  |   | 233                       |   | 12,463                 |   | 12,799    |   |
| Total rate-sensitive liabilities                                                                |   | $                    | 24,811 |                | $      | 1,451                     |   | $                      | 3,897  |      | $      | 14,523 |   | $ | 44,682 |   |
|                                                                                            |   |                 |   |                |   |                      |   |                   |   |      |   |
| Interest rate sensitivity gap                                                                   |   | (11,623              | )      | 2,956               |   | 29,034                    |   | (10,562                | )      | 9,805     |   |
| Cumulative interest rate sensitivity gap                                                        |   | (11,623              | )      | (8,667              | )      | 20,367                    |   | 9,805                  |   |      |   |
| Cumulative interest rate sensitivity gap as  a  percentage of total rate-sensitive  assets |   | (21                  | )%     | (16                 | )%     | 37                        | %      | 18                     | %      |      |   |

 

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(1)          Real estate property holdings are notconsidered interest rate sensitive.

 

**ITEM 4.  CONTROLSAND PROCEDURES**

 

**(A)****                ****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) and 15d-15(e) as ofthe end of the period covered by this report, have concluded that ourdisclosure controls and procedures were adequate and designed to ensure thatmaterial information relating to us and our consolidated subsidiaries would bemade known to us by others within these entities.

 

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**(B)****                 Changesin internal control over financial reporting**.  There were no significant changes in our internal control overfinancial reporting that occurred during our first fiscal quarter of 2004 thathave materially affected or are reasonably likely to materially affect ourinternal control over financial reporting.

 

**(C)****                 ReportableConditions – Fatburger. ** Prior to our acquisition of Fatburger, theindependent auditors, Ernst & Young LLP, determined that Fatburger hadsignificant deficiencies in internal control which may affect its ability torecord, process, summarize and report financial data.  While not constituting a material weakness, as of March 31,2004, the deficiencies had not been fully resolved by Fatburger.  The issues were as follows:

 

•                  A lack ofsufficient resources in the accounting department to handle the day-to-daytransactions and record all adjustments for the financial statements.

•                  A lack ofsufficient controls over the information reported to Fatburger from thefranchisees, which may result in a misstatement of royalty income.

 

The management of Fatburger is addressing these concerns, andanticipates that these issues will be resolved in the near future.

 

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FORWARD-LOOKING STATEMENTS

 

CERTAIN STATEMENTS CONTAINED HEREIN AND CERTAIN STATEMENTS CONTAINED INFUTURE FILINGS BY THE COMPANY WITH THE SEC MAY NOT BE BASED ON HISTORICAL FACTSAND ARE “FORWARD-LOOKING STATEMENTS” WITHIN THE MEANING OF SECTION 27A OFTHE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIESEXCHANGE ACT OF 1934, AS AMENDED. FORWARD-LOOKING STATEMENTS WHICH ARE BASED ON VARIOUS ASSUMPTIONS (SOMEOF WHICH ARE BEYOND THE COMPANY’S CONTROL) MAY BE IDENTIFIED BY REFERENCE TO AFUTURE PERIOD OR PERIODS, OR BY THE USE OF FORWARD-LOOKING TERMINOLOGY, SUCH AS“MAY,” “WILL,” “BELIEVE,” “EXPECT,” “ANTICIPATE,” “CONTINUE,” OR SIMILAR TERMSOR VARIATIONS ON THOSE TERMS, OR THE NEGATIVE OF THOSE TERMS.  ACTUAL RESULTS COULD DIFFER MATERIALLY FROMTHOSE SET FORTH IN FORWARD-LOOKING STATEMENTS DUE TO A VARIETY OF FACTORS,INCLUDING, BUT NOT LIMITED TO, THOSE RELATED TO THE ECONOMIC ENVIRONMENT,PARTICULARLY IN THE MARKET AREAS IN WHICH THE COMPANY OPERATES, THE FINANCIALAND SECURITIES MARKETS AND THE AVAILABILITY OF AND COSTS ASSOCIATED WITHSOURCES OF LIQUIDITY, COMPETITIVE PRODUCTS AND PRICING, THE REAL ESTATE MARKET,FISCAL AND MONETARY POLICIES OF THE U.S. GOVERNMENT, CHANGES IN PREVAILING INTEREST RATES, ACQUISITIONS AND THEINTEGRATION OF ACQUIRED BUSINESSES, PERFORMANCE OF RETAIL/CONSUMER MARKETS,DETERIORATION IN CONSUMER CREDIT, CREDIT RISK MANAGEMENT, ASSET/LIABILITYMANAGEMENT, THE IMPACT OF ONGOING LITIGATION, AND THE IMPACT OF AN ONGOINGINVESTIGATION OF THE COMPANY’S CHIEF EXECTUTIVE OFFICER.  EXCEPT AS MAY BE REQUIRED BY LAW, THECOMPANY DOES NOT UNDERTAKE, AND SPECIFICALLY DISCLAIMS ANY OBLIGATION, TOPUBLICLY RELEASE THE RESULTS OF ANY REVISIONS WHICH MAY BE MADE TO ANYFORWARD-LOOKING STATEMENTS TO REFLECT THE OCCURRENCE OF ANTICIPATED ORUNANTICIPATED EVENTS OR CIRCUMSTANCES AFTER THE DATE OF SUCH STATEMENTS.

