SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] |
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 |
Commission File Number: 0-17442
MERITAGE HOSPITALITY GROUP INC.
(Exact Name of Registrant as Specified in Its Charter)
Michigan |
|
38-2730460 |
(616) 776-2600
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
As of October 11, 2002, there were 5,341,948 outstanding Common Shares, $.01 par value.
Certain statements contained in this report that are not historical facts constitute forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, and are intended to be covered by the safe harbors created by that Act. Reliance should not be placed on forward-looking statements because they involve known and unknown risks, uncertainties and other factors which may cause actual results, performance or achievements to differ materially from those expressed or implied. Any forward-looking statement speaks only as of the date made. The Company undertakes no obligation to update any forward-looking statements to reflect events or circumstances after the date on which they are made.
Statements concerning expected financial performance, on-going business strategies and actions which the Company intends to pursue to achieve strategic objectives constitute forward-looking information. Implementation of these strategies and the achievement of such financial performance are subject to numerous conditions, uncertainties and risk factors. Factors which could cause actual performance to differ materially from these forward looking statements include, without limitation, competition; changes in local and national economic conditions; changes in consumer tastes and views about quick-service food; severe weather; changes in travel patterns; increases in food, labor and energy costs; the availability and cost of suitable restaurant sites; the ability to finance expansion; fluctuating interest rates; fluctuating insurance rates; the availability of adequate employees; directives issued by the franchisor; the general reputation of Wendy’s restaurants; and the recurring need for renovation and capital improvements. Also, the Company is subject to extensive government regulations relating to, among other things, zoning, minimum wage, public health certification, and the operation of its restaurants. Because the Company’s operations are concentrated in smaller urban areas of Michigan, a marked decline in the Michigan economy could adversely affect its operations.
PART I
FINANCIAL INFORMATION
The following unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not contain all the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the financial position, results of operations, stockholders’ equity and cash flows of the Company have been included. For further information, please refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 2, 2001. The results of operations for the third quarter and nine months ended September 1, 2002 are not necessarily indicative of the results to be expected for the full year.
2
Meritage Hospitality Group Inc. and Subsidiaries
Consolidated Balance Sheets
- --------------------------------------------------------------------------------
ASSETS
September 1,
2002 December 2,
(Unaudited) 2001
----------- -----------
Current Assets
Cash and cash equivalents $ 1,085,114 $ 1,663,900
Receivables 72,461 129,162
Inventories 202,844 202,708
Income taxes receivable 5,000 --
Prepaid expenses and
other current assets 118,433 201,885
----------- -----------
Total current assets 1,483,852 2,197,655
Property, Plant and Equipment, net 34,312,414 28,780,582
Other Assets
Note receivable 360,339 362,736
Assets held for sale and development 727,730 472,725
Goodwill, net of amortization
of $834,492 and
$698,345, respectively 4,475,231 4,611,378
Franchise fees, net of
amortization of $120,781
and $93,917, respectively 954,219 881,083
Financing costs, net of
amortization of $77,756
and $64,108, respectively 521,783 477,787
Deferred charges and other assets 75,627 96,889
----------- -----------
Total other assets 7,114,929 6,902,598
----------- -----------
Total assets $42,911,195 $37,880,835
=========== ===========
See notes to unaudited financial statements.
3
Meritage Hospitality Group Inc. and Subsidiaries
Consolidated Balance Sheets - continued
- --------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
September 1,
2002 December 2,
(Unaudited) 2001
------------ ------------
Current Liabilities
Current portion of
long-term obligations $ 920,225 $ 748,444
Current portion of
obligations under
capital lease 332,699 306,305
Trade accounts payable 1,133,325 1,583,295
Income taxes payable -- 17,264
Accrued liabilities 1,884,071 1,575,278
------------ ------------
Total current liabilities 4,270,320 4,230,586
Long-Term Obligations 27,263,374 22,701,377
Obligations Under Capital Lease 149,813 402,742
Deferred Revenue 3,792,894 4,209,108
Commitments and Contingencies -- --
Stockholders' Equity
Preferred stock - $0.01 par value
shares authorized: 5,000,000;
200,000 designated as Series A
convertible cumulative preferred
stock
shares issued and outstanding: 29,520
(liquidation value - $295,200) 295 295
Common stock - $0.01 par value
shares authorized: 30,000,000
shares issued: 5,899,499 and
5,878,413, respectively
shares outstanding: 5,344,885
and 5,323,799, respectively 53,449 53,238
Additional paid in capital 13,556,591 13,534,302
Note receivable from the sale of shares -- (538,900)
Accumulated deficit (6,175,541) (6,711,913)
------------ ------------
Total stockholders' equity 7,434,794 6,337,022
------------ ------------
Total liabilities and
stockholders' equity $ 42,911,195 $ 37,880,835
============ ============
See notes to unaudited financial statements.
