SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
[X] |
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 1, 2002 |
or
[ ] |
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____ TO ____. |
Commission File Number: 0-17442
Michigan |
38-2730460 |
1971 East Beltline Ave., N.E., Suite 200 |
49525 |
Registrant’s Telephone Number, Including Area Code: (616) 776-2600
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class |
Name of Each Exchange on which Registered |
Securities registered pursuant to Section 12(g) of the Act: None
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 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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [ ] No [X]As of January 29, 2003, there were 5,342,900 common shares of the registrant outstanding. The aggregate market value of the common shares held by non-affiliates was $17,061,858 based on the closing sales price on the American Stock Exchange on the last business day of the registrant’s most recently completed second fiscal quarter (i.e. May 31, 2002).
Documents Incorporated by Reference: None.
MERITAGE HOSPITALITY GROUP INC.
INDEX TO ANNUAL REPORT ON FORM 10-K
Part I Page
Item 1 - Business 3
Item 2 - Properties 7
Item 3 - Legal Proceedings 8
Item 4 - Submission of Matters to Vote of
Security-Holders 9
Part II
Item 5 - Market for Registrant’s Common Equity
and Related Stockholder Matters 9
Item 6 - Selected Financial Data 11
Item 7 - Management’s Discussion and Analysis
of Financial Condition and Results of
Operations 12
Item 7A - Quantitative and Qualitative Disclosures
About Market Risk 21
Item 8 - Financial Statements and Supplementary Data 22
Item 9 - Changes in and Disagreements With Accountants
on Accounting and Financial Disclosure 22
Part III
Item 10 - Directors and Executive Officers of the Registrant 23
Item 11 - Executive Compensation 25
Item 12 - Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters 26
Item 13 - Certain Relationships and Related Transactions 26
Item 14 - Controls and Procedures 26
Item 15 - Exhibits, Financial Statement Schedules,
and Reports on Form 8-K 27
Forward-Looking Statements
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. Meritage 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 action which Meritage intends to pursue to achieve strategic objectives, constitute forward-looking information. Implementation of these strategies and achievement of such financial performance are subject to numerous conditions, uncertainties and risk factors, which could cause actual performance to differ materially from these forward-looking statements include, without limitation: competition; changes in the national or local economy; changes in consumer tastes and views about quick-service food or the safety of menu items offered; severe weather; changes in travel patterns; increases in food, labor, fuel 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 labor; directives issued by the franchisor regarding operations and national advertising; the general reputation of Wendy’s restaurants; and the recurring need for renovation and capital improvements. Also, Meritage is subject to extensive government regulations relating to, among other things, zoning, minimum wage, public health, and the operation of its restaurants. Because Meritage’s operations are concentrated in certain areas of Michigan, a marked decline in this local economy could adversely affect its operations.
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PART I
Item 1. Business.
The Company
Meritage Hospitality Group Inc. is the nation’s only publicly traded “Wendy’s Old Fashioned Hamburgers” restaurant franchisee. Meritage serves approximately seven million customers annually through its operation of 46 Wendy’s restaurants in Western and Southern Michigan. All restaurants are operated pursuant to franchise agreements with Wendy’s International, Inc., the franchisor of the nationally recognized quick-service restaurant system that operates under the distinctive “Wendy’s” brand name. In 2002, Meritage built eight new Wendy’s restaurants, six at new locations and two that replaced 25-year old structures. The Company’s growth strategy is to expand its Wendy’s business through the development of new restaurants within the Company’s designated market area, and through the development and/or acquisition of Wendy’s restaurants in other market areas. The Company may also evaluate the acquisition or development of other franchised restaurant concepts.
Meritage was incorporated in Michigan in 1986, and is currently engaged in the quick-service restaurant business. The Company owns approximately 70% of its restaurant properties and leases the remaining properties.
Meritage’s principal executive office is located at 1971 East Beltline Ave., N.E., Suite 200, Grand Rapids, Michigan 49525. Its telephone number is (616) 776-2600, its facsimile number is (616) 776-2776, and its website address is www.meritagehospitality.com. The Company’s Wendy’s restaurants are operated by Wendy’s of Michigan, a Michigan limited partnership that is owned by a wholly-owned subsidiary of Meritage. For convenience, Meritage and its subsidiaries are collectively referred to as “Meritage” or “the Company” throughout this report.
Operations
Meritage’s restaurants are located in the Michigan counties of Allegan, Calhoun, Ionia, Kalamazoo, Kent, Muskegon, Newaygo, Ottawa and Van Buren. This includes the metropolitan areas encompassing the cities of Grand Rapids, Kalamazoo, Battle Creek, Muskegon and Holland. This geographical area generally comprises Meritage’s designated market area.
Menu
Each Wendy’s restaurant offers a diverse menu containing a variety of food items featuring hamburgers and chicken breast sandwiches, all of which are prepared to order with the customer’s choice of condiments. The Wendy’s menu includes other items such as chili, baked and French fried potatoes, chicken nuggets, freshly prepared salads, soft drinks, “Frosty” desserts and children’s meals. Each Wendy’s restaurant features soft drink products supplied by the Pepsi-Cola Company and its affiliates. Wendy’s International maintains significant discretion over the menu items that are offered in the Company’s restaurants.
Restaurant Layout and Operation
The Company’s restaurants typically range from 2,700 to 3,400 square feet with a seating capacity of between 90 and 130 people, and are typically open from 10:00 a.m. until midnight. Generally, the dining areas are carpeted and informal in design, with tables for two to four people. All restaurants also feature a drive-through window. Sales from drive-through customers accounted for over half of the total restaurant sales in fiscal 2002.
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A comprehensive reporting system provides restaurant sales and operating data (including product sales mix, food usage and labor cost information) with respect to each of the Company’s restaurants. Physical inventories of all food items and restaurant supplies are taken weekly and monthly.
Marketing and Promotion
Wendy’s International requires that at least 4% of the Company’s restaurant sales be contributed to an advertising and marketing fund, 3% of which is used to benefit all restaurants owned and franchised by Wendy’s International. The Wendy’s National Advertising Program uses these funds to develop advertising and sales promotion materials and concepts to be implemented nationally. The remainder of the funds must be used on local advertising. The Company typically spends local advertising dollars in support of national television advertising, local television and radio advertising, print media, local promotions and community goodwill projects.
Raw Materials & Energy
The Company’s restaurants comply with uniform recipe and ingredient specifications provided by Wendy’s International. Food and beverage inventories and restaurant supplies are purchased from independent vendors that are approved by Wendy’s International. Wendy’s International does not sell food or supplies to the Company. The Company’s principal sources of energy for its operations are electricity and natural gas.
The Company has not experienced any significant shortages of food, equipment, fixtures or other products that are necessary to restaurant operations. While no such shortages are anticipated, the Company believes that alternate suppliers are available if any shortage were to occur. To date, the supply of energy available to the Company has been sufficient to maintain normal operations.
Seasonality
The Company’s business is subject to seasonal fluctuations. Like the rest of the quick-service industry, traffic typically increases during the summer months, which results in increased revenues during those months.
Relationship with Wendy’s International
Meritage operates its restaurants pursuant to various agreements (including one franchise agreement for each restaurant) with Wendy’s International. These agreements grant privileges such as the right to utilize Wendy’s International’s trademarks, service marks, designs and other proprietary rights (such as “Wendy’s” and “Wendy’s Old Fashioned Hamburgers”) in connection with the operation of its Wendy’s restaurants. These agreements also impose requirements regarding the preparation and quality of food products, the level of service, capital improvements, and general operating procedures. The Company’s franchise agreements (including options to renew) range from approximately 24 to 29 years.
The franchise agreements with Wendy’s International provide, among other things, that a change in the operational control of Wendy’s of Michigan, or the removal of a guarantor of the franchise agreements, cannot occur without the prior consent of Wendy’s International. In addition, any proposed sale of the Wendy’s business, ownership interests or franchise rights is subject to the consent of, and a
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right of first refusal by, Wendy’s International. These agreements also grant Wendy’s International wide discretion over many aspects of the restaurant operations, and often require the consent of Wendy’s International to carry out certain operational transactions. If Meritage requires the consent of Wendy’s International to proceed with its business plans and such consent is not obtained, Meritage will not be able to proceed with its plans which, in turn, could adversely affect Meritage’s growth strategy. If Meritage were to proceed without Wendy’s International’s consent, Wendy’s International could terminate the franchise agreements or exercise its right to purchase the Wendy’s restaurants.