 

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## **PARTII** — OTHER INFORMATION

 

**Item 1.  LegalProceedings.**

 

As the Company has previously disclosed the Company’s Chief ExecutiveOfficer, Andrew Wiederhorn, and former President, Lawrence Mendelsohn, receivedletters from the United States Attorney’s Office for the District of Oregon(“USAODO”) in March 2001 advising them that they were targets of a grandjury investigation (the “CCL Investigation”) into the failure of CapitalConsultants, L.L.C (“CCL”).  CCL was alender to Wilshire Credit Corporation (“WCC”) and related and affiliatedcompanies. WCC was a mortgage loan servicing company owned by Mr. Wiederhornand Mr. Mendelsohn that provided mortgage loan servicing for Wilshire FinancialServices Group Inc., a public company for which Mr. Wiederhorn acted as CEO andMr. Mendelsohn acted as President and which was principally engaged in banking,loan pool purchasing, and investing in mortgage-backed securities.  As a result of the liquidity crisis in thefinancial markets in the fall of 1998, Wilshire Financial Services Group Inc.experienced significant losses and filed for bankruptcy, which in turn had asignificant impact on its affiliates, including WCC, which could not repay theamounts borrowed from CCL.  At the time,Wilshire Financial Services Group Inc. owned approximately 8.6% of theCompany’s common stock and managed the Company’s investments under a managementagreement.

 

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

 

The Company believes that the CCL Investigation isnearing conclusion as to Mr. Wiederhorn. Although the Company believes that theCCL Investigation is unrelated to Mr. Wiederhorn’s activities as CEO of theCompany or the Company’s activities, in the event an indictment is returnedagainst him or he pleads guilty to one or more offenses pursuant to anagreement with the USAODO, one or more potential negative consequences to theCompany could result, including, among other things (i) the strong possibilitythat Mr. Wiederhorn would be unable to continue as a director and officer ofthe Company, including the risk that incarceration would be required and thatthe Company would need to make sure an appropriate management team was inplace, (ii) concerns on the part of shareholders, clients and employees thatcould adversely affect the Company’s stock price, and (iii) inquiries byregulatory agencies, such as the NASD and the SEC.

 

Messrs. Wiederhorn andMendelsohn, pursuant to the terms of their respective employment agreements,may be entitled to indemnity from the Company for litigation expenses andpersonal losses in connection with these investigations and any relatedlitigation.  Messrs. Wiederhorn andMendelsohn have notified the Company that they are reserving their rights toseek indemnity from the Company, however, they may be entitled to primaryindemnification from other sources. At this time, it is not possible todetermine the extent of liability, if any, the Company may face with regard tothese potential indemnity claims. The Company has not agreed to any indemnityrequests.

