**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM10-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 June 30, 2004** |
|                            |
| **OR**                          |
|                            |
| **o**                           | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                            |
| **Commission File No. 0-23911** |

 

| **Fog Cutter Capital Group Inc.**                                |
|------------------------------------------------------------------|
| (Exact name of  registrant as specified in its charter)          |
|                                                             |
| **Maryland**                                                     | ** ** | **52-2081138** |
| (State or other  jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                             |
| **1410 SW  Jefferson Street   Portland, OR 97201**               |
| (Address of principal  executive offices) (Zip Code)             |
|                                                             |
| **(503)  721-6500**                                              |
| (Registrant’s telephone  number, including area code)       |

 

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

 

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

 

**APPLICABLE ONLY TO CORPORATEISSUERS:**

 

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

 

| **Class**                                  | ** ** | **Outstanding at June 30, 2004** |
|--------------------------------------------|------------|----------------------------------|
| Common Stock, par value  $0.0001 per share |       | 8,377,673 shares                 |

 

 

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FOG CUTTER CAPITAL GROUPINC.

 

FORM 10-Q

 

I N D E X

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

 

Available information

 

Our website is www.fccgi.com.  We make our annual report on Form 10-K, aswell as other reports filed with the Securities and Exchange Commission,available free of charge through our website as soon as reasonably practicableafter they are filed.  A copy of thesereports may also be obtained by writing to us at 1410 SW Jefferson Street,Portland, Oregon 97201, Attn:  InvestorReporting.

 

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PART I — FINANCIAL INFORMATION

 

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

 

FOGCUTTER CAPITAL GROUP INC.CONSOLIDATED STATEMENTS OFFINANCIAL CONDITION(dollars in thousands, except share data)

 
| ** **                                                                                                                                                                                                                                                                           | ** ** | **June 30  2004** | ** ** | **December 31  2003** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                                           | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
| Assets                                                                                                                                                                                                                                                                               |       |              |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                                                                                                                           |       | $                 | 8,237      |                  | $          | 19,607 |   |
| Securities  available for sale, pledged under repurchase agreements, at estimated fair  value                                                                                                                                                                                        |       | 15                |       | 35,010                |       |
| Securities  available for sale, at estimated fair value                                                                                                                                                                                                                              |       | 25                |       | 500                   |       |
| Loans held for  investment                                                                                                                                                                                                                                                           |       | 9,360             |       | 3,744                 |       |
| Investments in  real estate, net                                                                                                                                                                                                                                                     |       | 25,014            |       | 22,577                |       |
| Loans to senior  executives                                                                                                                                                                                                                                                          |       | 2,966             |       | 2,964                 |       |
| Investment in  Bourne End                                                                                                                                                                                                                                                            |       | 3,728             |       | 2,141                 |       |
| Restaurant  property, plant and equipment, net                                                                                                                                                                                                                                       |       | 6,069             |       | 5,897                 |       |
| Intangible  assets, net                                                                                                                                                                                                                                                              |       | 5,510             |       | 5,640                 |       |
| Goodwill                                                                                                                                                                                                                                                                             |       | 7,449             |       | 7,300                 |       |
| Other assets                                                                                                                                                                                                                                                                         |       | 5,516             |       | 3,596                 |       |
| Total assets                                                                                                                                                                                                                                                                         |       | $                 | 73,889     |                  | $          | 108,976 |   |
|                                                                                                                                                                                                                                                                                 |       |              |       |                  |       |
| Liabilities and  Stockholders’ Equity                                                                                                                                                                                                                                           |       |              |       |                  |       |
| Liabilities:                                                                                                                                                                                                                                                                         |       |              |       |                  |       |
| Repurchase  agreements                                                                                                                                                                                                                                                               |       | $                 | 25         |                  | $          | 25,318 |   |
| Borrowings and  notes payable                                                                                                                                                                                                                                                        |       | 7,974             |       | 7,804                 |       |
| Obligations under  capital leases                                                                                                                                                                                                                                                    |       | 12,681            |       | 12,942                |       |
| Obligation under  leave of absence agreement                                                                                                                                                                                                                                         |       | 2,750             |       | —                |       |
| Dividend payable                                                                                                                                                                                                                                                                     |       | 32                |       | 1,216                 |       |
| Deferred income                                                                                                                                                                                                                                                                      |       | 4,009             |       | 3,700                 |       |
| Deferred income  taxes                                                                                                                                                                                                                                                               |       | 5,962             |       | 6,980                 |       |
| Accrued expenses  and other liabilities                                                                                                                                                                                                                                              |       | 5,916             |       | 5,635                 |       |
| Total  liabilities                                                                                                                                                                                                                                                                   |       | 39,349            |       | 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; 11,754,073 shares issued as  of June 30, 2004 and 11,716,600 shares issued as of December 31, 2003;  8,377,673 shares outstanding as of June 30, 2004 and 8,670,700 shares  outstanding as of December 31, 2003 |       | 168,182           |       | 168,018               |       |
| Accumulated  deficit                                                                                                                                                                                                                                                                 |       | (123,578          | )          | (115,588              | )          |
| Option to  purchase common stock                                                                                                                                                                                                                                                     |       | (592              | )          | —                |       |
| Accumulated  other comprehensive income                                                                                                                                                                                                                                              |       | 330               |       | 968                   |       |
| Treasury stock;  3,376,400 common shares as of June 30, 2004, and 3,045,900 common shares as  of December 31, 2003, at cost                                                                                                                                                          |       | (9,802            | )          | (8,017                | )          |
| Total  stockholders’ equity                                                                                                                                                                                                                                                     |       | 34,540            |       | 45,381                |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                                                                                     |       | $                 | 73,889     |                  | $          | 108,976 |   |

 

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

 

3

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FOGCUTTER CAPITAL GROUP INC.CONSOLIDATED STATEMENTS OFOPERATIONS(Unaudited)*(dollars in thousands, except share data)*

 
| ** **                                    | ** ** | **Quarter Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------|------------|-----------------------------|------------|--------------------------------|------------|
| ** **                                    | ** ** | **2004**                    | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net Interest  Income:                         |       |                        |       |                           |       |   |   |   |   |
| Loans                                         |       | $                           | 585        |                           | $          | 179 |   | $ | 975 |   | $ | 315 |   |
| Loans to senior  executives                   |       | 51                          |       | 55                             |       | 87 |   | 109 |   |
| Securities                                    |       | 292                         |       | 699                            |       | 605 |   | 1,474 |   |
| Other  investments                            |       | 24                          |       | 36                             |       | 71 |   | 91 |   |
| Total interest  income                        |       | 952                         |       | 969                            |       | 1,738 |   | 1,989 |   |
| Interest expense                              |       | 41                          |       | 210                            |       | 112 |   | 418 |   |
| Net interest  income                          |       | 911                         |       | 759                            |       | 1,626 |   | 1,571 |   |
|                                          |       |                        |       |                           |       |   |   |   |   |
| Real Estate  Operations:                      |       |                        |       |                           |       |   |   |   |   |
| Operating income                              |       | 1,022                       |       | 959                            |       | 1,976 |   | 1,931 |   |
| Gain on sale of  real estate                  |       | 5                           |       | 281                            |       | 5 |   | 281 |   |
| Operating  expense                            |       | (420                        | )          | (528                           | )          | (876 | ) | (1,066 | ) |
| Interest expense                              |       | (281                        | )          | (360                           | )          | (562 | ) | (720 | ) |
| Depreciation                                  |       | (163                        | )          | (153                           | )          | (322 | ) | (306 | ) |
| Total real  estate operations                 |       | 163                         |       | 199                            |       | 221 |   | 120 |   |
|                                          |       |                        |       |                           |       |   |   |   |   |
| Restaurant  Operations:                       |       |                        |       |                           |       |   |   |   |   |
| Operating  revenue                            |       | 5,467                       |       | —                         |       | 10,751 |   | — |   |
| Cost of goods  sold                           |       | (3,461                      | )          | —                         |       | (6,538 | ) | — |   |
| Franchise and  royalty fee                    |       | 377                         |       | —                         |       | 649 |   | — |   |
| General and  administrative cost              |       | (2,702                      | )          | —                         |       | (5,417 | ) | — |   |
| Interest expense                              |       | (181                        | )          | —                         |       | (346 | ) | — |   |
| Depreciation and  amortization                |       | (391                        | )          | —                         |       | (743 | ) | — |   |
| Total restaurant  operations                  |       | (891                        | )          | —                         |       | (1,644 | ) | — |   |
|                                          |       |                        |       |                           |       |   |   |   |   |
| Other Operating  Income:                      |       |                        |       |                           |       |   |   |   |   |
| Gain on sale of  loans and securities         |       | 1,013                       |       | 4,595                          |       | 2,099 |   | 9,383 |   |
| Gain on sale of  prepaid servicing credit     |       | 1,530                       |       | —                         |       | 1,530 |   | — |   |
| Equity in income  of equity investees         |       | 1,490                       |       | 1,878                          |       | 1,512 |   | 870 |   |
| Loan origination  fees                        |       | 1,248                       |       | 1,453                          |       | 2,374 |   | 2,253 |   |
| Other revenue                                 |       | 662                         |       | 400                            |       | 873 |   | 591 |   |
| Total other  operating income                 |       | 5,943                       |       | 8,326                          |       | 8,388 |   | 13,097 |   |
|                                          |       |                        |       |                           |       |   |   |   |   |
| Operating Expenses:                           |       |                        |       |                           |       |   |   |   |   |
| Compensation and  employee benefits           |       | 2,762                       |       | 3,615                          |       | 5,523 |   | 5,818 |   |
| Leave of absence  expense                     |       | 4,750                       |       | —                         |       | 4,750 |   | — |   |
| Professional  fees                            |       | 928                         |       | 596                            |       | 1,169 |   | 1,095 |   |
| Fees paid to  related parties                 |       | 95                          |       | 156                            |       | 224 |   | 270 |   |
| Other                                         |       | 1,729                       |       | 862                            |       | 2,698 |   | 1,648 |   |
| Total operating  expenses                     |       | 10,264                      |       | 5,229                          |       | 14,364 |   | 8,831 |   |
|                                          |       |                        |       |                           |       |   |   |   |   |
| Net income  before provision for income taxes |       | (4,138                      | )          | 4,055                          |       | (5,773 | ) | 5,957 |   |
| Provision for  income taxes                   |       | —                      |       | 1,469                          |       | — |   | 1,711 |   |
| Net Income                                    |       | $                           | (4,138     | )                              | $          | 2,586 |   | $ | (5,773 | ) | $ | 4,246 |   |

 

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

 

4

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| ** **                                   | ** ** | **Quarter Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------|------------|-----------------------------|------------|--------------------------------|------------|
| ** **                                   | ** ** | **2004**                    | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| Basic net  (loss) income per share      |       | $                           | (0.49      | )                              | $          | 0.30 |   | $ | (0.68 | ) | $ | 0.50 |   |
|                                         |       |                        |       |                           |       |   |   |   |   |
| Basic weighted  average shares outstanding   |       | 8,417,005                   |       | 8,603,450                      |       | 8,507,260 |   | 8,549,057 |   |
|                                         |       |                        |       |                           |       |   |   |   |   |
| Diluted net  income per share                |       | $                           | (0.49      | )                              | $          | 0.28 |   | $ | (0.68 | ) | $ | 0.46 |   |
|                                         |       |                        |       |                           |       |   |   |   |   |
| Diluted weighted  average shares outstanding |       | 8,417,005                   |       | 9,261,450                      |       | 8,507,260 |   | 9,207,057 |   |
|                                         |       |                        |       |                           |       |   |   |   |   |
| Dividends  declared per share                |       | $                           | 0.13       |                           | $          | 0.13 |   | $ | 0.26 |   | $ | 0.26 |   |

 

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

 

5

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**FOG CUTTER CAPITAL GROUP INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OFSTOCKHOLDERS’ EQUITY**(Unaudited)(dollars in thousands)

 
| ** **                                                                                                    | ** ** | **Common Stock** | ** ** | **Treasury Stock** | ** ** | **Common Stock  Subject to Options** | ** ** | **Accumulated** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | ** **  | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|------------------|------------|--------------------|------------|--------------------------------------|------------|-----------------|------------|---------------------------------------|------------|-------------|------------|
| ** **                                                                                                    | ** ** | **Shares (1)**   | ** ** | **Amount**         | ** ** | **Shares**                           | ** ** | **Amount**      | ** ** | **Amount**                            | ** ** | **Deficit** | ** ** | **Income** | ** ** | **Total** | ** ** |
| Balance at  January 1, 2004                                                                              |       | 8,670,700        |       | $                  | 168,018    |                                 | 3,045,900  |            | $          | (8,017                                | )          | —      |       | $ | (115,588 | ) | $ | 968 |   | $ | 45,381 |   |
| Comprehensive  income (loss):                                                                                 |       |             |       |               |       |                                 |       |            |       |                                  |       |        |       |   |   |   |   |
| Net income  (loss)                                                                                            |       | —           |       | —             |       | —                               |       | —          |       | —                                |       | (5,773      | )          | — |   | (5,773 | ) |
| Other  comprehensive income:                                                                                  |       |             |       |               |       |                                 |       |            |       |                                  |       |        |       |   |   |   |   |
| Foreign currency  translation                                                                                 |       | —           |       | —             |       | —                               |       | —          |       | —                                |       | —      |       | 105 |   | 105 |   |
| Unrealized holding  gains on securities available for sale                                                    |       | —           |       | —             |       | —                               |       | —          |       | —                                |       | —      |       | 1,378 |   | 1,378 |   |
| Reclassification  adjustment for gains on securities and foreign currency translation included  in net income |       | —           |       | —             |       | —                               |       | —          |       | —                                |       | —      |       | (2,121 | ) | (2,121 | ) |
| Total  comprehensive income (loss)                                                                            |       | —           |       | —             |       | —                               |       | —          |       | —                                |       | —      |       | — |   | (6,411 | ) |
| Purchase of  treasury stock                                                                                   |       | (330,500         | )          | —             |       | 330,500                              |       | (1,785          | )          | —                                |       | —      |       | — |   | (1,785 | ) |
| Common stock  issued pursuant to exercise of stock options                                                    |       | 37,473           |       | 164                |       | —                               |       | —          |       | —                                |       | —      |       | — |   | 164 |   |
| Dividends declared                                                                                            |       | —           |       | —             |       | —                               |       | —          |       | —                                |       | (2,217      | )          | — |   | (2,217 | ) |
| Purchase of call  options                                                                                     |       | —           |       | —             |       | —                               |       | —          |       | (592                                  | )          | —      |       | — |   | (592 | ) |
| Balance at June  30, 2004                                                                                     |       | 8,377,673        |       | $                  | 168,182    |                                 | 3,376,400  |            | $          | (9,802                                | )          | $           | (592       | ) | $ | (123,578 | ) | $ | 330 |   | $ | 34,540 |   |
|                                                                                                               |            |                  |            |                    |            |                                      |            |                 |            |                                       |            |             |            |  |  |  |  |  |  |  |  |  |  |

 

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(1)                                  Issued and outstanding

 

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

 