4
Meritage Hospitality Group Inc. and Subsidiaries
Consolidated Statements of Earnings
For the Nine Months Ended September 1, 2002 and September 2, 2001
(Unaudited)
- --------------------------------------------------------------------------------
2002 2001
------------ ------------
Food and beverage revenue $ 34,559,034 $ 27,933,043
Costs and expenses
Cost of food and beverages 8,870,478 7,744,433
Operating expenses 19,650,283 16,081,317
General and administrative expenses 2,213,735 1,932,571
Depreciation and amortization 1,802,009 1,382,351
Gain on sale of impaired assets -- (459,767)
------------ ------------
Total costs and expenses 32,536,505 26,680,905
------------ ------------
Earnings from operations 2,022,529 1,252,138
Other income (expense)
Interest expense (1,430,256) (1,132,260)
Interest income 34,160 86,944
Miscellaneous income 23,535 23,510
(Loss) gain on disposal of assets (110,670) 267,083
------------ ------------
Total other expense (1,483,231) (754,723)
------------ ------------
Earnings before federal
income tax benefit 539,298 497,415
Federal income tax benefit 17,000 --
------------ ------------
Net earnings 556,298 497,415
Dividends on preferred stock 19,926 19,926
------------ ------------
Net earnings on common shares $ 536,372 $ 477,489
============ ============
Net earnings per common
share - basic $ 0.10 $ 0.09
============ ============
Net earnings per common
share - diluted $ 0.09 $ 0.09
============ ============
Weighted average shares
outstanding - basic 5,326,918 5,201,032
============ ============
Weighted average shares
outstanding - diluted 5,668,463 5,246,780
============ ============
See notes to unaudited financial statements.
5
Meritage Hospitality Group Inc. and Subsidiaries
Consolidated Statements of Earnings
For the Three Months Ended September 1, 2002 and September 2, 2001
(Unaudited)
- --------------------------------------------------------------------------------
2002 2001
------------ ------------
Food and beverage revenue $ 12,427,270 $ 10,325,627
Costs and expenses
Cost of food and beverages 3,147,528 2,877,423
Operating expenses 6,995,203 5,794,801
General and administrative expenses 707,721 670,979
Depreciation and amortization 625,440 478,251
------------ ------------
Total costs and expenses 11,475,892 9,821,454
------------ ------------
Earnings from operations 951,378 504,173
Other income (expense)
Interest expense (512,934) (370,120)
Interest income 10,130 33,157
Miscellaneous income 380 12,783
(Loss) gain on disposal of assets (6,057) 216,153
------------ ------------
Total other expense (508,481) (108,027)
------------ ------------
Net earnings 442,897 396,146
Dividends on preferred stock 6,641 6,641
------------ ------------
Net earnings on common
shares $ 436,256 $ 389,505
============ ============
Net earnings per common
share - basic and diluted $ 0.08 $ 0.07
============ ============
Weighted average shares
outstanding - basic 5,329,775 5,390,867
============ ============
Weighted average shares
outstanding - diluted 5,738,096 5,457,854
============ ============
See notes to unaudited financial statements.
6
Meritage Hospitality Group Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
For the Year Ended December 2, 2001
and the Nine months Ended June 2, 2002 (Unaudited)
- --------------------------------------------------------------------------------
Series A Note
onvertible Additional Receivable
Preferred Common Paid-In Sale of Accumulated
Stock Stock Capital Shares Deficit Total
--------- ------- ----------- --------- ------------ ----------
Balance at
December 1, 2000 $ 295 $44,548 $11,703,257 $ -- $(7,216,927) $4,531,173
Issuance of 978,211
shares of common
stock -- 9,783 2,068,341 (538,900) -- 1,539,224
Preferred stock
dividends paid -- -- -- -- (26,568) (26,568)
Purchase of 109,296
shares of common
stock -- (1,093) (237,296) -- -- (238,389)
Net earnings -- -- -- -- 531,582 531,582
----- ------- ----------- --------- ----------- ----------
Balance at
December 2, 2001 295 53,238 13,534,302 (538,900) (6,711,913) 6,337,022
Issuance of 21,086
shares of common
stock -- 211 22,289 -- -- 22,500
Payment received
on note receivable -- -- -- 538,900 -- 538,900
Preferred stock
dividends paid -- -- -- -- (19,926) (19,926)
Net earnings -- -- -- -- 556,298 556,298
----- ------- ----------- --------- ----------- ----------
Balance at
September 1, 2002 $ 295 $53,449 $13,556,591 $ -- $(6,175,541) $7,434,794
===== ======= =========== ========= =========== ==========
See notes to unaudited financial statements.