 

On October 6, 2003, the Official Committee of UnsecuredCreditors of Strouds Acquisition Corporation filed a lawsuit in the UnitedStates Bankruptcy Court (LA 03-23620-ER) which names the Company, among others,as a defendant.  The lawsuit was amendedon November 10, 2003 and limits the complaint against the Company solelyin its capacity as collateral agent for certain secured creditors ofStrouds.  The lawsuit, as it pertains tothe Company, seeks reimbursement of the proceeds from approximately $3.0million in funds received in October 2003, which the Company is holding ascollateral agent for other secured creditors. The $3.0 million being held as collateral agent will continue to be heldin trust, less reimbursements to the Company, from time-to-time, of theCompany’s related legal costs, until the bankruptcy court resolves the disputeregarding its distribution.  These fundsare not included in the assets of the Company in the accompanying statements offinancial position.  As ofDecember 31. 2003, the Company had been reimbursed for legal fees in theamount of $0.3 million from the collateral agent funds.

 

30

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The Committee of Unsecured Creditors is seeking the refund ofthose fees.  The Company believes thatit will prevail in this matter and has not established a reserve forreimbursement.

 

The Company is involved in various other legal proceedings occurring inthe ordinary course of business which the Company believes will not have amaterial adverse effect on the consolidated financial condition or operationsof the Company.

 

**Item 2.  Changesin Securities, Use of Proceeds and Purchases of Equity Securities.**

** **

### **OnApril 27, 2004, the Company amended its Shareholder Rights Plan (the“Plan”) to allow that if the Board of Directors determines in good faith that aperson who would otherwise be an Acquiring Person (as defined in the Plan) hasbecome such without materially adversely impacting the Company’s tax or NOLposition or without exceeding the change of ownership limits contained inSection 382 and other related provisions of US tax law, then such personshall not be deemed an “Acquiring Person” for any purposes of the Plan.**

 

**Item 3.  Defaults Upon Senior Securities.**

** **

Not applicable.

 

**Item 4.  Submission of Matters to a Vote ofSecurity Holders.**

** **

**None**

** **

**Item 5.  OtherInformation.**

# ** **

**STOCK PURCHASE**

** **

On April 28,2004, the Company purchased 330,500 shares of its common stock from astockholder.  The purchase price was$5.40 per share ($1.8 million) and the shares were added to treasurystock.  The purchase price represents asmall premium to the Company's current book value per share and current marketprice per share.  The Company and itsdirectors considered the following factors: (1) the potentially negative impact on the Company's share price if theshares were disposed of publicly; (2) the Company's favorable liquidityposition; (3) the potential reduction in the risk that shares are transferredin a transaction which would have an adverse impact on its NOL position; and(4) the reduction in the future expenditure of cash dividends by theCompany.  The Board of Directorsreviewed and approved the transaction to confirm that the transaction was inthe best interest of the Company and its other stockholders.

 

**2004 ANNUAL MEETING OF STOCKHOLDERS DELAYED**

 

The Company’s 2004 Annual Meeting of Stockholders has been delayed andwill not be scheduled until later in 2004. Stockholders wishing to include proposals in the proxy material inrelation to our 2004 Annual Meeting of Stockholders must submit the proposalsin writing so as to be received by the Secretary of the Company at theprincipal executive offices of the Company at 1410 SW Jefferson Street,Portland, OR 97201-2548, no later than the close of business on the 60thday prior to the announced meeting date. Such proposals must also meet the other requirements of the rules of theSecurities and Exchange Commission relating to stockholders’ proposals.  If the Company is not notified of an intentto present a proposal at our 2004 Annual Meeting of Stockholders by the 60thday prior to the announced meeting date, the Company will have the right toexercise its discretionary voting authority with respect to such proposal, ifpresented at the meeting, without including information regarding such proposalin its proxy materials.

# ** **

# **RESIGNATION OF ROBERT G. ROSEN**

 

Effective March 26,2004, the Company announced the resignation of Robert G. Rosen as a member ofthe Company’s board of directors and as president of the Company and all of itssubsidiaries and affiliates.  Theresignation was tendered by Mr. Rosen so that he could pursue other interests.

