ITEM 1. BUSINESS
Business Overview
Fog Cutter Capital Group Inc. is primarily engaged in the operations of its Fatburger Holdings, Inc. (“Fatburger”) restaurant business. We acquired the controlling interest in Fatburger in August 2003 and own 82% voting control as of December 31, 2007. In addition to our restaurant operation, we also conduct manufacturing activities, software development and sales activities, and make real estate and other real estate-related investments through various controlled subsidiaries.
The Company was originally incorporated as Wilshire Real Estate Investment Trust Inc. in the State of Maryland on October 24, 1997. However, we chose not to elect the tax status of a real estate investment trust and on January 25, 2001, we changed our name to Fog Cutter Capital Group Inc. to better reflect the diversified nature of our business. Our stock is traded on the OTC Bulletin Board market under the ticker symbol “FCCG.OB”.
Our website is www.fogcutter.com. We make our annual report on Form 10-K, as well as other periodic reports filed with the Securities and Exchange Commission, available free of charge through our website as soon as reasonably practicable after they are filed. A copy of our annual report may also be obtained by writing to us at 1410 SW Jefferson Street, Portland, Oregon 97201, Attn: Investor Reporting.
Segment financial data for the years ended December 31, 2007, 2006 and 2005 for the Company is included in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7, and in the related Consolidated Financial Statements and footnotes in Part II, Item 8 of this report on Form10-K.
Operating Segments
Our operating segments are:
(i) Restaurant Operations - conducted through our Fatburger subsidiary,
(ii) Manufacturing Operations - conducted through our wholly owned subsidiary, DAC International (“DAC”),
(iii) Real Estate and Finance Operations, and
(iv) Software Development and Sales Operations - conducted through our subsidiary, Centrisoft Corporation (“Centrisoft”).
Due to the varied nature of our operations, we do not utilize a standard array of key performance indicators in evaluating our results of operations. Our evaluation instead focuses on an investment-by-investment or asset-by-asset analysis within our operating segments.
Restaurant Operations
Fatburger, “The Last Great Hamburger Stand”®, opened its first restaurant in Los Angeles in 1952. As of December 31, 2007, there were 92 Fatburger restaurants located in 14 states and in Canada and China. The restaurants specialize in fresh, made to order hamburgers and other specialty sandwiches. French fries, homemade onion rings, hand-scooped ice cream shakes and soft drinks round out the menu.
We plan to open additional Fatburger restaurants throughout the United States and internationally, including Canada, China and the United Arab Emirates. Seven new restaurants were opened during 2007, which included five franchise locations and two company-owned locations. In addition, Fatburger purchased two restaurants from franchisees during 2007. We intend to continue to open company-owned restaurants in strategic markets and increase the number of franchised locations in the U.S. and internationally. Fatburger has opened a total of 43 restaurant locations since our acquisition in 2003. At December 31, 2007, franchisees owned and operated 53 of the Fatburger locations and we have agreements for approximately 245 new franchise locations. Many factors affect our ability to open new franchise locations and we expect that it will take several years for our current franchisees to open all of their restaurant locations. As is typical for our industry, the identification of qualified franchisees and quality locations has an impact on the rate of growth in the number of our restaurants.
Our restaurant business is moderately seasonal, as average restaurant sales are slightly higher during the summer months than during the winter months. As such, results from our restaurant operations for any quarter are not necessarily indicative of results for any other quarter or for the full fiscal year.
Fatburger’s fiscal year ends on the last Sunday in December and, as a result, a 53rd week is added to the fiscal year every 5 or 6 years. Fiscal year 2006 includes a 53rd week. In a 52-week year, all four quarters are comprised of 13 weeks. In a 53-week year, one extra
week is added to the fourth quarter.
Manufacturing Operations
We conduct manufacturing activities through our wholly-owned subsidiary, DAC International. We assumed 100% voting control of DAC in November 2005 and began reporting the operations of DAC on a consolidated basis as of November 1, 2005. DAC is a supplier of computer controlled lathes and milling machinery for the production of eyeglass, contact, and intraocular lenses. In order to focus our efforts on our restaurant segment, we intend to sell our equity position in DAC for an amount higher than our net investment. If we were to sell this segment, it would decrease our net revenue and increase our net loss. There can be no assurance that we will be able to sell this segment, or that we will be able to sell it for a profit.
Real Estate and Financing Operations
We own various interests in real estate and notes receivable. At December 31, 2007, real estate is comprised of leasehold interests in 72 freestanding retail buildings located throughout the United States and two apartment buildings located in Barcelona, Spain. At December 31, 2007, we also own notes receivable that have a carrying value of $1.8 million and are primarily secured by real estate. We expect that as we focus our attention on the expansion of Fatburger, our future investments in this segment will become less frequent. Subsequent to December 31, 2007, we sold our subsidiary, Fog Cap Retail Investors LLC (“FCRI”) which held the leasehold interest portfolio. Also subsequent to December 31, 2007, we received payment in full on one loan in the amount of $1.1 million.
Software Development and Sales Operations
We hold a 79% ownership interest in Centrisoft, which conducts software development and sales activities. We began reporting the operations of Centrisoft on a consolidated basis as of July 1, 2005, when majority voting control was obtained. Centrisoft develops and sells software that controls and enhances the productivity of enterprise networks and provides first level security against unauthorized applications and users. In order to focus our efforts on our restaurant segment, we intend to sell all, or a portion of, our equity position in Centrisoft. If we were to sell this segment, we believe that it would have a positive effect on our cash flow and decrease our net loss. There can be no assurance that we will be able to sell this segment. We do not expect any material positive contribution to our financial results from this segment in the near term.
Principal Assets
We have set forth below information regarding our principal assets at December 31, 2007 and 2006:
(1) Excludes loans to senior executives
The following sections provide additional information on our principal assets and operations as of December 31, 2007.
Restaurant Operations
We acquired the controlling interest in Fatburger in August 2003. Our investment at December 31, 2007 consists of:
(i) Series A Preferred Stock - convertible preferred stock which is convertible into a 50% ownership interest of the common stock of Fatburger on a fully diluted basis. As of December 31, 2007, we own approximately 93% of the issued and outstanding
Series A Preferred stock, and currently hold voting rights equal to 82% of the voting control of Fatburger. The Series A Preferred stock is not redeemable and does not pay dividends.
(ii) Series D Preferred Stock - redeemable convertible preferred stock which has a liquidation preference. Dividends accrue at a rate of 20% of the redemption value, compounded annually. As of December 31, 2007, the redemption amount totaled $19.8 million. The Series D Preferred Stock does not have any voting rights but may be converted into common stock under certain circumstances. We own all of the issued and outstanding shares of Series D Preferred Stock.
(iii) Common Stock - during 2006, we invested an additional $5.0 million in Fatburger to acquire common stock equal to 15% of the fully diluted ownership of Fatburger.
As a result of our voting control, we report the operations of Fatburger on a consolidated basis. The accompanying consolidated statements of financial condition include the following at December 31, 2007 relating to Fatburger:
· $8.3 million in property, plant and equipment, net;
· $4.8 million of intangible assets, primarily trademarks and franchises;
· $7.1 million of goodwill; and
· $7.2 million of borrowings and notes payable consisting of:
(i) $6.1 million debt secured by substantially all of the assets of Fatburger, bearing interest at rates currently ranging from 6.5% to 9.3%, and requiring monthly payments of principal and interest, primarily through 2014. At December 31, 2007 and 2006, Fatburger was not in compliance with all obligations under the agreements evidencing its indebtedness, as defined in the applicable agreements, due to its failure to meet the prescribed fixed charge coverage ratio and the prescribed debt-coverage ratio in three notes payable. The lender subsequently issued a waiver of the covenant violations for both December 31, 2007 and 2006. As such, on our Consolidated Statements of Financial Condition, $4.1 million of long-term debt that was classified as current at December 31, 2006 has been re-classified as long-term.
(ii) Mandatory redeemable preferred stock (the “Series B Preferred”) with a carrying value of $1.2 million which was issued by Fatburger to a third party on August 15, 2003. This stock is redeemable by Fatburger for $1.5 million at any time, but must be redeemed by August 15, 2009. Under certain circumstances, the Series B Preferred shareholders may convert their shares into the common stock of Fatburger in an amount equal to the redemption price based upon the fair value of the common stock at the time of conversion. The stock accrues dividends from Fatburger equal to 2.5% per annum of the redemption price and does not have voting rights.
In September 2007, Fatburger opened its first joint-venture location in China, at the Venetian Macao-Resort-Hotel in Macao. This joint-venture location pays a management fee to Fatburger in the amount or 10% of net sales, which is eliminated upon consolidation. In all other respects, this location operates similar to our other company-owned locations.
Manufacturing Operations
In November 2005, we assumed 100% voting control of DAC International through a Shareholder’s Pledge Agreement which was assigned to us in August 2002 as part of DAC’s debt restructuring. As a result of our voting control, we began consolidating the assets, liabilities and operations of DAC on November 1, 2005. The accompanying consolidated statements of financial condition include the following at December 31, 2007 relating to DAC:
· $2.3 million of inventory;
· $0.9 million in trade receivables;
· $1.5 million of goodwill;
· $0.5 million of borrowings; and
· $2.2 million of accounts payable and accrued liabilities, including $1.5 million of sales deposits.
Real Estate and Financing Operations
Real Estate - We invest, both directly and indirectly, in commercial and residential real estate. The following table sets forth information regarding our direct investments in real estate at December 31, 2007:
The following is a brief description of each of the properties set forth in the above table:
· Freestanding Retail Properties - We own, through capital leases, 32 freestanding retail buildings throughout the United States. The buildings are approximately 4,500 square feet each and were originally developed during the 1970’s and 1980’s. The buildings are leased to a variety of tenants including convenience stores, video rental outlets, shoe stores and other small businesses. As of December 31, 2007, one of the buildings was vacant. We also control 40 similar retail locations through operating leases. During 2007, we sold one similar property that had been held in the same portfolio for $0.4 million, and allowed the leases to expire on one similar property with no penalty. Subsequent to December 31, 2007, we sold FCRI, which held this leasehold portfolio. We have the option, but not the obligation, to re-purchase FCRI before February 2010.
· Barcelona Apartments - This investment includes two apartment buildings, consisting of 33 residential and commercial units, located in Barcelona, Spain. The two buildings were acquired subject to below market leases and we are working to relocate these tenants in order to enhance the value of the properties.
· Indebtedness - When it is beneficial to do so, our general strategy is to leverage our real estate investments by incurring borrowings secured by these investments. Set forth below is information regarding our indebtedness relating to our real estate as of December 31, 2007.
Notes receivable - Our portfolio consists primarily of three notes with a total outstanding principal balance of $0.6 million, not including loans to senior executives. One note, with a carrying value of $0.2 million, is secured by the stock of a restaurant business. The remaining notes, with a total carrying value of $0.4 million, are secured by commercial real estate.
Two notes mature in 2008 and the other matures in 2010. Based upon our carrying value, the effective aggregate interest rate on these notes at December 31, 2007 was approximately 14.4%. The effective interest rate does not reflect the effect of points and fees collected.
Software Development and Sales Operations
Between December 2004 and July 2005, we loaned a total of $2.2 million to Centrisoft Corporation. In July 2005, we converted our investment into a 51% controlling interest in Centrisoft and began consolidating their assets, liabilities and operations in our financial statements. Since July 2005, through various additional investments in Centrisoft, we have increased our ownership percentage to 79%. The accompanying consolidated statements of financial condition include the following at December 31, 2007 relating to Centrisoft.
· $0.9 million in software costs (net of amortization);
· $0.2 million in net intangible assets in the form of reseller agreements;
· $1.0 million of goodwill, net of $1.0 million impairment recognized in the year ended December 31, 2007;
· $0.6 million of accounts payable and accrued liabilities; and
· $0.7 million of notes payable.
Assets Held for Sale
At December 31, 2007, our wholly-owned subsidiary, FCRI, held our real estate lease portfolio. In the fourth quarter of 2007, FCRI met our requirements to be classified as held for sale, and we sold FCRI in February 2008, subsequent to year end. As such, all assets of FCRI have been classified as held for sale at December 31, 2007 and 2006. Prior to our decision to sell FCRI, it was part of our Real Estate and Financing Operations.
At December 31, 2006, we held a 51% ownership interest in George Elkins Mortgage Banking Company (“George Elkins”), a California commercial mortgage banking operation. In December 2006, we reached an agreement to sell George Elkins to a third party and the sale closed in February 2007. As such, all assets of George Elkins have been classified as held for sale at December 31, 2006. Prior to the decision to sell George Elkins, it was a reportable segment of our operations.
Funding Sources
Funding sources for real property assets generally involve capital leases or longer-term traditional mortgage financing with banks and other financial institutions. Other funding sources include short-term notes payables from private lenders and a line of credit from a financial institution. The following table sets forth information relating to our borrowings and other funding sources at December 31, 2007 and 2006:
The following table sets forth certain information related to our borrowings. During the reported periods, borrowings were comprised of various notes payable, mortgage debt on real estate and obligations under capital leases. Averages are determined by utilizing month-end balances.
Asset Quality
Our real estate investments are carried at the lower of historical cost (net of depreciation) or estimated market value. Our estimate of market value is based upon comparable sales information for similar properties and management’s best estimate of market value given current market conditions. Our notes receivable portfolio is secured by real estate and corporate stock. We evaluate the quality of our notes based upon the underlying value of the collateral. We also give consideration to the credit performance of these notes.
Employees
As of December 31, 2007, we had approximately 724 employees, which included approximately 660 employees of Fatburger, 50 employees of DAC, and 4 employees of Centrisoft.
Intellectual Property
We believe our trademarks and service marks have significant value and are important to our marketing efforts. To protect our proprietary rights, we rely primarily on a combination of copyright, trade secret and trademark laws, confidentiality agreements with employees and third parties, and protective contractual provisions such as those contained in license agreements with consultants, vendors and customers, although we have not signed these agreements in every case. Despite our efforts to protect our proprietary rights, unauthorized parties may copy aspects of our products and obtain and use information that we regard as proprietary. Other parties may breach confidentiality agreements and other protective contracts we have entered into, and we may not become aware of, or have adequate remedies in the event of, any breach. Our policy is to pursue registration of our marks whenever possible and to oppose vigorously any infringement of these marks.