7
Meritage Hospitality Group Inc. and Subsidiaries
Consolidated Statements of Cash Flows
For the Nine Months Ended September 1, 2002 and September 2, 2001
(Unaudited)
- --------------------------------------------------------------------------------
2002 2001
----------- -----------
Cash Flows from Operating Activities
Net earnings $ 556,298 $ 497,415
Adjustments to reconcile
net earnings to net cash
provided by operating activities
Depreciation and amortization 1,802,009 1,382,351
Compensation and fees paid by
issuance of common stock 22,500 26,355
Loss (gain) on disposal of assets 110,670 (267,083)
Gain on sale of impaired assets -- (459,767)
(Decrease) increase in deferred
revenue (416,214) 2,575,895
Decrease in current assets 137,414 43,172
(Decrease) increase
in current liabilities (158,441) 256,342
----------- -----------
Net cash provided by
operating activities 2,054,236 4,054,680
Cash Flows from Investing Activities
Purchase of property, plant
and equipment (7,490,740) (5,465,068)
Purchase of assets held for
sale and development (5,005) (697,816)
Payment for franchise agreements (100,000) (75,000)
Proceeds from sale of assets -- 1,750,056
Decrease (increase) in other assets 11,650 (25,166)
----------- -----------
Net cash used in investing activities (7,584,095) (4,512,994)
Cash Flows from Financing Activities
Proceeds from long-term obligations 4,883,435 898,781
Net increase (decrease) in
line of credit 421,071 (317,500)
Payment of financing costs (75,144) (37,596)
Principal payments on
long-term obligations (570,728) (678,430)
Payments on obligations
under capital lease (226,535) (270,566)
Proceeds from issuance of
common shares -- 1,504,868
Purchase of common shares -- (87,963)
Proceeds from note receivable
from sale of shares 538,900 --
Preferred dividends paid (19,926) (19,926)
----------- -----------
Net cash provided by
financing activities 4,951,073 991,668
----------- -----------
Net (decrease) increase in cash (578,786) 533,354
Cash and Cash Equivalents
- Beginning of Period 1,663,900 787,747
----------- -----------
Cash and Cash Equivalents
- End of Period $ 1,085,114 $ 1,321,101
=========== ===========
Supplemental Cash Flow Information - See Note A
See notes to unaudited financial statements.
8
Meritage Hospitality Group Inc. and Subsidiaries
Notes to Unaudited Financial Statements
For the Nine Months Ended September 1, 2002 and September 2, 2001
2002 2001
---------- ----------
Cash paid for interest expense,
net of capitalized interest $1,409,667 $1,132,000
========== ==========
Cash paid for income taxes $ 5,000 $ --
========== ==========
Schedule of Non-Cash Investing
and Financing Activities
Issuance of 250,000 shares of
common stock in exchange for
an 8% short-term note receivable $ -- $ 538,900
========== ==========
Basic earnings per share is computed by dividing earnings on common shares by the weighted average number of common shares outstanding during each period. Diluted earnings per share reflect per share amounts that would have resulted if dilutive potential common stock had been converted to common stock.