6

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FOGCUTTER CAPITAL GROUP INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)*(dollars in thousands)*

 
| ** **                                                                     | ** ** | **Quarter Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------------------------|------------|--------------------------------|------------|
| ** **                                                                     | ** ** | **2004**                    | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                         |       |                        |       |                           |       |   |   |   |   |
| Net income                                                                     |       | $                           | (4,138     | )                              | $          | 2,586 |   | $ | (5,773 | ) | $ | 4,246 |   |
| Adjustments to  reconcile net income to net cash used in operating activities: |       |                        |       |                           |       |   |   |   |   |
| Depreciation and  amortization                                                 |       | 575                         |       | 180                            |       | 1,102 |   | 372 |   |
| (Gain) on  foreign currency translation                                        |       | (5                          | )          | (239                           | )          | (20 | ) | (237 | ) |
| Gain on sale of  securities and loans                                          |       | (1,013                      | )          | (4,595                         | )          | (2,099 | ) | (9,383 | ) |
| Gain on sale of  real estate                                                   |       | (5                          | )          | (281                           | )          | (5 | ) | (281 | ) |
| Gain on sale of  prepaid servicing credit                                      |       | (1,530                      | )          | —                         |       | (1,530 | ) | — |   |
| Equity in income  of equity investees                                          |       | (1,490                      | )          | (1,878                         | )          | (1,512 | ) | (870 | ) |
| Other                                                                          |       | (282                        | )          | (23                            | )          | (645 | ) | (23 | ) |
| Change in:                                                                     |       |                        |       |                           |       |   |   |   |   |
| Deferred income                                                                |       | 149                         |       | —                         |       | 309 |   | — |   |
| Accrued interest  receivable                                                   |       | 55                          |       | 89                             |       | 48 |   | 76 |   |
| Other assets                                                                   |       | (1,345                      | )          | 156                            |       | (1,201 | ) | 658 |   |
| Accounts payable  and accrued liabilities                                      |       | 3,073                       |       | 2,655                          |       | 3,053 |   | 1,212 |   |
| Net cash used in  operating activities                                         |       | (5,956                      | )          | (1,350                         | )          | (8,273 | ) | (4,230 | ) |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                         |       |                        |       |                           |       |   |   |   |   |
| Repayments of  securities available for sale                                   |       | 4,571                       |       | 5,169                          |       | 6,818 |   | 7,308 |   |
| Investment in  real estate                                                     |       | (573                        | )          | —                         |       | (1,634 | ) | — |   |
| Investment in  variable interest entity                                        |       | (628                        | )          | —                         |       | (628 | ) | — |   |
| Proceeds from  sale of securities available for sale                           |       | 27,790                      |       | 6,431                          |       | 29,090 |   | 11,991 |   |
| Purchase of  loans and discounted loans                                        |       | (2,850                      | )          | (1,422                         | )          | (7,073 | ) | (1,486 | ) |
| Principal  repayments on loans and discounted loans                            |       | 984                         |       | 366                            |       | 1,054 |   | 493 |   |
| Proceeds from  sale of real estate                                             |       | 2                           |       | 281                            |       | 174 |   | 281 |   |
| Proceeds from  sale of prepaid servicing credit                                |       | 1,530                       |       | —                         |       | 1,530 |   | — |   |
| Investment in  and loans to equity investees                                   |       | —                      |       | —                         |       | — |   | (3,000 | ) |
| Proceeds from  investments in and loans to equity investees                    |       | —                      |       | 2,900                          |       | — |   | 2,900 |   |
| Purchase of restaurant  property plant and equipment                           |       | (227                        | )          | —                         |       | (784 | ) | — |   |
| Other                                                                          |       | 21                          |       | (487                           | )          | 27 |   | (510 | ) |
| Net cash  provided by investing activities                                     |       | 30,620                      |       | 13,238                         |       | 28,574 |   | 17,977 |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                         |       |                        |       |                           |       |   |   |   |   |
| Repayments under  capital leases                                               |       | (118                        | )          | —                         |       | (261 | ) | — |   |
| Repayments on  borrowings                                                      |       | (24,551                     | )          | (7,400                         | )          | (25,812 | ) | (8,220 | ) |
| Payment of  obligation to purchase treasury stock                              |       | —                      |       | —                         |       | — |   | (1,399 | ) |
| Proceeds from  issuance of common stock                                        |       | 140                         |       | 840                            |       | 164 |   | 875 |   |
| Investment in  option to purchase stock                                        |       | (593                        | )          | —                         |       | (593 | ) | — |   |
| Investment in  treasury stock                                                  |       | (1,785                      | )          | —                         |       | (1,785 | ) | — |   |
| Dividend  payments on common stock                                             |       | (1,153                      | )          | (1,127                         | )          | (3,400 | ) | (3,483 | ) |
| Other                                                                          |       | —                      |       | (293                           | )          | — |   | (293 | ) |
| Net cash used in  financing activities                                         |       | (28,060                     | )          | (7,980                         | )          | (31,687 | ) | (12,520 | ) |
| EFFECT OF  EXCHANGE RATE CHANGES ON CASH                                       |       | (5                          | )          | 12                             |       | 16 |   | (5 | ) |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                          |       | (3,401                      | )          | 3,920                          |       | (11,370 | ) | 1,222 |   |
| CASH AND CASH  EQUIVALENTS AT BEGINNING OF PERIOD                              |       | 11,638                      |       | 11,807                         |       | 19,607 |   | 14,505 |   |
| CASH AND CASH  EQUIVALENTS AT END OF PERIOD                                    |       | $                           | 8,237      |                           | $          | 15,727 |   | $ | 8,237 |   | $ | 15,727 |   |
| SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION:                            |       |                        |       |                           |       |   |   |   |   |
| Cash paid for  interest                                                        |       | $                           | 467        |                           | $          | 633 |   | $ | 975 |   | $ | 1,199 |   |
| Notes payable  issued to settle obligation to purchase treasury stock          |       | $                           | —     |                           | $          | — |   | $ | — |   | $ | 2,800 |   |
| Cash paid for  income taxes                                                    |       | $                           | —     |                           | $          | — |   | $ | 4 |   | $ | — |   |

 

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

 

7

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FOG CUTTERCAPITAL GROUP INC.NOTES TO CONSOLIDATED FINANCIALSTATEMENTS(Unaudited)

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

 

The accompanyinginterim consolidated financial statements of Fog Cutter Capital Group Inc. andSubsidiaries (“FCCG” or the “Company”) are unaudited and have been prepared inconformity with the requirements of Regulation S-X promulgated under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”), particularlyRule 10-01 thereof, which governs the presentation of interim financial statements.  Accordingly, they do not include all of theinformation and footnotes required by accounting principles generally acceptedin the United States for complete financial statements.  The accompanying interim consolidatedfinancial statements should be read in conjunction with the Company’s 2003Annual Report on Form 10-K/A.  A summaryof the Company’s significant accounting policies is set forth in Note 2 to theconsolidated financial statements in the 2003 Annual Report onForm 10-K/A.

 

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

 

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States requires theCompany to make estimates and assumptions that affect the reported amounts ofassets and liabilities and disclosures of contingent assets and liabilities atthe date of the financial statements and the reported amounts of revenues andexpenses during the reporting period. Actual results could differ from those estimates.  Certain items in the previously reportedconsolidated financial statements were reclassified to conform to the June 30,2004 presentation, none of which affected previously reported results ofoperations.

 

At June 30, 2004, certain Company officers anddirectors 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 controllinginterest in Fatburger Holdings, Inc. (“Fatburger”), and began reporting theoperations of Fatburger on a consolidated basis as of that date.  Fatburger operates or franchises 58 hamburgerrestaurants located in California, Nevada, Arizona, Colorado, Florida andWashington.  Franchisees currently ownand operate about half of the Fatburger locations and Fatburger has agreementsfor approximately 220 new franchise restaurants.  The terms of the original acquisition by theCompany were amended on January 12, 2004 and May 12, 2004.  Initially, the Company made a $5.4 millioninvestment and acquired approximately 83% of the voting control ofFatburger.  However, all but 15% of theownership investment was redeemable by Fatburger.  On May 12, 2004, the Company contributed anadditional $3.0 million, bringing its total investment to $8.4 million.  As a result of this transaction, theCompany’s voting control of Fatburger was reduced to approximately 71%, but theCompany retained a non-redeemable, fully diluted 47% ownership interest inFatburger.  The Company’s investmentconsists of the purchase of convertible preferred stock (the “Series A Preferred”) and redeemable preferred stock (the “Series DPreferred”).

 

The Series A Preferred isconvertible into a 50% ownership interest of the common stock of Fatburger on afully diluted basis.  The Company ownsapproximately 93% of the issued and outstanding Series APreferred, and currently holds voting rights equal to 71% of the voting controlof Fatburger.  The Series A Preferred is not redeemable and does not pay dividends.

 

8

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The Series D Preferred has a liquidation preferenceand is redeemable by Fatburger for $10.1 million plus accrued but unpaiddividends.  Dividends accrue at a rate of20% of the redemption value, compounded annually.  The Series D Preferred does not have anyvoting rights.  The Company owns all ofthe issued and outstanding Series D Preferred.

 

Mortgage-Backed Securities

 

During the six months ended June 30, 2004, the Companysold four mortgage-backed securities for $29.1 million in cash.  As a result of these transactions, theCompany recognized gains on the sale of securities of $2.1 million in theaccompanying consolidated statement of operations.  As of June 30, 2004, the Company’s investmentin mortgage-backed securities had decreased to less than $0.1 million.

 

Loans

 

During the six months ended June 30, 2004, the Companypurchased or funded three loans secured by real estate for a total of $6.6million.  The current yield to theCompany on these loans is approximately 16.8%.

 

Dividends

 

The Company hasdeclared and paid a $0.13 per share dividend for each quarter of 2004 todate.  The first quarter dividend waspaid on March 1, 2004 to stockholders of record on February 20, 2004.  The second quarter dividend was paid on June1, 2004 to stockholders of record on May 21, 2004.  On July 27, 2004, the Company announced thedeclaration of the $0.13 per share third quarter dividend, payable on September1, 2004 to stockholders of record on August 18, 2004.

 

Call Option

 

On April 26, 2004, the Company purchased a three yearcall option (the “Call Option”) from Andrew A. Wiederhorn, the Company’sChairman and former Chief Executive Officer and current Chief StrategicOfficer.  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 a purchaseprice of $3.99 per share.  The option maybe exercised at any time during the three year option period.  The Company paid $750,000 ($1.77 per optionshare) for the Call Option.  The premiumpaid for the Call Option, together with the strike price, represented a smallpremium to the Company’s book value per share and market price per share at thetime the option was purchased.  Inpurchasing the Call Option, the Company and its directors considered thefollowing factors:  (1) the potentiallynegative impact on the Company’s share price if the Option Shares were disposedof publicly; (2) the Company’s favorable liquidity position; (3) the potentialreduction in the risk that shares are transferred in a transaction which wouldhave an adverse impact on its NOL position; and (4) the reduction in the futureexpenditure of cash dividends by the Company once the Company exercises theCall Option.  The Board of Directorsreviewed and approved the transaction to confirm that the transaction was inthe best interest of the Company and its other stockholders.  As a result of the purchase of the CallOption, the Company recorded a direct reduction to stockholders’ equity of$593,000 and compensation expense of $157,000.

 

Treasury Stock Purchase

 

On April 28, 2004, the Company purchased 330,500shares of its common stock from Clarence B. Coleman, who at the time was agreater than 10% shareholder.  Thepurchase price was $5.40 per share ($1.8 million) and the shares were added totreasury stock.  At the time, thepurchase price represented a small premium to the Company’s book value pershare and 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.

 

9

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Leave of Absence Agreement

 

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

 

In August 2002, Mr. Mendelsohn resigned as Presidentand Director of the Company. In November 2003, Mr. Mendelsohn entered into anagreement with the USAODO pursuant to which he plead guilty to filing a false1998 personal tax return and agreed to cooperate in the CCL Investigation.

 

On June 3, 2004 the Company announced that ChiefExecutive Officer and Chairman of the Board Andrew Wiederhorn had entered intoa settlement with the USAODO regarding its investigation into CCL (the“Settlement”) and would take a leave of absence from his corporate positions atFog Cutter Capital.  Under the Settlement’sterms, Mr. Wiederhorn pled guilty on June 2, 2004 to two federal counts and wassentenced to 18 months incarceration and fined $2.0 million.  The charges to which Mr. Wiederhorn has pledguilty pursuant to the Settlement are not based upon any acts or omission ofthe Company or of Mr. Wiederhorn in his capacity as an officer or director ofthe Company.

 

In entering into Mr. Wiederhorn’s leave of absenceagreement, the Board of Directors considered the nature of the statutes towhich Mr. Wiederhorn pled and the fact that he relied entirely on the advice ofexpert legal counsel and a national accounting firm.  The Board also believed it was important toassure Mr. Wiederhorn’s return to active involvement with the Company becauseof his expertise and knowledge and to preserve a significant businessrelationship and the value of the Company’s investments.

 

Under the terms of the leave of absence agreement, Mr.Wiederhorn will continue to receive his regular salary and bonus pursuant toand as set forth in his employment agreement. In addition, for the reasons stated in the agreement, the Company made aleave of absence payment to Mr. Wiederhorn in the amount of $2.0 million onJune 2, 2004.

 

Mr. Wiederhorn began his leave of absence on August 2,2004 and is expected to remain in that status for a period of 14 to 18months.  The accompanying consolidatedfinancial statements reflect a charge to earnings of $4.8 million for the threemonth and six month periods ending June 30, 2004.  This is comprised of the $2.0 million paymentmade on June 2, 2004 and the accrual of the expected salary and bonus relatingto the leave of absence period.  (SeePart II, Item 1. “Legal Proceedings”.)

 

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

 

CCL Investigation

 

The Company’s former Chief Executive Officer andcurrent Chief Strategic Officer, Andrew Wiederhorn, and former President,Lawrence Mendelsohn, pursuant to the terms of their respective employmentagreements, may have been entitled to indemnity from the Company for litigationexpenses and personal losses in connection with the CCL investigations and anyrelated litigation.  Messrs. Wiederhornand Mendelsohn had notified the Company that, although they believed they wereentitled to primary indemnification from other sources, they were reservingtheir rights to seek indemnity from the Company.  The Company did not agree to any indemnityrequests.  Mr. Wiederhorn released theCompany from any and all claims he may have had relating to the CCL matter aspartial consideration for the leave of absence agreement in June 2004.  The USAODO has settled the CCL matter as itrelates to both Mr. Wiederhorn and Mr. Mendelsohn.  As a result, the Company believes that thecontingencies relating to the potential indemnification of these officers orformer officers have now been resolved.

 

10

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StroudsAcquisition Corporation

 

On October 6,2003, the Official Committee of Unsecured Creditors of Strouds AcquisitionCorporation (“Strouds”) filed a lawsuit in the United States Bankruptcy Court(LA 03-23620-ER) which named the Company, among others, as a defendant.  The lawsuit was amended on November 10, 2003and limits the complaint against the Company solely in its capacity ascollateral agent for certain secured creditors of Strouds AcquisitionCorporation.  The lawsuit, as it pertainsto the Company, sought reimbursement of the proceeds from approximately $3.0million in funds received in October 2003, which the Company was holding ascollateral agent for other secured creditors. These funds were not included in the assets of the Company, but werebeing held in trust.  On July 1, 2004,the lawsuit was settled and the Company distributed the trust funds, net oflegal reimbursements of $0.3 million, in accordance with the settlementagreement.  The Company received ageneral release from the parties and considers the matter closed.

 

ShareholderDerivative Complaint

 

On July 6, 2004,Jeff Allen McCoon, derivatively on behalf of the Company, filed a lawsuit inthe Circuit Court for the State of Oregon (Multnomah County Case No.0407-06900) which named all of the directors of the Company as defendants.  The lawsuit alleges that members of theCompany’s Board of Directors breached their duties to the Company by enteringinto the leave of absence agreement with Andrew Wiederhorn.  The lawsuit generally seeks restitution ofpayments made under the leave of absence agreement plus attorney fees andcosts.  The Board of Directors and theCompany believe that the allegations of the lawsuit are without merit andintend to put forth a vigorous defense. At the present time, it is not possible to determine the amount ofdamages, if any, that the Company may ultimately incur or recover as a resultof the derivative lawsuit.

 

Other 

 

The Company is involved in various other legalproceedings occurring in the ordinary course of business which the Companybelieves will not have a material adverse effect on the consolidated financialcondition or operations of the Company.

 

The Company may utilize a wide variety of off-balancesheet financial techniques to manage its interest rate risk.  In hedging the interest rate and/or exchangerate exposure of a foreign currency denominated asset or liability, the Companymay enter into hedge transactions to counter movements in the differentcurrencies, as well as interest rates in those currencies.  These hedges may be in the form of currencyand interest rate swaps, options, and forwards, or combinations thereof.

 

At June 30, 2004, the Company had no outstandingderivative instruments held for trading or hedging purposes.

 

11

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

 

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

 
| 2004                          |   | $     | 1,464  |   |
|-------------------------------|--------|-------|--------|--------|
| 2005                          |   | 2,764 |   |
| 2006                          |   | 2,324 |   |
| 2007                          |   | 1,751 |   |
| 2008                          |   | 1,191 |   |
| Thereafter                    |   | 3,076 |   |
| Total minimum  lease payments |   | $     | 12,570 |   |

 

In order to facilitate the development of franchiselocations, as of June 30, 2004, Fatburger had guaranteed the annual minimumlease payments of two restaurant sites owned and operated by franchisees.  The amount of theguarantees approximate $0.4 million plus certain contingent rentalpayments as defined in the respective leases. These leases expire at various times through 2008.

 

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

 

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

 

Primarily due to the acquisition of Fatburger, theCompany has goodwill in the amount of $7.4 million and other intangible assetsin the amount of $5.5 million. In accordance with SFAS No. 142, “Goodwill andOther Intangible Assets”, goodwill is not amortized, but is subject to anannual impairment test, which will be performed as of August 15, 2004.  Since the acquisition of Fatburger by theCompany, Fatburger has experienced operating losses and has funded its operationsand expansion with limited liquidity. The Company believes that these conditions are temporary in nature,however, should these conditions not be corrected, the Company may be requiredto recognize impairment losses on its recorded goodwill.  As of June 30, 2004, the Company was notaware of any events or changes in circumstances that would require theimpairment of the recorded goodwill.