 

# **TRANSACTIONS WITH AFFILIATES**

 

**Stock Purchase Loans to Officers**

 

Prior to the passage of the Sarbanes-Oxley Act of 2002, we hadnegotiated employment agreements with senior executives, which allowed theseexecutives to borrow a specified maximum amount from us to purchase shares ofcommon stock.  These loans are fullrecourse, secured loans bearing interest at the prime rate.  At March 31, 2004, in addition to the$2 million loan to Mr. Wiederhorn described below, we had outstanding stockpurchase loans to Mr. Wiederhorn including accrued interest, of approximately$1.0 million.  The Company is notobligated to make additional advances on loans under

 

31

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the employment agreements, and all other loans to executive officershave been paid in full.  The remainingoutstanding loans are described as follows:

 

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

 

Further information on these loans to Mr. Wiederhorn is included in ourannual proxy statement for 2002 and prior years and Mr. Wiederhorn’s employmentagreement has been previously filed with the SEC.

# ** **

# **Loanto Executive Officer**

 

Prior to the passage of the Sarbanes-Oxley Act of 2002, we had loanedMr. Wiederhorn $2.0 million.  This loanis fully recourse to Mr. Wiederhorn and is secured by trust deeds on tworesidences located in Oregon.  The loanis due on August 1, 2007 and bears interest at 8.5% per annum, payablemonthly.  The Board of Directors (withMr. Wiederhorn abstaining) concluded that the terms of the loan were at leastas favorable to the Company as would be available in an arms length, thirdparty transaction and approved the loan on July 9, 2002.

 

**Fog Cutter Long-Term Vesting Trust**

 

In the fourth quarter of 2000, we established a trust which purchased525,000 shares of the Company’s common stock from an unrelatedshareholder.  Our contribution to thetrust of approximately $1.3 million was included in compensation expense forthe year ended December 31, 2000. The trust was established for the benefit of our employees and directorsto raise their ownership in the Company, thereby strengthening the mutuality ofinterests between them and our shareholders. While these shares are held in trust, they will be voted ratably withballots cast by all other shareholders. In December 2002, using the retained earnings on trust assets, thetrust purchased an additional 100,000 shares of our stock in the open market.  In addition, during April 2004, thetrust purchased 69,500 shares of the Company’s stock from Clarence B. Coleman.

 

Andrew Wiederhorn, David Dale-Johnson and Don H. Coleman are thetrustees for the trust.  Pursuant to theterms of the trust, as amended, the trustees will, from time to time, allocatethe shares to our employees.  Anemployee shall not have any rights with respect to any shares allocated to himunless and until the employee completes five years of continuous service withthe Company, commencing with the date the employee is first allocated suchshares; provided, however, that such service need not be for a continuousperiod if so determined by the Company and the Trustees.  Upon the employee’s completion of thevesting period, the trustees shall promptly distribute to such employee theshares allocated to such employee; provided, however, that the trustees may, in lieu of distributing theshares, make a cash payment to the employee equal to the fair market value ofthe shares allocated to such employee as of the date immediately prior to thedate of distribution or distribute any combination of cash or shares, asdetermined by the trustees, in their sole discretion.

 

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Prior to March 31, 2004, the trustees had allocated 285,500 sharesto our employees and directors. Following the resignation of Mr. Rosen as president of the Company,50,000 shares previously allocated to him were forfeited and, as a result,currently only 235,500 are allocated to employees or directors.

 

**Business Use of Private Aircraft**

 

During the three months ended March 31, 2004, we paid $0.2 millionto Peninsula Capital Partners LLC (“Peninsula Capital”), an entity owned by Mr.Wiederhorn, for the Company’s business use of certain private aircraft.  The Board of Directors is aware of therelationship and approved the fees for the use of the aircraft.  The fee paid is a reimbursement of costs toPeninsula Capital for the Company’s use of the aircraft.

 

**Call Option**

 