Meritage’s growth strategy involves the expansion of its restaurant operations through the development and acquisition of additional Wendy’s restaurants. In addition to paying monthly fees, Meritage is required to pay Wendy’s International a technical assistance fee upon the opening of new Wendy’s restaurants. Meritage is permitted to develop new Wendy’s restaurants and convert competitive units located in its designated market area subject to the standard expandability criteria and site standards of Wendy’s International. Meritage is prohibited from acquiring or developing new Wendy’s restaurants outside of its designated market area unless Wendy’s International, in its sole discretion, consents. While the franchise agreements are in place, Meritage is also prohibited from acquiring or developing any other types of quick-service restaurants within Meritage’s designated market area, or outside of Meritage’s designated market area if the restaurant sells hamburgers, chicken sandwiches or products similar to Wendy’s International, and is located within a three mile radius of another Wendy’s restaurant. For two years after the expiration or termination of the franchise agreements, Meritage is prohibited from participating in any quick-service restaurant business that sells hamburgers, chicken sandwiches or products similar to Wendy’s International, and is located within Meritage’s designated market area.
The reputation of Meritage’s restaurants is largely dependent on the entire Wendy’s restaurant chain, which in turn is dependent upon the management and financial condition of Wendy’s International and the performance of Wendy’s restaurants operated by other Wendy’s franchisees. Should Wendy’s International be unable to compete effectively with similar restaurant chains in the future, Meritage would be materially and adversely affected. Furthermore, many of the attributes which lead to the success of Wendy’s operations are factors over which Meritage has no control, such as national marketing, introduction of new products, quality assurance and other operational systems.
Meritage cannot conduct its Wendy’s operation without its affiliation with Wendy’s International. Any termination of the franchise agreements would have a material adverse effect on Meritage’s financial condition and results of operations.
Personnel
Meritage employs approximately 1,700 people of which approximately 275 are full-time employees. The Company strives to maintain quality and uniformity throughout its restaurants by continual in-service training of employees and by field visits from Company supervisors and Wendy’s International representatives. In general, the Company believes that it fosters a good working relationship with its employees.
Competition and Industry Conditions
Meritage operates within the quick-service restaurant ("QSR") industry. This industry is characterized by customers who are looking for convenient and quick meals that are ordered, paid for and picked up at a cash register. Within the quick-service market, the hamburger market segment comprises approximately half of the entire market (with the pizza, chicken, other sandwich, and Mexican and Asian market segments comprising a significant portion of the remainder). The hamburger market segment is dominated by McDonald’s, Burger King and Wendy’s. According to the National Restaurant
5
Association, the QSR industry is forecasted to have total sales of $121 billion in 2003, representing approximately 28% of the total sales for the entire restaurant industry. The restaurant industry has grown for more than 10 years, but has registered softer gains since 2000. According to the National Restaurant Association, the primary challenges facing the QSR industry in 2003 will be recruiting and retaining employees, building and maintaining sales volume, competition, a soft economy and labor costs.
Most of the Wendy’s restaurants operated by the Company are located in close proximity to their principal quick-service restaurant competitors (e.g. McDonald’s, Burger King and Taco Bell) who are highly competitive on the basis of price and value perception, service, location, food quality, menu variety, quality and speed of service, attractiveness of facilities, effectiveness of marketing and new product development. In recent years, and particularly in recent months, these competitors have attempted to draw customer traffic through a strategy of deeply discounting the price of their primary food products. While the Company has recently lowered certain of its menu prices, it does not believe that this is a profitable long-term strategy. Instead, it believes that the competitive position of a Wendy’s restaurant is ultimately enhanced by its unique qualities such as the use of fresh ground beef, a diverse menu, food prepared to order with an emphasis on quality and taste, pleasant and speedy service, and the atmosphere of its restaurants.
The following table compares the Company’s average same-store restaurant sales (for restaurants in full operation during the given year) to all franchised domestic Wendy’s restaurants.
Meritage Operated Franchised Domestic
Fiscal Year Restaurants Restaurants*
----------- ----------------- -------------------
2001 $1,172,000 $1,164,000
2002 $1,142,000 $1,247,000
* Source: Wendy’s International, Inc.
The Company intends to achieve growth by (i) developing new Wendy’s restaurants in its existing market, (ii) developing and/or acquiring Wendy’s restaurants in other markets, and (iii) increasing sales and maintaining low costs at existing Wendy’s restaurants. Some of the Company’s new stores may replace older and outdated units. The Company may also explore other acquisitions or developments that complement its Wendy’s operations.
Risks and Governmental Regulations
Meritage is subject to numerous uncertainties and risk factors inherent in the food service industry. These include, among others: changes in local and national economic conditions; changes in consumer tastes and concerns about the nutritional quality of quick-service food; competition and promotional price discounting; severe weather; changes in travel patterns; road construction; the cost of food, labor, fuel and energy; the availability and cost of suitable restaurant sites; the ability to finance expansion; fluctuating interest rates; insurance costs; the availability of an adequate number of managers and hourly-paid employees; directives issued by the franchisor regarding its operations and nationally advertised pricing; the general reputation of Wendy’s restaurants; and the recurring need for renovation and capital improvements.
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Also, the Company is subject to various federal, state and local laws and governmental regulations relating to, among other things, zoning, restaurant operations, discharge of materials into the environment and minimum wages. Changes regarding minimum wage or other laws governing the Company’s relationship with its employees (e.g. overtime wages, health care coverage, employment of minors, etc.) could have an adverse effect on the Company’s operations. The Company’s restaurants are also subject to public health certification regarding the preparation and sale of food. The Company believes its operations would be adversely affected if these permits were terminated. The Company does not anticipate, however, that its permits will be terminated.
Item 2. Properties.
Each Wendy’s restaurant is built to specifications provided by Wendy’s International as to its exterior style and interior decor. Typical freestanding restaurants are one-story brick buildings constructed on sites of approximately 40,000 square feet, with parking for 50 to 70 vehicles. The restaurants, which range from 2,700 to 3,400 square feet, typically have a food preparation area, a dining room with seating capacity for 90 to 130 persons, and a double pick-up window for drive-through service. The dimensions and layout of three Wendy’s restaurants which are part of a combination store concept with a fuel purveyor are basically the same except that the restaurants are connected to a 3,500 square foot convenience store and gas station facility.
Of the 46 Wendy’s restaurants that the Company operates, it (i) owns the land and buildings comprising 32 restaurants, (ii) leases the land and buildings comprising 13 restaurants, and (iii) owns the building and leases the land comprising one restaurant. The term of the leases (including options to renew) range from approximately 6 to 28 years. The structures range from being brand new to approximately 28 years old. The land and buildings owned by the Company are subject to encumbrances described in “Financing and Encumbrances.”
The Company leases approximately 7,500 square feet of office space located at 1971 East Beltline Ave., N.E., Suite 200, Grand Rapids, Michigan, which serves as the corporate headquarters and the registered office of the Company and its subsidiaries. The office, which is equipped with a management training facility, is located only a few hundred feet from one of the Company’s newer Wendy’s restaurants.
The Company believes that its properties are adequately covered by insurance.
Financing and Encumbrances
In fiscal 1998 and 1999, the Company borrowed $11,740,000 from Captec Financial Group, Inc. ("Captec") to purchase existing Wendy’s restaurants, refinance existing restaurant indebtedness, and build new restaurants. This long-term indebtedness is secured by the real estate and equipment of 13 Company-owned Wendy’s restaurants. The Captec loans have terms ranging from fifteen to twenty years, require monthly payments of $99,980, and carry fixed interest rates that range from 7.8% to 8.5%.
From fiscal 1999 through fiscal 2002, the Company borrowed $16,178,000 from Fleet Business Credit, LLC ("Fleet") to build and equip 15 Wendy’s restaurants. This long-term indebtedness is secured by the related real estate and equipment. The Fleet loans have 15-year terms and 20-year amortizations, require monthly payments of $138,070, and carry fixed interest rates ranging from 6.3% to 8.7%. The Company’s CEO, Robert E. Schermer, Jr., has personally guaranteed over $4.6 million of the Fleet loans. These guarantees terminate three years from the date of the loan provided certain Company financial covenants and conditions are otherwise met.
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Beginning in fiscal 2002, the Company borrowed $2,037,000 from General Electric Capital Business Asset Funding Corporation (“GE”) to build and equip two Wendy’s restaurants. This long-term indebtedness is secured by the related real estate and equipment. The GE loans have 10-year terms and 20-year amortizations, require monthly payments of $12,540, and carry floating interest rates equal to 2.55% over the 30-day LIBOR. The Company also has approximately $1,418,000 outstanding under a construction loan with GE for the development of one additional Wendy’s restaurant. This construction loan requires monthly payments of interest only at a variable interest rate equal to the 30-day LIBOR plus 2.55% until conversion into a permanent mortgage loan, after which it will have terms and rates as noted above.