“Fatburger” and “The Last Great Hamburger Stand” are registered trademarks in the United States and in a number of international jurisdictions. All other trademarks or service marks appearing in this report are trademarks or service marks of the respective companies that use them. We pursue the registration of some trademarks and service marks in the United States and in other countries, but we have not secured registration of all our marks. In addition, the laws of some foreign countries do not protect our proprietary rights to the same
extent as do the laws of the United States, and effective copyright, trademark and trade secret protection may not be available in other jurisdictions. We license trademark rights to third parties through our franchise agreements. In the event that a licensee does not abide by compliance and quality control guidelines with respect to the licensed trademark rights or take actions that fail to adequately protect these marks, the value of these rights and our use of them in our business may be negatively impacted.
Competition
The restaurant industry, particularly the fast casual segment, is highly competitive and there are numerous well-established competitors possessing substantially greater financial, marketing, personnel and other resources than we have. In addition, the fast casual restaurant industry is characterized by the frequent introduction of new products, accompanied by substantial promotional campaigns. In recent years, numerous companies in the fast casual industry, including Fatburger, have introduced products positioned to capitalize on growing consumer preference for food products which are, or are perceived to be, healthful, nutritious, low in calories and low in fat content. It can be expected that Fatburger will be subject to competition from companies whose products or marketing strategies address these consumer preferences. In addition, the market for suitable restaurant locations, franchisees, and staff is highly competitive in that fast casual companies, major restaurant companies and non-food companies compete for the best in all of these resources.
Where You Can Find Additional Information We are a reporting company and file annual, quarterly and current reports, proxy statements and other information with the SEC. For further information with respect to us, you may read and copy our reports, proxy statements and other information, at the SEC’s public reference rooms at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549, as well as at the SEC’s regional offices at 500 West Madison Street, Suite 1400, Chicago, IL 60661 and at 233 Broadway, New York, NY 10279. You can request copies of these documents by writing to the SEC and paying a fee for the copying cost. Please call the SEC at 1-800-SEC-0330 for more information about the operation of the public reference rooms. Our SEC filings are also available at the SEC’s web site at www.sec.gov.
Copies of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, our proxy statement and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as well as certain of our corporate governance documents are all available on our website (www.fogcutter.com) or by sending a request for a paper copy to: 1410 SW Jefferson Street, Portland, Oregon 97201, Attn: Investor Reporting.
ITEM 1A.
ITEM 1A. RISK FACTORS
In addition to the other information contained in this annual report, you should carefully read and consider the following risk factors. If any of these risks actually occur, our business, financial condition or operating results could be materially adversely affected and the trading price of our common stock could decline.
Risks related to us and our common stock - Generally
The delisting of our common stock from the NASDAQ Stock Market could impair our ability to finance our operations through the sale of common stock or securities convertible into common stock.
Effective October 14, 2004, due to a NASDAQ staff determination to delist our common stock, our stock began trading in the over-the-counter (“OTC”) market. Prior to the delisting, our common stock was quoted on the NASDAQ Stock Market. The liquidity of our common stock is reduced by trading on the OTC market as compared to quotation on the NASDAQ Stock Market. The coverage of the Company by security analysts and media could be reduced, which could result in lower prices for our common stock than might otherwise prevail and could also result in increased spreads between the bid and ask prices for our common stock. Additionally, certain investors will not purchase securities that are not quoted on the NASDAQ Stock Market, which could materially impair our ability to raise funds through the issuance of common stock or other securities convertible into common stock.
Because the trading price of our common stock is current below $5.00 per share, trading in our common stock is subject to certain restrictions and the market for our common stock could diminish.
Because the trading price of our common stock is less than $5.00 per share, trading in our common stock is subject to Rule 15g-9 of the Securities Exchange Act of 1934, as amended. Under that Rule, brokers who recommend such securities to persons other than established customers and accredited investors must satisfy special sales practice requirements, including an individualized written suitability determination for the purchaser and the purchaser’s written consent prior to any transaction. The Securities Enforcement Remedies and Penny Stock Reform Act of 1990 also requires additional disclosure in connection with any trades involving a stock defined as a penny stock (generally, any equity security not traded on an exchange or quoted on NASDAQ that has a market price of less than $5.00 per share), including the delivery of a disclosure schedule explaining the penny stock market and the associated risks. Such requirements could severely limit the market liquidity of our common stock.
Changes in interest rates and currency exchange rates affect our net income.
Our borrowings and the availability of further borrowings are substantially affected by, among other things, changes in interest rates. Fluctuations in interest rates will affect our net income to the extent our operations and our fixed rate assets are funded by variable rate debt. We are also affected by foreign currency exchange rate changes, as a significant portion of our assets are invested in foreign currencies, mainly the euro. See Item 7A - Quantitative and Qualitative Disclosures about Market Risk for further analysis of the impact of interest and currency rate fluctuations on our financial condition and results of operations.
If we do not retain our key employees and management team our ability to execute our business strategy will be limited.
Our future performance will depend largely on the efforts and abilities of our key executive, finance and accounting, and managerial personnel, and on our ability to attract and retain them. The loss of one or more of our senior management personnel may adversely affect our business, financial condition or operating results. When we lose key employees, new employees must spend a significant amount of time learning our business model in addition to performing their regular duties and integration of these individuals often results in some disruption to our business. In addition, our ability to execute our business strategy will depend on our ability to recruit and retain key personnel. Our key employees are not obligated to continue their employment with us and could leave at any time. As part of our strategy to attract and retain personnel, we offer stock option grants to certain employees. However, given the fluctuations of the market price of our common stock, potential employees may not perceive our equity incentives such as stock options as attractive, and current employees whose options are no longer priced below market value may choose not to remain employed by us. In addition, due to the intense competition for qualified employees, we may be required to increase the level of compensation paid to existing and new employees, which could materially increase our operating expenses.
We may be subject to litigation, which may be expensive and may be time consuming for our management team.
We vigorously defend ourselves in litigation, which can cause increased professional fees from our external legal counsel, and may be time consuming for our management team. If we fail to succeed in defending ourselves in certain lawsuits, our liquidity could be negatively affected. See Item 3 - Legal Proceeds for detailed description of current litigation.
Changes to our liquidity may affect our net income and future business plans.
The Company considers the sale of real estate and other investments to be a normal, recurring part of operations and expects these transactions to generate adequate cash flow to meet the Company’s liquidity needs for the next year. The Company has experienced losses from operations since its 2004 fiscal year. During this period, the Company’s operations and activities have become more focused on restaurant and other more typical commercial business activities and have been transitioning away from finance and real estate activities. The growth strategies for the restaurant and other commercial operations, as well as administrative cost burdens, may threaten the Company’s liquidity position.
If our existing liquidity position were to prove insufficient, and we were unable to repay, renew or replace maturing indebtedness on terms reasonably satisfactory to us, we may be required to sell (potentially on short notice) a portion of our assets, and could incur losses as a result. Specific risks to our liquidity position include, but are not limited to, currency and interest rate risk, Fatburger’s debt covenants, Fatburger’s store expansion, and Centrisoft’s operating deficits.
Risks related to Fatburger
Fatburger debt covenant
At December 31, 2007 and 2006, Fatburger was not in compliance with all obligations under the agreements evidencing its indebtedness, as defined in the applicable agreements, due to its failure to meet the prescribed fixed charge coverage ratio and the prescribed debt-coverage ratio in three notes payable. The lender subsequently issued a waiver of the covenant violations for both December 31, 2007 and 2006. There can be no assurance that Fatburger will be able to comply with all of its obligations under the agreements evidencing its indebtedness in the future, or that lenders will agree to waive future defaults. Failure to satisfy covenants in the Company’s loan documents may result in a defaults and acceleration of outstanding obligations, which could have a material adverse impact on our business, prospects, financial condition, or results of operations.
Fatburger may not be able to achieve its planned expansion.
We believe the Fatburger segment of our business will constitute an increasingly important part of our business going forward. In addition to the risks associated generally with a restaurant business, such as changing consumer tastes and price pressure from competing businesses, our success depends in large part on our ability to expand Fatburger’s operations. We intend to grow Fatburger primarily through developing additional new franchisee and Company-owned restaurants. Development involves substantial risks, including:
· the availability of financing to Fatburger and to franchisees at acceptable rates and upon acceptable terms;
· the availability of sufficient liquidity to fund continued expansion;
· development costs exceeding budgeted or contracted amounts;
· delays in the completion of construction;
· the inability to identify, or the unavailability of, suitable sites on acceptable leasing or purchase terms;
· developed properties not achieving desired revenue or cash flow levels once opened;
· incurring substantial unrecoverable costs in the event that a development project is abandoned prior to completion;
· the inability to obtain all required governmental permits;
· changes in governmental rules, regulations and interpretations; and
· changes in general economic and business conditions.
Although we intend to manage Fatburger’s operations and development to reduce such risks, we cannot assure you that present or future development will perform in accordance with our expectations. We cannot assure you that we will complete the development and construction of the restaurants, or that any such development will be completed in a timely manner or within budget, or that any restaurants will generate our expected returns on investment. Our inability to expand Fatburger in accordance with our plans or to manage our growth could have a material adverse effect on our results of operations and financial condition.
We may not be able to obtain financing sufficient to fund our planned expansion of Fatburger.
We are implementing a nationwide and international expansion of franchise and company-owned locations of Fatburger, which will require significant liquidity. If Fatburger or its franchisees are unsuccessful in obtaining capital sufficient to fund this expansion, the timing of restaurant openings may be delayed and Fatburger’s results may be harmed.
Fatburger’s success depends on its ability to locate a sufficient number of suitable new restaurant sites.
One of the biggest challenges in meeting our growth objectives for Fatburger will be to secure an adequate supply of suitable new restaurant sites. We have experienced delays in opening some Fatburger restaurants and may experience delays in the future. There can be no assurance that sufficient suitable locations will be available for our planned expansion in any future period. Delays or failures in opening new restaurants could materially adversely affect Fatburger’s performance and our business, financial condition, operating results and cash flows. In addition, Fatburger is expanding into international markets which may have additional challenges and requirements.
New restaurants, once opened, may not be profitable, if at all, for several months.
We anticipate that new Fatburger restaurants will generally take several months to reach normalized operating levels due to inefficiencies typically associated with new restaurants, including lack of market awareness, the need to hire and train a sufficient number of team members, operating costs, which are often materially greater during the first several months of operation than thereafter, pre-opening costs and other factors. Further, some, or all of the new restaurants may not attain anticipated operating results or results similar to those of Fatburger’s existing restaurants. In addition, restaurants opened in new markets may open at lower average weekly sales volumes than restaurants opened in existing markets and may have higher restaurant-level operating expense ratios than in existing markets. Sales at restaurants opened in new markets may take longer to reach average annual company-owned restaurant sales, if at all, thereby affecting the profitability of these restaurants.
Fatburger’s existing systems and procedures may be inadequate to support our growth plans.
We face the risk that Fatburger’s existing systems and procedures, restaurant management systems, financial controls, information and accounting systems, management resources and human resources will be inadequate to support our planned expansion of company-owned and franchised restaurants. Expansion may strain Fatburger’s infrastructure and other resources, which could slow restaurant development or cause other problems. We may not be able to respond on a timely basis to all of the changing demands that our planned expansion will impose on Fatburger’s infrastructure and other resources. Any failure by us to continue to improve our infrastructure or to manage other factors necessary for us to achieve Fatburger’s expansion objectives could have a material adverse effect on our operating results.
The fast casual restaurant segment is highly competitive, and that competition could lower revenues, margins and market share.
The fast casual restaurant industry is highly competitive with respect to price, service, location, personnel and the type and quality of food, and there are many well-established competitors. Each of Fatburger’s restaurants competes directly and indirectly with a large number of national and regional restaurant chains, as well as with locally-owned quick service restaurants, fast casual restaurants, and sandwich shops and other similar types of businesses. The trend toward a convergence in grocery, deli and restaurant services may increase the number of Fatburger’s competitors. Such increased competition could have a material adverse affect on Fatburger’s financial condition and results of operations. Some of Fatburger’s competitors have substantially greater financial, marketing, operating and other resources than we have, which may give them a competitive advantage. Certain of Fatburger’s competitors have introduced a variety of new products and engaged in substantial price discounting in recent years and may continue to do so in the future. There can
be no assurance as to the success of any of Fatburger’s new products, initiatives or overall strategies, or assurance that competitive product offerings, pricings and promotions will not have an adverse effect upon Fatburger’s financial condition and results of operations.
Changes in economic, market and other conditions could adversely affect Fatburger and its franchisees, and thereby our operating results.
The fast casual restaurant industry is affected by changes in international, national, regional, and local economic conditions, consumer preferences and spending patterns, demographic trends, consumer perceptions of food safety, weather, traffic patterns, the type, number and location of competing restaurants, and the effects of war or terrorist activities and any governmental responses thereto. Factors such as inflation, food costs, labor and benefit costs, legal claims, and the availability of management and hourly employees also affect restaurant operations and administrative expenses. The ability of Fatburger and its franchisees to finance new restaurant development, improvements and additions to existing restaurants, and the acquisition of restaurants from, and sale of restaurants to, franchisees is affected by economic conditions, including interest rates and other government policies impacting land and construction costs and the cost and availability of borrowed funds.
Increases in the minimum wage may have a material adverse effect on Fatburger’s business and financial results.
A substantial number of Fatburger employees are paid wage rates at or slightly above the minimum wage. As federal and state minimum wage rates increase, Fatburger may need to increase not only the wages of its minimum wage employees, but also the wages paid to the employees at wage rates that are above minimum wage. If competitive pressures or other factors prevent Fatburger from offsetting the increased costs by price increases, profitability may decline. In addition, various other proposals that would require employers to provide health insurance for all of their employees are considered from time to time in Congress and various states. The imposition of any requirement that Fatburger provide health insurance to all employees on terms materially different from its existing programs could have a material adverse impact on the results of operations and financial condition of Fatburger.
Events reported in the media, such as incidents involving food-borne illnesses or food tampering, whether or not accurate, can cause damage to Fatburger’s brand’s reputation and swiftly affect sales and profitability.
Reports, whether true or not, of food-borne illnesses (such as e-coli, avian flu, bovine spongiform encephalopathy, hepatitis A, trichinosis or salmonella) and injuries caused by food tampering have in the past severely injured the reputations of participants in the fast casual restaurant segment and could, in the future, affect Fatburger as well. Fatburger’s brand reputation is an important asset to the business; as a result, anything that damages the brand’s reputation could immediately and severely hurt sales and, accordingly, revenues and profits. If customers become ill from food-borne illnesses, Fatburger could also be forced to temporarily close some restaurants. In addition, instances of food-borne illnesses or food tampering, even those occurring solely at the restaurants of competitors, could, by resulting in negative publicity about the restaurant industry, adversely affect sales on a local, regional or system-wide basis. A decrease in customer traffic as a result of these health concerns or negative publicity, or as a result of a temporary closure of any Fatburger restaurants, could materially harm Fatburger’s business.