 

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

 
| Amortized  intangible assets:      |   |   |   |
|------------------------------------|--------|--------|--------|
|                               |   |   |   |
| Franchise  Agreements              |   | $      | 1,017  |   |
| Other                              |   | 522    |   |
| Total amortized  intangible assets |   | $      | 1,539  |   |
|                               |   |   |   |
| Unamortized  intangible assets:    |   |   |   |
|                               |   |   |   |
| Trademarks                         |   | $      | 3,971  |   |

 

12

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Trademarks, which have indefinite lives, are notsubject to amortization.  All otherintangible assets are amortized using the straight-line method over five tofifteen years, the estimated useful lives of the assets.  Estimated amortization expense for theremainder of 2004 and the five succeeding years is as follows (dollars inthousands):

 
| 2004 |   | $   | 121    |   |
|------|--------|-----|--------|--------|
| 2005 |   | 242 |   |
| 2006 |   | 242 |   |
| 2007 |   | 242 |   |
| 2008 |   | 242 |   |
| 2009 |   | 242 |   |

 

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

 

**NOTE 5 –RECENTLY ISSUED ACCOUNTING STANDARDS**

 

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

 

In March 2004, the Financial Accounting StandardsBoard issued an exposure draft, “*Share-BasedPayment - An Amendment to FASB Statements No. 123 and 95”*, whichchanges the requirements of stock option accounting. The exposure draftrequires expense recognition of stock options and certain employee stockpurchase plans in the statement of operations. A final standard is expected tobe effective to the Company during the year ending December 31, 2005. Suchstock option expensing would require the Company to value its employee stockoption grants pursuant to an option valuation formula and then amortize thatvalue against its earnings over the vesting period in effect for those options.The Company currently account for stock-based awards to employees in accordancewith Accounting Principles Board Opinion No. 25, “*Accounting for Stock Issued to Employees*,” and have adoptedthe disclosure-only alternative of FASB Statement No. 123, “*Accounting for Stock-Based Compensation*.”If the Company is required to expense employee stock options in the future,this change in accounting treatment may adversely affect the Company’s futurereported results of operations.

 

**NOTE 6 – STOCK OPTIONS AND RIGHTS**

 

The Company has adopted a non-qualified stock optionplan (the “Option Plan”) which provides for options to purchase shares of the Company’scommon stock.  The maximum number ofshares of common stock that may be issued pursuant to options granted under theOption Plan is 3,500,000 shares.

 

13

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The Companyapplies Accounting Principles Board Opinion No. 25, *“Accountingfor Stock Issued to Employees,”*and related interpretations inaccounting for the Option Plan. Accordingly, no compensation expense has beenrecognized in the Consolidated Statements of Operations for grants under theOption Plan.  Had compensation expensefor the Company’s Option Plan been determined based on the fair value at thegrant date consistent with the methods of SFAS No. 123 “*Accountingfor Stock Based Compensation*”, the Company’s net income and incomeper share for the six months ended June 30, 2004 and 2002 would have beendecreased to the pro forma amounts indicated below:

 

| ** **                                                                | ** ** | **Six months ended June 30,**                 | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                | ** ** | **2004**                                      | ** ** | **2003** | ** ** |
| ** **                                                                | ** ** | **(dollars in thousands, except share data)** | ** ** |
| Net (loss)  income:                                                       |       |                                          |       |   |   |
| As reported                                                               |       | $                                             | (5,773     | ) | $ | 4,246 |   |
| Pro forma  compensation expense from stock based compensation, net of tax |       | (12                                           | )          | (20 | ) |
| Pro forma net  (loss) income                                              |       | $                                             | (5,785     | ) | $ | 4,226 |   |
| Net (loss)  income per common and common share equivalent:                |       |                                          |       |   |   |
| Basic income per  share:                                                  |       |                                          |       |   |   |
| As reported                                                               |       | $                                             | (0.68      | ) | $ | 0.50 |   |
| Pro forma                                                                 |       | $                                             | (0.68      | ) | $ | 0.49 |   |
| Diluted income  per share:                                                |       |                                          |       |   |   |
| As reported                                                               |       | $                                             | (0.68      | ) | $ | 0.46 |   |
| Pro forma                                                                 |       | $                                             | (0.68      | ) | $ | 0.46 |   |

 

There were no options granted with exercise pricesbelow the market value of the stock at the grant date. Fair values for 2004were estimated using the Black-Scholes option-pricing model with the followingweighted average assumptions used: 10% dividend yield, expected volatility of46%, risk-free interest rate of 2.8% and expected lives of five years.

 

**NOTE 7 – VARIABLE INTEREST ENTITIES**

 

In May 2004, the Company funded a $0.6 million loan toServitur Rent ABC, S.L., a Spanish entity formed to purchase, reposition andsell a 10 unit apartment building in Barcelona, Spain.  Under the terms of the loan, the Companyreceives a preferred 30% return on its investment plus an 80% share inadditional profits generated by the investment. The investment meets the definition of a Variable Interest Entity(“VIE”)  under FASB Interpretation 46(“FIN 46”) and the Company is the primary beneficiary of the VIE.  As a result, the assets and liabilities ofthe VIE have been consolidated into the accompanying consolidated financialstatements as of June 30, 2004.

 

The VIE purchased the 10 unit apartment building for$1.3 million in May 2004.  The purchasewas funded with a bank loan of $0.7 million, the Company’s $0.6 millioninvestment and a $0.1 million contribution from the project managers.  Neither the creditors nor the otherbeneficial interest holders have recourse to the Company with regard to thisinvestment and, as a result, the maximum limit of the Company’s exposure toloss on this investment is $0.6 million.

 

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

 
| Investment in  real estate, net        |   | $       | 1,291,000 |   |
|----------------------------------------|--------|---------|-----------|--------|
| Other assets                           |   | 111,000 |      |
| Borrowings and  notes payable          |   | 667,000 |      |
| Accrued expense  and other liabilities |   | 107,000 |      |

 

14

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**NOTE 8 – OPERATING SEGMENTS**

 

As a result of the acquisition of Fatburger duringAugust 2003, the Company began to report the results of operatingsegments.  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 58 hamburgerrestaurants located in California, Nevada, Arizona, Florida, Colorado andWashington.  The Company provided aninvestment and financing package for Fatburger which involved the acquisitionof the 93% of the entire class of the Series APreferred and the entire class of the Series D Preferred stock ofFatburger.  Currently, the Company ownsapproximately 71% of the voting control of Fatburger.  Fatburger has plans to open additionalrestaurants including expansion into Oregon, Louisiana, Georgia, New York,Ohio, New Jersey, Texas, Missouri, Kansas, Pennsylvania, West Virginia,Virginia, North Carolina, South Carolina, Washington D.C., British Columbia, Minnesotaand Michigan.  Franchisees currently ownand 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, in2003, provided brokerage services related to the production of over $600million in commercial real estate mortgages. George Elkins is headquartered inLos Angeles, with satellite offices located throughout the southern Californiaarea. As of June 30, 2004, the mortgage brokerage operation also manages acommercial loan servicing portfolio in excess of $700 million for variousinvestors.  The Company earned mortgageservicing fees of $0.4 million during the six months ended June 30, 2004, whichare included in other revenue in the accompanying consolidated statements ofoperations.

 

Real Estate, Merchant Banking and Financing Operations

 

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

 

15

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Segment data for the six months ended June 30, 2004,and 2003 are as follows (dollars in thousands):

 
| ** **                                | ** ** | **Merchant Banking,  Real Estate and Finance** | ** ** | **Mortgage Brokerage** | ** ** | **Restaurant** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|------------------------------------------------|------------|------------------------|------------|----------------|------------|-----------|------------|
| ** **                                | ** ** | **2004**                                       | ** ** | **2003**               | ** ** | **2004**       | ** ** | **2003**  | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net Interest  Income:                     |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Loans                                     |       | $                                              | 975        |                   | $          | 315            |       | $         | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | 975 |   | $ | 315 |   |
| Loans to senior  executives               |       | 87                                             |       | 109                    |       | —         |       | —    |       | — |   | — |   | 87 |   | 109 |   |
| Securities                                |       | 605                                            |       | 1,474                  |       | —         |       | —    |       | — |   | — |   | 605 |   | 1,474 |   |
| Other  investments                        |       | 70                                             |       | 90                     |       | 1              |       | 1         |       | — |   | — |   | 71 |   | 91 |   |
| Total interest  income                    |       | 1,737                                          |       | 1,988                  |       | 1              |       | 1         |       | — |   | — |   | 1,738 |   | 1,989 |   |
| Interest expense                          |       | 112                                            |       | 418                    |       | —         |       | —    |       | — |   | — |   | 112 |   | 418 |   |
| Net interest  income                      |       | 1,625                                          |       | 1,570                  |       | 1              |       | 1         |       | — |   | — |   | 1,626 |   | 1,571 |   |
|                                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Real estate  operations:                  |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Operating  revenue                        |       | 1,976                                          |       | 1,931                  |       | —         |       | —    |       | — |   | — |   | 1,976 |   | 1,931 |   |
| Operating  expense                        |       | (876                                           | )          | (1,066                 | )          | —         |       | —    |       | — |   | — |   | (876 | ) | (1,066 | ) |
| Gain on sale of  real estate              |       | 5                                              |       | 281                    |       | —         |       | —    |       | — |   | — |   | 5 |   | 281 |   |
| Interest expense                          |       | (562                                           | )          | (720                   | )          | —         |       | —    |       | — |   | — |   | (562 | ) | (720 | ) |
| Depreciation                              |       | (322                                           | )          | (306                   | )          | —         |       | —    |       | — |   | — |   | (322 | ) | (306 | ) |
| Total real  estate operations             |       | 221                                            |       | 120                    |       | —         |       | —    |       | — |   | — |   | 221 |   | 120 |   |
|                                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Restaurant  operations:                   |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Operating income                          |       | —                                         |       | —                 |       | —         |       | —    |       | 10,751 |   | — |   | 10,751 |   | — |   |
| Cost of goods  sold                       |       | —                                         |       | —                 |       | —         |       | —    |       | (6,538 | ) | — |   | (6,538 | ) | — |   |
| Franchise and  advertising fees           |       | —                                         |       | —                 |       | —         |       | —    |       | 649 |   | — |   | 649 |   | — |   |
| General and  administrative costs         |       | —                                         |       | —                 |       | —         |       | —    |       | (5,417 | ) | — |   | (5,417 | ) | — |   |
| Interest Expense                          |       | —                                         |       | —                 |       | —         |       | —    |       | (346 | ) | — |   | (346 | ) | — |   |
| Depreciation and  amortization            |       | —                                         |       | —                 |       | —         |       | —    |       | (743 | ) | — |   | (743 | ) | — |   |
| Total restaurant  operations              |       | —                                         |       | —                 |       | —         |       | —    |       | (1,644 | ) | — |   | (1,644 | ) | — |   |
|                                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Other operating  income:                  |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Market  valuations loss / impairment      |       | 76                                             |       | —                 |       | —         |       | —    |       | — |   | — |   | 76 |   | — |   |
| Gain on sale of  prepaid servicing credit |       | 1,530                                          |       | —                 |       | —         |       | —    |       | — |   | — |   | 1,530 |   | — |   |
| Equity in losses  of equity investees     |       | 1,512                                          |       | 870                    |       | —         |       | —    |       | — |   | — |   | 1,512 |   | 870 |   |
| Gain on sale of  loans and securities     |       | 2,099                                          |       | 9,383                  |       | —         |       | —    |       | — |   | — |   | 2,099 |   | 9,383 |   |
| Loan origination  fees                    |       | —                                         |       | —                 |       | 2,374          |       | 2,253     |       | — |   | — |   | 2,374 |   | 2,253 |   |
| Other revenue  (loss)                     |       | 549                                            |       | 347                    |       | 248            |       | 244       |       | — |   | — |   | 797 |   | 591 |   |
| Total other  operating income             |       | 5,766                                          |       | 10,600                 |       | 2,622          |       | 2,497     |       | — |   | — |   | 8,388 |   | 13,097 |   |
|                                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Operating  expenses:                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Compensation and  employee benefits       |       | 3,278                                          |       | 3,705                  |       | 2,245          |       | 2,113     |       | — |   | — |   | 5,523 |   | 5,818 |   |
| Leave of absence  expense                 |       | 4,750                                          |       | —                 |       | —         |       | —    |       | — |   | — |   | 4,750 |   | — |   |
| Professional  fees                        |       | 1,154                                          |       | 1,050                  |       | 15             |       | 45        |       | — |   | — |   | 1,169 |   | 1,095 |   |
| Fees paid to  related parties             |       | 224                                            |       | 270                    |       | —         |       | —    |       | — |   | — |   | 224 |   | 270 |   |
| Other                                     |       | 2,273                                          |       | 1,265                  |       | 425            |       | 383       |       | — |   | — |   | 2,698 |   | 1,648 |   |
| Total operating  expenses                 |       | 11,679                                         |       | 6,290                  |       | 2,685          |       | 2,541     |       | — |   | — |   | 14,364 |   | 8,831 |   |
|                                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Net income  (loss) before provisions      |       | (4,067                                         | )          | 6,000                  |       | (62            | )          | (43       | )          | (1,644 | ) | — |   | (5,773 | ) | 5,957 |   |
| Provision for  income taxes               |       | —                                         |       | 1,711                  |       | —         |       | —    |       | — |   | — |   | — |   | 1,711 |   |
| Net income  (loss)                        |       | $                                              | (4,067     | )                      | $          | 4,289          |       | $         | (62        | ) | $ | (43 | ) | $ | (1,644 | ) | $ | — |   | $ | (5,773 | ) | $ | 4,246 |   |
| Segment assets                            |       | $                                              | 60,065     |                   | $          | 101,215        |       | $         | 1,944      |   | $ | 2,960 |   | $ | 11,880 |   | $ | — |   | $ | 73,889 |   | $ | 104,175 |   |

 

16

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Segment data for the three months ended June 30, 2004,and 2003 are as follows (dollars in thousands):

 
| ** **                                | ** ** | **Merchant Banking,  Real Estate and Finance** | ** ** | **Mortgage Brokerage** | ** ** | **Restaurant** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|------------------------------------------------|------------|------------------------|------------|----------------|------------|-----------|------------|
| ** **                                | ** ** | **2004**                                       | ** ** | **2003**               | ** ** | **2004**       | ** ** | **2003**  | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net Interest  Income:                     |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Loans                                     |       | $                                              | 585        |                   | $          | 179            |       | $         | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | 585 |   | $ | 179 |   |
| Loans to senior  executives               |       | 51                                             |       | 55                     |       | —         |       | —    |       | — |   | — |   | 51 |   | 55 |   |
| Securities                                |       | 292                                            |       | 699                    |       | —         |       | —    |       | — |   | — |   | 292 |   | 699 |   |
| Other  investments                        |       | 23                                             |       | 35                     |       | 1              |       | 1         |       | — |   | — |   | 24 |   | 36 |   |
| Total interest  income                    |       | 951                                            |       | 968                    |       | 1              |       | 1         |       | — |   | — |   | 952 |   | 969 |   |
| Interest expense                          |       | 41                                             |       | 210                    |       | —         |       | —    |       | — |   | — |   | 41 |   | 210 |   |
| Net interest  income                      |       | 910                                            |       | 758                    |       | 1              |       | 1         |       | — |   | — |   | 911 |   | 759 |   |
|                                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Real estate  operations:                  |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Operating  revenue                        |       | 1,022                                          |       | 959                    |       | —         |       | —    |       | — |   | — |   | 1,022 |   | 959 |   |
| Operating  expense                        |       | (420                                           | )          | (528                   | )          | —         |       | —    |       | — |   | — |   | (420 | ) | (528 | ) |
| Gain on sale of  real estate              |       | 5                                              |       | 281                    |       | —         |       | —    |       | — |   | — |   | 5 |   | 281 |   |
| Interest expense                          |       | (281                                           | )          | (360                   | )          | —         |       | —    |       | — |   | — |   | (281 | ) | (360 | ) |
| Depreciation                              |       | (163                                           | )          | (153                   | )          | —         |       | —    |       | — |   | — |   | (163 | ) | (153 | ) |
| Total real  estate operations             |       | 163                                            |       | 199                    |       | —         |       | —    |       | — |   | — |   | 163 |   | 199 |   |
|                                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Restaurant  operations:                   |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Operating income                          |       | —                                         |       | —                 |       | —         |       | —    |       | 5,467 |   | — |   | 5,467 |   | — |   |
| Cost of goods  sold                       |       | —                                         |       | —                 |       | —         |       | —    |       | (3,461 | ) | — |   | (3,461 | ) | — |   |
| Franchise and  advertising fees           |       | —                                         |       | —                 |       | —         |       | —    |       | 377 |   | — |   | 377 |   | — |   |
| General and  administrative costs         |       | —                                         |       | —                 |       | —         |       | —    |       | (2,702 | ) | — |   | (2,702 | ) | — |   |
| Interest Expense                          |       | —                                         |       | —                 |       | —         |       | —    |       | (181 | ) | — |   | (181 | ) | — |   |
| Depreciation and  amortization            |       | —                                         |       | —                 |       | —         |       | —    |       | (391 | ) | — |   | (391 | ) | — |   |
| Total restaurant  operations              |       | —                                         |       | —                 |       | —         |       | —    |       | (891 | ) | — |   | (891 | ) | — |   |
|                                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Other operating  income:                  |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Market  valuations loss / impairment      |       | 34                                             |       | —                 |       | —         |       | —    |       | — |   | — |   | 34 |   | — |   |
| Gain on sale of  prepaid servicing credit |       | 1,530                                          |       | —                 |       | —         |       | —    |       | — |   | — |   | 1,530 |   | — |   |
| Equity in losses  of equity investees     |       | 1,490                                          |       | 1,878                  |       | —         |       | —    |       | — |   | — |   | 1,490 |   | 1,878 |   |
| Gain on sale of  loans and securities     |       | 1,013                                          |       | 4,595                  |       | —         |       | —    |       | — |   | — |   | 1,013 |   | 4,595 |   |
| Loan origination  fees                    |       | —                                         |       | —                 |       | 1,248          |       | 1,453     |       | — |   | — |   | 1,248 |   | 1,453 |   |
| Other revenue  (loss)                     |       | 533                                            |       | 351                    |       | 95             |       | 49        |       | — |   | — |   | 628 |   | 400 |   |
| Total other  operating income             |       | 4,600                                          |       | 6,824                  |       | 1,343          |       | 1,502     |       | — |   | — |   | 5,943 |   | 8,326 |   |
|                                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Operating  expenses:                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Compensation and  employee benefits       |       | 1,628                                          |       | 2,266                  |       | 1,134          |       | 1,349     |       | — |   | — |   | 2,762 |   | 3,615 |   |
| Leave of absence  expense                 |       | 4,750                                          |       | —                 |       | —         |       | —    |       | — |   | — |   | 4,750 |   | — |   |
| Professional  fees                        |       | 920                                            |       | 588                    |       | 8              |       | 8         |       | — |   | — |   | 928 |   | 596 |   |
| Fees paid to  related parties             |       | 95                                             |       | 156                    |       | —         |       | —    |       | — |   | — |   | 95 |   | 156 |   |
| Other                                     |       | 1,530                                          |       | 650                    |       | 199            |       | 212       |       | — |   | — |   | 1,729 |   | 862 |   |
| Total operating  expenses                 |       | 8,923                                          |       | 3,660                  |       | 1,341          |       | 1,569     |       | — |   | — |   | 10,264 |   | 5,229 |   |
|                                      |       |                                           |       |                   |       |           |       |      |       |   |   |   |   |   |   |   |   |
| Net income  (loss) before provisions      |       | (3,250                                         | )          | 4,121                  |       | 3              |       | (66       | )          | (891 | ) | — |   | (4,138 | ) | 4,055 |   |
| Provision for  income taxes               |       | —                                         |       | 1,469                  |       | —         |       | —    |       | — |   | — |   | — |   | 1,469 |   |
| Net income  (loss)                        |       | $                                              | (3,250     | )                      | $          | 2,652          |       | $         | 3          |   | $ | (66 | ) | $ | (891 | ) | $ | — |   | $ | (4,138 | ) | $ | 2,586 |   |
| Segment assets                            |       | $                                              | 60,065     |                   | $          | 101,215        |       | $         | 1,944      |   | $ | 2,960 |   | $ | 11,880 |   | $ | — |   | $ | 73,889 |   | $ | 104,175 |   |