The Company also holds a $2.4 million forward commitment from GE to provide additional financing for the construction and equipment associated with the development of two additional Wendy’s restaurants, and is considering a financing proposal for up to $6 million in additional financing to develop five additional Wendy’s restaurants. Indebtedness under the commitments will be secured by the real estate and equipment of the new restaurants. The Company can choose between fixed interest rates (2.61% plus the 10-year Swap rate) or floating interest rates (2.55% over the 30-day LIBOR with an option to covert to a fixed rate during the first two years).
In December 2002, the Company borrowed $1,225,000 from Fifth Third Bank to build and equip one new restaurant. This long-term indebtedness is secured by the related real estate and equipment. This loan has a 5-year term and graduated amortization (from 18 to 13.5 years during the term of the loan), requiring graduated monthly payments (from $8,800 to $11,000 during the term of the loan), and carry a floating interest rate equal to Fifth Third Bank’s prime rate.
The Captec, Fleet, GE and Fifth Third loan documents contain financial covenants that require the maintenance of certain financial ratios, and requirements that limit the amount of currently generated operating cash flow that can be utilized to fund corporate level expenses.
Finally, the Company has a $3.5 million revolving line of credit with Fleet requiring monthly payments of interest only at a variable interest rate equal to 30-day LIBOR plus 2.5% through July 2003 when any outstanding balance will be converted to a term loan that requires 48 monthly installments of principal and interest to fully amortize the loan. In late January 2003, Fleet agreed to extend the line of credit from July 2003 to December 31, 2003. As of January 29, 2003, the outstanding balance on the line of credit is approximately $380,000.
Item 3. Legal Proceedings.
The Company is involved in various routine legal proceedings that are incidental to its business. Except as noted below, all of these proceedings arose in the ordinary course of the Company’s business and, in the opinion of the Company, any potential liability of the Company with respect to these legal proceedings will not, in the aggregate, be material to the Company’s financial condition or operations. The Company maintains various types of insurance standard to the industry that cover (subject to deductibles) most legal proceedings brought against the Company.
In December 2001, the Company filed a complaint against the Michigan Department of Treasury in the Court of Claims seeking a refund of approximately $100,000 in Michigan Single Business Taxes (“SB Taxes”) paid from 1991 through 1994 associated with fees paid to the Company’s franchisor during those years (WM Limited Partnership - 1998 v. Revenue Division, Department of Treasury, State of Michigan, Case No. 01-18129-CM). The Company’s position was that the tax payments related to these fees should be refunded because Wendy’s International already paid taxes relating to these fees to the Department of Treasury, and because the fee at issue was incorrectly characterized as a “royalty” by the Department of Treasury. In September 2002, a settlement was reached wherein the Company received a full refund along with interest. The Company also received bills for unpaid SB Taxes from 1997 through 2000
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of approximately $125,000 plus interest and penalties. As with the above-described tax matter for years 1991 through 1994, this matter is associated with fees paid to the franchisor that the Company believes were incorrectly characterized as a “royalty” by the Department of Treasury. A Department of Treasury Referee has been assigned to the matter and a conference will likely occur in 2003.
In the fall of 2002, vendees under a land contract with the Company relating to the sale of a former restaurant site committed various breaches (including nonpayment of taxes and monthly installments payments). While the Company sent "cure notices" to the vendees, to date no cure has occurred. The current principal balance on the land contract is approximately $363,000. The Company intends to exercise legal and equitable remedies (including foreclosure or forfeiture proceedings).
Item 4. Submission of Matters to a Vote of Security-Holders.
There were no matters submitted to a vote of security holders of the Company during the fourth quarter of fiscal 2002.
PART II
Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters.
Market Information
Meritage’s common shares have been listed on the American Stock Exchange under the symbol "MHG" since 1999. The following table sets forth the high and low closing sales prices reported by the American Stock Exchange for the Company’s common shares for the two most recent fiscal years.
High Low
------ ------
Fiscal Year Ended December 2, 2001
----------------------------------
First Quarter $ 2.13 $ 1.88
Second Quarter $ 2.40 $ 1.89
Third Quarter $ 2.48 $ 2.15
Fourth Quarter $ 3.65 $ 2.03
High Low
------ ------
Fiscal Year Ended December 1, 2002
----------------------------------
First Quarter $ 5.15 $ 3.60
Second Quarter $ 5.50 $ 4.59
Third Quarter $ 6.70 $ 5.00
Fourth Quarter $ 6.75 $ 4.95
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Holders
As of January 29, 2003, there were approximately 630 record holders of the Company’s common shares, which the Company believes represents approximately 1,200 beneficial holders.
Dividends
Meritage paid no dividends on its common shares in the last two fiscal years. Because the Company intends to reinvest excess cash into the development of new Wendy’s restaurants, it does not intend to pay any dividends on common shares in fiscal 2003. In addition, certain of the Company’s loan agreements contain restrictions which may limit the Company’s ability to declare a dividend.
Securities Authorized for Issuance Under Equity Compensation Plans
The following is information as of January 29, 2003:
Equity Compensation Plan Information
Number of
securities
remaining
Number of available
securities Weighted- for future
to be average issuance
issued upon exercise under equity
exercise of price of compensation
outstanding outstanding plans (excluding
options, options, securities
warrants, warrants reflected in
and right and rights column (a))
Plan Category (a) (b) (c)
- ---------------------------- ------------ ------------ -----------------
Equity compensation
plans approved
by security holders:
1996 Management Equity
Incentive Plan 706,525 $ 2.67 2,504
1996 Directors’ Share
Option Plan (1) 62,000 $ 5.31 0
2002 Management Equity
Incentive Plan 223,730 $ 5.07 526,270
Equity compensation
plans not approved by
security holders:
1999 Directors’
Compensation Plan (2) (2) (2)
2001 Directors’ Share
Option Plan (3) 8,000 $ 3.67 110,000
--------- ------ -------
Total 1,000,255 $ 3.38 638,774
========= ====== =======
(1) |
The 1996 Directors’ Share Option Plan terminated in April 2001. Certain options granted under the Plan remain outstanding. |
(2) |
The 1999 Directors’ Compensation Plan, as amended, was adopted by the Board of Directors in February 1999. Pursuant to the Plan, all non-employee directors receive a retainer of $1,000 for each meeting of the Board of Directors attended, and $1,000 for each committee meeting attended. The committee fees are reduced by 50% if the committee meeting is held on the same day as a Board meeting. Compensation is paid quarterly in arrears in the form of Company common shares which are priced at the average fair market value during the five trading days prior to the end of the fiscal quarter. The Plan will terminate pursuant to its terms on November 30, 2008. |
(3) |
The 2001 Directors’ Share Option Plan, as amended, was adopted by the Board of Directors in May 2001. The Plan provides for 120,000 common shares to be the subject of options which may be granted to non-employee directors. Under the Plan, non-employee directors are granted an option to purchase 5,000 common shares upon initial election to the Board, and another option to purchase 1,000 common shares upon each subsequent election. The committee administering the Plan may also, from time to time, grant additional options on such terms and conditions as the committee may determine. The Plan will terminate pursuant to its terms on May 15, 2006. |
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Item 6. Selected Financial Data.
In 2001, the Company elected a 52-53 week fiscal year for tax and financial reporting purposes. The fiscal year ends on the Sunday closest to November 30th. The following table sets forth the selected financial information of the Company for the fiscal years ended December 1, 2002 and December 2, 2001, and the fiscal years ended November 30, 1998, 1999 and 2000 (all of which contained 52 weeks).
(In thousands except for per share information)
Fiscal Year Ended
------------------------------------------------
2002 2001 2000 1999 1998
------- ------- ------- ------- -------
SUMMARY OF OPERATIONS
Continuing operations
Total revenue $45,953 $38,356 $33,105 $29,752 $27,044
Operating expenses 43,278 36,649 33,407 28,898 27,590
Operating income (loss) 2,675 1,708 (302) 854 (546)
Earnings (loss) from
continuing operations 709 532 (1,353) 322 (1,374)
Discontinued operations
Loss from operations -- -- -- -- (479)
Gain on disposal of
business segment -- -- -- 150 3,711
Net earnings (loss) 709 532 (1,353) 472 1,131
Preferred stock dividends 27 27 33 40 108
Net earnings (loss) on
common shares 683 505 (1,386) 432 1,023
Earnings (loss) per
common share - basic
Earnings (loss) from
continuing operations $ 0.13 $ 0.10 $ (0.25) $ 0.05 $ (0.30)
Net earnings (loss) $ 0.13 $ 0.10 $ (0.25) $ 0.08 $ 0.21
Earnings (loss) per
common share - diluted
Earnings (loss) from
continuing operations $ 0.12 $ 0.10 $ (0.25) $ 0.05 $ (0.30)
Net earnings (loss) $ 0.12 $ 0.10 $ (0.25) $ 0.08 $ 0.21
BALANCE SHEET DATA
Property & equipment $38,076 $28,781 $19,093 $16,684 $13,183
Net assets of discontinued
operations -- -- -- -- (594)
Total assets 46,756 37,881 27,045 25,201 24,964
Long-term obligations (1) 32,281 24,159 18,224 15,091 13,513
Stockholders’ equity 7,609 6,337 4,531 5,883 5,434
Cash dividends declared
per common share $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 0.00
(1) For comparative purposes, long-term obligations include current portions of long-term obligations.