Changing health or dietary preferences may cause consumers to avoid products offered by Fatburger in favor of alternative foods.
The food service industry is affected by consumer preferences and perceptions. Fatburger’s success depends, in part, upon the popularity of burgers and fast casual dining. Shifts in consumer preferences away from this cuisine or dining style could have a material adverse affect on our future profitability. The restaurant industry is characterized by the continual introduction of new concepts and is subject to rapidly changing consumer preferences, tastes and eating and purchasing habits. While consumption of hamburgers and related food items in the United States has grown over the past 20 years, the demand may not continue to grow or taste trends may change. Fatburger’s success will depend in part on our ability to anticipate and respond to changing consumer preferences, tastes and eating and purchasing habits, as well as other factors affecting the food service industry, including new market entrants and demographic changes. If prevailing health or dietary preferences and perceptions cause consumers to avoid these products offered by Fatburger restaurants in favor of alternative or healthier foods, demand for Fatburger’s products may be reduced and its business could be harmed.
Fatburger is subject to health, employment, environmental and other government regulations, and failure to comply with existing or future government regulations could expose Fatburger to litigation, damage Fatburger’s reputation and lower profits.
Fatburger and its franchisees are subject to various federal, state and local laws affecting their businesses. The successful development and operation of restaurants depend to a significant extent on the selection and acquisition of suitable sites, which are subject to zoning, land use (including the placement of drive-thru windows), environmental (including litter), traffic and other regulations. Restaurant operations are also subject to licensing and regulation by state and local departments relating to health, food preparation, sanitation and safety standards, federal and state labor laws (including applicable minimum wage requirements, overtime, working and safety conditions and citizenship requirements), federal and state laws prohibiting discrimination and other laws regulating the design and operation of facilities, such as the Americans with Disabilities Act of 1990. If Fatburger fails to comply with any of these laws, it may be subject to governmental action or litigation, and its reputation could be accordingly harmed. Injury to Fatburger’s reputation would, in turn, likely reduce revenues and profits.
In recent years, there has been an increased legislative, regulatory and consumer focus on nutrition and advertising practices in the food industry, particularly among fast casual restaurants. As a result, Fatburger may become subject to regulatory initiatives in the area of nutrition disclosure or advertising, such as requirements to provide information about the nutritional content of its food products, which could increase expenses. The operation of Fatburger’s franchise system is also subject to franchise laws and regulations enacted by a number of states and rules promulgated by the U.S. Federal Trade Commission. Any future legislation regulating franchise relationships may negatively affect Fatburger’s operations, particularly its relationship with its franchisees. Failure to comply with new or existing franchise laws and regulations in any jurisdiction or to obtain required government approvals could result in a ban or temporary suspension on future franchise sales. Changes in applicable accounting rules imposed by governmental regulators or private governing bodies could also affect Fatburger’s reported results of operations, and thus cause our stock price to fluctuate or decline.
Fatburger’s earnings and business growth strategy depends in large part on the success of its franchisees, and Fatburger’s reputation may be harmed by actions taken by franchisees that are outside of its control.
A portion of Fatburger’s earnings comes from royalties and other amounts paid by Fatburger’s franchisees. Franchisees are independent contractors, and their employees are not employees of Fatburger. Fatburger provides training and support to, and monitors the operations of, its franchisees, but the quality of their restaurant operations may be diminished by any number of factors beyond Fatburger’s control. Consequently, franchisees may not successfully operate stores in a manner consistent with Fatburger’s high standards and requirements and franchisees may not hire and train qualified managers and other restaurant personnel. Any operational shortcoming of a franchise restaurant is likely to be attributed by consumers to an entire brand, thus damaging Fatburger’s reputation and potentially affecting revenues and profitability.
Risks related to Centrisoft
If Centrisoft is unable to compete successfully in the highly competitive market for network productivity and security products for any reason, its business will fail.
Centrisoft currently has a limited customer base. The market for enterprise network productivity and security products is intensely competitive and we expect competition to intensify in the future. An increase in competitive pressures in this market or Centrisoft’s failure to compete effectively may result in pricing reductions, reduced gross margins and a failure to obtain market share. Other competitors offering similar products have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical, marketing and other resources than Centrisoft does. In addition, larger competitors may bundle products competitive with Centrisoft’s with other products that they may sell to our potential customers. These customers may accept these bundled products rather than separately purchasing our products.
Customer demand, competitive pressure and rapid changes in technology and industry standards could render Centrisoft’s products and services unmarketable or obsolete, and Centrisoft may be unable to introduce new or improved products and services, or update existing products or services, timely and successfully.
To succeed, Centrisoft must continually change and improve its products, add new products and services, provide updates to products and services and replace existing products and services in response to changes in customer demand, competitive pressure, rapid technological developments and changes in operating systems, Internet access and communications, application and networking software, computer and communications hardware, programming tools, computer language technology and computer hacker techniques. Centrisoft may be unable to successfully and timely develop and introduce these new, improved or updated products and services or achieve and maintain market acceptance for new, improved or updated products and services we develop and introduce.
The development and introduction of new enterprise network and security products and updates to existing products, is a complex and uncertain process that requires great innovation, the ability to anticipate technological and market trends, the ability to deliver updates in a timely fashion and the ability to obtain required domestic and foreign governmental and regulatory certifications. Releasing new or improved products and services, or updates to products or services, prematurely may result in quality problems, and releasing them late may result in loss of customer confidence and market share. When Centrisoft introduces new or enhanced products and services, it may be unable to successfully manage the transition from its existing products and services to deliver enough new products and services to meet customer demand.
Undetected product errors or defects could result in loss of revenues, delayed market acceptance and claims against Centrisoft.
Centrisoft’s products and services may contain undetected errors or defects, especially when first released. Despite extensive testing, some errors are discovered only after a product has been installed and used by customers. Any errors discovered after commercial release could result in loss of revenues or claims against Centrisoft or its resellers.
Centrisoft may be required to defend lawsuits or pay damages in connection with the alleged or actual failure of Centrisoft’s products and services.
Because Centrisoft’s products provide and monitor network security and may protect valuable information, Centrisoft may face claims for product liability, tort or breach of warranty relating to its products and services. Anyone who circumvents Centrisoft’s security measures could misappropriate the confidential information or other property of end-users using our products and services or interrupt their operations. If that happens, affected end-users or channel customers may sue Centrisoft. In addition, Centrisoft may face liability for breaches caused by faulty installation and implementation of its products by end-users or channel customers. Although Centrisoft attempts to reduce the risk of losses from claims through contractual warranty disclaimers and liability limitations, these provisions may be unenforceable. Some courts, for example, have found contractual limitations of liability in standard software licenses to be unenforceable because the licensee does not sign the license. Defending a suit, regardless of its merit, could be costly and could divert management attention. Although Centrisoft currently maintains business liability insurance, this coverage may be inadequate or may be unavailable in the future on acceptable terms, if at all.
Centrisoft may be unable to adequately protect its proprietary rights, which may limit its ability to compete effectively.
Despite Centrisoft’s efforts to protect its proprietary rights, unauthorized parties may misappropriate or infringe on its patents, trade secrets, copyrights, trademarks, service marks and similar proprietary rights. Centrisoft may, however, be unsuccessful in protecting its trade secrets or, even if successful, any required litigation may be costly and time consuming, which could harm our business.
If Centrisoft fails to obtain and maintain patent protection for its technology, we may be unable to compete effectively. In addition, Centrisoft relies on unpatented proprietary technology. Because this proprietary technology does not have patent protection, Centrisoft may be unable to meaningfully protect this technology from unauthorized use or misappropriation by a third party. Centrisoft’s competitors may independently develop similar or superior technologies or duplicate any unpatented technologies that we have developed which could significantly reduce the value of its proprietary technology or threaten its market position.
Risks related to our real estate holdings
Our performance and value are subject to risks associated with our real estate assets and with the real estate industry.
Our economic performance and the value of our real estate assets, and consequently the value of our stock, are subject to the risk that if our real estate properties do not generate revenues sufficient to meet our operating expenses, including debt service and capital expenditures, our cash flow will be adversely affected. The following factors, among others, may adversely affect the income generated by our real estate properties:
· downturns in the international, national, regional and local economic conditions (particularly increases in unemployment);
· competition from other office and commercial buildings;
· local real estate market conditions, particularly in Barcelona, Spain, such as oversupply or reduction in demand for commercial or residential space;
· changes in interest rates and availability of attractive financing;
· vacancies, changes in market rental rates and the need to periodically repair, renovate and re-let space;
· increased operating costs, including insurance expense, utilities, real estate taxes, state and local taxes and heightened security costs;
· civil disturbances, natural disasters, or terrorist acts or acts of war which may result in uninsured or underinsured losses;
· significant expenditures associated with each investment, such as debt service payments, real estate taxes, insurance and maintenance costs which are generally not reduced when circumstances cause a reduction in revenues from a property;
· declines in the financial condition of our tenants and our ability to collect rents from our tenants; and
· decreases in the underlying value of our real estate.
Acquired properties may expose us to unknown liability.
We may acquire properties subject to liabilities and without any recourse, or with only limited recourse against the prior owners or other third parties, with respect to unknown liabilities. As a result, if a liability were asserted against us based upon ownership of those properties, we might have to pay substantial sums to settle or contest it, which could adversely affect our results of operations and cash flow. Unknown liabilities with respect to acquired properties might include:
· liabilities for clean-up of undisclosed environmental contamination or hazardous substances;
· claims by tenants, vendors or other persons against the former owners of the properties;
· liabilities incurred in the ordinary course of business; and
· claims for indemnification by general partners, directors, officers and others indemnified by the former owners of the properties.
Because we rely on our ability to sell assets to generate liquidity, fluctuations in the real estate market could negatively affect our cash flow.
We currently generate a substantial portion of our liquidity from sales of assets, including real estate assets. If we are unable to sell
assets at effective prices, it may affect our liquidity and profitability.
We may have difficulty selling our properties, which may limit our flexibility.
Our real estate properties could be difficult to sell. This may limit our ability to adjust our portfolio promptly in response to changes in economic or other conditions. In addition, tax laws limit our ability to sell properties and this may affect our ability to sell properties without adversely affecting our performance or returns. These restrictions reduce our ability to respond to changes in the performance of our investments and could adversely affect our financial condition and results of operations.
ITEM 1B.
ITEM 1B. UNRESOLVED SEC COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
Our corporate headquarters are located in Portland, Oregon, where we lease approximately 5,000 square feet of office space under a lease expiring in December 2009. Fatburger leases approximately 8,700 square feet of corporate office space in Santa Monica, California under a lease that will expire in January 2013. Fatburger also operates 39 restaurant locations in California, Nevada, Louisiana, Florida, Pennsylvania, New Jersey, Virginia, New York, and China. Two of the restaurant sites in Nevada are operated from properties owned by Fatburger, while the remaining locations are leased. Centrisoft leases approximately 3,000 square feet of office space in Portland, Oregon under a lease that will expire in May 2008. In March 2008, Centrisoft combined their office space with our corporate headquarters. DAC leases approximately 17,500 square feet of office and production space in Carpinteria, California under a lease that will expire in December 2017.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Warlick Complaint
Fatburger Holdings, Inc., et al. v. Keith A. Warlick/ Warlick v. Fatburger, et al, Superior Court of California for the County of Los Angeles, Case No. SC 091436. On October 16, 2006, Fatburger Holdings, Inc., Fatburger Corporation and Fatburger North America, Inc. filed suit against Keith A. Warlick (“Warlick”) the former Chief Executive Officer of Fatburger Holdings, Inc. and Fatburger Corporation. Warlick’s employment with Fatburger was terminated on September 21, 2006 by resolution of the board of directors of Fatburger Holdings, Inc. The Fatburger companies initiated the lawsuit to recover damages from Warlick arising from wrongful acts and conduct during and after his employment, and are asserting claims for: breach of contract, breach of duty of loyalty, breach of fiduciary duty, conversion - embezzlement; fraud/commencement; intentional interference with contractual relations, and equitable indemnity. Warlick filed an answer to the lawsuit denying the allegations and included a Cross-complaint against Fatburger Holdings, Inc., Fatburger Corporation, Fatburger North America, Inc., Fog Cutter Capital Group, Inc., and Andrew Wiederhorn (“Cross-Defendants”), for breach of contract, employment discrimination based on race and retaliation, wrongful termination and defamation - slander without any specification of damages. On a motion filed by the Cross-Defendants, the Court dismissed Warlick’s cross-claim for employment discrimination based on race and retaliation. In further response Warlick initiated a second lawsuit against the Company, various Fatburger companies, and members of the Fatburger board of directors, which is set out below. The defendants to the Cross-complaint filed by Warlick dispute the allegations of the cross-complaint and intend to vigorously defend against the cross-complaint.
Keith Warlick, et al. v. Fog Cutter Capital Group, et al., Superior Court of California for the County of Los Angeles, Case No. 58365915
On February 6, 2007, Warlick, his wife, and a limited liability company controlled by Warlick, each of whom is a minority shareholder of Fatburger Holdings, Inc., filed a complaint against various Fatburger entities, the Company, Andrew Wiederhorn, and members of the Fatburger board of directors. The complaint alleges fraud, negligent misrepresentation against Wiederhorn and the Company, and breach of contract and breach of fiduciary duty against all the defendants, related to business transactions which the plaintiff’s allege were not in the best interests of Fatburger Holdings, Inc., or the plaintiff minority shareholders. The defendants dispute the allegations of the lawsuit and intend to vigorously defend against the claims.
We are obligated to indemnify our officers and directors to the extent permitted by applicable law in connection with this action, and have insurance for such individuals, to the extent of the limits of the applicable insurance policies and subject to potential reservations of rights. We are unable, however, to predict the ultimate outcome of the matter. We cannot assure you that we will be successful in defending against this action and, if we are unsuccessful, we may be subject to significant damages that could have a material adverse
effect on our business, financial condition and operating results. Even if we are successful, defending against this action has been, and will likely continue to be, expensive, time consuming and may divert management’s attention from other business concerns and harm our business.