 

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**NOTE 9– INCOME TAXES**

 

As of June 30, 2004, the Company had, for U.S. Federaltax purposes, 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 Certain Built-In Losses FollowingChange in Control*.  Inaddition, to the extent the Fatburger NOL is utilized, the recognition of therelated tax benefits would first reduce goodwill related to Fatburgeracquisition, 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 IncomeTaxes.*

 

United States tax regulations impose limitations onthe use of NOL carry 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 six months ended June 30, 2004, a provisionfor income taxes was not required. During the six months ended June 30, 2003, the Company recognized aprovision for income taxes of $ 1.7 million.

 

**NOTE 10 – SUBSEQUENT EVENTS**

 

Dividends

 

On July 27, 2004, the Board of Directors declared a$0.13 per share dividend for the third quarter of 2004.  The dividend is payable on September 1, 2004to shareholders of record on August 18, 2004.

 

Auditor Resignation

 

On July 16,2004, Ernst & Young LLP advised the Company that the firm will resign asthe Company’s auditors upon completion of its review of the interim financialinformation for the second quarter of 2004 and filing of the Company’squarterly report on Form 10-Q for the quarter ending June 30, 2004.  The resignation was not the result ofdisagreements with Ernst & Young LLP on any matter of accounting principlesor practices, financial statements disclosure, or auditing scope or procedure.The Company’s audit committee did not recommend a change in accountants,however, as a result of the resignation; the Audit Committee has begun a searchfor a new independent auditing firm.

 

Nasdaq Notice

 

Shares of the Company’s stock are currently traded onthe Nasdaq Stock Market.  On July 20,2004, the Company was notified by Nasdaq of a staffdetermination to de-list the Company effective July 29, 2004.  The Company has challenged the staffdetermination and has requested an oral hearing by a Listing QualificationsPanel to review the staff’s conclusions. A hearing has been scheduled for September 9, 2004.  The Company will continue to be listed on theNasdaq Stock Market while the Listing Qualifications Panel’s decision is pending.  There can be no assurance that the Company’sappeal will be successful.  If theCompany is de-listed by Nasdaq, the Company will seekarrangements to facilitate over-the-counter trading of its securities.

 

Bourne End

 

On August 6, 2004, Bourne Endsold the Southend Shopping Center for approximately 28.0 million Great Britainpounds (“GBP”).  The Company’s share ofthe pre-tax gain on this transaction is $2.8 million.

 

18

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George Elkins Mortgage Banking Company

 

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

 

The Company disputes the claim that a Change inControl Transaction has occurred as a result of the leave of absence agreementwith Mr. Wiederhorn.  However, if theCompany were unsuccessful in defending this position, an analysis of theeconomic effect of the buyback formula indicates that the Company would notincur a loss on the transaction.  As aresult, no reserves are required due to the receipt of the notice.

 

Chief Strategic Officer

 

On August 13, 2004, the Board of Directors adopted aresolution changing the role of Andrew Wiederhorn from Co-Chief ExecutiveOfficer to Chief Strategic Officer during the leave of absence period.  The Board had discussed this alternative withMr. Wiederhorn prior to the effective date of his leave of absence.  The Board determined that during the leave ofabsence period, Mr. Wiederhorn would be in a better position to developstrategies that would be of future benefit to the Company, while his currentstatus would significantly limit his ability to perform the full functions ofCo-Chief Executive Officer.  All otherprovisions of the Leave of Absence Agreement and employment agreement with Mr.Wiederhorn remain in force.  Donald J.Berchtold will continue as sole Chief Executive Officer and will serve as theprincipal executive of the Company.

 

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**ITEM 2.****  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

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

* *

**GENERAL**

 

Fog Cutter CapitalGroup Inc. (“FCCG” or the “Company”) is a Nasdaq-listed corporation whichfocuses on the acquisition of assets where its expertise in intensive assetmanagement and financial structuring can create value.

 

Our businessstrategy consists of developing, strengthening and expanding our restaurant andcommercial real estate mortgage brokerage operations and continuing to identifyand acquire real estate investments with favorable risk-adjusted returns. Wealso seek to identify and acquire controlling interests in other operatingbusinesses in which we feel we can add value.

 

We makeacquisitions where our expertise in intensive asset management, credit analysisand financial structuring can create value and provide an appropriaterisk-adjusted rate of return. We maintain a flexible approach with respect tothe nature of our business, seeking to take advantage of opportunities as theyarise or are developed.

 

We haveredeployed a large portion of the capital generated through our sale ofmortgage-backed securities and from cash distributions from our Bourne Endsubsidiary.  We used a portion of thiscapital to acquire voting control of Fatburger Holdings Inc. in August 2003 andfurther increased our investment in Fatburger in May 2004.  The expansion and success of Fatburger iscurrently one of our primary focuses. Since our acquisition, Fatburger has opened eight additional restaurantlocations and currently has agreements for approximately 250 new franchiserestaurants.

 

We have alsobeen investing in special situation real estate loans, and funded three loanstotaling $6.6 million during the six months ended June 30, 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 unique circumstances relating to these loans,the interest rate charged the borrower is significantly higher thanconventional real estate lending.  Basedon current activity levels, we expect that special situation lending will be agrowing part of our business.

 

Due to thevaried nature of our operations, management does not utilize a standard arrayof key performance indicators in evaluating the progress of the Company.  Management’s evaluation, instead, focuses onan asset-by-asset analysis within the Company’s operating segments.

 

**CriticalAccounting Policies**

** **

**Management’sDiscussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which havebeen prepared in accordance with accounting principles generally accepted inthe United States.  The preparation ofthese financial statements requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities and thedisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period.  Management bases itsestimates and judgments on historical experience and on various other factorsthat are believed to be reasonable under the circumstances.  Actual results may differ from theseestimates under different assumptions or conditions.  Management believes the following criticalaccounting policies, affect its more significant judgments and estimates usedin the preparation of its financial statements.**

** **

**20**

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** **

***Accounting For EquityInvestees***

** **

The equitymethod of accounting is used for investments in associated companies which arenot unilaterally controlled by the Company and in which the Company’s interestis generally between 20% and 50% of the outstanding voting rights.  The Company’s share of earnings or losses ofassociated companies, in which at least 20% of the voting securities is owned,is included in the consolidated statement of operations.

** **

***Sale Recognition***

** **

**Duringthe six months ended June 30, 2004, we completed the sale of substantially allof our mortgage-backed securities and in the future may, from time-to-time,sell other 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 were cash sales, andthe cash proceeds were not contingent upon any future event.**

** **

***FatburgerRestaurant and Franchise Revenue***

** **

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

** **

**Fatburger operates on a 52-weekcalendar and its fiscal year ends on the Sunday closest to December 31.  Consistent with the industry, Fatburgermeasures its stores’ performance based upon 7 day work weeks.  Using the 52-week cycle ensures consistentweekly reporting for operations and ensures that each week has the same days,since certain days are more profitable than others.  Accordingly, the accompanying consolidatedfinancial statements reflect a Fatburger quarter end of June 27, 2004.**

** **

***Goodwilland Other Intangible Assets***

** **

**Goodwill** represents the excess of the purchase price andother acquisition related costs over the estimated fair value of the nettangible and intangible assets acquired. The Company does not amortize goodwill. Intangible assets are stated at cost and include trademarks, operating manuals,franchise agreements and leasehold interests. Trademarks, which have indefinite lives, are not subject toamortization.  All other intangibleassets are amortized over their estimated useful lives, which range from fiveto fifteen years.  The Company assessespotential 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. Judgments regarding the existence ofimpairment indicators and future cash flows related to intangible assets arebased on operational performance of the acquired businesses, market conditionsand other factors.

 

***Long-lived Assets***

 

The Companyevaluates its real estate properties, including properties under capitalleases, and other similar long-lived assets at least annually, or wheneverevents or changes in circumstances indicate that the carrying amounts may notbe recoverable.  The Company firstevaluates these assets for indicators of impairment such as significantdecreases in the estimated market price of a real estate asset, a significantadverse change in the extent or manner in which a real estate assets is beingused or in its physical 

 

21

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condition,or cash flow combined with a history of operating cash flow losses or aprojection or forecast that demonstrates continuing losses associated with theuse of the long-lived asset.  When anysuch indicators of impairment are noted, the Company compares the carryingamount of these assets to the future estimated undiscounted net cash flowsexpected to result from the use and eventual disposition of the assets.  If the undiscounted cash flows are less thanthe carrying amount, the Company records an impairment charge equal to theexcess of carrying value over the asset’s estimated fair value. Fair value isestimated in consideration of third party value opinions and comparativesimilar asset prices, whenever available, or internally developed discountedcash flow analysis.

 

Any long-livedassets which the Company expects to sell or dispose in the near term are statedat the lower of their carrying amounts or fair value less cost to sell, and areevaluated for impairment throughout the sales process.

 

**RESULTS OF OPERATIONS**3⁄4SIX MONTHS ENDED JUNE 30, 2004 COMPARED TO SIX MONTHS ENDED JUNE 30, 2003

 

NET INCOME. Our net loss for the six months ended June 30, 2004, was $5.8 million,or $0.68 per share, compared with a net income of $4.2 million, or $.50 pershare, for the six months ended June 30, 2003. The net loss for the 2004 period is primarily attributable to operatingexpenses of $14.3 million and losses from restaurant operations of $1.6million, partially offset by net interest income of $1.6 million, gain on saleof loans and securities of $2.1 million, loan origination fees of $2.4 million,equity in earnings of equity investees of $1.5 million, and gain on sale of aprepaid servicing credit of $1.5 million.

 

We believethat operating expenses were higher than normal during the six months endedJune 30, 2004 due to a $2.0 million leave of absence payment to its formerChief Executive Officer and current Chief Strategic Officer and the accrual of$2.8 million of future expenses associated with the leave of absence.  We believe that operating expenses willreturn to more normal levels in the third quarter of 2004 and, together withthe recent disposal of the Southend Shopping Center by our Bourne Endsubsidiary, will result in a profitable third quarter of 2004.  There can be no assurance, however, that thiswill be the case.

 

The net incomefor the 2003 period is primarily attributable to net interest income of $1.6million, gain on sale of loans and securities of $9.4 million, loan originationfees of $2.3 million and equity in earnings of equity investees of $0.9million, partially offset by other operating expenses of $8.8 million andprovision for income taxes of $1.7 million.

 

The followingsections describe the results of operations of our operating segments for thesix months ended June 30, 2004:

 

**RestaurantSegment Operations**

 

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

 

During the sixmonths ending June 30, 2004, we recognized a net loss from our restaurantsegment of $1.6 million.  This wasprimarily the result of net sales (net of cost of goods sold) of  $4.2 million and franchise and royaltyrevenue of $0.6 million, offset by general and administrative costs of $5.4million, interest expense of $0.3 million, and depreciation and amortization of$0.7 million.  The Company’s strategy withrespect to Fatburger is to increase the number of franchises, thus increasingthe franchise fees and future royalty income to the operation.

 

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**CommercialReal Estate Mortgage Brokerage Segment Operations**

 

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

 

Our net lossfrom the commercial real estate brokerage segment was $0.1 million for the sixmonths ended June 30, 2004, compared to break-even operations during the 2003period.  During the 2004 period, werecognized loan brokerage fees of $2.4 million, loan servicing and otherrevenue of $0.2 million, which was offset by compensation expense of $2.2million and other operating expense of $0.4 million.  During the 2003 period, we recognized loanbrokerage fees of $2.2 million, loan servicing and other revenue of $0.2million, which was offset by compensation expense of $2.1 million and otheroperating expense of $0.4 million.

 

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

 

NET INTEREST INCOME.  Our net interest income for the six monthsended June 30, 2004 was $1.6 million, compared with $1.6 million for the sixmonths ended June 30, 2003.  These resultsreflect a reduction in interest income on securities of $0.9 million as theresult of the sale or repayment of mortgage-backed securities.  This decrease was offset by an increase ininterest income on loans (reflecting our increased investment in specialty realestate lending) of $0.6 million and a decrease in interest expense of $0.3million as a result of our repayment of debt related to the mortgage-backedsecurities.  The following tables setforth information regarding the total amount of income from interest-earningassets and expense from interest-bearing liabilities and the resulting averageyields and rates:

 
| ** **                                                             | ** **   | **For the Six Months Ended June 30, 2004** | ** **   |
|------------------------------------------------------------------------|--------------|--------------------------------------------|--------------|
| ** **                                                             | ** **   | **Average  Balance**                       | ** **   | **Interest  Income (Expense)** | ** ** | **Annualized  Yield/Rate** | ** ** |
| *** ***                                                           | *** *** | **(dollars in thousands)**                 | *** *** |
| Interest-Earning Assets:                                               |         |                                       |         |   |   |   |   |
|                                                                   |         |                                       |         |   |   |   |   |
| Loan portfolios (1)                                                    |         | $                                          | 9,724        |   | $ | 1,062 |   | 21.8 | % |
| Mortgage-backed securities available for  sale                         |         | 23,814                                     |         | 605 |   | 5.1 | % |
| Other investments                                                      |         | 13,472                                     |         | 71 |   | 1.1 | % |
| Total interest-earning assets                                          |         | $                                          | 47,010       |   | $ | 1,738 |   | 7.4 | % |
|                                                                   |         |                                       |         |   |   |   |   |
| Interest-Bearing Liabilities:                                          |         |                                       |         |   |   |   |   |
|                                                                   |         |                                       |         |   |   |   |   |
| Borrowings (2)                                                         |         | $                                          | 17,622       |   | $ | (112 | ) | 1.3 | % |
| Total interest-bearing liabilities                                     |         | $                                          | 17,622       |   | $ | (112 | ) | 1.3 | % |
|                                                                   |         |                                       |         |   |   |   |   |
| Net interest income before provision for  loan losses/spread  (3) |         |                                       |         | $ | 1,626 |   | 6.1 | % |
| Net interest margin  (4)                                          |         |                                       |         |   |   | 6.9 | % |

 

----

(1)   Includesloans to senior executives.

(2)   Excludes borrowings related to investments inreal estate.

(3)   Netinterest spread represents the difference between the average rate oninterest-earning assets and the average cost of interest-bearing liabilities.

(4)   Net interest margin represents net interestincome divided by average interest-earning assets.