Effective May 31, 1998, the Company began accounting for the operations of its former lodging industry segment as discontinued operations. The 1998 and 1999 selected financial data has been restated to reflect the former lodging industry segment as a discontinued operation.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Results of Operations
The following summarizes the results of operations for the years ended December 1, 2002, December 2, 2001 and November 30, 2000.
Statements of Operations
-------------------------------------------------
$ in Thousands % of Revenue
------------------------- ----------------------
2002 2001 2000 2002 2001 2000
------- ------- ------- ------ ------ ------
Food and beverage revenue $45,953 $38,356 $33,105 100.0% 100.0% 100.0%
Costs and expenses
Cost of food and beverages 11,695 10,635 9,588 25.5 27.7 29.0
Operating expenses 26,349 21,998 19,658 57.3 57.4 59.4
General and administrative
Restaurant operations 1,352 1,198 1,075 2.9 3.1 3.2
Corporate level
expenses 1,239 1,177 813 2.7 3.1 2.5
Michigan single
business tax 173 205 137 0.4 0.5 0.4
Depreciation and
amortization 2,288 1,717 1,401 5.0 4.5 4.2
Goodwill amortization 182 182 182 0.4 0.5 0.5
(Gain) loss on
impairment of assets -- (464) 553 -- (1.2) 1.7
------- ------- ------- ----- ----- -----
Total costs and
expenses 43,278 36,648 33,407 94.2 95.6 100.9
------- ------- ------- ----- ----- -----
Earnings (loss) from
operations 2,675 1,708 (302) 5.8 4.4 (0.9)
Other income (expense)
Interest expense (1,982) (1,515) (1,361) (4.3) (4.0) (4.1)
Interest income 100 106 98 0.2 0.3 0.3
Miscellaneous income 33 31 70 0.1 0.1 0.2
Loss (gain) on disposal
of assets (134) 217 142 (0.3) 0.6 0.4
------- ------- ------- ----- ----- -----
Total other income
(expense) (1,983) (1,161) (1,051) (4.3) (3.0) (3.2)
------- ------- ------- ----- ----- -----
Earnings (loss) before
income taxes 692 547 (1,353) 1.5 1.4 (4.1)
Income tax benefit
(expense) 17 (15) -- 0.0 (0.0) --
------- ------- ------- ----- ----- -----
Net earnings (loss) $ 709 $ 532 $(1,353) 1.5% 1.4% (4.1)%
======= ======= ======= ===== ===== =====
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Comparison of Fiscal Years 2002 and 2001
Revenue
Food and beverage revenue increased 19.8% in fiscal 2002 compared to fiscal 2001. This increase was almost entirely attributable to revenue from new restaurants. Quarterly revenue on a per restaurant basis for restaurants in full operation during the same quarters of fiscal 2002 and 2001 ("same store sales") is set forth below:
Increase Increase
2002 2001 (Decrease) (Decrease)%
---------- ---------- --------- -----------
Fourth Quarter $ 271,224 $ 289,942 $(18,718) (6.5)%
Third Quarter 302,937 303,959 (1,022) (0.3)%
Second Quarter 295,328 287,763 7,565 2.6%
First Quarter 273,234 255,885 17,349 6.8%
---------- ---------- --------
Year to Date $1,142,723 $1,137,549 $ 5,174 0.5%
========== ========== ========
The slight increase in same store sales in fiscal 2002 was attributable to (i) increased menu prices that increased the average customer ticket by approximately 2%, (ii) improved customer service times and better trained restaurant teams, and (iii) strong demand for Wendy’s new "Garden Sensations" salads introduced in January 2002. As illustrated in the table above, the Company experienced a negative sales trend over the course of fiscal 2002. Factors contributing to this trend included (i) intense promotional discounting by the Company’s major competitors, especially during the fourth quarter of fiscal 2002, (ii) a sluggish consumer spending environment, and (iii) an overall decline in the West Michigan economy including rising unemployment. These factors contributed to a decrease in customer traffic of approximately 2% in fiscal 2002 compared to fiscal 2001. This unfavorable sales trend has continued into the new fiscal year and follows the sales trend that has been reported throughout the quick-service restaurant industry. Management cautions that it is becoming increasingly difficult to accurately forecast how competitor discounting, current consumer spending trends and the current economic climate in West Michigan will affect the Company’s future revenue.
Cost of Food and Beverages
The 7.9% reduction in cost of food and beverages from fiscal 2001 to fiscal 2002, from 27.7% of revenue to 25.5% of revenue, was largely due to improved food cost controls as the Company realized the benefits of a new food cost software program and improved operational procedures. Increased menu prices combined with declining beef and chicken costs also contributed to the second consecutive year of improvement in the cost of food and beverage percentage (this percentage has been reduced from 29.0% of revenue in fiscal 2000 to 25.5% of revenue in fiscal 2002). Most of the Company’s food products are purchased under agreements negotiated by Wendy’s International that are outside of the Company’s control. The cost of food and beverage in fiscal 2001 and 2002 were in line with or below guidelines established by the Company and Wendy’s International.
Operating Expenses
Operating expenses in fiscal 2002, as a percentage of revenue, were consistent with fiscal 2001 (57.3% in fiscal 2002 compared to 57.4% in fiscal 2001). Specific expense categories with significant year-to-year fluctuations are presented below:
13
Increase
2002 2001 (Decrease)
---- ---- ----------
As a percentage of revenue:
Labor and related expenses 33.7 34.0 (0.3)
Occupancy expenses 8.6 8.8 (0.2)
Other operating expenses 3.7 3.4 0.3
The decrease in labor and related expenses as a percentage of revenue was primarily the result of decreases in (i) hourly wages, (ii) training labor costs, and (iii) employee health insurance costs (in May 2002 the Company moved to a self-insured health care plan). The reduction in hourly wages was partially due to a slight decrease in the Company’s average hourly wage rate of less than 1%, which followed an increase of only 2% in fiscal 2001. This wage rate trend is slightly better than that experienced by Wendy’s International on a nationwide basis, but is reflective of the weaker economy in West Michigan. These reductions were partially offset by increases in store management salaries.
As a percentage of revenue, the decrease in occupancy expense was due to lower rent expense as the percentage of Company owned versus leased restaurants has increased over last year. Of the fourteen new stores opened since the beginning of fiscal 2001, thirteen are owned. Also, two previously leased restaurants were purchased this year. In total, 32 of 45 stores in operation at year-end were owned. The decrease in rent was partially offset by increases in property taxes, property insurance rates and utility costs.
The increase in other operating expenses was primarily due to monthly fees for the new food cost software program implemented in January 2002 which has helped reduce food costs.
General and Administrative
The decrease in general and administrative expenses as a percentage of revenue was primarily due to the increase in revenue. In 2001 the Company added new positions to facilitate its aggressive development plan, the costs of which were spread over higher sales volumes in 2002. General and administrative expenses for restaurant operations increased 12.8% in fiscal 2002 over fiscal 2001 while corporate level general and administrative expenses increased 5.3%. Of the increase, $47,000 was attributable to property taxes incurred on surplus land held for sale and development. The percentage increases compare favorably with the 19.8% increase in revenue. The decrease in Michigan Single Business Tax expense was due to a tax refund following the filing of amended tax returns.
Depreciation and Amortization
Increases in depreciation and amortization expense were primarily due to the depreciation of buildings and equipment associated with new restaurants (Meritage opened fourteen new restaurants since the beginning of fiscal 2001). Meritage owns the buildings and equipment associated with thirteen of these restaurants. Meritage also acquired four restaurant properties in the last two fiscal years that were previously leased. Restaurants at two of these locations were demolished and rebuilt in fiscal 2002. Additional depreciation resulted from remodeling five restaurants since the second quarter of 2001.