On April 27, 2004, the Company purchased an option (the “CallOption”) to acquire 423,245 shares of the Company’s Common Stock from Mr.Wiederhorn, the Company’s CEO, during a three year period commencingApril 27, 2004, for an exercise price of $3.99 per share.  The purchase price for the Call Option was$750,000, resulting in an “all-in” cost to the Company on exercise ofapproximately $5.76 per share.  TheCompany and its directors believe that the Call Option gives the Company auseful option to acquire a large block of stock over an extended period at anexercise price well below the current market price and the aggregate price tothe Company on exercise of $5.76 per share would be a small premium to theCompany’s current book value per share and current market price per share, butis at a discount to the Company’s current net asset value per share (takinginto account the Company’s NOL position and certain other assets).  The price was determined based on arm’slength negotiations and the Company obtained valuations of the Call Optionthrough standard option pricing models available on Bloomberg.  The Company and its directors alsoconsidered the following factors:  (1)the potentially negative impact on the Company’s share price if the OptionShares were disposed of publicly; (2) the Company’s favorable liquidityposition; (3) the potential reduction in the risk that shares are transferredin a transaction which would have an adverse impact on its NOL position; and(4) the reduction in the future expenditure of cash dividends by the Companyonce the Company exercises the Call Option. The Board of Directors reviewed the transaction to confirm that thetransaction was in the best interest of the Company and its other stockholders.

 

**Item 6.  Exhibits and Reports on Form 8-K.**

 

(a)     Reportson Form 8-K:

 

A Form 8-K was filed with the Securities and Exchange Commission by theCompany on February 11, 2004, announcing the completion of an amended andrestated employment agreement with Robert G. Rosen, its president.

 

A Form 8-K was filed with the Securities and Exchange Commissionby the Company on March 22, 2004 announcing the results of operations andfinancial condition for the year ending December 31, 2003.

 

A Form 8-K was filed with the Securities and Exchange Commission by theCompany on April 1, 2004 announcing the resignation on March 26, 2004of Robert G. Rosen as president and as a director of the Company and all of itssubsidiaries and affiliates.

 

(b)   Exhibits

 

See Exhibit Index immediately following the signature page andcertifications.

 

33

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**SIGNATURES**

 

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

 
|                     | FOG CUTTER CAPITAL GROUP INC.                     |
|--------------------------|---------------------------------------------------|
|                     |                                              |
|                     |                                              |
|                     | By:  /s/ Andrew A. Wiederhorn                |   |
|                     | Andrew A. Wiederhorn                              |
|                     | Chairman and Chief Executive Officer              |
|                     |                                              |
|                     |                                              |
|                     | By:  /s/ R. Scott Stevenson                  |   |
|                     | R. Scott Stevenson                                |
|                     | Senior Vice President and Chief Financial Officer |
|                     |                                              |
|                     |                                              |
| Date:  May 12, 2004 |                                              |
|                          |                                                   |  |  |

 

34

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**ExhibitIndex**

 

2.1                                 Purchase and SaleAgreement between WREP Islands, Limited and The Aggmore Limited Partnership,dated November 19, 2001, incorporated by reference to Exhibit 2.1 to aForm 8-K dated November 19, 2001, as previously filed with the SEC onDecember 4, 2001.

 

2.2                                 Loan Option Agreement,by and between the Registrant and entities listed therein, datedJanuary 1, 2002, incorporated by reference to Exhibit 2.1 to the Form 8-Kdated March 6, 2002, as previously filed with the SEC on March 8,2002.

 

2.3                                 Property OptionAgreement, by and between the Registrant and the entities listed therein, datedeffective March 6, 2002, incorporated by reference to Exhibit 2.2 to theForm 8-K dated March 6, 2002, as previously filed with the SEC onMarch 8, 2002.

 

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

 

2.5                                 Interim Finance andStock Purchase Agreement, by and between the entities listed therein and theRegistrant, dated as of August 15, 2003, incorporated by reference toExhibit 2.5 to the Form 10-Q for the period ended September 30, 2003, aspreviously filed with the SEC on November 13, 2003.

 

2.6                                 Fatburger Holdings Inc. PreferredStock Purchase Agreement, by and between the entities listed therein and theRegistrant, dated as of January 12, 2004, incorporated by referenceto Exhibit 2.6 to the Form 10-K for the year ended December 31, 2003, aspreviously filed with the SEC on March 19, 2004.

 

2.7                                 March 2004 SupplementalAgreement, by and between Fatburger Holdings, Inc. and the Registrant, dated asof March 10, 2004, incorporated by reference to Exhibit 2.7 to theForm 10-K for the year ended December 31, 2003, as previously filed withthe SEC on March 19, 2004.

 

3.1                                 Amended and RestatedArticles of Incorporation of the Registrant, incorporated by reference toExhibit 3.1 to the Form 10-Q for the period ended September 30, 1999, aspreviously filed with the SEC on November 22, 1999.