The following table reconciles the numerators and denominators used to calculate basic and diluted earnings per share for the third quarter and year-to-date ended September 1, 2002 and September 2, 2001:
Three months ended Nine months ended
-------------------------- --------------------------
September 1, September 2, September 1, September 2,
2002 2001 2002 2001
------------ ------------ ------------ ------------
Numerators
Net earnings from
operations $ 442,897 $ 396,146 $ 556,298 $ 497,415
Less preferred stock
dividends 6,641 6,641 19,926 19,926
---------- ---------- ---------- ----------
Net earnings on common
shares - basic
and diluted $ 436,256 $ 389,505 $ 536,372 $ 477,489
========== ========== ========== ==========
Denominators
Weighted average common
shares outstanding
- basic 5,329,775 5,390,867 5,326,918 5,201,032
Effect of dilutive
securities:
Stock options 408,321 66,987 341,545 45,748
---------- ---------- ---------- ----------
Weighted average common
shares outstanding
- diluted 5,738,096 5,457,854 5,668,463 5,246,780
========= ========= ========= =========
For the three and nine months ended September 1, 2002 and September 2, 2001, convertible preferred stock was not included in the computation of diluted earnings per share because the effect of conversion of preferred stock would be antidilutive.
9
Meritage Hospitality Group Inc. and Subsidiaries
Notes to Unaudited Financial Statements - Continued
For the Nine Months Ended September 1, 2001 and September 2, 2001
Note C - Recently Issued Accounting Standards
On July 20, 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting ("SFAS") No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Intangible Assets". SFAS 141 is effective for all business combinations completed after June 30, 2001. SFAS 142 is effective for fiscal years beginning after December 15, 2001; however, certain provisions of this Statement apply to goodwill and other intangible assets acquired between July 1, 2001, and the effective date of SFAS 142. Major provisions of these Statements and their effective dates relating to Meritage are as follows:
- |
All business combinations initiated after June 30, 2001, must use the purchase method of accounting. The pooling of interest method of accounting is prohibited except for transactions initiated before July 1, 2001. |
- |
Intangible assets acquired in a business combination must be recorded separately from goodwill if they arise from contractual or other legal rights, or are separable from the acquired entity and can be sold, transferred, licensed, rented or exchanged, either individually or as part of a related contract, asset or liability. |
- |
Goodwill, as well as intangible assets with indefinite lives, acquired after June 30, 2001, will not be amortized. Beginning in fiscal year 2003, all previously recognized goodwill and intangible assets with indefinite lives will no longer be subject to amortization. |
- |
Beginning in fiscal year 2003, goodwill and intangible assets with indefinite lives will be tested for impairment annually and whenever there is an impairment indicator. |
- |
All acquired goodwill must be assigned to reporting units for purposes of impairment testing and segment reporting. |
Meritage is in the process of determining the impact of these pronouncements on its financial statements.
In December 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations", which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The standard is effective for fiscal years beginning after June 15, 2002. Meritage does not expect this pronouncement to have an impact on its financial statements.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. While SFAS 144 supersedes SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," it retains many of the fundamental provisions of that statement. The standard is effective for fiscal years beginning after December 15, 2001.
10
Meritage Hospitality Group Inc. and Subsidiaries
Notes to Unaudited Financial Statements - Continued
For the Nine Months Ended September 1, 2001 and September 2, 2001
Note C - Recently Issued Accounting Standards (Continued)
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statement No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections". This statement rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishments of Debt", and an amendment of that Statement, SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements". This Statement also rescinds SFAS No. 44, "Accounting for Intangible Assets of Motor Carriers". This statement amends SFAS No. 13, "Accounting for Leases', to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modification that have economic effects that are similar to sale-leaseback transactions. This Statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings or describe their applicability under changed conditions. The provisions of this statement related to the rescission of SFAS No. 4 will be applied in fiscal years beginning after May 15, 2002. The Company is in the process of evaluating the impact of this statement on its financial statements and will adopt the provisions of this statement in the first quarter of fiscal 2003.
In June 2002, the FASB issues SFAS No. 146, "Accounting for Exit or Disposal Activities". This statement addresses significant issues regarding the recognition, measurement, and reporting of costs that are associated with the exit and disposal activities, including restructuring activities, that are currently accounted for pursuant to the guidance that the Emerging Issues Task Force (EITF) has set forth in EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)". This statement also addresses accounting and reporting standards for costs related to terminating a contract that is not a capital lease and termination benefits that employees who are involuntarily terminated receive under the terms of a one-time benefit arrangement or an individual deferred-compensation contract. This statement will be effective for exit or disposal activities that are initiated after December 31, 2002. The Company is in the process of evaluating the impact of this statement on its financial statements and will adopt the provisions of this statement in the first quarter of fiscal 2003.