Sale of Impaired Assets
The gain on sale of impaired assets in fiscal 2001 resulted from the sale of a closed restaurant in March 2001. An impairment loss had been recognized in fiscal 2000.
14
Interest Expense
The increase in interest expense was primarily related to additional long-term debt of $8.0 million in fiscal 2002 to develop new restaurants, combined with a full year of interest expense on $6.4 million of long-term debt incurred in fiscal 2001 for the development of new restaurants. This increase was partially offset by a decrease in interest expense on capital leases that are nearing maturity (fourteen months remain on the lease terms). Most of the Company’s long-term debt is at fixed interest rates. See Item 2 - Financing and Encumbrances of this report and Note F of the Company’s financial statements (beginning on page F-1) for additional details regarding the Company’s long-term debt.
(Loss) Gain on Disposal of Assets
The loss on disposal of assets in 2002 resulted primarily from the write-off of assets located at two previously leased restaurants that were purchased in May 2002. Meritage demolished and rebuilt these restaurants in fiscal 2002. The gain on disposal of assets in 2001 resulted from the sale of surplus property. As Meritage continues to proceed with its development plan, it may from time to time acquire surplus real estate adjacent to a restaurant site that it is developing that it will attempt to sell following the development of such restaurant. While the goal is to realize a gain on the disposition of such surplus real estate, there are no assurances that this will occur. The Liquidity and Capital Resources section of this item discusses current pending sales of surplus real estate.
Comparison of Fiscal Years 2001 and 2000
Revenue
Food and beverage revenue increased 15.9% in fiscal 2001 compared to fiscal 2000. This increase was primarily due to sales from new restaurants which provided a net increase in sales of $3,740,000 or 11.3% of the 15.9% increase. Quarterly revenue on a per restaurant basis for restaurants in operation during the same periods of fiscal 2001 and 2000 ("same store sales") is set forth below:
Increase Increase
2001 2000 (Decrease) (Decrease)%
---------- ---------- ---------- -----------
Fourth Quarter $ 295,173 $ 295,735 $ (562) (0.2)%
Third Quarter 322,958 294,388 28,570 9.7%
Second Quarter 296,697 287,533 9,164 3.2%
First Quarter 257,382 255,595 1,787 0.7%
---------- ---------- ------- -----
Year to Date $1,172,210 $1,133,251 $38,959 3.4%
========== ========== ======= =====
The 3.4% increase in same store sales in fiscal 2001 was primarily attributable to increased menu prices that went into effect in the fourth quarter of fiscal 2000 and remained in effect throughout fiscal 2001. These price increases contributed to an increase in the average customer ticket of approximately 6%. The increase in same store sales was also attributable to a continued focus on key operating, training and productivity programs, and improved customer service times. Same store sales were negatively impacted by a decrease in customer traffic of approximately 3% in fiscal 2001 compared to fiscal 2000 due to (i) the discontinuance of certain discount card programs, (ii) competitive markets wherein the Company’s primary competitors engaged in menu price discounting, and (iii) the declining condition of the local economy. In addition, fourth quarter revenue was adversely impacted by a decline in customer traffic for several weeks following the September 11th tragedy.
15
Cost of Food and Beverages
The 4.5% reduction in cost of food and beverages from fiscal 2000 to fiscal 2001, from 29.0% of revenue to 27.7% of revenue, was the result of increases in menu prices and improved food cost controls. Product cost increases somewhat offset the effect of the increased menu prices. Beef costs increased approximately 13% during this period and accounted for 22% of all food and beverage purchases in fiscal 2001. Most of the Company’s food products are purchased under agreements negotiated by Wendy’s International that are outside of the Company’s control. The cost of food and beverage in fiscal 2000 and 2001 were in line with guidelines established by the Company and Wendy’s International.
Operating Expenses
The following table illustrates operating expense categories with significant year-to-year fluctuations:
2001 2000 Decrease
As a percentage of revenue: ---- ---- --------
Labor and related expenses 34.0 34.6 0.6
Occupancy expenses 8.8 9.2 0.4
Advertising expenses 4.0 5.0 1.0
The decrease in labor and related costs as a percentage of revenue was primarily the result of reductions in crew and store management labor which occurred despite (i) increases in the average hourly rate of approximately 2%, and (ii) increases in store manager salaries in excess of 2%. The 2% increase in average hourly rate was the lowest annual increase in several years, and was slightly less than increases experienced by Wendy’s International on a nationwide basis. Increases in training costs and workers compensation expense were partially offset by a reduction in health insurance costs following a restructuring of the Company’s health insurance plan in 2001.
As a percentage of revenue, the decrease in occupancy expense for fiscal 2001 was due to (i) lower rent expense as a result of purchasing two restaurants in January 2001 that were previously leased and the closing of an outdated leased restaurant in August 2000, (ii) reduced utility expense, (iii) reduced business insurance costs brought about by a reduction in customer liability claims, and (iv) reduced building repair and maintenance costs.
The decrease in advertising expense as a percentage of revenue was primarily due to (i) the discontinuation of certain discount and coupon programs, (ii) less use of promotional products, and (iii) the replacement of billboard advertising with less expensive highway signage.
General and Administrative
General and administrative expenses for restaurant operations increased 17.5% in fiscal 2001 over fiscal 2000, compared to the 15.9% increase in revenue. As a percentage of revenue, general and administrative expenses were 3.3% in fiscal 2000 compared to 3.4% in fiscal 2001. The increase was primarily the result of (i) increased payroll costs related to supervisory, accounting and administrative personnel added to support new store openings and operations, (ii) costs related to the Company’s office relocation and consolidation, and (iii) an increase in the use of outside computer consultants. The increase at the corporate level was due to (i) additional positions filled to facilitate the Company’s new store growth, (ii) increased incentive pay based on improved operating results in fiscal 2001, and (iii) an increase in professional and consulting fees. The increase in Michigan Single Business Tax expense was due to the Company’s improved operating results and the elimination of the capital acquisition deduction from the Michigan Single Business Tax calculation. These increases were partially offset by a reduction in public market expenses.
16
Depreciation and Amortization
The increase in depreciation and amortization expense was primarily due to the depreciation of buildings and equipment associated with new restaurants. Also contributing to the increase was (i) the January 2001 purchase of two restaurants that were previously leased, (ii) capital expenditures to remodel existing restaurants, and (iii) amortization of loan costs and franchise fees related to new restaurants. These increases were partially offset by reductions in depreciation associated with three closed restaurants (two closed in September 2000 and one closed in February 2001).
Sale of Impairment Assets
In fiscal 2001, the Company recorded a gain on the sale of impaired assets of $464,000 that resulted from the sale of two restaurant buildings that were written down to their estimated fair market value in fiscal 2000. The property and equipment at the restaurants had been written down in fiscal 2000 after these restaurants were listed for sale, resulting in an impairment loss in fiscal 2000 of $554,000.
Interest Expense
The increase in interest expense was primarily related to additional long-term debt of $6.4 million borrowed in fiscal 2001 to construct new restaurants, combined with a full year of interest expense on $4.4 million of long-term debt incurred in fiscal 2000 for the development of new restaurants. This increase was partially offset by a decrease in interest expense on capital leases that are nearing maturity, and the early retirement of certain equipment loans in March 2001. Nearly all of the Company’s long-term debt was at fixed interest rates. As a percentage of revenue, there was no significant change in interest expense from fiscal 2000 to fiscal 2001.
Gain on Disposal of Assets
The gain on disposal of assets resulted from the sale of excess land at two restaurant sites in fiscal 2001 which was partially offset by losses on disposal of assets related to the corporate office relocation and the remodeling of three restaurants. In fiscal 2000, the gain on disposal of assets resulted from the sale of excess land at one restaurant and the receipt of insurance proceeds for replacement of fire damaged equipment.
Liquidity and Capital Resources
Cash Flows - Fiscal Year Ended December 1, 2002
Cash and cash equivalents ("cash") decreased $763,000 to $901,000 as of December 1, 2002:
Net cash provided by operating activities $ 2,751,000
Net cash used in investing activities (12,013,000)
Net cash provided by financing activities 8,499,000
------------
Net decrease in cash $ (763,000)
============
17
The $2,006,000 decrease in net cash provided by operating activities from fiscal 2001 to fiscal 2002 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. Partially offsetting this decrease was a $1,564,000 improvement in net earnings before depreciation and amortization, and gains/losses on the disposal/impairment of assets (non-cash adjustments to net earnings). The remaining decrease was primarily due to changes in current assets and liabilities.