 

23

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| ** **                                                             | ** **   | **For the Six Months Ended June 30, 2003** | ** **   |
|------------------------------------------------------------------------|--------------|--------------------------------------------|--------------|
| ** **                                                             | ** **   | **Average  Balance**                       | ** **   | **Interest  Income (Expense)** | ** ** | **Annualized  Yield/Rate** | ** ** |
| *** ***                                                           | *** *** | **(dollars in thousands)**                 | *** *** |
| Interest-Earning Assets:                                               |         |                                       |         |   |   |   |   |
|                                                                   |         |                                       |         |   |   |   |   |
| Loan portfolios (1)                                                    |         | $                                          | 6,208        |   | $ | 424 |   | 13.7 | % |
| Mortgage-backed securities available for  sale                         |         | 57,306                                     |         | 1,474 |   | 5.1 | % |
| Other investments                                                      |         | 15,727                                     |         | 91 |   | 1.2 | % |
| Total interest-earning assets                                          |         | $                                          | 79,241       |   | $ | 1,989 |   | 5.0 | % |
|                                                                   |         |                                       |         |   |   |   |   |
| Interest-Bearing Liabilities:                                          |         |                                       |         |   |   |   |   |
|                                                                   |         |                                       |         |   |   |   |   |
| Borrowings (2)                                                         |         | $                                          | 33,817       |   | $ | (418 | ) | 2.5 | % |
| Total interest-bearing liabilities                                     |         | $                                          | 33,817       |   | $ | (418 | ) | 2.5 | % |
|                                                                   |         |                                       |         |   |   |   |   |
| Net interest income before provision for  loan losses/spread  (3) |         |                                       |         | $ | 1,571 |   | 2.5 | % |
| Net interest margin  (4)                                          |         |                                       |         |   |   | 4.0 | % |
|                                                                        |              |                                            |              |  |  |  |  |  |  |  |

 

----

(1)   Includesloans to senior executives.

(2)   Excludes borrowings related to investments inreal estate.

(3)   Netinterest spread represents the difference between the average rate oninterest-earning assets and the average cost of interest-bearing liabilities.

(4)   Net interest margin represents net interestincome divided by average interest-earning assets.

 

REAL ESTATE OPERATIONS.  Our real estate operations represent activityfrom our direct investment in commercial property, as well as the operations ofour leasehold interest in freestanding retail buildings.  During the six months ended June 30, 2004, werealized a net income from real estate operations of $0.2 million, comparedwith a net income from real estate operations of $0.1 million for the sixmonths ended June 30, 2003.

 

In October 2002, the Company assumed leasehold interests in 109 free-standingretail stores located throughout the United States.  We have sold or terminated 7 of the leaseholdinterests and have purchased the direct fee ownership interest in 21 of theretail buildings.  As a result, as ofJune 30, 2004 we owned 21 properties directly with a carrying value of $7.2million.  Of the remaining leases, 36were on terms and conditions that required capitalization of theobligation.  As of June 30, 2004, we hadreal estate subject to capital leases of $13.5 million and a related capitallease obligation of $12.5 million. The remaining 45 leases are classified asoperating leases.  All of our subleasesare accounted for as operating leases.

 

The properties are sublet to a broad tenant mix including conveniencestores, shoe stores, video rental outlets, auto parts dealers, carpet retailersand other small businesses.  The retailproperties cover approximately 460,000 square feet of retail space located in24 states. The stores are free-standing, retail locations ranging from 4,500-7,000square feet each.  The initial term ofthe leasehold interests has an average expiration of approximately 6years.  However, the Company is entitledto exercise extension options which will allow the Company to control theproperties for an additional 15 to 30 years. As of June 30, 2004, there were vacancies in 9 of the retail buildings.

 

OTHER OPERATING INCOME.  Our other operating income was approximately$8.4 million for the six months ended June 30, 2004.  This compares to other operating income of$13.1 million for the six months ended June 30 2003.  The primary components of our net otheroperating income include the following:

 

24

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*Equity In EarningsOf Equity Investees*. We recognized our share of the earnings of equity investees in theamount of $1.5 million during the six months ended June 30, 2004.  This compares to earnings of $0.9 millionduring the 2003 period.  In February2001, we participated in the purchase of all of the outstanding capital stockof Bourne End Properties Ltd. (“Bourne End”) through a 26% owned Jersey,Channel Islands Company known as BEP Acquisitions (“BEP”).  Bourne End is a specialist investor in retailproperty located in England and Scotland. BEP is highly leveraged and operating income from the properties isoffset by interest expense and depreciation. We account for this investment using the equity method, therebyrecording our share of income and expense generated by BEP.  Equity in earnings of equity investees duringthe 2004 and 2003 periods are primarily the result of our investment in BourneEnd.

 

*Prepaid Loan Servicing Credit.** *During the sixmonths ended June 30, 2004, we sold our Wilshire Credit Corporation (WCC)prepaid loan servicing credit (the “Loan Servicing Credit”) for $1.7 million incash.  The Loan Servicing Credit wasoriginally acquired by us in 1998, when we were an affiliate of WCC.  The Loan Servicing Credit may be used,subject to certain limitations, to pay for loan portfolio servicing activitiesperformed by WCC.  As a result of thesale, we recognized a gain in the amount of $1.5 million.

 

*Gain On The Sale Of Loans AndSecurities. *Duringthe six months ended June 30, 2004 and 2003, we sold loans and securities tounrelated third parties for approximately $29.1 million and $12.0 million,respectively, resulting in gains of approximately $2.1 million and $9.4million, respectively.

 

*Loan OriginationIncome.** *George Elkins generated $2.4million and $2.3 million, respectively, in loan origination income which isincluded in our consolidated statements of operation for the six months endedJune 30, 2004 and 2003.

 

OPERATING EXPENSES.  During the six months ended June 30, 2004,operating expenses from our merchant banking, real estate and finance segmentwere comprised of compensation and employee benefits of $3.2 million, leave ofabsence expense of $4.8 million, professional fees of $1.2 million and othercosts of $2.5 million.  The leave ofabsence expense consists of the $2.0 million leave of absence payment that waspaid to Mr. Wiederhorn on June 2, 2004 and an accrual of $2.8 million which isexpected to be paid during the period of the leave of absence.

 

During the six months ended June 30, 2003, operating expenses from ourmerchant banking, real estate and finance segment were comprised ofcompensation and employee benefits of $3.7 million, professional fees of $1.1million and other costs of $1.5 million.

 

**RESULTS OFOPERATIONS****3⁄4 QUARTER ENDED JUNE30, 2004 COMPARED TO QUARTER ENDED JUNE 30, 2003**

 

NET INCOME. Our net loss for the quarter ended June 30, 2004 was $4.1 million, or$0.49 per share, compared with net income of $2.6 million, or $0.30 per share,for the quarter ended June 30, 2003.  Thenet loss for the 2004 period is attributable to operating expenses of $10.3million, partially offset by net interest income of $0.9 million; gain on saleof loans and securities of $1.0 million, equity in earnings of equity investeesof $1.5 million, gain on sale of our prepaid loan servicing credit of $1.5million.

 

We believethat operating expenses were higher than normal during the six months endedJune 30, 2004 due to a $2.0 million leave of absence payment to its formerChief Executive Officer and current Chief Strategic Officer and the accrual of$2.8 million of future expenses associated with the leave of absence. Webelieve that operating expenses will return to more normal levels in the thirdquarter of 2004 and, together with the recent disposal of the Southend ShoppingCenter by our Bourne End subsidiary, will result in a profitable third quarterof 2004. There can be no assurance, however, that this will be the case.

 

The net incomefor the 2003 period is attributable to net interest income of $0.8 million;gain on sale of loans and securities of $4.6 million, equity in earnings ofequity investees of $1.9 million, and loan origination fees of $1.5 million,partially offset by other operating expenses of $5.2 million and $1.5 millionin provision for income taxes.

 

The followingsections describe the results of operations of our operating segments for thethree months ended June 30, 2004:

 

25

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**RestaurantSegment Operations**

 

As a result of ourvoting control, we began reporting the operations of Fatburger on aconsolidated basis beginning August 15, 2003.

 

During the threemonths ending June 30, 2004, we recognized a net loss from our restaurantsegment of $0.9 million.  This wasprimarily the result of net sales (net of cost of goods sold) of  $2.0 million and franchise and royaltyrevenue of $0.4 million, offset by general and administrative costs of $2.7million, interest expense of $0.2 million, and depreciation and amortization of$0.4 million.

 

**CommercialReal Estate Mortgage Brokerage Segment Operations**

 

The commercialreal estate brokerage segment operated at break even for the three months endedJune 30, 2004, compared to a loss of $0.1 million during the comparable 2003period.  During the 2004 period, werecognized loan brokerage fees of $1.2 million, loan servicing and otherrevenue of $0.1 million, which was offset by compensation expense of $1.1million and other operating expense of $0.2 million.  During the 2003 period, we recognized loanbrokerage fees of $1.4 million, loan servicing and other revenue of $0.2million, which was offset by compensation expense of $1.3 million and otheroperating expense of $0.2 million.

 

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

 

NET INTEREST INCOME.  Our net interest income for the quarter endedJune 30, 2004 was $0.9 million, compared with $0.8 million for the quarterended June 30, 2003.  The increase isprimarily attributable to an increase in interest income on loans (reflectingour increased investment in specialty real estate lending) of $0.4 million anda decrease in interest expense of $0.2 million as a result of our repayment ofdebt related to the mortgage-backed securities. This increase was partially offset by a reduction in interest income onsecurities of $0.4 million as the result of the sale or repayment ofmortgage-backed securities.  Thefollowing tables set forth information regarding the total amount of incomefrom interest-earning assets and expense from interest-bearing liabilities andthe resulting average yields and rates:

 
| ** **                                                             | ** **   | **For the Quarter Ended June 30, 2004** | ** **   |
|------------------------------------------------------------------------|--------------|-----------------------------------------|--------------|
| ** **                                                             | ** **   | **Average  Balance**                    | ** **   | **Interest  Income (Expense)** | ** ** | **Annualized  Yield/Rate** | ** ** |
| *** ***                                                           | *** *** | **(dollars in thousands)**              | *** *** |
| Interest-Earning Assets:                                               |         |                                    |         |   |   |   |   |
|                                                                   |         |                                    |         |   |   |   |   |
| Loan portfolios (1)                                                    |         | $                                       | 11,528       |   | $ | 636 |   | 22.1 | % |
| Mortgage-backed securities available for  sale                         |         | 15,856                                  |         | 292 |   | 7.4 | % |
| Other investments                                                      |         | 10,694                                  |         | 24 |   | 1.0 | % |
| Total interest-earning assets                                          |         | $                                       | 38,078       |   | $ | 952 |   | 10.0 | % |
|                                                                   |         |                                    |         |   |   |   |   |
| Interest-Bearing Liabilities:                                          |         |                                    |         |   |   |   |   |
|                                                                   |         |                                    |         |   |   |   |   |
| Borrowings (2)                                                         |         | $                                       | 12,278       |   | $ | (41 | ) | 1.3 | % |
| Total interest-bearing liabilities                                     |         | $                                       | 12,278       |   | $ | (41 | ) | 1.3 | % |
|                                                                   |         |                                    |         |   |   |   |   |
| Net interest income before provision for  loan losses/spread  (3) |         |                                    |         | $ | 911 |   | 8.7 | % |
| Net interest margin  (4)                                          |         |                                    |         |   |   | 9.6 | % |

 

----

(1)   Includesloans to senior executives.

(2)   Excludes borrowings related to investments inreal estate.

(3)   Netinterest spread represents the difference between the average rate oninterest-earning assets and the average cost of interest-bearing liabilities.

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

 

26

----

 
| ** **                                                             | ** ** | **For the Quarter Ended June 30, 2003** | ** ** |
|------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                             | ** ** | **Average  Balance**                    | ** ** | **Interest  Income (Expense)** | ** ** | **Annualized  Yield/Rate** | ** ** |
| ** **                                                             | ** ** | **(dollars in thousands)**              | ** ** |
| Interest-Earning Assets:                                               |       |                                    |       |   |   |   |   |
|                                                                   |       |                                    |       |   |   |   |   |
| Loan portfolios (1)                                                    |       | $                                       | 6,989      |   | $ | 234 |   | 13.4 | % |
| Mortgage-backed securities available for  sale                         |       | 54,343                                  |       | 699 |   | 5.1 | % |
| Other investments                                                      |       | 14,819                                  |       | 36 |   | 1.0 | % |
| Total interest-earning assets                                          |       | $                                       | 76,151     |   | $ | 969 |   | 5.1 | % |
|                                                                   |       |                                    |       |   |   |   |   |
| Interest-Bearing Liabilities:                                          |       |                                    |       |   |   |   |   |
|                                                                   |       |                                    |       |   |   |   |   |
| Borrowings (2)                                                         |       | $                                       | 32,603     |   | $ | (210 | ) | 2.6 | % |
| Total interest-bearing liabilities                                     |       | $                                       | 32,603     |   | $ | (210 | ) | 2.6 | % |
|                                                                   |       |                                    |       |   |   |   |   |
| Net interest income before provision for  loan losses/spread  (3) |       |                                    |       | $ | 759 |   | 2.5 | % |
| Net interest margin  (4)                                          |       |                                    |       |   |   | 4.0 | % |

 

----

(1)   Includesloans to senior executives.

(2)   Excludes borrowings related to investments inreal estate.

(3)   Netinterest spread represents the difference between the average rate oninterest-earning assets and the average cost of interest-bearing liabilities.

(4)   Net interest margin represents net interestincome divided by average interest-earning assets.

 

REAL ESTATE OPERATIONS.  Our real estate operations represent activityfrom our investment in various office buildings, retail stores, and othercommercial property.  During the quarterended June 30, 2004, we realized net income of $0.2 million from real estateoperations, compared with net income of $0.2 million for the quarter ended June30, 2003.

 

OTHER OPERATING INCOME.  Our other operating income was approximately$5.9 million for the three months ended June 30, 2004.  This compares to other operating income of$8.3 million for the three months ended June 30, 2003.  The primary components of our other operatingincome include the following:

 

*                Equity inEarnings of Equity Investees.*  We recognized our share of the earnings ofequity investees in the amount of $1.5 million during the three months endedJune 30, 2004.  This compares to earningsof $1.9 million during the 2003 period. Equity in earnings of equity investees during the 2004 and 2003 periodsare primarily the result of our investment in Bourne End.

 

                *Gain on theSale of Loans and Securities. *Duringthe three months ended June 30, 2004 and 2003, we sold loans and securities tounrelated third parties for approximately $27.8 million and $6.4 million,respectively, resulting in gains of approximately $1.0 million and $4.6million, respectively.

 

*Prepaid Loan Servicing Credit.** *During the threemonths ended June 30, 2004, we sold our Wilshire Credit Corporation (WCC)prepaid loan servicing credit for $1.7 million in cash.  As a result of the sale, we recognized a gainin the amount of $1.5 million.

 

*Loan OriginationIncome.***GeorgeElkins generated $1.2 million and $1.5 million, respectively, in loanorigination income which is included in our consolidated statements ofoperation for the three months ended June 30, 2004 and 2003.

 

27

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OPERATING EXPENSES.  During the three months ended June 30, 2004,operating expenses from our merchant banking, real estate and financial segmentwere comprised of compensation and employee benefits of $1.6 million, leave ofabsence expense of $4.8 million, professional fees of $0.9 million and othercosts of $1.6 million.  The leave ofabsence expense consists of the $2.0 million leave of absence payment that waspaid to Mr. Wiederhorn on June 2, 2004 and an accrual of $2.8 million which isexpected to be paid during the period of the leave of absence.

 

During the three months ended June 30, 2003, operating expenses werecomprised of compensation and employee benefits of $2.3 million, professionalfees of $0.6 million and other costs of $0.8 million.

 

**CHANGES INFINANCIAL CONDITION**

 

GENERAL. Total assets decreased from approximately $109.0 million at December 31,2003 to approximately $73.9 million at June 30, 2004.  Total liabilities decreased fromapproximately $63.6 million at December 31, 2003 to approximately $39.3 millionat June 30, 2004.  The decline in totalassets and liabilities was primarily the result of sales of our mortgage-backedsecurities and repayment of the related borrowings.  Stockholders’ equity decreased byapproximately $10.8 million resulting primarily from our net loss of $5.8million, dividends declared of $2.2 million, the purchase of treasury stock of$1.8 million and purchase of a call option of $0.6 million.

 

SECURITIES AVAILABLE FOR SALE.  The balance of mortgage-backed securitiesavailable for sale decreased from $35.5 million at December 31, 2003 to lessthan $0.1 million at June 30, 2004.   Thedecrease was primarily the result of the sale of mortgage-backed securities with a carrying value of $29.1 millionand cash repayments of securities of $6.9 million, partially offset byincreases in market value of $1.4 million.

 

LOAN PORTFOLIO.  We invest in special situation loans,generally secured by real estate.  Theseloans are typically short-term, with maturities ranging from 6 to 24 months.  Due to the unique circumstances relating tothe loans, the interest rate charged the borrower is significantly higher thanconventional real estate lending.  As ofJune 30, 2004, our special situation loan portfolio consisted of six individualloans with a combined carrying value of $9.4 million.  Five of the six loans are secured by realestate consisting of multi-family, commercial and single-family propertieslocated in California, Texas, Maine, and Nevada.  One loan is secured by all of the stock andassets of a commercial manufacturing business. The loans have a weighted average interest rate of 14.9% and a weightedaverage maturity of nine months.

 

During the sixmonths ended June 30, 2004, our loan portfolio increased by approximately $5.6million.  This was primarily the resultof the acquisition of three new loans with a carrying value totaling $6.6million.  As of June 30, 2004, two of theCompany’s loans totaling $2.0 million had been restructured to provide additionaltime for repayment by the borrowers in exchange for various extension fees orother new terms.  As a result, theseloans were considered impaired for accounting purposes, however, no impairmentreserves were required on these loans due to management’s expectation that thecarrying amounts will be collected.