11
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Results of Operations
Results of operations for the three and nine months ended September 1, 2002 and September 2, 2001 are summarized in the following tables:
Statements of Earnings
------------------------------------------------------------------
Third quarter ended Year-to-date ended (nine months)
-------------------------------- --------------------------------
$ (000's) % of Revenue $ (000's) % of Revenue
---------------- -------------- ----------------- -------------
9/1/02 9/2/01 9/1/02 9/2/01 9/1/02 9/2/01 9/1/02 9/2/01
------- ------- ------ ------ -------- ------- ------ ------
Food and beverage
revenue $12,427 $10,326 100.0% 100.0% $34,559 $27,933 100.0% 100.0%
Costs and expenses
Cost of food and
beverages 3,148 2,878 25.3 27.9 8,870 7,744 25.7 27.7
Operating expenses 6,995 5,795 56.3 56.1 19,650 16,081 56.9 57.6
General and
administrative
Restaurant
operations 357 303 2.9 2.9 1,039 848 3.0 3.0
Corporate level
expenses 298 304 2.4 3.0 992 898 2.8 3.2
Michigan single
business tax 53 64 0.4 0.6 183 188 0.5 0.7
Depreciation and
amortization 580 433 4.7 4.2 1,666 1,246 4.8 4.5
Goodwill amortization 45 45 0.3 0.4 136 136 0.4 0.5
Gain on sale of
impaired assets -- -- -- -- -- (460) -- (1.7)
-----------------------------------------------------------------
Total costs and
expenses 11,476 9,822 92.3 95.1 32,536 26,681 94.1 95.5
-----------------------------------------------------------------
Earnings from operations 951 504 7.7 4.9 2,023 1,252 5.9 4.5
Other income (expense)
Interest expense (513) (370) (4.1) (3.6) (1,430) (1,132) (4.1) (4.1)
Interest income 10 33 0.0 0.3 34 87 0.1 0.3
Other income 1 13 0.0 0.1 23 23 0.0 0.1
(Loss) gain on
sale of assets (6) 216 (0.0) 2.1 (111) 267 (0.3) 1.0
-----------------------------------------------------------------
Total other expense (508) (108) (4.1) (1.1) (1,484) (755) (4.3) (2.7)
-----------------------------------------------------------------
Earnings before federal
income tax benefit $ 443 $ 396 3.6% 3.8% $ 539 $ 497 1.6% 1.8%
=================================================================
Food and beverage revenue increased 20.4% and 23.7%, respectively, for the third quarter and nine months ended September 1, 2002, compared to the similar periods last year. These increases were primarily due to sales from new restaurants open for less than one year which contributed $2,896,000 and $6,888,000 for the respective periods. Also contributing to the year-to-date increase were improved same store sales which were helped by strong demand for Wendy’s new “Garden Sensations” salads introduced in January 2002. Offsetting the increase in third quarter sales from new stores was (i) promotional discounting by the Company’s major competitors, (ii) a general softening of sales in the quick service industry combined with an overall decline in the economic climate in West Michigan, (iii) the closing of a twenty-five year old restaurant for nearly two months for demolition and rebuilding, and (iv) highway construction that impacted several of the Company’s highest revenue stores.
12
Average food and beverage revenue for stores in full operation during the first three quarters of 2002 (“same store sales”) are as set forth below:
Increase Increase
2002 2001 (Decrease) (Decrease)
-------- -------- ---------- ---------
Third Quarter - sales per unit $302,937 $303,959 $ (1,022) (0.3)%
Second Quarter - sales per unit 295,328 287,763 7,565 2.6%
First Quarter - sales per unit 273,234 255,885 17,349 6.8%
-------- -------- --------
Year-To-Date - sales per unit $871,499 $847,607 $ 23,892 2.8%
======== ======== ========
The increase in same store sales in 2002 was primarily attributable to (i) increased menu prices, contributing to an increase in average ticket of approximately 3% and 5% respectively, for the three and nine months ended September 1, 2002, (ii) improved customer service times, and (iii) improved training. These increases were offset by intense promotional discounts by the Company’s major competitors in the third quarter and a decline in customer traffic of approximately 5% and less than 1% respectively, for the three and nine months ended September 1, 2002.
The Company’s same store sales were positive for the first nine months of 2002. During the third quarter, however, same store sales began following a downward sales trend that has been reported throughout the quick-service restaurant industry. Management cautions that it is becoming increasingly difficult to accurately forecast how current consumer spending trends and a declining economic climate in West Michigan will affect the Company’s future revenues.