Net cash used in investing activities increased $1,119,000. In fiscal 2002, the Company invested $11,923,000 in property, plant and equipment including (i) $8,342,000 used to develop new restaurants, (ii) $2,365,000 used to purchase two formerly leased restaurants and develop new restaurants on the sites, and (iii) $1,216,000 used to upgrade and remodel existing restaurants. This compares to $12,514,000 invested in 2001 in connection with (i) the development of new restaurants ($9,737,000), (ii) the purchase of two restaurants that were previously leased ($800,000), (iii) improvements to existing restaurants and offices ($881,000), and (iv) the purchase of surplus property held for sale or development ($1,096,000). In 2001, these investments in assets were offset by proceeds from the sale of assets of $1,779,000 including the sale of closed restaurant properties for $847,000 and the sale of surplus land for $932,000.
Net cash provided by financing activities increased $1,486,000 due to (i) a $2,096,000 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 $91,000. Also, in fiscal 2002 the Company made no open market purchases of the Company’s common stock, compared to fiscal 2001 when $239,000 of Company stock was purchased. These increases in fiscal 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.
Cash Flows - Fiscal Year Ended December 2, 2001
Cash and cash equivalents ("cash") increased $876,000 to $1,664,000 as of December 2, 2001:
Net cash provided by operating activities $ 4,756,000
Net cash used in investing activities (10,893,000)
Net cash provided by financing activities 7,013,000
------------
Net increase in cash $ 876,000
Net cash provided by operating activities increased $4,020,000 as a result of (i) a $1,884,000 improvement in net earnings, (ii) the receipt of $3,000,000 in marketing funds from the Company’s beverage supplier, and (iii) an increase in depreciation and amortization expense of $316,000. This improvement was partially offset by an increase of $1,092,000 from the net gain associated with the impairment and disposal of assets.
Net cash used in investing activities increased $6,338,000 and included (i) $9,737,000 used to develop new restaurants, (ii) $881,000 for upgrades and remodels at existing restaurants, (iii) the purchase of two restaurants that were previously leased for $800,000, and (iv) purchases of $1,096,000 for surplus land held for sale. This compares to $5,013,000 invested in fiscal 2000 including (i) $4,425,000 invested into new restaurants, and (ii) upgrades to existing restaurants of $588,000. These increases in investments in property and equipment from the prior year were partially offset by an increase in proceeds from the sale of assets of $1,587,000.
18
Net cash provided by financing activities increased $3,985,000 primarily due to (i) a $2,704,000 increase in new borrowings for the development of new restaurants, and (ii) an increase in proceeds from the issuance of common stock of $1,476,000 associated with a private placement in February 2001. These increases were slightly offset by increases in (i) principal payments on long-term obligations including capital leases of $378,000, and (ii) open market purchases of the Company’s common stock of $206,000.
Financial Condition
As of December 1, 2002, current liabilities exceeded current assets by $3,178,000 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 $1,694,000 at December 1, 2002, and by $978,000 at December 2, 2001. At these dates, the ratios of current assets to current liabilities were 0.32:1 and 0.52:1, respectively. The cash flows discussion explains the decrease in cash and the primary 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 in fiscal 2002 was primarily due to initiatives to effectively manage growth and operational performance including improved cost controls. Management believes that, with results similar to those experienced in fiscal 2002, Meritage can meet its obligations from existing operations, including debt service and necessary capital improvements to existing restaurants, for the foreseeable future. However, because of Meritage’s continued new store development plans and store remodel plans in fiscal 2003, 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 plan to continue making equity investments of 18% - 25% in new stores, and (iii) the negative sales trend experienced over the course of fiscal 2002 that has continued into fiscal 2003.
Capital investment into existing restaurants including store remodels is estimated at approximately $1,200,000 for fiscal 2003. 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 which is discussed below. Meritage plans to open up to five new restaurants during fiscal 2003 depending on availability of capital. New 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 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 by Meritage. Borrowings are secured with mortgages maturing in ten years with monthly payments based on a 20-year amortization schedule which permit Meritage to select either a fixed or variable interest rate. As of January 29, 2003, Meritage has financed three restaurants under this commitment at variable interest rates equal to 2.55% plus the one month LIBOR rate (adjusted monthly). These loan agreements contain covenants similar to the covenants contained in Meritage’s other existing loan agreements as described below. Meritage has received and is evaluating financing proposals containing similar terms as described above to provide additional financing for its planned new store growth.
19
Meritage’s various loan and franchise agreements contain covenants requiring the maintenance of certain financial ratios including:
At December 1, 2002 Meritage was in compliance with these covenants.
The downward sales trend discussed above could have an impact on the Company’s new store development plans or may delay plans until sales rebound. In response to the decline in revenue, the Company has reduced prices on certain menu items since year-end and is considering other sales promotions to compete with the extremely intense competition currently impacting the quick-service restaurant industry. Meritage has also implemented certain cost cutting measures and will continue to emphasize cost containment while evaluating additional cost cutting measures. To lessen the negative effect that the reduction in revenue may have on profits and cash flow, non-operating cash flow is expected during the first half of fiscal 2003 on contracts for the sale of surplus real estate totaling approximately $900,000. Excluding this surplus real estate, the Company has additional surplus real estate that management believes has a market value of between $400,000 and $600,000. In addition to cash generated from existing restaurant operations and from the sale of surplus real estate, Meritage could use the following other sources to meet its current obligations in fiscal 2003:
There can be no assurances, however, that Meritage will be able to complete the above activities or that completion would yield the results expected.
Critical Accounting Policies
The Company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s financial statements, which have been prepared in accordance with accounting principles accepted in the United States. The preparation of these financial statements requires the Company to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. The significant accounting policies are discussed in Note A of the Company’s financial statements (beginning on page F-1). These critical accounting policies are subject to judgments and uncertainties, which affect the application of these policies. The Company bases its estimates on historical experience and on various other assumptions believed to be reasonable under the circumstances. On an on-going basis, the Company evaluates its estimates. In the event estimates or assumptions prove to be different from actual results, adjustments are made in subsequent periods to reflect more current information. The material accounting policies that the Company believes are most critical to the understanding of the Company’s financial position and results of operations that require significant management estimates and judgments are discussed below.
The Company is self-insured for health costs up to a certain stop loss level. The Company bases its estimated liability upon a review conducted by the Company and an independent broker of claims filed, and other historical data supplied by the independent broker. Because the Company has been self-insured for only a limited period (since May 2002), and because of the unpredictable nature of self-insurance, actual future events could result in adjustments to our estimated liability.
Income taxes are accounted for by using an asset and liability approach. Deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial basis and tax basis of assets and liabilities. 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. Because the Company has a significant net operating loss carryforward and future taxable income is uncertain, the ability to utilize the deferred tax assets is also uncertain. Therefore a valuation allowance in the amount of the net deferred tax assets has been recorded.
Depreciation is computed principally using the straight-line method based upon estimated useful lives ranging from 3 to 15 years for machinery and equipment and up to 30 years for property. Amortization of leasehold improvements is provided over the terms of the various leases. These estimates require assumptions which are believed to be reasonable. Long-lived assets are tested for impairment annually and when an event occurs that indicates an impairment may exist.
An accrual has been made for estimated Michigan single business taxes related to bills received from the Michigan Department of Treasury (“Treasury”) for unpaid single business taxes for fiscal years 1997 through 2001, related to fees paid to the Company’s franchisor (Wendy’s International) during those years. Among other things, the Company believes these fees have been incorrectly characterized as a “royalty” by Treasury. The estimated liability was based on the settlement of litigation between the Company and Treasury related to the same matter for fiscal years 1991 through 1994 and on the tax treatment by Treasury of other quick-service restaurant franchisees relating to the same tax issue.
Inflation and Changing Prices
Inflation did not have a significant impact on the Company’s operations in fiscal 2002. For several years prior to fiscal 2002, the food service industry was affected by a shortage of management and hourly employees. Rising wage rates, due to that shortage, negatively impacted the Company’s prior year’s operating results. Periodic increases in food, labor and other operating expenses such as fuel and utility costs, would normally be passed on to customers in the form of price increases. However, highly competitive market conditions could limit the Company’s ability to offset higher costs through menu price increases.
20
Item 7A. 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 approximately 90% of its debt is at fixed interest rates which limits financial instrument risk. The Company’s three recent mortgage loans at variable interest rates contain provisions to convert to a fixed interest rate between the seventh and twenty-fourth month after the loan closing date. This would allow the company to continue to limit exposure to interest rate fluctuations. 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) that 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 adjust its menu pricing to offset these increases.
Item 8. Financial Statements and Supplementary Data.
The financial statements and supplementary data included in the report under this Item are set forth at the end of this report beginning on page F-1.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None.21
PART III
Item 10. Directors and Executive Officers of the Registrant.