Other Legal Matters
We are involved in various other legal proceedings occurring in the ordinary course of business which we believe will not have a material adverse effect on our consolidated financial condition or results of operations.
Shareholder Derivative Complaint
On July 6, 2004, Jeff Allan McCoon, derivatively on behalf of Fog Cutter, filed a lawsuit in the Circuit Court for the State of Oregon (Multnomah County) which named us and all of our directors as defendants. In January 2006, the Circuit Court dismissed the entire derivative lawsuit, ruling that Mr. McCoon was unfit to represent the Company’s shareholders. Mr. McCoon filed an appeal to this ruling. In December 2006, the Company reached a settlement with the plaintiff in which the Company agreed to pay $125,000 in legal fees and is released from further liability under this complaint. The settlement agreement was accepted by the court on January 2, 2007, and Fog Cutter paid the settlement on January 24, 2007.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our shareholders during the quarter ended December 31, 2007.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Trading Market and Historical Prices
From April 6, 1998 through October 13, 2004, our common stock, par value $0.0001 per share (the “Common Stock”) was quoted on the NASDAQ National Market. From October 14, 2004 to June 23, 2007, our common stock was quoted in the over-the-counter market on the OTC “pink sheets.” Effective June 24, 2007, our common stock began trading on the OTC Bulletin Board (the “OTCBB”) market as FCCG.OB. The approximate number of holders of record (not beneficial stockholders, as most shares are held in brokerage name) of our common stock was 82 at February 29, 2008.
The following table sets forth the high and low sales prices for our common stock as quoted on the OTC market for the periods indicated.
Dividends
During the year ended December 31, 2007 we did not declare or pay any distributions to shareholders. During the year ended December 31, 2006 we declared one cash distribution of $0.13 per share ($1.0 million). While we do not have a fixed dividend policy, we may declare and pay new dividends on our common stock, subject to our financial condition, results of operations, capital requirements and other factors deemed relevant by the Board of Directors. One factor the Board of Directors may consider is the impact of dividends on our liquidity.
Equity Compensation Plan Information
The information presented in the table below is as of December 31, 2007.
(1) In fiscal year 2000, we established the Fog Cutter Long-Term Vesting Trust (the “Trust”), which purchased 525,000 shares of our common stock from an unrelated shareholder. Our contribution to the Trust of approximately $1.3 million was included in compensation expenses for the year ended December 31, 2000. Subsequently, the Trust has used Trust earnings to fund the purchase of 389,755 additional shares of our common stock.
The Trust was established for the benefit of our employees and directors to raise their ownership in the Company, thereby strengthening the mutuality of interests between them and our shareholders. While these shares were held in trust, they were voted ratably with ballots cast by all other shareholders.
On March 1, 2007, by action of the trustees, all allocated shares under the Trust became fully vested to the beneficiaries. The Trust distributed the shares to the beneficiaries in 2007, and was terminated upon completion of the distribution process.
Comparison of Five-Year Cumulative Total Shareholder Return-December 2002 through December 2007
The following performance graph covers the period beginning December 31, 2002 through December 31, 2007. The graph compares the return on our common stock to the Standard & Poor’s 500 Stock Index (“S&P 500”) and a peer group of companies (“PGI”). The stock price performance shown on the graph below is not necessarily indicative of future stock price performance.
(1) Assumes all distributions to stockholders are reinvested on the payment dates.
(2) Assumes $100 invested on December 31, 2002 in our common stock, the S&P 500 and the PGI.
(3) The companies included in the PGI are FirstCity Financial, Back Yard Burgers Inc., Rubio’s Restaurants Inc., Sonic Corp., and MCG Capital Corp.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected historical, financial and operating data on a consolidated basis at December 31, 2007, 2006, 2005, 2004 and 2003 and for the years then ended. The information contained in this table should be read in conjunction with Item 7
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Executive Summary
Business Overview
Fog Cutter Capital Group Inc. is primarily engaged in the operations of its Fatburger Holdings, Inc. (“Fatburger”) restaurant business. We acquired the controlling interest in Fatburger in August 2003 and own 82% voting control as of December 31, 2007. Fatburger, “The Last Great Hamburger Stand”®, opened its first restaurant in Los Angeles in 1952. As of December 31, 2007, there were 92 Fatburger restaurants located in 14 states and in Canada and China. The restaurants specialize in fresh, made to order hamburgers and other specialty sandwiches. French fries, homemade onion rings, hand-scooped ice cream shakes and soft drinks round out the menu.
We plan to open additional Fatburger restaurants throughout the United States and internationally, including Canada, China and the United Arab Emirates. We intend to continue to open company-owned restaurants in strategic markets and increase the number of franchised locations in the U.S. and internationally. Fatburger has opened a total of 43 restaurant locations since our acquisition in 2003. At December 31, 2007, franchisees owned and operated 53 of the Fatburger locations and we have agreements for approximately 245 new franchise locations. Many factors affect our ability to open new franchise locations and we expect that it will take several years for our current franchisees to open all of their restaurant locations. As is typical for our industry, the identification of qualified franchisees and quality locations has an impact on the rate of growth in the number of our restaurants.
In addition to our restaurant operation, we also conduct manufacturing activities, software development and sales activities, and make real estate and other real estate-related investments through various controlled subsidiaries.
Operating Segments
Our operating segments are:
(i) Restaurant Operations - conducted through our Fatburger subsidiary,
(ii) Manufacturing Operations - conducted through our wholly owned subsidiary, DAC International (“DAC”),
(iii) Real Estate and Finance Operations, and
(iv) Software Development and Sales Operations - conducted through our subsidiary, Centrisoft Corporation (“Centrisoft”).
Due to the varied nature of our operations, we do not utilize a standard array of key performance indicators in evaluating our results of operations. Our evaluation instead focuses on an investment-by-investment or asset-by-asset analysis within our operating segments.
Significant Events
The following significant events affected our operations for the year ended December 31, 2007:
· Restaurant openings - During the year ended December 31, 2007, we opened seven additional Fatburger restaurant locations (five franchise and two company-owned), and one franchise location was closed. We also purchased the net assets of a franchisee with two locations and converted them to company-owned locations. In the acquisition, we issued a note payable to the franchisee for $0.2 million, and assumed accounts payable and notes payable totaling $0.3 million, in exchange for $0.5 million of property, plant and equipment.
· Sale of real estate - In July 2007, we sold one stand-alone retail location for $0.4 million in cash. The property had a net book value of $0.4 million at the time of disposal, and we recognized a gain on the sale of less than $0.1 million.
· Repayment of notes receivable - In August 2007, we received payment on one note receivable of approximately half of the $0.5 million book value, which was due on August 18, 2007. The remaining principal was extended for one year. Upon extension, we received and deferred a loan fee of less than $0.1 million, which will be amortized over the remaining life of the note receivable.
· Discontinued operations (FCRI) - At December 31, 2007, our wholly-owned subsidiary, FCRI, held our real estate lease portfolio. In the fourth quarter of 2007, FCRI met our requirements to be classified as held for sale, and we sold FCRI in February 2008, subsequent to year end. As such, all assets and liabilities related to FCRI have been classified as held for sale at December 31, 2007 and 2006. Prior to our decision to sell FCRI, it was part of our Real Estate and Financing Operations.
· Discontinued operations (George Elkins) - On February 28, 2007, Fog Cap Commercial Lending Inc., our wholly-owned subsidiary, sold its 51% interest in George Elkins Mortgage Banking Company (“George Elkins”). We received $2.9 million for our portion of the proceeds and recorded a gain on sale of $2.5 million.
· Borrowings on notes payable - We borrowed an additional $1.1 million in January 2007 and $0.2 million in December 2007 on a note payable that had a balance of $2.1 million at December 31, 2006. The amended note has a balance of $3.4 million at December 31, 2007 and is secured primarily by our interest in DAC.
· Borrowings on notes payable - In May 2007, we borrowed an additional $1.0 million on a note payable that had a balance of $2.1 million at December 31, 2006. Including loan fees, the amended note has a balance of $4.0 million at December 31, 2007 and is secured primarily by our interest in our real estate lease portfolio. This note was paid in full subsequent to December 31, 2007, upon the sale of our real estate lease portfolio.
· OTC Bulleting Board listing - Effective June 24, 2007, our common stock began trading on the OTC Bulletin Board (the “OTCBB”) market as FCCG.OB. The OTC Bulletin Board is a regulated quotation service that displays real-time quotes, last-sale prices, and volume information in qualifying over-the-counter equity securities. Prior to being listed on the OTCBB, our shares were quoted by Pink Sheets LLC.
Critical Accounting Policies
Our consolidated financial statements, found under Item 8 Financial Statements and Supplementary Data in this filing, have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. We base our estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements.
Valuation
At December 31, 2007, our largest asset consisted of our portfolio of real estate. We value our real estate holdings either by independent appraisal or through internally generated analysis using comparable market data.
Fatburger Restaurant and Franchise Revenue
Revenue from the operation of Fatburger company-owned restaurants is recognized when sales occur.
Franchise fee revenue from the sale of individual Fatburger franchises is recognized only when we have substantially performed or satisfied all material services or conditions relating to the sale. The completion of training and the opening of a location by the franchisee constitutes substantial performance on our part. Currently, Fatburger charges franchise fees of $50,000 per domestic location and $65,000 per international location. One-half of the fees for domestic locations are collected in cash at the time the franchise rights are granted and the balance is collected at the time the lease for the location is executed. The entire fee for international locations is collected at the time the franchise rights are granted. Nonrefundable deposits collected in relation to the sale of franchises are recorded as deferred franchise fees until the completion of training and the opening of the restaurant, at which time the franchise fee revenue is recognized.
Fatburger also collects a royalty ranging from 5% to 6% of gross sales from restaurants operated by franchisees. Fatburger recognizes royalty fees as the related product, beverage, and merchandise sales are made by the franchisees. Costs relating to continuing franchise support are expensed as incurred.
Manufacturing revenue recognition
We recognize revenue from our manufacturing operations when substantially all of the usual risks and rewards of ownership of the inventory have been transferred to the buyer. Generally, this occurs when the inventory is shipped to the customer.
Long-lived assets, held for sale
We classify our long-lived assets to be sold as held for sale in the period when the following criteria are met:
(i) management commits to a plan to sell the asset;
(ii) the asset is available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets;
(iii) an active program to locate a buyer and other actions required to complete the plan to sell the asset have been initiated;
(iv) the sale of the asset is probable, and transfer of the asset is expected to qualify for recognition as a completed sale, within one year;
(v) the asset is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and
(vi) actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn.
Recognition of Sale of Assets
Our accounting policy calls for the recognition of sales of financial instruments and other assets only when we have irrevocably surrendered control over these assets. We do not retain any recourse or performance obligations with respect to our sales of assets. We recognize gain on sales of real estate under the full accrual method when:
(i) a sale is consummated,
(ii) the buyer’s initial and continuing investments are adequate to demonstrate a commitment to pay for the property,
(iii) any receivable from the buyer is not subject to future subordination, and
(iv) the usual risks and rewards of ownership of the property have been transferred to the buyer.
If any of these conditions are not met, our accounting policy requires that gain on sale be deferred until all of the conditions have been satisfied.
Goodwill and Other Intangible Assets
Goodwill represents the excess of the purchase price and other acquisition related costs over the estimated fair value of the net tangible and intangible assets acquired. We do not amortize goodwill. Intangible assets are stated at the estimated value at the date of acquisition and include trademarks, operating manuals, franchise agreements and leasehold interests. Trademarks, which have indefinite lives, are not subject to amortization. All other intangible assets are amortized over their estimated useful lives, which range from five to fifteen years.
We assess potential impairments to goodwill and intangible assets at least annually, or when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset may not be recovered. Our judgments regarding the existence of impairment indicators and future cash flows related to intangible assets are based on operational performance of our acquired businesses, market conditions and other factors. Future events could cause us to conclude that impairment indicators exist and that goodwill or other
intangible assets associated with our acquired businesses are impaired. Any resulting impairment loss could have an adverse impact on our results of operations.
Impairment of long-lived assets
In accordance with FAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“FAS 144”), we review our long-lived assets for impairment whenever an event occurs that indicates an impairment may exist. We test for impairment using the estimated future cash flows of the asset.
Minority interests
We apply Accounting Research Bulletin No. 51, “Consolidated Financial Statements” (“ARB 51”), which requires the elimination of all intercompany profit or loss and balances between consolidated companies. ARB 51 also requires the recognition of minority interest in consolidated subsidiaries. Consistent with ARB 51, where losses applicable to a minority interest exceed the minority interest in the capital of the subsidiary, such excess and any further losses are charged against the Company. Should the subsidiary become profitable, the Company will be credited to the extent of such losses previously absorbed.
Share-based payments
On January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” (“FAS 123R”), which requires all share-based awards to employees, including grants of employee stock options, to be recognized in results of operations based on their fair value. Prior to January 1, 2006, the Company applied Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees” (“APB 25”) and related interpretations in accounting for share-based payments. Accordingly, no compensation expense was recognized in results of operations prior to January 1, 2006 relating to share-based payments.
Results of Operations
During the most recent three full fiscal years, our operations have resulted in net losses as follows:
Net Loss
The loss from continuing operations for the year ended December 31, 2007 was $13.5 million, or $1.70 per share. The loss is primarily due to significant operating expenses associated with our management infrastructure and $4.7 million in recognized market value impairments. We have put in place a management structure that we believe will enable us to significantly expand our operations, notably our Fatburger subsidiary. However, until the growth in operations is realized, the cost of our management structure will be borne by our existing operations. Our results for 2007 compare to a loss from continuing operations of $10.9 million, or $1.37 per share for 2006 and $8.7 million, or $1.09 per share for 2005. These results were also primarily attributable to our operating expenses as we transitioned the Statement of Financial Condition and began focusing on our restaurant operations and other key subsidiaries.
The following sections describe the results of operations of our operating segments for each of the three years ended December 31, 2007, 2006 and 2005.
Restaurant Segment Operations
The following table shows our operating margin for company owned restaurants for each of the three years ended December 31:
The following table shows our total operating results from the restaurant segment for each of the three years ended December 31:
For the year ended December 31, 2007, company owned restaurant sales increased 3.9% to $29.5 million from $28.4 million in 2006. This increase was the mainly the result of two new company owned stores in 2007 and a price increase in June 2006. Same store sales for company-owned restaurants decreased 8.8% for the year ended December 31, 2007 compared to the same period in 2006. The operating margin for company-owned locations decreased to 35.7% in 2007 from 39.1% in 2006, due to increased labor costs and depreciation expense as a percentage of company owned restaurant sales.