 

3.2                                 Bylaws of theRegistrant, incorporated by reference to Exhibit 3.2 to Amendment No. 3 to theRegistration Statement (Registration No. 333-39035) on Form S-11, as previouslyfiled with the SEC on March 30, 1998.

 

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

 

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

 

4.3                                 Form of Stock OptionPlan, incorporated by reference to Exhibit 10.3 to Amendment No. 3 to theRegistration Statement (Registration No. 333-39035) on Form S-11, as previouslyfiled with the SEC on March 30, 1998.

 

4.4                                 Long Term VestingTrust Agreement among the Registrant and Lawrence Mendelsohn, Andrew Wiederhornand David Egelhoff, dated October 1, 2000, incorporated by reference toExhibit 4.4 to the Form 10-K for the year ended December 31, 2002, aspreviously filed with the SEC on March 3, 2003.

 

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4.5                                 Waiver, Release,Delegation and Amendment to Stock Option and Voting Agreement among Andrew A.Wiederhorn, Lawrence A. Mendelsohn, Joyce Mendelsohn, Tiffany Wiederhorn, andthe Registrant, dated July 31, 2002, incorporated by reference to Exhibit2.1 to the Form 8-K dated August 8, 2002, as previously filed with the SECon August 15, 2002.

 

4.6                                 Summary of Rights toPurchase Shares, incorporated by reference to Exhibit 99.1 to the Form 8-Kdated October 18, 2002, as previously filed with the SEC onOctober 18, 2002.

 

4.7                                 Rights Agreement datedas of October 18, 2002 between the Registrant and The Bank of New York,incorporated by reference to Exhibit 1 to Form 8-A, as previously filed withthe SEC on October 29, 2002.

 

10.1                           Deed of Trust, by and amongWREP Islands Limited, The Aggmore Limited Partnership and the Registrant andFog Cap L.P., dated November 19, 2001, incorporated by reference toExhibit 2.2 to the Form 8-K dated November 19, 2001, as previously filedwith the SEC on December 12, 2001.

 

10.2                           Stock Option Agreement, byand among individuals listed on Schedule 4 thereto, Aggmore LimitedPartnership acting through its General Partner, Anglo Irish Equity Limited andthe Registrant, dated November 19, 2001, incorporated by reference toExhibit 2.3 to the Form 8-K dated November 19, 2001, as previously filedwith the SEC on December 4, 2001.

 

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

 

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

 

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

 

11.1                           Computation of Per ShareEarnings.

 

31.1                           Certification of ChiefExecutive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of2002.

 

31.2                           Certification of ChiefFinancial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of2002.

 

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

 

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

 

99.1                           Letter, datedOctober 28, 1998, from Steven Kapiloff to Andrew Wiederhorn, incorporatedby reference to Schedule 99.2 to the Form 10-Q for the period endedSeptember 30, 1998, as previously filed with the SEC on November 23,1998.

 

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

 

99.3                           Settlement Agreement, datedas of December 10, 1999 by and between the Registrant, on behalf of itselfand all of its subsidiaries and affiliates, Andrew A. Wiederhorn, and LawrenceA. Mendelsohn, and Wilshire Financial Services Group Inc., on behalf of itselfand all of its subsidiaries and affiliates, other than First Bank of BeverlyHills, F.S.B., incorporated by reference to Exhibit 99.1 to the Form 8-K datedDecember 13, 1999, as previously filed with the SEC on December 17,1999.

 

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99.4                           Jordan D. SchnitzerResignation Letter dated March 5, 2002, incorporated by reference toExhibit 1.1 to the Form 8-K dated March 5, 2002, as previously filed withthe SEC on March 7, 2002.

 

99.5                           Settlement Agreement,incorporated by reference to Exhibit 99.1 to the Form 8-K dated May 13, 2002,as previously filed with the SEC on May 14, 2002.

 

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

 

99.7                           RobertG. Rosen Resignation Letter dated March 26, 2004, incorporated byreference to Exhibit 99.1 to the Form 8-K dated April 1, 2004, aspreviously filed with the SEC on April 1, 2004.

 

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