 

INVESTMENTS IN REAL ESTATE.  Investments in real estate increased by $2.4million during the six months ended June 30, 2004.  The increase was primarily due to thepurchase of the fee interest in two freestanding retail buildings for $0.4million, the purchase of an apartment building in Barcelona, Spain for $1.3million and capital improvements of $1.2 million, partially offset by the saleof one property for $0.2 million and depreciation of $0.3 million.

 

LOANS TO SENIOREXECUTIVES.  Prior to the passage of the Sarbanes-OxleyAct of 2002, we had an employment agreement with Mr. Wiederhorn which allowedhim to borrow a specified maximum amount from us to purchase shares of CommonStock.  The resulting loans are fullrecourse, secured loans bearing interest at the prime rate.  At June 30, 2004, in addition to the $2million loan to Mr. Wiederhorn described below, we had outstanding loans to Mr.Wiederhorn, including accrued interest, of 

 

28

----

 

approximately $1.0 million. The Company is not obligated to make additional advances on loans underthe current employment agreement.  Theloans to Mr. Wiederhorn are further described as follows:

 

On February 21, 2002, weloaned Mr. Wiederhorn $175,000 to finance the purchase of Common Stock.  This loan is full recourse to Mr. Wiederhornand is secured by all of Mr. Wiederhorn’s rights under his employmentagreement.  We are entitled to netamounts payable under the employment agreement against any amounts payable byMr. 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, we loaned alimited partnership controlled by Mr. Wiederhorn’s spouse (the “LP”) $687,000to finance the purchase of Common Stock. The loan is secured by the membership interests of two limited liabilitycompanies owned by the LP.  The limited liabilitycompanies each own a parcel 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, aspublished in the Wall Street Journal, which interest is added to the principalannually.

 

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 inOregon.  The loan is due on August 1,2007 and bears interest at 8.5% per annum, payable monthly.  The Board of Directors (with Mr. Wiederhornabstaining) concluded that the terms of the loan were at least as favorable tothe Company as would be available in an arms length, third party transactionand approved the loan on July 9, 2002.

 

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.  The employment agreementhas been previously filed with the SEC.

 

INVESTMENT IN BOURNE END.  In December 2000, we organized and led a group of investors to purchaseall of the outstanding capital stock of Bourne End, a specialist investor inretail property.  At the time of theacquisition, Bourne End had approximately GBP 169.6 million of assets and GBP123.1 million of debt.  The real estateassets consisted of 1.7 million square feet in fifteen shopping centers locatedin the United Kingdom.  As of June 30,2004, 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.

 

Subsequent to June 30, 2004,Bourne End sold the Southend Shopping Center for approximately 38 million GreatBritain pounds (“GBP”).  Our share of thepre-tax gain on this transaction is $2.8 million.

 

Bourne End is in the process ofimproving and selling its last remaining shopping center, which it hopes tosell within the next 12 months.  At thatpoint, Bourne End is expected to be liquidated and we will receive our share ofany remaining assets or proceeds of Bourne End.

 

Our investment in Bourne End increased by$1.6 million to $3.7 million at June 30, 2004.  Theincrease was primarily the result of the recognition of our share of theearnings of Bourne End.

 

RESTAURANT PROPERTY, PLANT AND EQUIPMENT, NET.  Our investment in restaurant property, plantand equipment, net of depreciation, increased $0.2 million during the sixmonths ended June 30, 2004 to a balance of $6.1 million.  The increase was primarily the result ofadditions to equipment, furniture and fixtures relating to new restaurantopenings.

 

INTANGIBLE ASSETS, NET.  Primarily as a result of the acquisition andconsolidation of Fatburger, as of June 30, 2004 we had intangible assets, netof amortization, of $5.5 million.  Thisconsisted of trademark rights of approximately $4.0 million, franchise agreementsof approximately $1.0 million and 

 

29

----

 

othermiscellaneous intangible assets of $0.5 million.  Intangible assets decreased $0.1 millionduring the six months ended June 30, 2004 primarily as the result ofamortization expense.

 

GOODWILL. Primarily as a result of the acquisition and consolidation of Fatburger,we had recorded goodwill of $7.4 million as of June 30, 2004.

 

OTHER ASSETS.  At June 30, 2004, the Company’s other assetsconsisted of the following (dollars in thousands):

 

 
| Capitalized deferred compensation        |   | $     | 1,064  |   |
|------------------------------------------|--------|-------|--------|--------|
| Deposit in escrow to acquire real estate |   | 1,601 |   |
| Prepaid expenses                         |   | 561   |   |
| Rent receivable                          |   | 319   |   |
| Investment in operating leases           |   | 370   |   |
| Mortgage servicing rights                |   | 261   |   |
| Other                                    |   | 1,340 |   |
| Total                                    |   | $     | 5,516  |   |

 

The capitalizeddeferred compensation included in other assets relates to the acquisition ofGeorge Elkins.  In conjunction with theacquisition, certain employees of George Elkins entered into long-termemployment agreements.  These employeesreceived payments totaling $1.9 million which we capitalized as deferredcompensation.  The employees areobligated to perform under the employment agreements and must repay anyunearned deferred compensation payments upon early termination.  The deferred compensation is earned ratablyover the terms of the employment agreements, and we are amortizing the $1.9million investment over the remaining terms, which range from 11 to 35 months.

 

REPURCHASE AGREEMENTS, BORROWINGS AND NOTES PAYABLE.  Our repurchase agreements, borrowings andnotes payable decreased $25.1 million during the six months ended June 30, 2004to an ending balance of $8.0 million. This was primarily the result of the repayment of repurchase agreementsupon the sale of mortgage-backed securities.

 

OBLIGATIONS UNDER CAPITAL LEASES.  Obligations under capital leases decreasedapproximately $0.3 million during the six months ended June 30, 2004.  This decrease was primarily the result of thescheduled amortization of the obligations.

 

DEFERRED INCOME.  Franchise fee revenue from the sales ofindividual Fatburger franchises is recognized only when all material servicesor conditions relating to the sales have been substantially performed orsatisfied.  The completion of trainingand the opening of a location by the franchisee constitute substantialperformance.  Nonrefundable depositscollected in relation to the sale of franchises are recorded as deferredfranchise fees until the completion of training and the opening of therestaurant, at which time the franchise fee revenue is recognized.  As of June 30, 2004, our deferred incomerelating to the collection of unearned Fatburger franchise fees was $4.0million, an increase of $0.3 million from December 31, 2003.  The increase was primarily the result of thecollection of nonrefundable deposits on new franchises.

 

DEFERRED INCOME TAXES.  Our deferred income taxes decreased $1.0million to $6.0 million at June 30, 2004. This was primarily the result of a decrease in the accrued taxesassociated with unrealized gains on mortgage-backed securities.  As of June 30, 2004, we had, for U.S. Federaltax purposes, a net operating loss (“NOL”) carryforward of approximately $80.9million, including $12.9 million relating to Fatburger.  The NOL carryforward may reduce the futurecash payment of the deferred income tax liability.  Our NOL begins to expire in 2018.  Fatburger’s NOL begins to expire in 2004 andis generally subject to an annual limitation under the Internal Revenue Code of1986, Section 382, Limitation on Net Operating Loss Carryovers and CertainBuilt-In Losses Following Change in Control. In addition, to the extent the Fatburger NOL is utilized, therecognition of the related tax benefits would first reduce goodwill related toFatburger acquisition, then other non-current intangible assets related to that

 

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acquisition, and then income tax expense inaccordance with Statement on Financial Accounting Standards No. 109, Accountingfor 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, we established aShareholder Rights Plan dated as of October 18, 2002, which discourages, undercertain circumstances, ownership changes which would trigger the NOLlimitations.

 

STOCKHOLDERS’ EQUITY.  Stockholders’ equity decreased byapproximately $10.8 million resulting primarily from our net loss of $5.8million, purchase of treasury stock of $1.8 million, the purchase of a calloption on the Company’s stock of $0.6 million and dividends declared of $2.2million.

 

In April 2004we purchased 330,500 shares of our common stock from a stockholder.  The purchase price was $5.40 per share ($1.8million) and the shares were placed in treasury.

 

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

 

 

**LIQUIDITYAND CAPITAL 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 six months ended June 30, 2004, consisted of net cash provided byinvesting activities, including interest and principal payments related to ourmortgage-backed securities portfolio and the sale of mortgage-backedsecurities.  As of June 30, 2004, we hadcash and cash equivalents of $8.2 million, which we believe will be sufficientto meet our current liquidity requirements.

 

Our borrowings and the availability of further borrowings aresubstantially affected by, among other things, changes in interest rates, ordecreases in credit quality of underlying assets.  Fluctuations in interest rates will continueto impact our net interest income to the extent our fixed rate assets arefunded by variable rate debt or our variable rate assets reprice on a differentschedule or in relation to a different index than any floating rate debt whichin turn could impact potential returns to shareholders.  See “Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKETRISK.”

 

At June 30, 2004, we had total consolidated secured indebtedness of$20.7 million, as well as $18.7 million of other liabilities. The consolidatedsecured indebtedness consisted of (i) $12.7 million outstanding of obligationsunder capital leases maturing between 2010 and 2040 which are primarily securedby real estate, (ii) long-term debt of Fatburger of $7.3 million secured bysubstantially all of the assets of Fatburger and (iii) borrowings secured by anapartment building in Barcelona, Spain in the amount of $0.7 million.  None of this indebtedness had terms whichallowed the lender to request additional collateral if the value of the underlyingcollateral declined.

 

If our existing liquidity position were to prove insufficient, and wewere unable to repay, renew or replace maturing indebtedness on termsreasonably satisfactory to us, we may be required to sell (potentially on shortnotice) a portion of our assets, and could incur losses as a result.  Also, Fatburger is involved in a nationwideexpansion of franchise and Fatburger owned locations, which will requiresignificant liquidity.  If Fatburger orits franchisees are unsuccessful in obtaining credit lines sufficient to fundthis expansion, the timing of restaurant openings may be delayed.

 

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Historically, we have regularly sold assets as a normal, recurring partof our operations and we have been generating positive cash flow as a result ofthese transactions.  However, excludingthe sale of assets from time to time, we would have been operating withnegative cash 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 adequate forpurposes 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, greaterdemands for liquidity at our operating subsidiaries, including Fatburger andour real estate operations, or material decreases in monthly cash receipts,generally would negatively impact our liquidity.  On the other hand, improvements in cash flowfrom our operating subsidiaries or real estate investments, or a decrease inoperating expense would positively affect our liquidity.

 

**CONTRACTUALOBLIGATIONS**

 

The following table provides information on the amounts of payments dueunder contractual obligations as of June 30, 2004 (dollars in thousands):

 
| ** **                                         | ** ** | **Payments due by Period** | ** ** |
|----------------------------------------------------|------------|----------------------------|------------|
| ** **                                         | ** ** | **Total**                  | ** ** | **Less than 1  year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than 5   years** | ** ** |
| Contractual obligations:                           | ** ** | ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Borrowings and notes payable                       |       | $                          | 7,999      |   | $ | 2,025 |   | $ | 2,997 |   | $ | 1,472 |   | $ | 1,505 |   |
| Interest payments on borrowings and notes  payable |       | 2,573                      |       | 565 |   | 511 |   | 273 |   | 1,224 |   |
| Obligations under capital leases (1)               |       | 35,505                     |       | 1,683 |   | 3,344 |   | 3,190 |   | 27,288 |   |
| Obligations under operating leases                 |       | 12,570                     |       | 2,846 |   | 4,582 |   | 2,785 |   | 2,357 |   |
| Obligations under employment contracts             |       | 3,208                      |       | 2,525 |   | 683 |   | — |   | — |   |
| Purchase obligations (2)                           |       | 394                        |       | 394 |   | — |   | — |   | — |   |
| Total                                              |       | $                          | 62,249     |   | $ | 10,038 |   | $ | 12,117 |   | $ | 7,720 |   | $ | 32,374 |   |

 

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(1) The amount of imputed interestto reduce the minimum capital lease payments to present value is $23.8 millionusing an effective interest rate of 8.5%.

(2) As of June 30, 2004, Fatburgerwas under contract to purchase advertising for $0.4 million.

 

 

**OFFBALANCE SHEET ARRANGEMENTS**

 

In order to facilitate the development of franchise locations, as ofJune 30, 2004 Fatburger had guaranteed the annual minimum lease payments of tworestaurant sites owned and operated by franchisees.  The amount of theguarantees approximate $0.4 million plus certain contingent rentalpayments as defined in the respective leases. These leases expire at various times though 2008.

 

We did not have any other off balance sheet arrangements in place as ofJune 30, 2004.

 

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**ITEM 3****.  QUANTITATIVEAND QUALITATIVE DISCLOSURES 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 some exposure toforeign currency fluctuations (approximately 15% of the Company’s equity isinvested in assets located in Europe at June 30, 2004).

 

With the sale of substantially all of our mortgage-backed securities,our exposure to interest rate risk has been significantly reduced.  However, we continue to face interest raterisk, primarily in our special situation loan portfolio.  This type of risk is highly sensitive tomany factors beyond our control, including governmental monetary and taxpolicies, domestic and international economic and political considerations, andother factors.  Changes in the generallevel of interest rates can affect our net interest income by affecting thespread between our interest-earning assets and our interest-bearingliabilities.  Changes in the level ofinterest rates can also affect, among other things, the value of ourinterest-earning assets and our ability to acquire loans.  Our real estate and restaurant operationsare primarily funded by fixed rate debt or equity.  As demonstrated in the tables below, we believe that a modestincrease in interest rates will not have a significant effect on ourprofitability 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, the sensitivityof our assets and liabilities to interest rate changes, the book and marketvalues of assets and liabilities, unrealized gains and losses, including thoseattributable to hedging transactions, purchase and securitization activity, andmaturities of investments and borrowings.

 

The following table quantifies the potential changes in net interestincome and net portfolio value as of June 30, 2004 should interest rates go upor down (shocked) by 100 or 200 basis points, assuming the yield curves of the rateshocks will be parallel to each other and instantaneous. Net portfolio value iscalculated as the sum of the value of off-balance sheet instruments and thepresent value of cash in-flows generated from interest-earning assets net ofcash out-flows in respect of interest-bearing liabilities. The cash flowsassociated 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 types areused to produce the projected loss and prepayment assumptions that are includedin the cash flow projections of the securities.  The following table applies the U.S. Treasury yield curvegenerally for assets and LIBOR for repurchase agreement liabilities and assumea uniform change in both rates.  Thetable assumes that changes in interest rates occur instantaneously.  Actual results could differ significantlyfrom those estimated in the table.

 
| **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                  |   | -12.0 | % | -4.4 | % | $ | (203,000 | ) | $ | (1,502,000 | ) |
| -100 Basis Points                  |   | -7.8 | % | -2.1 | % | $ | (132,000 | ) | $ | (707,000 | ) |
| 0 Basis Points                     |   | 0.0 | % | 0.0 | % | $ | — |   | $ | — |   |
| 100 Basis Points                   |   | 9.0 | % | 2.0 | % | $ | 153,000 |   | $ | 700,000 |   |
| 200 Basis Points                   |   | 18.0 | % | -3.8 | % | $ | 306,000 |   | $ | 1,305,000 |   |

 

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(1)                                  Assumes that uniformchanges occur instantaneously in both the yield on 10-year U.S. Treasury notesand the interest rate applicable to U.S. dollar deposits in the London interbank market.

 

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The following table sets forth information as to the type of funding usedto finance the Company’s assets as of June 30, 2004.  As indicated in the table, a large percentage of the Company’sfixed-rate assets are currently not financed and the Company’s variable-rateassets are generally funded by variable-rate liabilities.

 

Assets and Liabilities

As of June 30, 2004

(dollars in thousands)

 
|                                     |   | **Basis  Amount** |   | **Coupon  Type** |   | **Liability** |   | **Type** |   |
|------------------------------------------|--------|-------------------|--------|------------------|--------|---------------|--------|----------|--------|
| Interest-Bearing Assets                  |   |              |   |             |   |          |   |     |   |
| Fixed-rate asset, financed floating      |   | $                 | 15     |             | Fixed  |          | $      | 25       |   | LIBOR |   |
| Fixed-rate assets, no financing          |   | 9,385             |   | Fixed            |   | —        |   | None     |   |
| Variable-rate, financed variable         |   | —            |   | 1 TCM (1)        |   | —        |   | LIBOR    |   |
| Variable-rate assets, no financing       |   | 2,966             |   | Prime            |   | —        |   | None     |   |
| Cash and cash equivalents                |   | 8,237             |   | N/A              |   | —        |   | None     |   |
| Subtotal                                 |   | 20,603            |   |             |   | 25            |   |     |   |
|                                     |   |              |   |             |   |          |   |     |   |
| Other Assets                             |   |              |   |             |   |          |   |     |   |
| Investments in real estate               |   | 25,014            |   | N/A              |   | 13,348        |   | Fixed    |   |
| Investment in BEP                        |   | 3,728             |   | N/A              |   | —        |   | None     |   |
| Restaurant property, plant and equipment |   | 6,069             |   | N/A              |   | 7,307         |   | Fixed    |   |
| Intangible assets, net                   |   | 5,510             |   | N/A              |   | —        |   | None     |   |
| Goodwill                                 |   | 7,449             |   | N/A              |   | —        |   | None     |   |
| Other                                    |   | 5,516             |   | N/A              |   | —        |   | None     |   |
| Subtotal                                 |   | 53,286            |   |             |   | 20,655        |   |     |   |
|                                     |   |              |   |             |   |          |   |     |   |
| Liability Only                           |   |              |   |             |   |          |   |     |   |
| Deferred income                          |   | —            |   |             |   | 4,009         |   | None     |   |
| Deferred income taxes                    |   | —            |   |             |   | 5,962         |   | None     |   |
| Other                                    |   | —            |   |             |   | 8,698         |   | None     |   |
| Total                                    |   | $                 | 73,889 |             |   |          | $      | 39,349   |   |   |   |

 

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(1)  1TCM means the one year Treasury Constant Maturity Index.