Royalty revenue decreased 4.5%, from $2.2 million in 2006 to $2.1 million in 2007, primarily due to decreased same store sales for franchise operations. Franchise fee revenue decreased 60.0%, from $0.5 million in 2006 to $0.2 million in 2007, as we added four new franchise locations in 2007 compared to six locations in 2006. Same store sales for franchise locations decreased 10.6% for the year ended December 31, 2007 compared to the same period in 2006.
System-wide same store sales decreased 9.8% for the year ended December 31, 2007 compared to the same period in 2006. Our loss from restaurant operations was 15.1% of total revenue for 2007 compared to 15.2% for 2006. The increase in cost of sales as a percentage of total revenue was offset by a decrease in general and administrative, interest and other non-operating expenses as a percentage of total revenue.
For the year ended December 31, 2006, company owned restaurant sales increased 18.8% to $28.4 million from $23.9 million in 2005. This increase was primarily the result of nine new company owned stores in 2006 and a price increase n June 2006. Same store sales for company-owned restaurants increased 1.2% for the year ended December 31, 2006 compared to the same period in 2005. The operating margin for company-owned locations increased to 39.1% in 2006 from 36.9% in 2005, due to the price increase combined with the continued implementation of cost control measures. Royalty revenue increased 22.2%, from $1.8 million in 2005 to $2.2 million in 2006, while Franchise fee revenue decreased 16.7%, from $0.6 million in 2005 to $0.5 million in 2006. Both of these changes were a result of our restaurant operations growth strategy, as Fatburger opened 18 franchise stores in 2005. Our net loss from restaurant operations increased to 15.2% of total revenue for 2006 (compared to 5.5% in 2005) due to increased general and administrative expenses as we continued to establish our infrastructure to support our planned expansion.
We plan to open additional Fatburger restaurants throughout the United States and internationally, including Canada, China and the United Arab Emirates. We intend to continue to open company-owned restaurants in strategic markets and increase the number of franchised locations in the U.S. and internationally. Fatburger has opened a total of 43 restaurant locations since our acquisition in 2003. As is typical for our industry, the identification of qualified franchisees and quality locations has an impact on the rate of growth in the number of our restaurants.
Manufacturing Segment Operations
Total revenue for this segment was $11.6 million for the year ended December 31, 2007, compared to $9.8 million for the year ended December 31, 2006. Net income for this segment was $1.0 million for 2007, compared to $1.4 million for 2006.
Operating results for the year ended December 31, 2006 are not comparable to the same period of 2005 because we began consolidating DAC’s operations in November 2005 when we acquired voting control of DAC.
In order to focus our efforts on our restaurant segment, we intend to sell our equity position in DAC for an amount higher than our net investment. If we were to sell this segment, it would decrease our net revenue and increase our net loss. There can be no assurance that we will be able to sell this segment for a profit.
Real Estate and Finance Segment Operations
Real Estate Operations:
During the year ended December 31, 2007, our operating margin on real estate decreased to negative $4.1 million from positive $1.2 million in 2006. This is due to $3.6 million of market value impairments in 2007 (compared to $1.0 million in 2006), combined with a $2.9 million decrease in gain on sale of real estate compare to 2006. In the third quarter of 2007, we sold one building for proceeds of $0.4 million, resulting in a net gain on sale of less than $0.1 million. Interest expense for the year ended December 31, 2007 increased compared to the same period of 2006 as we borrowed money on various notes payable secured by certain real estate investments. In 2007, we recognized market value impairments totaling $3.6 million relating to one of our remaining Barcelona apartment buildings (compared to $1.0 million in 2006).
During the year ended December 31, 2006, our operating margin on real estate was stable at $1.2 compared to 2005. In the first quarter of 2006, we sold seven buildings for total proceeds of $3.5 million, resulting in a net gain on sale of approximately $0.5 million. In the second quarter of 2006, we sold a parcel of vacant land for total proceeds of $2.6 million, resulting in a gain on sale of approximately $1.2 million. In the third quarter of 2006, we sold our Eugene warehouse property for total proceeds of $2.8 million, resulting in a gain on sale of approximately $1.2 million. Interest expense for the year ended December 31, 2006 increased compared to the same period of 2005 as we borrowed money on various notes payable secured by certain real estate investments in 2006. In 2006, we established a market value reserve of $1.0 million relating to one of our remaining Barcelona apartment buildings.
In 2005, we sold eight buildings for total proceeds of $4.5 million, providing a gain on sale of $1.8 million. In addition, we sold one building in Barcelona, Spain in 2005 for total proceeds of $1.9 million, resulting in a gain on sale of $0.4 million.
Interest Income - Our interest income for the year ended December 31, 2007 was $0.2 million, compared with $0.3 million for 2006 and $1.3 million for 2005. The decrease in each subsequent year is primarily attributable to a net reduction in average asset balance, reflecting the sale of most of our mortgage-backed securities and the sale or repayment of notes in our notes receivable portfolio.
Foreign Exchange Gains - Changes in foreign currency exchange rates resulted in a net gain of approximately $1.0 million in this segment for the year ended December 31, 2007, compared to gains of $1.0 million for 2006 and losses of $0.4 million in 2005. At December 31, 2007, approximately 16% of our total assets and 3% of our total liabilities were denominated in Euros. See Item 7A
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our market risks result from instruments entered into other than for trading purposes and consists primarily of exposure to loss resulting from changes in foreign currency exchange rates, interest rates and commodity prices.
Foreign Currency Exchange Rate Risk
Our exposure to foreign currency fluctuations arises mainly from our investment in Barcelona real estate. At December 31, 2007, approximately 16% of our total assets and 3% of our total liabilities were denominated in Euros. The following table illustrates the projected effect on our net asset value as a result of hypothetical changes in foreign currency rates as of December 31, 2007:
(1) Assumes that uniform percentage changes occur instantaneously in the euro. A decrease in the foreign exchange rate indicates a strengthening of the U.S. dollar against the euro. An increase in the foreign exchange rate indicates a weakening of the U.S. dollar against the euro.
We can utilize a wide variety of financial techniques to assist in the management of currency risk, including currency swaps, options, and forwards, or combinations thereof. No such currency hedging techniques were in use as of December 31, 2007.
Interest Rate Risk
Changes in interest rates can affect net income by increasing the cost associated with operating and expanding our restaurant operation. Changes in the level of interest rates can also affect, among other things, the value of our interest-earning assets (and the associated default rates), our ability to borrow funds, and general levels of consumer spending.
Other Market Risks
Our restaurant operations are exposed to the impact of commodity and utility price fluctuations related to unpredictable factors such as weather and various other market conditions outside our control. Our ability to recover increased costs through higher prices is limited
by the competitive environment in which we operate.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 15 of Part IV of this report on Form 10-K.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There has been no change of accountants or any disagreements with accountants on any matter of accounting principles or practices, or financial statement disclosure required to be reported under this item.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures
Our Chief Executive Officer and our Chief Financial Officer, after evaluating the effectiveness of the Company’s “disclosure controls and procedures” (as defined in the Securities and Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report, have concluded that our disclosure controls and procedures were effective and designed to ensure that material information relating to us and our consolidated subsidiaries is accumulated and communicated to our management to allow timely decisions regarding required disclosure.
The Company does not expect that its disclosure controls and procedures will prevent all error and all fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedures are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The Company considered these limitations during the development of its disclosure controls and procedures, and will continually reevaluate them to ensure they provide reasonable assurance that such controls and procedures are effective.
Management Report on Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) and 15d-15(f) promulgated under the Exchange Act. Those rules define internal control over financial reporting as a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
(i) Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;
(ii) Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and the receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
(iii) Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisitions, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. Our internal controls over financial reporting are subject to various inherent limitations, including cost limitations, judgments used in decision making, assumptions about the likelihood of future events, the soundness of our systems, the possibility of human error and the risk of fraud. Moreover, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007. In making this assessment, the Company’s management used the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).
Based on our assessment and those criteria, management believes that, as of December 31, 2007, the Company’s internal control over financial reporting is effective.
This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
Changes in internal control over financial reporting
There were no significant changes in our internal control over financial reporting in connection with an evaluation that occurred during our fiscal year of 2007 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
During the fourth quarter of 2007, there were no disclosures required to be reported on Form 8-K that were not reported.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) The information regarding our directors required by this item is incorporated into this annual report by reference to the section entitled “Election of Directors” in the proxy statement for our 2008 annual meeting of stockholders which is expected to be held in May 2008.
(b) The information regarding our executive officers required by this item is incorporated into this annual report by reference to the section entitled “Executive Officers” in the proxy statement for our 2008 annual meeting of stockholders which is expected to be held in May 2008.
We plan to file the proxy statement for our 2008 annual meeting of stockholders within 120 days of December 31, 2007, our fiscal year-end.
Code of Ethics
The Board of Directors has adopted a code of ethics designed, in part, to deter wrongdoing and to promote honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships, full, fair, accurate, timely and understandable disclosure in reports and documents that we file with or submit to the Securities and Exchange Commission and in our other public communications, compliance with applicable governmental laws, rules and regulations, prompt internal reporting of violations of the code to an appropriate person or persons, as identified in the code, and accountability for adherence to the code.
The code of ethics applies to officers, directors and employees of the Company. A copy of the code is posted in the “Management Team” section on our internet website, www.fogcutter.com. In addition, we intend to post any future amendments to or waivers of our code of ethics as it applies to certain persons on our website.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information regarding executive compensation required by this item is incorporated into this annual report by reference to the section entitled “Executive Compensation” in the proxy statement for our 2008 annual meeting of stockholders which is expected to be held in May 2008. We plan to file the proxy statement for our 2008 annual meeting of stockholders within 120 days of December 31, 2007, our fiscal year-end.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information regarding beneficial ownership of our common stock required by this item is incorporated into this annual report by reference to the section entitled “Security Ownership of Certain Beneficial Owners and Management” in the proxy statement for our 2008 annual meeting of stockholders which is expected to be held in May 2008. We plan to file the proxy statement within 120 days of December 31, 2007, our fiscal year-end.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information regarding certain relationships and related transactions required by this item is incorporated into this annual report by reference to the section entitled “Certain Relationships and Related Transactions” in the proxy statement for our 2008 annual meeting of stockholders which is expected to be held in May 2008. We plan to file the proxy statement within 120 days of December 31, 2007, our fiscal year-end.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information regarding principal accountant fees and services required by this item is incorporated into this report by reference to the section entitled “Independent Auditors” in the proxy statement for our 2008 annual meeting of stockholders which is expected to be held in May 2008. We plan to file the proxy statement within 120 days of December 31, 2007, our fiscal year-end.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Financial Statements
Consolidated Statements of Financial Condition at December 31, 2007 and 2006
Consolidated Statements of Operations for the Years Ended December 31, 2007, 2006, and 2005
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2007, 2006, and 2005
Consolidated Statements of Cash Flows for the Years Ended December 31, 2007, 2006, and 2005
Notes to Consolidated Financial Statements
Financial Statement Schedule III - Real Estate and Accumulated Depreciation
(b) Exhibits
See Exhibit Index immediately following the signature pages.
Page
Reports of Independent Registered Public Accounting Firms
Consolidated Financial Statements:
Consolidated Statements of Financial Condition at December 31, 2007 and 2006
Consolidated Statements of Operations for the years ended December 31, 2007, 2006 and 2005
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2007, 2006 and 2005
Consolidated Statements of Cash Flows for the years ended December 31, 2007, 2006 and
Notes to Consolidated Financial Statements
Financial Statement Schedule III - Real Estate and Accumulated Depreciation
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Fog Cutter Capital Group Inc.
We have audited the accompanying consolidated statement of financial condition of Fog Cutter Capital Group Inc. and subsidiaries (the “Company’’) as of December 31, 2007 and 2006, and the related consolidated statements of operations, stockholders’ equity, and cash flows and the financial statement schedule for each of the two years in the period ended December 31, 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements and schedule referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2007 and 2006, and the consolidated results of its operations and its consolidated cash flows for each of the two years in the period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America.
We have also audited the reclassifications for discontinued operations described in Note 23 to the consolidated financial statements that were applied to reclassify the 2005 consolidated financial statements. In our opinion, such reclassifications were appropriate and have been properly applied.
/s/ PKF, CERTIFIED PUBLIC ACCOUNTANTS, A PROFESSIONAL CORPORATION
Los Angeles, California
March 31,
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders Fog Cutter Capital Group Inc.
We have audited the accompanying consolidated statements of operations, stockholders’ equity, and cash flows of Fog Cutter Capital Group Inc. and subsidiaries (the “Company’’) for the year ended December 31, 2005 (prior to the effects of the discontinued operations discussed in Note 23 to the 2007 consolidated financial statements), none of which are presented herein. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated results of the Company’s operations and its consolidated cash flows for the year ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.
/s/ UHY LLP
Los Angeles, California
March 9, 2006
FOG CUTTER CAPITAL GROUP INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
FOG CUTTER CAPITAL GROUP INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
FOG CUTTER CAPITAL GROUP INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(dollars in thousands, except share data)
(1) Issued and outstanding
The accompanying notes are an integral part of these consolidated financial statements.
FOG CUTTER CAPITAL GROUP INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND RELATIONSHIPS
The Company was originally incorporated as Wilshire Real Estate Investment Trust Inc. in the State of Maryland on October 24, 1997. The Company is not a Real Estate Investment Trust (“REIT”) for tax purposes and has never elected to be treated as such. Effective January 25, 2001, the Company changed its name to Fog Cutter Capital Group Inc. to better reflect the diversified nature of its business and investments. At December 31, 2007 and 2006, certain Company officers and directors controlled, directly or indirectly, a significant voting majority of the Company.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of operations - Fog Cutter Capital Group Inc. is primarily engaged in the operations of its Fatburger Holdings, Inc. (“Fatburger”) restaurant business. Fog Cutter acquired the controlling interest in Fatburger in August 2003 and owns 82% voting control as of December 31, 2007. In addition to its restaurant operation, the Company also conducts manufacturing activities, software development and sales activities, and makes real estate and other real estate-related investments through various controlled subsidiaries.