The decreases in the cost of food and beverage percentages compared to the prior year periods resulted from improved inventory control measures, an increase in menu prices, and a reduction in beef and chicken costs. Meritage’s costs are in line with guidelines established by Wendy’s International.
The following table presents operating expense categories that have had an impact on the above year-to-year fluctuations:
Third quarter ended Nine months ended
--------------------------- --------------------------
Increase Increase
9/1/02 9/2/01 (Decrease) 9/1/02 9/2/01 (Decrease)
------ ------ ---------- ------ ------ ----------
As a percentage of
revenue:
Labor and related
costs 33.0 32.9 0.1 33.2 33.8 (0.5)
Occupancy expenses 8.2 8.4 (0.2) 8.7 9.2 (0.5)
Other operating
expenses 3.6 3.4 0.2 3.7 3.4 0.3
For the third quarter, labor and related costs remained stable as salary increases for store management labor were offset by a reduction in training costs. The year-to-date decrease in labor and related costs was primarily the result of a reduction in hourly labor costs due to better trained store management teams combined with a slight decrease in average hourly rates. The decrease in hourly labor for the nine months ended September 1, 2002, was partially offset by salary increases for store management labor.
As a percentage of revenue, the decrease in occupancy expense for the three and nine months ended September 1, 2002, was due to lower rent expense as the percentage of Company owned versus leased restaurants has increased over this period. Of the twelve new stores opened since the beginning of fiscal 2001, 11 are owned. Also, two previously leased restaurants were purchased this year. In total, 30 of 43 stores are now owned. For the third quarter, the decrease in rent was partially offset by increases in property taxes and utility costs.
13
The increase in other operating expenses was primarily due to monthly fees for a new food cost software program implemented at the beginning of fiscal 2002 which has helped reduce food costs.
The decrease in general and administrative expenses as a percentage of revenue was primarily due to the increase in revenue for both the three and nine months ended September 1, 2002 compared to the prior periods. In 2001 Meritage added new positions to facilitate the Company’s aggressive development plan, which costs are spread over higher sales volumes in 2002.
Increases in depreciation and amortization expense were primarily due to the depreciation of buildings and equipment associated with new restaurants (Meritage opened twelve new restaurants since the beginning of fiscal 2001). Meritage owns the buildings and equipment associated with eleven of these restaurants. Meritage also acquired four restaurant properties in the last two fiscal years that were previously leased. The restaurant at one of these locations was demolished and rebuilt in the third quarter of 2002. Additional depreciation resulted from remodeling five restaurants since the second quarter of 2001.
The gain on sale of impaired assets in 2001 resulted from the sale of a closed restaurant in March 2001. An impairment loss had been recognized in 2000.
The increase as a percentage of revenue for the third quarter was due to the opening of nine new restaurants since October 2001, the land and building of which were all financed. Nearly all of the Company’s long-term obligations as of September 1, 2002 are first mortgages secured by restaurant real estate at fixed interest rates.
The decrease in interest income for the three and nine months ended September 1, 2002 was due primarily to the elimination of interest earned on a note receivable from the sale of shares which was repaid in February 2002.
The loss on disposal of assets in 2002 resulted primarily from the write-off of assets located at a previously leased restaurant that was purchased in May 2002. Meritage demolished and rebuilt this restaurant in the third quarter. The gain on disposal of assets in 2001 resulted from the sale of surplus property.
14
Liquidity and Capital Resources
Cash and cash equivalents (“cash”) decreased $579,000, to $1,085,000 as of September 1, 2002:
Net cash provided by operating activities $ 2,054,000
Net cash used in investing activities (7,584,000)
Net cash provided by financing activities 4,951,000
------------
Net decrease in cash $ (579,000)
============
The $2,000,000 decrease in net cash provided by operating activities was primarily the result of the receipt of $3,000,000 in marketing funds from the Company’s primary beverage supplier in March 2001. Since then, no additional marketing funds have been received. Offsetting this decrease was a $1,316,000 improvement in net earnings before depreciation and amortization, and gains on the sale of surplus property (non-cash adjustments to net earnings) realized in 2001.