Directors, Executive Officers and Significant Employees
The following is information concerning the current directors, executive officers and significant employees of the Company as of January 29, 2003:
Common Shares
Beneficially Owned
----------------------
Name and Age (1) Position Amount (2) Percentage
- -------------------------------- ------------------------ ----------- ----------
Robert E. Schermer, Sr.(3)(4) Chairman of the Board 772,400 14.4%
67 of Directors
Robert E. Schermer, Jr.(3)(5)(6) Chief Executive Officer 678,823 12.3%
44 and Director
Robert E. Riley (3)(6)(7) President and Director 647,861 11.8%
55
Robert H. Potts (6) Vice President of 74,203 1.4%
49 Real Estate
James R. Saalfeld (6) Vice President, 93,936 1.7%
35 Secretary,
Treasurer and
General Counsel
James P. Bishop (8)(9) Director 42,770 *
62
Joseph L. Maggini (8)(9) Director 253,102 4.7%
63
Jerry L. Ruyan (8)(9) Director 141,151 2.6%
56
All Current Executive
Officers and Directors 2,704,246 47.2%
as a Group (8 persons)
* Less than 1%
(1) |
Unless otherwise indicated, the persons named have sole voting and investment power and beneficial ownership of the securities. |
(2) |
Includes options held by non-employee directors to acquire from 6,000 to 9,000 shares pursuant to the 1996 Directors’ Share Option Plan and the 2001 Directors’ Share Option Plan. |
(3) |
Executive Committee Member. |
(4) |
Includes 5,000 shares held by Mr. Schermer, Sr.’s wife. |
(5) |
Includes 6,850 shares held by Mr. Schermer, Jr. as a custodian for his minor child. |
(6) |
Includes options presently exercisable, or exercisable within 60 days, pursuant to the 1996 Management Equity Incentive Plan and the 2002 Management Equity Incentive Plan as follows: for Mr. Schermer, Jr. 181,682 shares, for Mr. Riley 147,661 shares, for Mr. Potts 25,500 shares, and for Mr. Saalfeld 81,659 shares. |
(7) |
Includes 7,500 shares held by a trust for the benefit of Mr. Riley’s wife, and 10,275 shares held by Mr. Riley’s spouse in an IRA account. |
(8) |
Compensation Committee Member. |
(9) |
Audit Committee Member. |
Robert E. Schermer, Sr. has been a director of the Company since January 25, 1996. He is currently Senior Vice President and a Managing Director of Robert W. Baird & Co. Incorporated, an investment banking and securities brokerage firm headquartered in Milwaukee, Wisconsin. Mr. Schermer has held this position for more than five years. He is the father of Robert E. Schermer, Jr.
Robert E. Schermer, Jr. has been a director of the Company since January 25, 1996. He has been Chief Executive Officer of the Company since October 6, 1998. Mr. Schermer also served as President of the Company from October 1998 until October 2000, Treasurer of the Company from January 1996 until September 1996, and Executive Vice President from January 1996 until October 1998.
22
Robert E. Riley has been a director of the Company since May 2002, and has been the President of the Company since October 25, 2000. From 1984 until 1999, Mr. Riley was with Meijer Inc., a multi-billion dollar supermarket and general merchandise retailer, where he held the position of Senior Vice President, General Counsel and Secretary since 1986.
Robert H. Potts has been Vice President of Real Estate for the Company since March 5, 2001. From 1989 to 2001, Mr. Potts was with Meijer where he held the position of Senior Counsel. Mr. Potts is a licensed member of the Michigan Bar.
James R. Saalfeld has been Vice President, Secretary and General Counsel of the Company since March 20, 1996. Mr. Saalfeld has been Treasurer of the Company since June 2002. From 1992 until 1996, Mr. Saalfeld was with Dykema Gossett PLLC, a law firm headquartered in Detroit, Michigan. Mr. Saalfeld is a licensed member of the Michigan Bar.
James P. Bishop has been a director of the Company since July 16, 1998. He is a CPA and the President and majority owner of the Bishop, Gasperini & Flipse, P.C. accounting firm in Kalamazoo, Michigan, where he has worked since 1973. Mr. Bishop was appointed by Michigan’s Governor to the Administrative Committee on Public Accountancy in 1993.
Joseph L. Maggini has been a director of the Company since January 25, 1996. Since founding the company in 1974, Mr. Maggini has served as President and Chairman of the Board of Magic Steel Corporation, a steel service center located in Grand Rapids, Michigan.
Jerry L. Ruyan has been a director of the Company since October 24, 1996. Since 1995, Mr. Ruyan has been a partner in Redwood Holdings, Inc. He is a founder, and a former officer and director, of Meridian Bioscience, Inc., a producer of medical diagnostic products. In addition, Mr. Ruyan is Chairman of the Board of Schonstedt Instrument Company, and from October 1999 to February 2002, Mr. Ruyan served as Chairman and CEO of Hemagen Diagnostics, Inc. (HMGN:NAS), a manufacturer of medical diagnostic test kits.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires the Company’s officers, directors and persons who own more than ten percent of the Company’s common shares to file reports of ownership with the SEC and to furnish the Company with copies of these reports. Based solely upon its review of reports received by it, or upon written representation from certain reporting persons that no reports were required, the Company believes that during fiscal 2002 all filing requirements were met except for Mr. Schermer, Sr. who untimely reported a purchase of 1,000 common shares owned by his wife.
23
Item 11. Executive Compensation.
The following table sets forth information regarding compensation paid by the Company to its Chief Executive Officer and executive officers or significant employees earning in excess of $100,000 in fiscal 2002:
SUMMARY COMPENSATION TABLE
- --------------------------------------------------------------------------------
ANNUAL COMPENSATION LONG-TERM COMPENSATION
--------------------- ------------------------
Securities
Name and Fiscal (1) Underlying Other Annual
Principal Position Year Salary Bonus Options Compensation
- ------------------------- ------ ----------- ---------- ---------- -------------
Robert E. Schermer, Jr. 2002 $172,000(2) $39,715 71,631 ---
Chief Executive Officer 2001 $150,500(2) $34,848 90,000 ---
2000 $136,585 $ -- 20,205 ---
Robert E. Riley 2002 $170,150(2) $39,715 71,631 ---
President 2001 $145,000 $34,848 190,000 ---
2000 $ 21,367(3) $ -- --- ---
James R. Saalfeld 2002 $113,096 $25,860 54,018 ---
Vice President, General 2001 $107,125 $22,616 27,500 ---
Counsel, Secretary 2000 $ 93,817 $ 5,000 --- ---
and Treasurer
Robert H. Potts 2002 $112,346 $25,860 22,000 ---
Vice President of 2001 $ 74,136(3) $17,366(3) 15,000 ---
Real Estate
(1) |
Includes bonuses earned during the fiscal year but paid in the next fiscal year. |
(2) |
Also received an annual automobile allowance. |
(3) |
Reflects salary and bonus for partial year of employment. |
Stock Options
The following tables contain information concerning the grant of stock options to the executives and employees identified in the Summary Compensation Table and the appreciation of such options:
OPTION GRANTS IN FISCAL 2002
- --------------------------------------------------------------------------------------
Potential
Realizable
Value at
% of Total Assumed Annual
Options Rates of
Number of Granted Stock Price
Securities to Appreciation for
Underlying Employees Exercise Option Term
Options in Fiscal Price ($ Expiration ------------------
Name Granted 2002 per share) Date 5% 10%
- ----------------------- ---------- ---------- ---------- ---------- --------- --------
Robert E. Schermer, Jr. 71,631 28.0% (1) (1) $217,338 $550,773
Robert E. Riley 71,631 28.0% (1) (1) $217,338 $550,773
James R. Saalfeld 54,018 21.1% (2) (2) $161,359 $408,913
Robert H. Potts 22,000 8.6% (3) (3) $57,440 $145,564
(1) |
Messrs. Schermer and Riley each received two separate option grants during fiscal 2002: (a) 16,275 shares with an exercise price of $3.68 and an expiration date of 12/18/11, and (b) 55,356 shares with an exercise price of $5.16 and an expiration date of 5/21/12. |
(2) |
Mr. Saalfeld received two separate option grants during fiscal 2002: (a) 15,000 shares with an exercise price of $3.68 and an expiration date of 12/18/11, and (b) 39,018 shares with an exercise price of $5.16 and an expiration date of 5/21/12. |
(3) |
Mr. Potts received two separate option grants during fiscal 2002: (a) 15,000 shares with an exercise price of $3.68 and an expiration date of 12/18/11, and (b) 7,000 shares with an exercise price of $5.16 and an expiration date of 5/21/12. |
24
FISCAL 2002 OPTION EXERCISES AND FISCAL YEAR-END OPTION VALUES
- --------------------------------------------------------------------------------
Number of Value of
Securities Unexercised
Underlying In-the-Money
Unexercised Options
Shares Options at at Fiscal
Acquired Year End Year End
Name on Value Exercisable/ Exercisable/
Exercise Realized Unexercisable Unexercisable
- ---------------------- -------- -------- ---------------- -------------------
Robert E. Schermer, Jr --- --- 155,248 / 121,588 $335,993 / $229,339
Robert E. Riley --- --- 115,176 / 146,455 $265,292 / $311,205
James R. Saalfeld --- --- 67,177 / 52,082 $140,375 / $53,390
Robert H. Potts --- --- 13,000 / 24,000 $28,313 / $38,588
Item 12. Security Ownership of Certain Beneficial Owners and Management.