Principles of consolidation - The accompanying consolidated financial statements include the accounts of Fog Cutter Capital Group Inc. and its subsidiaries, including Fatburger Holdings, Inc., DAC International Inc. (“DAC”), Centrisoft Corporation (“Centrisoft”), WREP 1998-1 LLC, Fog Cutter Servicing Inc., Fog Cap Commercial Lending Inc., Fog Cutter Capital Markets Inc., Fog Cap Retail Investors LLC, Fog Cap Development LLC, Fog Cap Acceptance Inc., BEP Islands Limited, and Padraig LLC. Intercompany accounts have been eliminated in consolidation.
Use of estimates in the preparation of the consolidated financial statements - The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements. Significant estimates include the determination of fair values of certain financial instruments for which there is no active market, the allocation of basis between assets sold and retained, and valuation allowances for notes receivable and real estate owned. Estimates and assumptions also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Fatburger restaurant and franchise revenue - Revenues from the operation of Fatburger company-owned restaurants are recognized when sales occur. Franchise fee revenue from the sale of individual Fatburger franchises is recognized only when all material services or conditions relating to the sales have been substantially performed or satisfied. The completion of training and the opening of a location by the franchisee constitute substantial performance on the part of Fatburger. Nonrefundable deposits collected in relation to the sale of franchises are recorded as deferred franchise fees until the completion of training and the opening of the restaurant, at which time the franchise fee revenue is recognized. In addition to franchise fee revenue, Fatburger collects a royalty ranging from 5% to 6% of gross sales from restaurants operated by franchisees. Fatburger recognizes royalty fees as the related sales are made by the franchisees. Costs relating to continuing franchise support are expensed as incurred.
Fatburger operates on a 52-week calendar and its fiscal year ends on the Sunday closest to December 31. Consistent with the industry, Fatburger measures its stores’ performance based upon 7 day work weeks. Using the 52-week cycle ensures consistent weekly reporting for operations and ensures that each week has the same days, since certain days are more profitable than others. Accordingly, the accompanying consolidated financial statements reflect a Fatburger fiscal year end of December 30, 2007 and December 31, 2006. The use of this fiscal year means a 53rd week is added to the fiscal year every 5 or 6 years. Fiscal year 2006 includes a 53rd week. In a 52-week year, all four quarters are comprised of 13 weeks. In a 53-week year, one extra week is added to the fourth quarter.
Manufacturing revenue recognition - Revenues from manufacturing operations are recognized when substantially all of the usual risks and rewards of ownership of the inventory have been transferred to the buyer. Generally, this occurs when the inventory is shipped to the customer.
Long-lived assets, held for sale - The Company classifies its long-lived assets to be sold as held for sale in the period when (1) management commits to a plan to sell the asset, (2) the asset is available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets, (3) an active program to locate a buyer and other actions required to complete the plan to sell the asset have been initiated, (4) the sale of the asset is probable, and transfer of the asset is expected to qualify for recognition as a completed sale, within one year, (5) the asset is being actively marketed for sale at a price that is reasonable in relation to its current
fair value, and (6) actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. Any long-lived assets held for sale are stated at the lower of their carrying amounts or fair value less costs to sell and are evaluated for impairment throughout the sales process.
Recognition of sale of assets - The Company has been involved in significant sales of real estate and other assets. The recognition of sales of these assets occurs only when the Company has irrevocably surrendered control over the asset. The Company will recognize gain on sales of assets under the full accrual method when (1) a sale is consummated, (2) the buyer’s initial and continuing investments are adequate to demonstrate a commitment to pay for the property, (3) any receivable from the buyer is not subject to future subordination, and (4) the usual risks and rewards of ownership of the property have been transferred to the buyer. If any of these conditions are not met, the accounting policy requires that gain on sale be deferred until all of the conditions have been satisfied.
Goodwill and other intangible assets - Goodwill represents the excess of the purchase price and other acquisition related costs over the estimated fair value of the net tangible and intangible assets acquired. In accordance with FAS No. 142, “Goodwill and Other Intangible Assets” (“FAS 142”), goodwill is not amortized, but is subject to an annual impairment test. Intangible assets are stated at the estimated fair value at the date of acquisition and include trademarks, operating manuals, franchise agreements, leasehold interests, and customer contracts. Trademarks, which have indefinite lives, are not subject to amortization. All other intangible assets are amortized over their estimated useful lives, which range from five to fifteen years. Management assesses potential impairments to intangible assets at least annually, or when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset may not be recovered. Judgments regarding the existence of impairment indicators and future cash flows related to intangible assets are based on operational performance of the acquired businesses, market conditions and other factors.
Impairment of long-lived assets - In accordance with FAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“FAS 144”), the Company reviews its long-lived assets for impairment whenever an event occurs that indicates an impairment may exist. The Company tests for impairment using the estimated future cash flows of the asset.
Cash and cash equivalents - For purposes of reporting the consolidated financial condition and cash flows, cash and cash equivalents include non-restricted cash amounts held at banks, shares in money market funds and time deposits with original maturities of 90 days or less.
Notes receivable - Upon origination or purchase of a note receivable, the Company classifies the note as held for sale or held for investment. All notes held by the Company at December 31, 2007 and 2006 are classified as held for investment based on the Company’s intent and ability to hold the notes for the foreseeable future or until their maturity or payoff. Notes held for investment are recorded at their unpaid principal balance, net of discounts and premiums, unamortized net deferred origination costs and fees and allowance for losses. Origination fees and certain direct origination costs are deferred and recognized as adjustments to income over the lives of the related notes. Unearned income, discounts and premiums are amortized to income over the estimated life of the note using methods that approximate the interest method. Interest is recognized as revenue when earned according to the terms of the notes and when, in the opinion of management, it is collectible.
Based upon management’s assessment, no allowance for losses was required with respect to notes receivable held for investment at December 31, 2007. Specific valuation allowances may be established for notes that are deemed impaired when, based upon current information and events, it is probable that the Company will be unable to collect all amounts due, both principal and interest, according to the contractual terms of the note. Impairment is measured based on the present value of expected future cash flows discounted at the note’s effective interest rate, based on a note’s observable market price, or the fair value of the collateral if the note is collateral dependent.
Investments in real estate - Real estate purchased directly is originally recorded at the purchase price. Any excess of net cost basis over the fair value less estimated selling costs of real estate is charged to an allowance for impairment of real estate. Any subsequent operating expenses or income, reductions in estimated fair values, as well as gains or losses on disposition of such properties, are recorded in current operations. Depreciation and amortization on investments in real estate is computed using the straight-line method over the estimated useful lives of the assets as follows:
Expenditures for repairs and maintenance are charged to operations as incurred. Significant renovations are capitalized and amortized over their expected useful lives. Fees and costs incurred in the successful negotiation of leases are deferred and amortized on a straight-line basis over the terms of the respective leases. Rental revenue is reported on a straight-line basis over the terms of the respective leases.
Management evaluates real estate properties, including properties under capital leases, and other similar long-lived assets at least annually, or whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable. These assets are evaluated for indicators of impairment, such as significant decreases in the estimated market price, a significant adverse change in the extent or manner in which an asset is being used or in its physical condition, or cash flow combined with a history of operating cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of the long-lived asset. When any such indicators of impairment are noted, management compares the carrying amount of these assets to the future estimated undiscounted net cash flows expected to result from the use and eventual disposition of the assets. If the undiscounted cash flows are less than the carrying amount, an impairment charge equal to the excess of carrying value over the asset’s estimated fair value is recorded. Fair value is estimated in consideration of third party value opinions and comparative similar asset prices, whenever available, or internally developed discounted cash flow analysis.
Investment in equity investees - The equity method of accounting is used for investments in associated companies which are not controlled by us and in which the Company’s interest is generally between 20% and 50%. The Company’s share of earnings or losses of associated companies, in which at least 20% of the voting securities is owned, is included in the consolidated statements of operations.
Share based payments - The Company has a non-qualified stock option plan (“the Option Plan”) which provides for options to purchase shares of the Company’s common stock. The Company adopted Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” (“FAS 123R”) effective January 1, 2006, using the modified prospective transition method. Under that transition method, compensation cost recognized in 2006 includes (a) compensation cost for all share based awards granted prior to, but not yet vested as of January 1, 2006, based on the attribution method and grant date fair value estimated in accordance with the original provisions of FAS 123, and (b) compensation cost for all share based awards granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of FAS 123R, all recognized as the requisite service periods are rendered. Results for prior periods have not been restated.
The adoption of FAS 123R resulted in the Company’s net loss for the year ended December 31, 2007 being approximately $2.0 million higher ($0.8 million for the same period in 2006), and caused basic and diluted loss per share as reported for the same period to be $0.25 higher than if the Company had continued to account for share based compensation under Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees” (“APB 25”).
Prior to January 1, 2006, the Company applied APB 25 and related interpretations in accounting for the Option Plan. Accordingly, no compensation expense was recognized in the Consolidated Statements of Operations prior to January 1, 2006 for grants under the Option Plan. Had compensation expense for the Option Plan been determined based on the fair value at the grant date consistent with the methods of FAS 123, the Company’s net loss and loss per share for the year ended December 31, 2005 would have been as indicated below:
There were no options granted with exercise prices below the market value of the stock at the grant date. The weighted average fair value of options granted during 2007, 2006 and 2005 was $1.73, $1.67, and $1.27, respectively. Fair values were estimated using the Black-Scholes option-pricing model. The following weighted average assumptions were used to determine the value of the 2007 options granted: 0% dividend yield, expected volatility of 76%, risk-free interest rate of 4.7% and expected lives of ten years. See Note 20 - Stock Options and Rights for further information on the Option Plan.
Minority interests - The Company applies Accounting Research Bulletin No. 51, “Consolidated Financial Statements” (“ARB 51”), which requires the elimination of all intercompany profit or loss and balances between consolidated companies. ARB 51 also requires
the recognition of minority interest in consolidated subsidiaries. Consistent with ARB 51, where losses applicable to a minority interest exceed the minority interest in the capital of the subsidiary, such excess and any further losses are charged against the company. Should the subsidiary become profitable, the Company will be credited to the extent of such losses previously absorbed.
Income taxes - The Company files its income tax returns with the relevant tax authorities in the United States on a consolidated basis. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided when it is not probable that some portion or all of the deferred tax assets will be realized. In January 2007, the Company adopted FASB Interpretation No. 48 (“FIN 48”) which clarifies the manner in which enterprises account for uncertainty in income taxes recognized in an enterprises financial statements. The adoption of FIN 48 did not have a material effect on the Company’s consolidated financial position and results of operations.
Earnings per share - Basic EPS excludes dilution and is computed by dividing the net loss available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. During the year ended December 31, 2007, 2006, and 2005, the Company experienced net losses which result in common stock equivalents having an anti dilutive effect on earnings per share.
Reclassifications - The Company’s operations and activities are becoming more focused on restaurant and other more typical commercial businesses, and less focused on finance and real estate. As a result, certain reclassifications of the balances and modifications to the presentation of the financial statements for 2006 and 2005 have been made to conform to the 2007 presentation, including the reclassification of certain investments in real estate as held for sale. None of these changes in presentation affected previously reported results of operations.
NOTE 3 - RECENTLY ISSUED ACCOUNTING STANDARDS
In December 2007, the FASB issued FASB Statement of Financial Accounting Standards No. 160 (“SFAS 160”) clarifying the manner in which entities present non-controlling interests in consolidated financial statements. SFAS 160 is effective for fiscal years beginning after December 15, 2008, and early adoption is prohibited. The Company has not yet determined the effect, if any, of this new standard on its consolidated financial position and results of operations.
In December 2007, the FASB issued FASB Statement of Financial Accounting Standards No. 141R (“SFAS 141R”) clarifying the manner in which entities record business combinations in consolidated financial statements. SFAS 141R is effective for fiscal years beginning after December 15, 2008, and early adoption is prohibited. The Company has not yet determined the effect, if any, of this new standard on its consolidated financial position and results of operations.
NOTE 4 - NOTES RECEIVABLE
Notes receivable are comprised of the following categories at December 31, 2007, and 2006:
As of December 31, 2007 and 2006, all notes receivable carried fixed rates of interest. One note with a carrying value of $0.2 million was pledged to secure borrowings. All notes were classified as held in portfolio. As of December 31, 2007, the Company did not believe that an impairment reserve was required on notes receivable.
NOTE 5 - INVESTMENTS IN REAL ESTATE
At December 31, 2007 and 2006, investments in real estate were comprised of the following:
In the fourth quarter of 2007, the leased real estate portfolio met the Company’s requirements to be classified as held for sale and was classified as held for sale at December 31, 2007 and 2006. The portfolio was sold in February 2008, subsequent to year end.
NOTE 6 - INVESTMENT IN BOURNE END
The Company owned a 26% interest in Bourne End Properties Plc. (“Bourne End”) and accounted for the investment using the equity method. In 2006, Bourne End completed the sale of its last remaining shopping center in Speke, England. Bourne End recognized a gain under U.S. financial reporting standards of approximately $1.1 million, of which, the Company’s share was approximately $0.3 million. The Company was also allocated additional income from Bourne End in the approximate amount of $0.5 million as a result of exceeding certain profitability measures under a revenue sharing agreement with the other investors. The Company recognized $0.7 million in income from equity investees during the year ended December 31, 2006. In 2006, Bourne End distributed the majority of its net assets to its investors, and the Company received $1.6 million for its share. Summary financial information for Bourne End is as follows:
NOTE 7 -PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is depreciated straight-line over the shorter of its useful life or lease term, and consists of:
In December 2007, the Company recorded an impairment reserve of $0.2 million related to the leasehold improvements on one company-owned restaurant location.
NOTE 8 - GOODWILL AND OTHER INTANGIBLE ASSETS
Primarily as a result of the acquisitions of Fatburger, Centrisoft, and DAC, the Company has goodwill in the amount of $9.5 million and investments in intangible assets of $5.0 million. Since the acquisitions of Fatburger and Centrisoft by the Company, both segments have experienced operating losses and have conducted their operations with limited liquidity. The Company believes that these conditions are
temporary in nature, however, should these conditions not be corrected, the Company may be required to recognize impairment losses on its recorded goodwill. In December 2007, the Company recognized an impairment of goodwill from Centrisoft in the amount of $1.0 million. As of December 31, 2007, the Company was not aware of any events or changes in circumstances that would require the additional impairment of the recorded goodwill.