 

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 June 30, 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 maturingor repricing within a given time period. A gap is considered positive when the amount of interest-ratesensitive assets exceeds the amount of interest-rate sensitiveliabilities.  A gap is considerednegative when the amount of interest-rate sensitive liabilities exceedsinterest-rate sensitive assets. During a period of rising interest rates, a negative gap would tend toadversely affect net interest income, while a positive gap would tend to resultin an increase in net interest income. During a period of falling interest rates, a negative gap would tend toresult in an increase in net interest income, while a positive gap would tendto affect net interest income adversely. Since different types of assets and liabilities with the same or similarmaturities may react differently to changes in overall market rates orconditions, changes in interest rates may affect net interest income positivelyor negatively even if an institution were perfectly matched in each maturitycategory.

 

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The following table sets forth the estimated contractual maturity orrepricing of our interest-earning assets and interest-bearingliabilities at June 30, 2004.

 

As of June 30, 2004

(dollars in thousands)

 
|                                                                                     |   | **Within   3 Months** |   | **4 to 12   Months** |   | **One Year  to   3 Years** |   | **More than   3 Years** |   | **TOTAL** |   |
|------------------------------------------------------------------------------------------|--------|-----------------------|--------|----------------------|--------|----------------------------|--------|-------------------------|--------|-----------|--------|
| Interest-sensitive assets(1):                                                            |   |                  |   |                 |   |                       |   |                    |   |      |   |
| Cash and cash equivalents                                                                |   | $                     | 8,237  |                 | $      | —                     |   | $                       | — |      | $      | — |   | $ | 8,237 |   |
| Securities available for sale                                                            |   | —                |   | —               |   | —                     |   | 40                      |   | 40        |   |
| Loans                                                                                    |   | 1,430                 |   | 6,867                |   | 1,063                      |   | —                  |   | 9,360     |   |
| Loans to senior executives                                                               |   | —                |   | 966                  |   | —                     |   | 2,000                   |   | 2,966     |   |
| Total rate-sensitive assets                                                              |   | $                     | 9,667  |                 | $      | 7,833                      |   | $                       | 1,063  |      | $      | 2,040 |   | $ | 20,603 |   |
|                                                                                     |   |                  |   |                 |   |                       |   |                    |   |      |   |
| Interest-sensitive liabilities:                                                          |   |                  |   |                 |   |                       |   |                    |   |      |   |
| Borrowings and notes payable                                                             |   | $                     | 463    |                 | $      | 1,314                      |   | $                       | 4,171  |      | 2,051  |   | $ | 7,999 |   |
| Obligations under capital leases                                                         |   | 29                    |   | 87                   |   | 232                        |   | 12,333                  |   | 12,681    |   |
| Total rate-sensitive liabilities                                                         |   | $                     | 492    |                 | $      | 1,401                      |   | $                       | 4,403  |      | $      | 14,384 |   | $ | 20,680 |   |
|                                                                                     |   |                  |   |                 |   |                       |   |                    |   |      |   |
| Interest rate sensitivity gap                                                            |   | 9,175                 |   | 6,432                |   | (3,340                     | )      | (12,344                 | )      |      |   |
| Cumulative interest rate sensitivity gap                                                 |   | 9,175                 |   | 15,607               |   | 12,267                     |   | (77                     | )      |      |   |
| Cumulative interest rate sensitivity gap as  a percentage of total rate-sensitive assets |   | 45                    | %      | 76                   | %      | 60                         | %      | 0                       | %      |      |   |

 

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(1)  Real estate propertyholdings are not considered interest rate sensitive.

 

 

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

 

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

 

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

 

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

 

•                  Alack of sufficient resources in the accounting department to handle theday-to-day transactions and record all adjustments for the financialstatements.

•                  Alack of sufficient 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-LOOKINGSTATEMENTS

 

CERTAINSTATEMENTS CONTAINED HEREIN AND CERTAIN STATEMENTS CONTAINED IN FUTURE FILINGSBY THE COMPANY WITH THE SEC MAY NOT BE BASED ON HISTORICAL FACTS AND ARE“FORWARD-LOOKING STATEMENTS” WITHIN THE MEANING OF SECTION 27A OF THESECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACTOF 1934, AS AMENDED.  FORWARD-LOOKINGSTATEMENTS WHICH ARE BASED ON VARIOUS ASSUMPTIONS (SOME OF WHICH ARE BEYOND THECOMPANY’S CONTROL) MAY BE IDENTIFIED BY REFERENCE TO A FUTURE PERIOD ORPERIODS, OR BY THE USE OF FORWARD-LOOKING TERMINOLOGY, SUCH AS “MAY,” “WILL,”“BELIEVE,” “EXPECT,” “ANTICIPATE,” “CONTINUE,” OR SIMILAR TERMS OR VARIATIONSON THOSE TERMS, OR THE NEGATIVE OF THOSE TERMS.  ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE SET FORTH INFORWARD-LOOKING STATEMENTS DUE TO A VARIETY OF FACTORS, INCLUDING, BUT NOTLIMITED TO, THOSE RELATED TO THE ECONOMIC ENVIRONMENT, PARTICULARLY IN THEMARKET AREAS IN WHICH THE COMPANY OPERATES, THE FINANCIAL AND SECURITIESMARKETS AND THE AVAILABILITY OF AND COSTS ASSOCIATED WITH SOURCES OF LIQUIDITY,COMPETITIVE PRODUCTS AND PRICING, THE REAL ESTATE MARKET, FISCAL AND MONETARYPOLICIES OF THE U.S.  GOVERNMENT,CHANGES IN PREVAILING INTEREST RATES, ACQUISITIONS AND THE INTEGRATION OFACQUIRED BUSINESSES, PERFORMANCE OF RETAIL/CONSUMER MARKETS, DETERIORATION INCONSUMER CREDIT, CREDIT RISK MANAGEMENT, ASSET/LIABILITY MANAGEMENT, THE IMPACTOF ONGOING LITIGATION, AND THE IMPACT OF THE SETLLEMENT OF THE INVESTIGATION OFTHE COMPANY’S CHIEF EXECTUTIVE OFFICER. EXCEPT AS MAY BE REQUIRED BY LAW, THE COMPANY DOES NOT UNDERTAKE, ANDSPECIFICALLY DISCLAIMS ANY OBLIGATION, TO PUBLICLY RELEASE THE RESULTS OF ANYREVISIONS WHICH MAY BE MADE TO ANY FORWARD-LOOKING STATEMENTS TO REFLECT THEOCCURRENCE OF ANTICIPATED OR UNANTICIPATED EVENTS OR CIRCUMSTANCES AFTER THE DATEOF SUCH STATEMENTS.

 

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**PART II****– OTHER INFORMATION**

 

**Item 1.**           Legal Proceedings.

 

CapitalConsultants LLC

 

As the Company has previously disclosed, the Company’s former ChiefExecutive Officer and current Chief Strategic Officer, Andrew Wiederhorn, andformer President, Lawrence Mendelsohn, received letters from the United StatesAttorney’s Office for the District of Oregon (“USAODO”) in March 2001 advisingthem that they were targets of a grand jury investigation (the “CCLInvestigation”) into the failure of Capital Consultants, L.L.C (“CCL”).  CCL was a lender to Wilshire CreditCorporation (“WCC”) and related and affiliated companies. WCC was a mortgageloan servicing company owned by Mr. Wiederhorn and Mr. Mendelsohn that providedmortgage loan servicing for Wilshire Financial Services Group Inc., a publiccompany for which Mr. Wiederhorn acted as CEO and Mr. Mendelsohn acted asPresident and which was principally engaged in banking, loan pool purchasing, andinvesting in mortgage-backed securities. As a result of the liquidity crisis in the financial markets in the fallof 1998, Wilshire Financial Services Group Inc. experienced significant lossesand filed for bankruptcy, which in turn had a significant impact on itsaffiliates, including WCC, which could not repay the amounts borrowed fromCCL.  At the time, Wilshire FinancialServices Group Inc. owned approximately 8.6% of the Company’s common stock andmanaged the Company’s investments under a management agreement.

 

In August 2002, Mr. Mendelsohn resigned as President and Director ofthe Company. In November 2003, Mr. Mendelsohn entered into an agreement withthe USAODO pursuant to which he plead guilty to filing a false 1998 personaltax return and agreed to cooperate in the CCL Investigation.

 

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

 

Under theSettlement’s terms, Mr. Wiederhorn pled guilty on June 2, 2004 to two federalcounts and was sentenced to 18 months incarceration and fined $2.0million.  The first count, a violationof an ERISA provision, involved a federal law that required no criminal intentand for which the advice of counsel was not a defense. The second count relatedto a violation involving a deduction on a personal tax return, which did not reduceMr. Wiederhorn’s tax liability or reduce the government’s tax collections.  The charges to which Mr. Wiederhorn has pledguilty pursuant to the Settlement are not based upon any acts or omission ofthe Company or of Mr. Wiederhorn in his capacity as an officer or director ofthe Company.

 

In enteringinto Mr. Wiederhorn’s leave of absence agreement, the Board of Directorsconsidered the nature of the statutes to which Mr. Wiederhorn pled and the factthat he relied entirely on the advice of expert legal counsel and a nationalaccounting firm.  The Board alsobelieved it was important to assure Mr. Wiederhorn’s return to activeinvolvement with the Company because of his expertise and knowledge and topreserve a significant business relationship and the value of the Company’sinvestments.

 

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

 

To address the management transition, the Company appointed DonaldBerchtold as Co-Chief Executive Officer. Mr. Berchtold has been Senior Vice President of Administration at FogCutter Capital since October 1999 and became a director in March 2004.  He currently sits on the board of directorsof Fatburger and has more than 25 years experience in the restaurantbusiness.  Mr. Berchtold is thefather-in-law of Mr. Wiederhorn.  Inorder to further assist the transition, David Dale-Johnson and Don Coleman willserve as co-Chairmen of the Board.  BothMr. Dale-Johnson and Mr. Coleman have been directors of the 

 

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

 

Mr. Wiederhorn began his leave of absence on August 2, 2004 and isexpected to remain in that status for a period of 14 to 18 months.  On August 13, 2004, the Board of Directorsadopted a resolution changing the role of Andrew Wiederhorn from Co-ChiefExecutive Officer to Chief Strategic Officer during the leave of absenceperiod.  The Board had discussed thisalternative with Mr. Wiederhorn prior to the effective date of his leave ofabsence.  The Board determined that duringthe leave of absence period, Mr. Wiederhorn would be in a better position todevelop strategies that would be of future benefit to the Company, while hiscurrent status would significantly limit his ability to perform the fullfunctions of Co-Chief Executive Officer. All other provisions of the Leave of Absence Agreement and employmentagreement with Mr. Wiederhorn remain in force. Donald J. Berchtold will continue as sole Chief Executive Officer andwill serve as the principal executive of the Company.

 

Mr. Wiederhorn and Mr.Mendelsohn, pursuant to the terms of their respective employment agreements,may have been entitled to indemnity from the Company for litigation expensesand personal losses in connection with the CCL investigations and any relatedlitigation.  Messrs. Wiederhorn andMendelsohn had notified the Company that, although they believed they wereentitled to primary indemnification from other sources, they were reservingtheir rights to seek indemnity from the Company.  The Company did not agree to any indemnity requests.  Mr. Wiederhorn released the Company from anyand all claims he may have had relating to the CCL matter as partialconsideration for the leave of absence agreement in June 2004.   The USAODO has settled the CCL matter as itrelates to both Mr. Wiederhorn and Mr. Mendelsohn.  As a result, the Company believes that the contingencies relatingto the potential indemnification of these officers or former officers have nowbeen resolved.

 

Nasdaq

 

Shares of theCompany’s stock are currently traded on the Nasdaq stock exchange.  On July 20, 2004 theCompany was notified by Nasdaq of a staff determination to de-list the Companyeffective July 29, 2004.  The Companyhas challenged the staff determination and has requested an oral hearing by aListing Qualifications Panel to review the staff’s conclusions.  A hearing has been scheduled for September9, 2004.  The Company will continue tobe listed on the Nasdaq Stock Market while the Listing Qualifications Panel’sdecision is pending.  There can be noassurance that the Company’s appeal will be successful.  If the Company is de-listed by Nasdaq, theCompany will seek arrangements to facilitate over-the-counter trading of itssecurities.

 

Derivative Action

 

On July 6, 2004, Jeff Allen McCoon, derivatively on behalf of theCompany, filed a lawsuit in the Circuit Court for the State of Oregon(Multnomah County Case No. 0407-06900) which named all of the directors of theCompany as defendants.  The lawsuitalleges that members of the Company’s Board of Directors breached their dutiesto the Company by entering into the leave of absence agreement with AndrewWiederhorn.  The lawsuit generally seeksrestitution of payments made under the leave of absence agreement plus attorneyfees and costs.  The Board of Directorsand the Company believe that the allegations of the lawsuit are without meritand intend to put forth a vigorous defense. At the present time, it is not possible to determine the amount ofdamages, if any, that the Company may ultimately incur or recover as a result ofthe derivative lawsuit.

 

Strouds Acquisition Corporation

 

On October 6, 2003, the Official Committee of Unsecured Creditorsof Strouds Acquisition Corporation (“Strouds”) filed a lawsuit in the UnitedStates Bankruptcy Court (LA 03-23620-ER) which named the Company, among others,as a defendant.  The lawsuit was amendedon November 10, 2003 and limits the complaint against the Company solely in itscapacity as collateral agent for certain secured creditors of StroudsAcquisition Corporation.  The lawsuit,as it pertains to the Company, sought reimbursement of the proceeds fromapproximately $3.0 million in funds received in October 2003, which the Companywas holding as collateral agent for other secured creditors.  These funds were not included in the assetsof the Company, but were being held in trust. On July 1, 2004, the lawsuit was settled and the Company distributed thetrust funds, net of legal reimbursements of $0.3 million, in accordance withthe settlement agreement.  The Companyreceived a general release from the parties and considers the matter closed.

 

38

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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.**           Changes in Securities, Use of Proceeds andPurchases of Equity Securities.

 

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.  At the time of the purchase, thepurchase price represented a small premium to the Company’s book value pershare and market price per share. The Company and its directors considered,among other things, 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.

 

 

**ISSUER PURCHASES OFEQUITY SECURITIES**

 
| **Period**          |   | **(a) Total  number   of shares (or units)   purchased** |   | **(b)  Average price   paid per share (or   unit)** |   | **(c) Total  number   of shares (or units)  purchased as part   of publicly   announced plans   or programs** |   | **(d)  Maximum   number (or   approximate dollar  value) of shares (or   units) that may yet  be purchased under   the plans or   programs** |   |
|---------------------|--------|----------------------------------------------------------|--------|-----------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------|--------|
| April 1 to April 30 |   | 330,500                                                  |   | $                                                   | 5.40   |                                                                                                          | 0      |                                                                                                                                         | 0      |   |
| May 1 to May 31     |   | 0                                                        |   | 0                                                   |   | 0                                                                                                             |   | 0                                                                                                                                            |   |
| June 1 to June 30   |   | 0                                                        |   | 0                                                   |   | 0                                                                                                             |   | 0                                                                                                                                            |   |
| Total               |   | 330,500                                                  |   | $                                                   | 5.40   |                                                                                                          | 0      |                                                                                                                                         | 0      |   |

 

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

Not applicable.

**Item 4.**           Submission of Matters to a Vote of SecurityHolders.

None

**Item 5.**           Other Information.

 

**2004 ANNUAL MEETING OF STOCKHOLDERS DELAYED**

 

The Company’s2004 Annual Meeting of Stockholders has been delayed and will not be scheduleduntil later in 2004.  Stockholderswishing to include proposals in the proxy material in relation to our 2004Annual Meeting of Stockholders must submit the proposals in writing so as to bereceived by the Secretary of the Company at the principal executive offices ofthe Company at 1410 SW Jefferson Street, Portland, OR 97201-2548, no later thanthe close of business on the 60th day prior to the announced meetingdate.  Such proposals must also meet theother requirements of the rules of the Securities and Exchange Commissionrelating to stockholders’ proposals.  Ifthe Company is not notified of an intent to present a proposal at our 2004Annual Meeting of Stockholders by the 60th day prior to theannounced meeting date, the Company will have the right to exercise itsdiscretionary voting authority with respect to such proposal, if presented atthe meeting, without including information regarding such proposal in its proxymaterials.