Net cash used in investing activities increased $3,071,000. In fiscal 2002 the Company has invested $7,951,000 in property, plant and equipment including (i) $5,302,000 used to develop new restaurants, (ii) $1,511,000 used to purchase and develop new restaurants that were previously leased (two previously leased sites were purchased in May 2002), and (iii) $778,000 used to upgrade and remodel existing restaurants. This compares to $6,238,000 invested in 2001 in connection with (i) the development of new restaurants ($4,181,000), (ii) the purchase of two restaurants that were previously leased ($800,000), (iii) improvements to existing restaurants and offices ($559,000), and (iv) the purchase of surplus property held for sale or development ($698,000). In 2001, these investments in assets were offset by proceeds from the sale of assets of $1,750,000 including the sale of a closed restaurant property for $812,000 and the sale of surplus land for $938,000.
Net cash provided by financing activities increased $3,959,000 due to (i) a $4,723,000 increase in net loan proceeds (after net increases/reductions to the Company’s line of credit) used to finance new store development, (ii) proceeds of $539,000 from a note receivable in February 2002, and (iii) a decrease in principal payments on long-term obligations including capital leases of $152,000. These increases in 2002 were offset by a decrease in cash provided by financing activities of $1,505,000 from a private placement of common stock in February 2001.
As of September 1, 2002, current liabilities exceeded current assets by $2,786,000 compared to December 2, 2001, when current liabilities exceeded current assets by $2,033,000. Excluding the current portion of occupancy related long-term obligations and capital leases, current liabilities exceeded current assets by $1,534,000 at September 1, 2002, and by $978,000 at December 2, 2001. At these dates, the ratios of current assets to current liabilities were 0.35:1 and 0.52:1, respectively. The cash flows discussion explains the decrease in cash and the significant reasons for the decrease in working capital.
Excluding the $3,000,000 in marketing funds from the Company’s primary beverage supplier in March 2001, the increase in cash flows from existing operations during the past year was primarily due to initiatives to effectively manage growth and operational performance. Management believes that, at current operating levels, Meritage can meet its obligations from existing operations, including debt
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service and necessary capital improvements to existing restaurants, for the foreseeable future. However, because of Meritage’s aggressive development plans, certain liquidity issues remain including (i) negative cash flow experienced by new stores during the pre-opening and start-up phase of operations, (ii) the decision in mid-2001 to make larger equity investments (of 18% - 25%) in new stores, and (iii) plans to remodel certain restaurants.
Capital investment into existing restaurants is estimated at approximately $1,200,000 over the next twelve months. It is anticipated that the capital resources for this investment will be from cash generated from existing operations and proceeds generated from the sale of surplus real estate. Meritage plans to open six to eight additional restaurants over the next twelve months, including at least one replacement of an existing restaurant. In early October 2002, management decided to demolish and rebuild a twenty-five year old formerly leased store. As a result, the Company will incur a loss on the disposal of assets of approximately $60,000 in the fourth quarter of 2002.
New planned restaurants require an investment in real estate and equipment. Investments average approximately $1.25 million per restaurant, of which Meritage typically invests $225,000 to $300,000 of equity per restaurant. Any remaining investment will be funded through long-term financing. In fiscal 2001, Meritage received an $8,000,000 forward commitment for debt financing for eight new restaurants which was completed in August 2002.
In July 2002, Meritage obtained a twelve month financing commitment from GE Capital Franchise Finance Corporation to build five new restaurants. The commitment requires a minimum 18% equity investment required by Meritage. Borrowings will be secured with mortgages maturing in ten years with monthly payments based on a 20-year amortization schedule. The commitment allows Meritage to select either a fixed or variable interest rate. It is Meritage’s present intention to use the variable interest rate (2.55% plus the one month LIBOR rate, adjusted monthly) which would result in a current interest rate of approximately 4.4%. Meritage began utilizing this commitment in September 2002 when it closed its first loan under the commitment. These loan agreements contain covenants similar to the covenants contained in Meritage’s other existing loan agreements as described below. Meritage received and is evaluating financing proposals containing similar terms as described above to provide additional financing for its planned new store growth.