Net intangible assets included franchise agreements, leasehold interests, and sales contracts. Summarized information for acquired intangible assets is as follows (dollars in thousands):
Trademarks, which have indefinite lives, are not subject to amortization. All other intangible assets are amortized using the straight-line method over the estimated useful lives of the assets of five to fifteen years. Amortization expense was $0.3 million for each of the years ended December 31, 2007, 2006, and 2005. Estimated amortization expense for the five succeeding years is as follows (dollars in thousands):
The recorded values of goodwill and other intangible assets may become impaired in the future. The determination of the value of such intangible assets requires management to make estimates and assumptions that affect the consolidated financial statements. Potential impairments to intangible assets are assessed when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset may not be recovered. This assessment is based on the operational performance of acquired businesses, market conditions and other factors including future events. Any resulting impairment loss could have an adverse impact on the results of operations of the Company.
NOTE 9 - INVENTORIES
Inventories consist of the following:
NOTE 10 - OTHER ASSETS
Other current assets consist of the following:
Other assets consist of the following:
Software costs represent the allocation of the purchase price based upon the market value of the Centrisoft software at the time of acquisition in July 2005. This asset is being amortized over 5 years.
NOTE 11 - BORROWINGS AND NOTES PAYABLE
Borrowings at December 31, 2007 and 2006 consist of various notes payable, a line of credit, and mortgage debt. Proceeds from the various credit facilities are used primarily for the acquisition of real estate and restaurant facilities.
Following is information about borrowings:
At December 31, 2007 and 2006, borrowings and notes payable consist of the following:
At December 31, 2007, the contractual maturities of borrowings and notes payable are approximately as follows (dollars in thousands):
At December 31, 2007 and 2006, Fatburger was not in compliance with all obligations under the agreements evidencing its indebtedness, as defined in the applicable agreements, due to its failure to meet the prescribed fixed charge coverage ratio and the prescribed debt-coverage ratio in three notes payable. The lender subsequently issued a waiver of the covenant violations for both December 31, 2007 and 2006. As such, on our Consolidated Statements of Financial Condition, $4.1 million of long-term debt that was classified as current at December 31, 2006 has been re-classified as long-term.
Borrowings related to the Barcelona properties, held through the VIE, are classified as maturing in 2008 due to management’s intention to sell these properties.
NOTE 12 - LEASES
In October 2002, the Company purchased leasehold interests in 109 free-standing retail stores located throughout the United States. The transaction was completed through a wholly-owned subsidiary, Fog Cap Retail Investors LLC. The stores are free-standing, retail locations ranging from 4,500-7,000 square feet each. The initial term of the leasehold interests at the time of acquisition had an average expiration of approximately 6 years. However, the Company is entitled to exercise extension options which will allow it to control the properties for an additional 15 to 30 years.
In some cases, the Company has the option to terminate a lease by giving notice to the property owner. The notice to terminate must include an offer to purchase the property at a price calculated using a declining percentage of the original fair market value of the property at the time the original lease was initiated (generally in the 1970’s and 1980’s). The property owner then has the option to accept the offer to purchase the property or allow the lease to terminate.
Since the acquisition, there have been 14 leases sold, terminated or allowed to expire. In addition, the Company purchased the entire ownership interests in 23 of the properties which had been part of the lease portfolio. As a result, as of December 31, 2007, the Company continues to lease 72 of the original 109 properties. Of the remaining 72 leases, 32 were on terms and conditions that required capitalization of the obligation. As of December 31, 2007, the Company had an $11.2 million net investment in real estate as a result of the transaction, and a capital lease obligation of $10.0 million. The remaining 40 leases are classified as operating leases.
The leased properties are sublet to a broad tenant mix including convenience stores, shoe stores, video rental outlets, auto parts dealers, carpet retailers and other small businesses. The aggregate future minimum rent to be received by the Company under non-cancelable subleases as of December 31, 2007, was $7.5 million for the properties subject to capital leases and $7.8 million for the properties subject to operating leases.
In the fourth quarter of 2007, the leased real estate portfolio met the Company’s requirements to be classified as held for sale and was classified as held for sale at December 31, 2007 and 2006. The portfolio was sold in February 2008, subsequent to year end.
In October 2006, the Company acquired an aircraft through a capital lease. Through this acquisition, we recorded an asset of $1.8 million under property, plant, and equipment, and recognized a related capital lease obligation of $1.8 million. Under the terms of the lease, we will pay $6,409 per month for the lease. After August 1, 2008 we have the option to purchase the aircraft for $2.0 million, and we are required to purchase the aircraft for that amount by July 31, 2009.
Assets held under capital leases are summarized as follows:
Future minimum lease payments required under capital leases that have initial or remaining non-cancelable lease terms in excess of one year at December 31, 2007, are as follows (dollars in thousands):
(1) Assumes that the lease will not be terminated under the termination/purchase clause described above. Includes $22.0 million in payments expected to be made under bargain lease renewals. The amount of imputed interest to reduce the minimum lease payments to present value is $17.3 million using an effective interest rate of approximately 9.4%.
Rental expense for all operating leases for the fiscal year ended December 31, 2007, 2006 and 2005 was $5.0 million, $4.4 million, $3.4 million, respectively. Future minimum lease payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year at December 31, 2007, are as follows (dollars in thousands):
NOTE 13 - DIVIDENDS
No dividends were declared or paid in the year ended December 31, 2007. During the year ended December 31, 2006, the Company declared and paid one cash dividend totaling $0.13 per share (approximately $1.0 million).
NOTE 14 - INCOME TAXES
As of December 31, 2007, the Company had, for U.S. Federal tax purposes, a net operating loss (“NOL”) carry forward of approximately $93.5 million, including $8.6 million relating to Fatburger and $6.9 million relating to Centrisoft. The Company’s NOL begins to expire in 2018. Fatburger’s NOL began to expire in 2004 and Centrisoft’s will begin to expire in 2020.
The Fatburger and Centrisoft NOLs are generally subject to an annual limitation under the Internal Revenue Code of 1986, Section 382, Limitation on Net Operating Loss Carryovers and Certain Built-In Losses Following Change in Control. In addition, to the extent the Fatburger or Centrisoft NOLs are utilized, the recognition of the related tax benefits on certain of the NOLs utilized would first reduce goodwill related to those acquisitions, then other non-current intangible assets related to those acquisitions, and then income tax expense in accordance with Statement on Financial Accounting Standards No. 109, Accounting for Income Taxes.
United States tax regulations impose limitations on the use of NOL carry forwards following certain changes in ownership. If such a change were to occur with respect to the Company, the limitation could significantly reduce the amount of benefits 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 Company established a Shareholder Rights Plan dated as of October 18, 2002, which discourages, under certain circumstances, ownership changes which would trigger the NOL limitations.
During the year ended December 31, 2007, the Company determined that it was more likely than not that certain NOL carryovers would be available to offset prior taxable income. As a result, the Company recognized an income tax benefit of $4.4 million and reduced the deferred tax liability by the same amount. During the year ended December 31, 2006, the Company recognized an income tax benefit of $1.2 million due to similar circumstances.
The provision (benefit) for income taxes includes the following:
A reconciliation of the U.S. federal statutory rate to the effective tax rate on the income or loss from continuing operations, stated as a percentage of pretax income or loss, is as follows:
The tax effects of temporary differences and carry forwards resulting in deferred income taxes are as follows:
Given the lack of sufficient earnings history, management does not believe it is appropriate to recognize a deferred tax asset at this time.
NOTE 15 - COMMITMENTS, CONTINGENCIES AND OFF-BALANCE SHEET RISK
Warlick Complaints
On October 16, 2006, Fatburger Holdings, Inc., Fatburger Corporation and Fatburger North America, Inc. filed suit against Keith A. Warlick (“Warlick”) the former Chief Executive Officer of Fatburger Holdings, Inc. and Fatburger Corporation. Warlick’s employment with Fatburger was terminated on September 21, 2006 by resolution of the board of directors of Fatburger Holdings, Inc. The Fatburger companies initiated the lawsuit to recover damages from Warlick arising from wrongful acts and conduct during and after his employment, and are asserting claims for: breach of contract, breach of duty of loyalty, breach of fiduciary duty, conversion - embezzlement; fraud/commencement; intentional interference with contractual relations, and equitable indemnity. Warlick filed an answer to the lawsuit denying the allegations and included a Cross-complaint against Fatburger Holdings, Inc., Fatburger Corporation, Fatburger North America, Inc., Fog Cutter Capital Group, Inc., and Andrew Wiederhorn (“Cross-Defendants”), for breach of contract, employment discrimination based on race and retaliation, wrongful termination and defamation - slander without any specification of damages. On a motion filed by the Cross-Defendants, the Court dismissed Warlick’s cross-claim for employment discrimination based on race and retaliation. In further response Warlick initiated a second lawsuit against the Company, various Fatburger companies, and
members of the Fatburger board of directors, which is set out below. The defendants to the Cross-complaint filed by Warlick dispute the allegations of the cross-complaint and intend to vigorously defend against the cross-complaint.
On February 6, 2007, Warlick, his wife, and a limited liability company controlled by Warlick, each of whom is a minority shareholder of Fatburger Holdings, Inc., filed a complaint against various Fatburger entities, the Company, Andrew Wiederhorn, and members of the Fatburger board of directors. The complaint alleges fraud, negligent misrepresentation against Wiederhorn and the Company, and breach of contract and breach of fiduciary duty against all the defendants, related to business transactions which the plaintiff’s allege were not in the best interests of Fatburger Holdings, Inc., or the plaintiff minority shareholders. The defendants dispute the allegations of the lawsuit and intend to vigorously defend against the claims.
Shareholder Derivative Complaint
On July 6, 2004, Jeff Allen McCoon, derivatively on behalf of the Company, filed a lawsuit in the Circuit Court for the State of Oregon (Multnomah County case number 0407-06900) which named the Company and all of its directors as defendants. In January 2006, the Circuit Court dismissed the entire derivative lawsuit, ruling that Mr. McCoon was unfit to represent the Company’s shareholders. Mr. McCoon filed an appeal to this ruling. In December 2006, the Company reached a settlement with the plaintiff in which the Company agrees to pay $125,000 in legal fees and is released from further liability under this complaint. The settlement agreement was accepted by the court on January 2, 2007, and Fog Cutter paid the settlement on January 24, 2007.
Other litigation
The Company is involved in various other legal proceedings occurring in the ordinary course of business which management believes will not have a material adverse effect on the consolidated financial condition or operations of the Company.
Liquidity
Borrowings related to the Barcelona properties of $1.0 million, held through the VIE, are reflected as maturing in 2007 due to management’s intention to sell these properties and repay the related debt at the time of sale. The sale of real estate and other investments is considered to be a normal, recurring part of operations and management expects these transactions to generate adequate cash flow to meet the Company’s liquidity needs for the 2008 fiscal year.
Dividends
The Company does not have a fixed dividend policy, and may declare and pay new dividends on common stock, subject to financial condition, results of operations, capital requirements and other factors deemed relevant by the Board of Directors. One factor the Board of Directors may consider is the impact of dividends on the Company’s liquidity. No dividends have been declared or paid in 2007.
Fatburger Debt Covenant
At December 31, 2007 and 2006, Fatburger was not in compliance with all obligations under the agreements evidencing its indebtedness, as defined in the applicable agreements, due to its failure to meet the prescribed fixed charge coverage ratio and the prescribed debt-coverage ratio in three notes payable. The lender subsequently issued a waiver of the covenant violations for both December 31, 2007 and 2006. As such, on our Consolidated Statements of Financial Condition, $4.1 million of long-term debt that was classified as current at December 31, 2006 has been re-classified as long-term.
Fatburger operations
The Company expects that Fatburger will require capital resources and have negative cash flow in the near term while it pursues a growth strategy through developing additional franchisee and Company-owned restaurants. Fatburger development involves substantial risks that the Company intends to manage; however, it cannot be assured that present or future development will perform in accordance with the Company’s expectations or that any restaurants will generate the Company’s expected returns on investment. The Company’s inability to expand Fatburger in accordance with planned expansion or to manage that growth could have a material adverse effect on the Company’s operations and financial condition. In addition, if Fatburger or its franchisees are unsuccessful in obtaining capital sufficient to fund this expansion, the timing of restaurant openings may be delayed and Fatburger’s results may be harmed.
Centrisoft operations
The Company expects that Centrisoft will require capital resources and have negative cash flow in the near term. Since Centrisoft is in the early stages of its marketing, there can be no assurance that it will be successful in attracting a significant customer base. Centrisoft is currently marketing its software to potential customers both directly and through re-seller relationships. There can be no assurance that Centrisoft will be successful in generating sufficient cash flow to support its own operations in the near term.
Related Party Transactions
During the year ended December 31, 2006, the Company paid $0.4 million to Peninsula Capital Partners LLC (“Peninsula Capital”), an
entity owned by the Company’s chief executive officer, as reimbursement of costs for the Company’s business use of certain private aircraft. In July 2006, the Company accepted assignment of a fractional interest lease, between NetJets Services Inc. (“NetJets”) and Peninsula Capital for the lease of a 6.25% undivided interest in an aircraft. The lease calls for annual payments of approximately $420,000 plus specific costs relating to the operation of the aircraft. The lease expires in December 2010; however, the Company has the right to terminate the lease with 90 days notice beginning in December 2008. The future minimum lease payments are as follows (dollars in thousands):
The Board of Directors is aware of the relationship and approved the fees for the use of the aircraft and the assignment of the fractional lease.
Other
In order to facilitate the development of franchise locations, as of December 31, 2007, Fatburger had guaranteed the annual minimum lease payments of three restaurant sites owned and operated by franchisees. The guarantees approximate $0.8 million plus certain contingent rental payments as defined in the respective leases. These leases expire at various times through 2015.
The lease guarantees by Fatburger do not provide us with a material source of liquidity, capital resources or other benefits. There are no revenues, expenses or cash flows connected with the lease guarantees other than the receipt of normal franchise royalties. As of December 31, 2007, management was not aware of any event or demand that was likely to trigger the guarantee by Fatburger.
The Company has various operating leases for office and retail space which expire through 2015. The leases provide for varying minimum annual rental payments including rent increases and free rent periods. Future minimum rental payments under non-cancelable operating leases with initial or remaining terms of one year or more total approximately $29.6 million as of December 31, 2007.
Management may utilize a wide variety of financial techniques to assist in the management of currency risk, including currency swaps, options, and forwards, or combinations thereof. No such currency hedging techniques were in use as of December 31, 2007.
There were no other off balance sheet arrangements in place as of December 31, 2007.
NOTE 16 - ARRANGEMENTS WITH SENIOR OFFICERS
The Company has employment agreements with Andrew A. Wiederhorn (as Chief Executive Officer), and R. Scott Stevenson (as Senior Vice President and Chief Financial Officer) (each an “Executive” and collectively, the “Executives”).