 

39

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**TRANSACTIONS WITHAFFILIATES**

 

**StockPurchase Loans to Officers**

 

Prior to thepassage of the Sarbanes-Oxley Act of 2002, we had negotiated employmentagreements with senior executives, which allowed these executives to borrow aspecified maximum amount from us to purchase shares of common stock.  These loans are full recourse, secured loansbearing interest at the prime rate.  AtJune 30, 2004, in addition to the $2 million loan to Mr. Wiederhorn describedbelow, we had outstanding stock purchase loans to Mr. Wiederhorn includingaccrued interest, of approximately $1.0 million.    The Company is not obligated to make additional advances on loansunder the employment agreements, and all other loans to executive officers havebeen paid in full.  The remainingoutstanding loans are described in the following section and as follows:

 

On February21, 2002, we loaned Mr. Wiederhorn $175,000 to finance the purchase of commonstock.  This loan is fully recourse toMr. Wiederhorn and is secured by all of Mr. Wiederhorn’s rights under hisemployment agreement.  We are entitledto net amounts payable under the employment agreement against any amounts payableby Mr. Wiederhorn upon any default or at maturity of the loan.  At Mr. Wiederhorn’s direction (in accordancewith the terms of his employment agreement), on February 21, 2002, we loaned alimited partnership controlled by Mr. Wiederhorn’s spouse (the “LP”) $687,000to finance the purchase of common stock. The loan is secured by the membership interests of two limited liabilitycompanies owned by the LP.  The limitedliability companies each own a parcel of real property in Oregon and have noliabilities.  At the time of the loan,the real property had an appraised value of $725,000.  The loan is also guaranteed by Mr. Wiederhorn.  The common stock purchased with the proceedsof these loans does not serve as security for the loans.  The loans are due on February 21, 2007, andbear interest at the prime rate, as published in the Wall Street Journal, whichinterest is added to the principal annually.

 

Furtherinformation on these loans to Mr. Wiederhorn is included in our annual proxystatement for 2002 and prior years and Mr. Wiederhorn’s employment agreementhas 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.  Thetrust was established for the benefit of our employees and directors to raisetheir 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, the trustpurchased an additional 100,000 shares of our stock in the open market.  In addition, during April 2004, the trustagain used its retained earnings and purchased 69,500 shares of the Company’sstock from a shareholder.

 

40

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Andrew Wiederhorn, K. Kenneth Kotler 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 the vestingperiod, the trustees shall promptly distribute to such employee the sharesallocated to such employee;  provided,however, that the trustees may, in lieu of distributing the shares, make a cashpayment to the employee equal to the fair market value of the shares allocatedto such employee as of the date immediately prior to the date of distributionor distribute any combination of cash or shares, as determined by the trustees,in their sole discretion.

 

Prior to June 30, 2004, the trustees had allocated 285,500 shares tocertain employees and directors.  Ofthis amount, 50,000 shares previously allocated to a former employee wereforfeited.  During July 2004, thetrustees allocated an additional 367,500 shares to certain employees anddirectors.  As a result, 603,000 shareshave been allocated to employees and directors and 91,500 shares remainunallocated.

 

**Business Use of Private Aircraft**

 

During the six months ended June 30, 2004, the Company paid $0.2million to Peninsula Capital Partners LLC (“Peninsula Capital”), an entityowned by Mr. Wiederhorn, for the Company’s business use of certain privateaircraft.  The Board of Directors isaware of the relationship and approved the fees for the use of theaircraft.  The fee paid is areimbursement of costs to Peninsula Capital for the Company’s use of theaircraft.

 

**StockPurchase**

 

On April 28,2004, the Company purchased 330,500 shares of its common stock from Clarence B.Coleman, who at the time was a greater than 10% stockholder.  The purchase price was $5.40 per share ($1.8million) and the shares were added to treasury stock.  At the time of the purchase, the price represented a smallpremium to the Company’s book value per share and market price per share. TheCompany and its directors considered, among other things, the followingfactors:  (1) the potentially negativeimpact on the Company’s share price if the shares were disposed of publicly;(2) the Company’s favorable liquidity position; (3) the potential reduction inthe risk that shares are transferred in a transaction which would have anadverse impact on its NOL position; and (4) the reduction in the futureexpenditure of cash dividends by the Company. The Board of Directors reviewed and approved the transaction to confirmthat the transaction was in the best interest of the Company and its otherstockholders.

 

**Call Option**

 

On April 27,2004, the Company purchased an option (the “Call Option”) to acquire 423,245shares of the Company’s Common Stock from Mr. Wiederhorn, the Company’s formerChief Executive Officer and current Chief Strategic Officer, during a threeyear period commencing April 27, 2004, for an exercise price of $3.99 pershare.  The purchase price for the CallOption was $750,000, resulting in an “all-in” cost to the Company on exerciseof approximately $5.76 per share.  TheCompany and its directors believe that the Call Option gives the Company auseful option to acquire a large block of stock over an extended period.  The aggregate price to the Company onexercise of $5.76 per share represented a small premium to the Company’s bookvalue per share and market price per share at the time the option waspurchased.  The price was determinedbased on arm’s length negotiations and the Company obtained internal andindependent valuations of the Call Option. The Company and its directors also considered the followingfactors:  (1) the potentially negativeimpact on the Company’s share price if the Option Shares were disposed ofpublicly; (2) the Company’s favorable liquidity position; (3) the potentialreduction in the risk that shares are transferred in a transaction which wouldhave an adverse impact on its NOL position; and (4) the reduction in the futureexpenditure of cash dividends by the Company once the Company exercises theCall Option.  The Board of Directorsreviewed the transaction to confirm that the transaction was in the bestinterest of the Company and its other stockholders.

 

41

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**Leaveof Absence Agreement**

 

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

 

Under the Settlement’sterms, Mr. Wiederhorn pled guilty on June 2, 2004 to two federal counts and wassentenced to 18 months incarceration and fined $2.0 million.  The first count, a violation of an ERISAprovision, involved a federal law that required no criminal intent and forwhich the advice of counsel was not a defense. The second count related to aviolation involving a deduction on a personal tax return, which did not reduceMr. Wiederhorn’s tax liability or reduce the government’s tax collections.  The charges to which Mr. Wiederhorn has pledguilty pursuant to the Settlement are not based upon any acts or omission ofthe Company or of Mr. Wiederhorn in his capacity as an officer or director ofthe Company.

 

In enteringinto Mr. Wiederhorn’s leave of absence agreement, the Board of Directorsconsidered the nature of the statutes to which Mr. Wiederhorn pled and the factthat he relied entirely on the advice of expert legal counsel and a nationalaccounting firm.  The Board alsobelieved it was important to assure Mr. Wiederhorn’s return to activeinvolvement with the Company because of his expertise and knowledge and topreserve a significant business relationship and the value of the Company’sinvestments.

 

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

 

**Item 6.****           Exhibitsand 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 April 1, 2004 announcing the resignation on March 26, 2004 of RobertG. Rosen as president and as a director of the Company and all of its subsidiariesand affiliates.

 

A Form 8-K was filed with the Securities and ExchangeCommission by the Company on May 13, 2004 announcing the results of operationsand financial condition for the three months ending March 31, 2004.

 

A Form 8-K was filed with the Securities and Exchange Commission by theCompany on May 14, 2004 announcing an increase in the Company’s investment inFatburger Holdings, Inc.

 

A Form 8-K was filed with the Securities and Exchange Commission by theCompany on June 4, 2004 announcing that Chairman and Chief Executive OfficerAndrew Wiederhorn had reached a settlement in the government investigation ofthe collapse of Capital Consultants LLC and would take a paid leave of absencefrom the Company.

 

A Form 8-K was filed with the Securities and Exchange Commission by theCompany on July 23, 2004 announcing that Ernst & Young LLP would resign asthe Company’s certifying accountants following the completion of the Company’sForm 10-Q for the six months ending June 30, 2004.

 

A Form 8-K was filed with the Securities and Exchange Commission by theCompany on August 13, 2004 announcing the Nasdaq staff determination to de-listthe Company from the Nasdaq Stock Market.

 

(b) Exhibits

 

See Exhibit Index immediately following the signature page andcertifications.

 

42

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**SIGNATURES**

 

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

 
|                        | FOG CUTTER  CAPITAL GROUP INC.                     |   |
|-----------------------------|----------------------------------------------------|--------|
|                        |                                               |   |
|                        | By:  /s/ Donald J. Berchtold                  |   |
|                        | Donald J.  Berchtold                               |   |
|                        | Chief  Executive Officer                           |   |
|                        |                                               |   |
|                        | By:  /s/ R. Scott Stevenson                   |   |
|                        | R. Scott  Stevenson                                |   |
|                        | Senior Vice  President and Chief Financial Officer |   |
|                        |                                               |   |
| Date:  August 16, 2004 |                                               |
|                             |                                                    |        |  |

 

43

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**Exhibit Index**

 
| 2.1    |   | Purchase and  Sale Agreement between WREP Islands, Limited and The Aggmore Limited  Partnership, dated November 19, 2001, incorporated by reference to Exhibit  2.1 to a Form 8-K dated November 19, 2001, as previously filed with the SEC  on December 4, 2001.                                                |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                             |
| 2.2    |   | Loan Option  Agreement, by and between the Registrant and entities listed therein, dated  January 1, 2002, incorporated by reference to Exhibit 2.1 to the Form 8-K  dated March 6, 2002, as previously filed with the SEC on March 8, 2002.                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                             |
| 2.3    |   | Property  Option Agreement, by and between the Registrant and the entities listed  therein, dated effective March 6, 2002, incorporated by reference to Exhibit  2.2 to the Form 8-K dated March 6, 2002, as previously filed with the SEC on  March 8, 2002.                                                    |
|   |   |                                                                                                                                                                                                                                                                                                             |
| 2.4    |   | Medium Term  Participation Agreement by and among Fog Cap L.P. and participants listed  therein, dated March 6, 2002, incorporated by reference to Exhibit 2.3 to the  Form 8-K dated March 6, 2002, as previously filed with the SEC on March 8,  2002.                                                         |
|   |   |                                                                                                                                                                                                                                                                                                             |
| 2.5    |   | Interim  Finance and Stock Purchase Agreement, by and between the entities listed  therein and the Registrant, dated as of August 15, 2003, incorporated by  reference to Exhibit 2.5 to the Form 10-Q for the period ended September 30,  2003, as previously filed with the SEC on November 13, 2003.          |
|   |   |                                                                                                                                                                                                                                                                                                             |
| 2.6    |   | Fatburger  Holdings Inc. Preferred Stock Purchase Agreement, by and between the entities  listed therein and the Registrant, dated as of January 12, 2004, incorporated by reference to Exhibit  2.6 to the Form 10-K for the year ended December 31, 2003, as previously  filed with the SEC on March 19, 2004. |
|   |   |                                                                                                                                                                                                                                                                                                             |
| 2.7    |   | March 2004  Supplemental Agreement, by and between Fatburger Holdings, Inc. and the  Registrant, dated as of March 10, 2004, incorporated by reference to Exhibit 2.7 to the  Form 10-K for the year ended December 31, 2003, as previously filed with the  SEC on March 19, 2004.                               |
|   |   |                                                                                                                                                                                                                                                                                                             |
| 3.1    |   | Amended and  Restated Articles of Incorporation of the Registrant, incorporated by  reference to Exhibit 3.1 to the Form 10-Q for the period ended September 30,  1999, as previously filed with the SEC on November 22, 1999.                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                             |
| 3.2    |   | Bylaws of  the Registrant, incorporated by reference to Exhibit 3.2 to Amendment No. 3  to the Registration Statement (Registration No. 333-39035) on Form S-11, as  previously filed with the SEC on March 30, 1998.                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                             |
| 4.1    |   | Common Stock  Certificate Specimen, incorporated by reference to Exhibit 4.1 to Amendment  No. 3 to the Registration Statement (Registration No. 333-39035) on Form  S-11, as previously filed with the SEC on March 30, 1998.                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                             |
| 4.2    |   | Form of  Registration Rights Agreement, incorporated by reference to Exhibit 10.8 to  Amendment No. 3 to the Registration Statement (Registration No. 333-39035) on  Form S-11, as previously filed with the SEC on March 30, 1998.                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                             |
| 4.3    |   | Form of  Stock Option Plan, incorporated by reference to Exhibit 10.3 to Amendment No.  3 to the Registration Statement (Registration No. 333-39035) on Form S-11, as  previously filed with the SEC on March 30, 1998.                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                             |
| 4.4    |   | Long Term  Vesting Trust Agreement among the Registrant and Lawrence Mendelsohn, Andrew  Wiederhorn and David Egelhoff, dated October 1, 2000, incorporated by  reference to Exhibit 4.4                                                                                                                         |

 

44

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|   |   | to the Form  10-K for the year ended December 31, 2002, as previously filed with the SEC  on March 3, 2003.                                                                                                                                                                                                                                                         |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                |
| 4.5    |   | Waiver,  Release, Delegation and Amendment to Stock Option and Voting Agreement among  Andrew A. Wiederhorn, Lawrence A. Mendelsohn, Joyce Mendelsohn, Tiffany  Wiederhorn, and the Registrant, dated July 31, 2002, incorporated by  reference to Exhibit 2.1 to the Form 8-K dated August 8, 2002, as previously  filed with the SEC on August 15, 2002.          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                |
| 4.6    |   | Summary of  Rights to Purchase Shares, incorporated by reference to Exhibit 99.1 to the  Form 8-K dated October 18, 2002, as previously filed with the SEC on October  18, 2002.                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                |
| 4.7    |   | Rights  Agreement dated as 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 with the SEC on October 29, 2002.                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                |
| 10.1   |   | Deed of  Trust, by and among WREP Islands Limited, The Aggmore Limited Partnership and  the Registrant and Fog Cap L.P., dated November 19, 2001, incorporated by  reference to Exhibit 2.2 to the Form 8-K dated November 19, 2001, as  previously filed with the SEC on December 12, 2001.                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                |
| 10.2   |   | Stock Option  Agreement, by and among individuals listed on Schedule 4 thereto, Aggmore  Limited Partnership acting through its General Partner, Anglo Irish Equity  Limited and the Registrant, dated November 19, 2001, incorporated by  reference to Exhibit 2.3 to the Form 8-K dated November 19, 2001, as  previously filed with the SEC on December 4, 2001. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                |
| 10.3   |   | Amended and  restated Employment Agreement between the Registrant and Andrew A.  Wiederhorn, incorporated by reference to Exhibit 10.3 to the Form 8-K dated  August 13, 2003, as previously filed with the SEC on August 13, 2003.                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                |
| 10.4   |   | Amended and  restated Employment Agreement, effective as of December 1, 2003, between the  Registrant and Robert G. Rosen, incorporated by reference to Exhibit 99.1 to  the Form 8-K as previously filed with the SEC on February 11, 2004.                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                |
| 10.5   |   | Employment  Agreement between the 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.                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                |
| 10.6   |   | Leave of  Absence Agreement between the Registrant and Andrew A. Wiederhorn dated as of  June 2, 2004, incorporated by reference to Exhibit 10.1 to the Form 8-K dated  June 4, 2004, as previously filed with the SEC on June 4, 2004.                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                |
| 11.1   |   | Computation  of Per Share Earnings.                                                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                |
| 31.1   |   | Certification  of Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002.                                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                |
| 31.2   |   | Certification  of Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002.                                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                |
| 32.1   |   | Certification  of the Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                           |

 

45

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| 32.2   |   | Certification  of the Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                         |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 99.1   |   | Letter,  dated October 28, 1998, from Steven Kapiloff to Andrew Wiederhorn,  incorporated by reference to Schedule 99.2 to the Form 10-Q for the period  ended September 30, 1998, as previously filed with the SEC on November 23,  1998.                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 99.2   |   | Letter dated  November 12, 1999 from Arthur Andersen LLP, incorporated by reference to  Exhibit 99.1 to the Form 8-K dated November 12, 1999, as previously filed  with the SEC on November 15, 1999.                                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 99.3   |   | Settlement  Agreement, dated as of December 10, 1999 by and between the Registrant, on  behalf of itself and all of its subsidiaries and affiliates, Andrew A.  Wiederhorn, and Lawrence A. Mendelsohn, and Wilshire Financial Services Group  Inc., on behalf of itself and all of its subsidiaries and affiliates, other  than First Bank of Beverly Hills, F.S.B., incorporated by reference to  Exhibit 99.1 to the Form 8-K dated December 13, 1999, as previously filed  with the SEC on December 17, 1999. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 99.4   |   | Jordan D.  Schnitzer Resignation Letter dated March 5, 2002, incorporated by reference  to Exhibit 1.1 to the Form 8-K dated March 5, 2002, as previously filed with  the 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   |   | Lawrence A.  Mendelsohn Resignation Letter dated August 30, 2002, incorporated by  reference to Exhibit 1.1 to the Form 8-K dated August 30, 2002, as previously  filed with the SEC on September 3, 2002.                                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 99.7   |   | Robert G.  Rosen Resignation Letter dated March 26, 2004, incorporated by reference to  Exhibit 99.1 to the Form 8-K dated April 1, 2004, as previously filed with  the SEC on April 1, 2004.                                                                                                                                                                                                                                                                                                                     |

 

46

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