Meritage’s various loan and franchise agreements contain covenants requiring the maintenance of certain financial ratios including:
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• |
Fixed Charge Coverage Ratio ("FCCR") of not less than 1.2:1 for the Wendy's operations; |
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FCCR of not less than 1.2:1 for certain Wendy’s restaurants subject to a real estate mortgage; |
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FCCR of not less than 1.4:1 for certain Wendy’s restaurants subject to both a real estate mortgage and a business value loan; |
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Leverage Ratio (Funded Debt: Earnings Before Interest, Taxes, Depreciation and Amortization) not to exceed 6.0:1 through 11/30/02, and not to exceed 5.5:1 after 11/30/02; |
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Debt Service Coverage Ratio of not less than 1.2:1; and |
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restrictions against using operating cash flow from the Wendy’s business for other means if such use would cause the FCCR to be less than 1.2:1. |
At September 1, 2002 Meritage was in compliance with these covenants.
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Meritage may use any of the following sources to meet its current obligations over the next twelve months:
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• |
utilizing cash balances; |
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using operating cash generated from existing Wendy's restaurants; |
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borrowing on its $3.5 million line of credit; |
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selling surplus real estate; |
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financing or deferring capital expenditures and renovations; |
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deferring new store openings; and |
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financing equipment packages at new restaurants. |
There can be no assurances, however, that Meritage will be able to complete the above activities or that completion would yield the results expected.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Because all of Meritage’s operations are in the United States, currency exposure is eliminated. All of Meritage’s debt is in U.S. dollars and substantially all present debt is at fixed interest rates which limits financial instrument risk. Accordingly, Meritage does not utilize any derivatives to alter interest rate risk. In the normal course of business, Meritage purchases certain products (primarily food items) which can be affected by fluctuating commodity prices. Most of these products are purchased under agreements negotiated by Wendy’s International that are outside Meritage’s control. It is the Company’s understanding that Wendy’s utilizes various purchasing and pricing techniques in an effort to minimize volatility. As a result, Meritage does not make use of financial instruments to hedge commodity prices. While fluctuating commodity prices may impact the Company’s cost of food, Meritage retains some ability to increase its menu pricing to offset these increases.
As of September 1, 2002, an evaluation was performed under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Controller (Chief Accounting Officer), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that evaluation, the Company’s management, including the CEO and Controller, concluded that the Company’s disclosure controls and procedures were effective as of September 1, 2002. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls subsequent to September 1, 2002.
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PART II
OTHER INFORMATION
The Company opened its 48th and 49th Wendy’s restaurant during the third fiscal quarter. The new restaurants are located on the East Beltline in Grand Rapids, Michigan, and on Capital Avenue in Battle Creek, Michigan. During the third fiscal quarter, the Company also tore down and rebuilt a 25-year old formerly leased restaurant on Westnedge Avenue in Kalamazoo, Michigan.
Item 6. Exhibits and Reports on Form 8-K.
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(a) |
Exhibit List. |
Exhibit No. |
Description of Document
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Exhibits filed herewith.
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(b) |
Reports on Form 8-K. No reports on Form 8-K were filed during the quarter for which this period is filed. |
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Dated: October 11, 2002 |
MERITAGE HOSPITALITY GROUP INC. |
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Certification of Principal Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
and Securities and Exchange Commission Release 34-46427
I, Robert E. Schermer, Jr., the principal executive officer of Meritage Hospitality Group Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Meritage Hospitality Group Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
| (a) | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; |
| (b) | evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and |
| (c) | presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; |
5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):
| (a) | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and |
| (b) | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and |
6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Dated: October 11, 2002 |
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Certification of Principal Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
and Securities and Exchange Commission Release 34-46427
I, William D. Badgerow, the principal financial officer of Meritage Hospitality Group Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Meritage Hospitality Group Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
| (a) | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; |
| (b) | evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and |
| (c) | presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; |
5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):
| (a) | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and |
| (b) | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and |
6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Dated: October 11, 2002 |
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In connection with the filing with the Securities and Exchange Commission of the Quarterly Report of Meritage Hospitality Group Inc. (the “Company”) on Form 10-Q for the period ending September 1, 2002 (the “Report”), I, Robert E Schermer, Jr., Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:
| (1) | The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and |
| (2) | The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. |
Dated: October 11, 2002 |
MERITAGE HOSPITALITY GROUP INC. |
In connection with the filing with the Securities and Exchange Commission of the Quarterly Report of Meritage Hospitality Group Inc. (the “Company”) on Form 10-Q for the period ending September 1, 2002 (the “Report”), I, William D. Badgerow, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:
| (1) | The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and |
| (2) | The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. |
Dated: October 11, 2002 |
MERITAGE HOSPITALITY GROUP INC. |
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Exhibit No. |
Description of Document
|
Exhibits filed herewith.
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