The latest employment agreement with Mr. Wiederhorn was effective June 1, 2006. The employment agreement provides for an initial three-year term commencing June 1, 2006, which is automatically renewable for successive two-year terms unless either party gives written notice of termination to the other at least 180 days prior to the expiration of the then-current employment term. The employment agreement with Mr. Wiederhorn provides for a base salary of not less than $350,000 annually, plus an annual bonus, which is typically paid in quarterly installments, as determined by the Compensation Committee of the Board of Directors.
The latest employment agreement with Mr. Stevenson was effective June 1, 2006. The employment agreement provides for an initial two year term commencing June 1, 2006, which is automatically renewable for successive one year terms unless either party gives written notice of termination to the other at least 60 days prior to the expiration of the then-current employment term. The employment agreement with Mr. Stevenson provides for a base salary of not less than $175,000 annually, plus an annual bonus as determined by the Compensation Committee of the Board of Directors.
The Company incurred salary and bonus expenses of $3.4 million, $4.2 million, and $1.1 million, respectively, for the years ended December 31, 2007, 2006 and 2005, relating to the Executives under current or prior employment agreements.
Prior to the passage of the Sarbanes-Oxley Act of 2002, Mr. Wiederhorn’s employment agreement allowed him to borrow a specified maximum amount from the Company to purchase shares of common stock. Under this program, on February 21, 2002, the Company loaned Mr. Wiederhorn $175,000 to finance the purchase of common stock. This loan was full recourse to Mr. Wiederhorn and was secured by all of Mr. Wiederhorn’s rights under his employment agreement. At Mr. Wiederhorn’s direction (in accordance with the terms of his employment agreement), on February 21, 2002, the Company also loaned a limited partnership controlled by Mr. Wiederhorn’s spouse (the “LP”) $687,000 to finance the purchase of common stock. The loan was secured by the membership interests
of two limited liability companies owned by the LP. The limited liability companies each own a parcel of real property in Oregon and have no liabilities. 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 proceeds of these loans did not serve as security for the loans. The loans bore interest at the prime rate, as published in the Wall Street Journal, which interest was added to the principal annually.
The total amount of loans receivable from Mr. Wiederhorn, including compounded interest, was $1.1 million at December 31, 2007 and 2006. The loans matured on February 21, 2007. The Company did not extend the maturity date of the loans or amend any other terms. The loans were repaid in full, including interest, subsequent to year end on February 21, 2008.
NOTE 17 - STOCK OPTIONS AND RIGHTS
The Company has a non-qualified stock option plan (the “Option Plan”) which provides for options to purchase shares of the Company’s common stock. The maximum number of shares of common stock that may be issued pursuant to options granted under the Option Plan is 3,500,000 shares. Newly elected directors receive 5,000 vested options on the day they join the Board at an exercise price equivalent to the closing price on that day. In addition, each independent director receives, on the last day of each quarter, an automatic non-statutory option grant to purchase 1,500 shares of common stock at 110% of the fair market value on that day. Automatic grants vest one third on each of the first three anniversaries of the grant date and expire on the tenth anniversary of the grant date. Resigning directors have the right to exercise any options that are vested at the date of resignation for a period of one year.
The Company adopted FAS 123R effective January 1, 2006. The Company expensed $2.0 million in share based compensation for the year ended December 31, 2007, and $0.8 million for the year ended December 31, 2006. Prior to January 1, 2006, the Company applied APB 25 and related interpretations in accounting for the Option Plan. Accordingly, no compensation expense was recognized in the Consolidated Statements of Operations prior to January 1, 2006 for grants under the Option Plan. Results for prior periods have not been restated.
There were no options granted with exercise prices below the market value of the stock at the grant date. All outstanding options at December 31, 2007 had no intrinsic value because the Company’s stock price was lower than all option exercise prices. A summary of the Company’s stock options as of and for the year ended December 31, 2007, 2006 and 2005 is presented below:
On October 18, 2002, the Company declared a distribution of one right (a “Right”) to purchase one one-tenth of a share of its common stock for each outstanding share of common stock, payable to the stockholders of record on October 28, 2002.
NOTE 18 - ACQUISITION OF TREASURY STOCK
In December 2007, the Company acquired 2,500 shares of its common stock from the Fog Cutter Long-Term Vesting Trust (the “Trust”). The Trust was established in 2000 for the benefit of our employees and directors to raise their ownership in the Company. In March 2007, the
Trust distributed all allocated shares to the beneficiaries. In December 2007, the Trust transferred its remaining 2,500 shares to the Company, and in exchange, the Company will pay the remaining wrap-up costs of the Trust. As a result of this transaction, the Company recorded treasury stock of $2,500.
NOTE 19 - VARIABLE INTEREST ENTITIES
As of December 31, 2007, the Company has loaned $10.3 million to two related Spanish entities formed to purchase, reposition and sell apartment buildings in Barcelona, Spain. Under the terms of the loans, the investment meets the definition of a Variable Interest Entity (“VIE”) under FASB Interpretation No. 46 (“FIN 46”) and the Company is the primary beneficiary of the VIE. As a result, the assets, liabilities, and results of operations of the VIE have been consolidated into the accompanying consolidated financial statements. Neither the creditors nor the other beneficial interest holders have recourse to the Company with regard to these investments and, as a result, the maximum limit of the Company’s exposure to loss on this investment was $10.3 million as of December 31, 2007.
The VIE currently owns two apartment buildings, consisting of 33 residential units with a book value of approximately $8.5 million, including capital improvements and carrying costs. During the year ended December 31, 2007, the Company loaned $0.2 million to the VIE, while the VIE spent approximately $0.1 million for improvements and carrying costs on its two apartment buildings. The two properties, met the criteria to be classified as “held for sale”, and were classified as such on the Statement of Financial Condition at December 31, 2007. In December 2006, the VIE entered into an agreement to sell one of the two buildings for approximately $8.6 million. In June 2007, the buyer failed to perform under terms of the contract, the Company recognized $0.7 million in revenue from a forfeited deposit, and the building was re-listed for sale. Based upon management’s estimate of the current fair value, the Company has recorded market value impairments totaling $3.6 million on this building in the year ended December 31, 2007. Assets and liabilities of the VIE included in the accompanying consolidated statements of financial condition are summarized as follows:
NOTE 20 - ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The following table presents the ending balance in accumulated other comprehensive income (loss) for each component:
The following table presents the changes in accumulated other comprehensive income (loss):
NOTE 21 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company has estimated fair value amounts using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop estimates of fair value. Accordingly, the estimates presented
herein are not necessarily indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
The methods and assumptions used to estimate the fair value of each class of financial instrument for which it is practicable to estimate that value are explained below:
Cash and cash equivalents - The carrying amounts approximate fair values due to the short-term nature of these instruments.
Notes Receivable - The fair value of notes receivable is based upon the present value of the expected cash flows from the notes.
Borrowing and notes payable - The fair value of notes payable by Fatburger and Centrisoft is based on a comparison of the terms of those loans with market terms for similar loans at those dates. The carrying value of the Company’s other borrowings approximate fair values due to the short-term nature of these instruments.
Obligations under capital leases - The fair value of obligations under capital leases is estimated based on current market rates for similar obligations with similar characteristics.
The fair value estimates presented herein are based on pertinent information available to management as of December 31, 2007 and 2006. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date, and therefore, current estimates of fair value may differ significantly from the amounts presented herein.
NOTE 22 - OPERATING SEGMENTS
Operating segments consist of (i) restaurant operations conducted through Fatburger, (ii) manufacturing activities conducted through DAC International, (iii) real estate and financing activities, and (iv) software development and sales conducted through Centrisoft Corporation. Each segment operates with its own management and personnel. Beginning in 2006, the Company began allocating certain corporate expenses to Fatburger through a management fee. This management fee is reflective of management’s increased involvement in the restaurant operations. The Company began charging this fee to more closely represent the true costs of restaurant operations in the appropriate segment reporting. The management fee is eliminated upon consolidation. The following is a summary of each of the operating segments:
Restaurant Operations
As of December 31, 2007, the Company owned approximately 82% of the voting control of Fatburger, which operates or franchises 92 hamburger restaurants located primarily in California and Nevada, as well as 12 other states, Canada, and China. Franchisees currently own and operate 53 of the Fatburger locations. Five new franchise restaurants were opened and one franchise restaurant was closed during 2007. In the third quarter of 2007, Fatburger acquired the net assets of two franchise locations and converted them to company-owned locations.
Manufacturing Operations
The Company conducts manufacturing activities through its wholly-owned subsidiary, DAC International. The Company assumed 100% voting control of DAC in November 2005 and began reporting the operations of DAC on a consolidated basis as of November 1, 2005. DAC is a supplier of computer controlled lathes and milling machinery for the production of eyeglass, contact, and intraocular lenses.
Real Estate and Financing Operations
The Company owns various interests in real estate and notes receivable. At December 31, 2007, real estate is comprised of leasehold interests in 72 freestanding retail buildings located throughout the United States and two apartment buildings located in Barcelona, Spain. At December 31, 2007, notes receivable have a carrying value of $0.6 million and are primarily secured by real estate.
Other non-operating income for the year ended December 31, 2007 includes foreign currency gains ($1.0 million) and commission and other non-operating revenue ($1.0 million). Other non-operating income for the year ended December 31, 2006 includes gain on sale of real estate ($2.9 million), gain on sale of notes receivable ($0.5 million), foreign currency gains ($1.0 million), and commission and other non-operating revenue ($0.4 million).
Software Development and Sales
The Company holds a 79% ownership interest in Centrisoft, which conducts software development and sales activities. The Company began reporting the operations of Centrisoft on a consolidated basis as of July 1, 2005, when majority voting control was obtained. Centrisoft develops and sells software that controls and enhances the productivity of enterprise networks and provides first level security against unauthorized applications and users.
Reconciliation to net loss
Corporate expenses for the year ended December 31, 2006 includes $0.4 million paid to Peninsula Capital, an entity owned by the Company’s chief executive officer, as reimbursement of costs for the Company’s business use of certain private aircraft and $0.3 million paid under the terms of a fractional lease assumed by the Company from Peninsula Capital. The Board of Directors is aware of the relationship and approved the fees for the use of the aircraft and the assignment of the fractional lease.
NOTE 23 - DISCONTINUED OPERATIONS
In the fourth quarter of 2007, the leased real estate portfolio met the Company’s requirements to be classified as held for sale and was classified as held for sale at December 31, 2007 and 2006. The portfolio was sold in February 2008, subsequent to year end. Prior to reclassification, the leased real estate portfolio was part of the Real Estate and Financing Operations segment.
Prior to February 2007, the Company held a 51% ownership interest in George Elkins, a California commercial mortgage banking operation. In December 2006, the Company reached an agreement to sell George Elkins to a third party and the sale closed in February 2007. The Company received $2.9 million for its portion of the proceeds and recorded a gain on sale of $2.5 million. As such, all assets of George Elkins were classified as held for sale at December 31, 2006 and results from operations of George Elkins for the years ended December 31, 2007, 2006 and 2005 have been classified as discontinued operations. Prior to disposal, George Elkins was a reportable segment of the Company’s operations.
NOTE 24 - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
NOTE 25 - SUBSEQUENT EVENTS
Restaurant openings
Subsequent to December 31, 2007, Fatburger has opened three additional franchisee locations.
Loans to senior executives
On February 21, 2008, subsequent to year end, the Company received payment in full, including interest, on notes receivable from its CEO that had a carrying value of $1.1 million at December 31, 2007.
Sale of leased real estate portfolio
In February 2008, the Company sold its ownership interest in Fog Cap Retail Investors LLC (“FCRI”), a wholly-owned subsidiary that held the Company’s leased real estate portfolio, for $8.5 million cash proceeds. A part of the proceeds was used to repay a loan that had a carrying value of $4.0 million at December 31, 2007.
Schedule III
Real Estate and Accumulated Depreciation
As of December 31, 2007
(dollars in thousands)
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934 as amended, the Registrant has duly caused this report to be signed on its behalf on March 31, 2008, by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 31, 2008 by the following persons on behalf of the Registrant and in the capacities indicated.
/s/ Andrew A. Wiederhorn
Andrew A. Wiederhorn
Chief Executive Officer and Director
/s/ Donald Berchtold
Donald Berchtold
Senior Vice President of Administration and Director
/s/ R. Scott Stevenson
R. Scott Stevenson
Senior Vice President and Chief Financial Officer
/s/ Don H. Coleman
Don H. Coleman
Director
/s/ K. Kenneth Kotler
K. Kenneth Kotler
Director
/s/ Kenneth J. Anderson
Kenneth J. Anderson
Director
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 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 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
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.
4.5
Summary of Rights to Purchase Shares, incorporated by reference to Exhibit 99.1 to the Form 8-K dated October 18, 2002, as previously filed with the SEC on October 18, 2002.
4.6
Rights Agreement dated as of October 18, 2002 between the Registrant and The Bank of New York, incorporated by reference to Exhibit 1 to Form 8-A, as previously filed with the SEC on October 29, 2002.
4.7
Amendment to the Rights Agreement, dated as of May 1, 2004, by and between the Registrant and The Bank of New York, as previously filed with the SEC on March 30, 2005.
4.8
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 to the Form 10-K for the year ended December 31, 2002, as previously filed with the SEC on March 3, 2003.
4.9
Amendment Number 1 to the Long Term Vesting Trust Agreement, dated as of September 19, 2002, by and between the Registrant and Andrew Wiederhorn, Don Coleman, and David Dale-Johnson, as previously filed with the SEC on March 30, 2005.
4.10
Amendment Number 2 to the Long Term Vesting Trust Agreement, dated as of May 26, 2004, by and between the Registrant and Andrew Wiederhorn, Don Coleman, and David Dale-Johnson, as previously filed with the SEC on March 30, 2005.
10.1
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.
10.2
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.
10.3
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.
10.4
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.
10.5
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.
10.6
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.
10.7
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.
11.1
Computation of Per Share Earnings.
21.1
List of Subsidiaries of Registrant.
23.1
Consent of independent registered public accounting firm.
23.2
Consent of independent registered public accounting firm.
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.
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
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.
99.4
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.
99.5
Robert G. Rosen Resignation Letter dated March 26, 2004, incorporated by reference to exhibit 99.1 of the Form 8-K dated March 26, 2004, as previously filed with the SEC on March 30, 2004.