Other than certain of the Company’s directors and officers as identified in Item 10 above, no other shareholders are known by the Company to beneficially own 5% or more of the Company’s outstanding common shares as of January 29, 2003, except for Peter D. Wierenga who reported beneficial ownership of 271,109 (5.0%) on November 9, 2000. Mr. Wierenga’s business address is reported in his Schedule 13D as 3703 S. Division Ave., Grand Rapids, Michigan 49503.
As required by Item 201(d) of Regulation S-K, the Company incorporates in this Item 12 the Equity Compensation Plan Information table contained in Item 5 of this report.
Item 13. Certain Relationships and Related Transactions.
No new items to report.
Item 14. Controls and Procedures.
As of December 1, 2002, an evaluation was completed under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Office, President, General Counsel and Controller, 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 Chief Executive Office, President, General Counsel and Controller, concluded that the Company’s disclosure controls and procedures were effective as of December 1, 2002. There have been no significant changes to the Company’s internal controls or other factors that could significantly affect internal controls subsequent to December 1, 2002.
25
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a)(1) and (2) Financial Statements and Schedules.
All financial statements and schedules required to be filed by Item 8 of this Form and included in this report are set forth at the end of this report beginning on page F-1. No additional financial statements or schedules are being filed since the requirements of paragraph (d) under Item 14 are not applicable to the Company.
(a)(3) Exhibit List.
The following documents are exhibits to this Annual Report:
Exhibit No. Description of Document
- ---------- ---------------------------------------------------------------------
3.1 Amended and Restated Articles of Incorporation (1).
3.2 Restated and Amended Bylaws (2).
4.1 Certificate of Designation of Series A Convertible Preferred Shares
(3).
10.1 Sample Construction Loan Agreement with Captec Financial Group, Inc.
(4).
10.2 Sample Promissory Note with Captec Financial Group, Inc. regarding
real estate financing (4).
10.3 Sample Mortgage with Captec Financial Group, Inc. regarding real
estate financing (4).
10.4 Sample Promissory Note with Captec Financial Group, Inc. regarding
leasehold financing (4).
10.5 Sample Mortgage with Captec Financial Group, Inc. regarding leasehold
financing (4).
10.6 Sample Promissory Note with Captec Financial Group, Inc. regarding
business value financing (4).
10.7 Sample Security Agreement with Captec Financial Group, Inc. regarding
business value financing (4).
10.8 Sample Loan Agreement with Fleet Business Credit Corporation (5).
10.9 Sample Promissory Note with Fleet Business Credit Corporation (5).
10.10 Sample Mortgage with Fleet Business Credit Corporation (5).
10.11 Sample Guaranty with Fleet Business Credit Corporation (5).
10.12 Line of Credit, Term Loan & Security Agreement with Fleet Business
Credit Corporation (6).
26
10.13 Promissory Note for Line of Credit with Fleet Business Credit
Corporation (6).
10.14 Sample Promissory Note with GE Capital Franchise Finance Corporation
(7).
10.15 Sample Mortgage with GE Capital Franchise Finance Corporation (7).
10.16 Sample Guaranty with GE Capital Franchise Finance Corporation (7).
10.17 Sample Construction Loan Agreement with GE Capital Franchise Finance
Corp. (8).
10.18 Consent Agreement dated May 16, 1997 between Wendy’s International,
Inc., Wendy’s of Michigan, Meritage Hospitality Group Inc., MHG
Food Service Inc., Meritage Capital Corp., MCC Food Service Inc.,
Robert E. Schermer, Jr. and Christopher B. Hewett, with sample Unit
Franchise Agreement, Guaranties, and Release of Claims attached as
exhibits (9).
10.19 Agreement and Consent dated August 7, 1998 between WM Limited
Partnership - 1998, Meritage Hospitality Group Inc., MHG Food Service
Inc., Meritage Capital Corp., MCC Food Service Inc., Robert E.
Schermer, Jr., and Christopher B. Hewett (4).
10.20 Agreement and Consent dated December 16, 1998 between WM Limited
Partnership - 1998, Meritage Hospitality Group Inc., MHG Food Service
Inc., Meritage Capital Corp., MCC Food Service Inc., S & Q Management,
LLC, Robert E. Schermer, Jr., Christopher B. Hewett, and Ray E. Quada
(10).
10.21 Agreement and Consent dated June 11, 2001 between WM Limited Partnership
- 1998, Meritage Hospitality Group Inc., MHG Food Service Inc., RES
Management, LLC, S & Q Management, LLC, Robert E. Schermer, Jr. and
The Estate of Ray E. Quada (11).
10.22 Sample indemnification agreement for officers and directors of the
Company (12).
10.23 Indemnification Agreement dated February 18, 2002 among Meritage
Hospitality Group Inc., MHG Food Service Inc., WM Limited Partnership
- 1998, RES Management, LLC, and Robert E. Schermer, Jr. (11).
10.24 Guaranty by Meritage Hospitality Group Inc. to Huntington National
Bank dated March 1, 2002 relating to Promissory Note by Robert E.
Schermer, Jr. to Huntington National Bank (13).
Management Compensatory Contracts
10.25 Amended 1996 Management Equity Incentive Plan (14).
10.26 Amended 1996 Directors’ Share Option Plan (9).
10.27 Amended 2001 Directors’ Share Option Plan (11).
10.28 Amended 1999 Directors’ Compensation Plan (15).
10.29 2002 Management Equity Incentive Plan (16).
----------------------------------
27
21 Subsidiaries of the Registrant (11). 23 Consent of Grant Thornton LLP (8).
Exhibits previously filed and incorporated by reference from:
(1) |
The Quarterly Report on Form 10-Q for the Company’s fiscal quarter ended May 31, 2000. |
(2) |
The Quarterly Report on Form 10-Q for the Company’s fiscal quarter ended June 2, 2002. |
(3) |
The Annual Report on Form 10-K for the Company’s fiscal year ended November 30, 1996. |
(4) |
The Quarterly Report on Form 10-Q for the Company’s fiscal quarter ended August 31, 1998. |
(5) |
The Quarterly Report on Form 10-Q for the Company’s fiscal quarter ended May 31, 1999. |
(6) |
The Quarterly Report on Form 10-Q for the Company’s fiscal quarter ended August 31, 2000. |
(7) |
The Quarterly Report on Form 10-Q for the Company’s fiscal quarter ended September 1, 2002. |
(8) |
Filed herewith. |
(9) |
The Quarterly Report on Form 10-Q for the Company’s fiscal quarter ended May 31, 1997. |
(10) |
The Annual Report on Form 10-K for the Company’s fiscal year ended November 30, 1998. |
(11) |
The Annual Report on Form 10-K for the Company’s fiscal year ended December 2, 2001. |
(12) |
The Annual Report on Form 10-K for the Company’s fiscal year ended November 30, 1997. |
(13) |
The Quarterly Report on Form 10-Q for the Company’s fiscal quarter ended March 3, 2002. |
(14) |
The Annual Report on Form 10-K for the Company’s fiscal year ended November 30, 2000. |
(15) |
The Quarterly Report on Form 10-Q for the Company’s fiscal quarter ended May 31, 2001. |
(16) |
Registration Statement No. 333-88876 on Form S-8 filed with the SEC on May 23, 2002. |
(b) Reports on Form 8-K.
None.
28
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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: February 7, 2003 |
MERITAGE HOSPITALITY GROUP INC. |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.
Signature Title Date
- --------------------------- ----------------------------- ----------------
/s/ Robert E. Schermer, Sr. Chairman of the Board February 7, 2003
- --------------------------- of Directors
Robert E. Schermer, Sr.
/s/ Robert E. Schermer, Jr. Chief Executive Officer February 7, 2003
- --------------------------- and Director
Robert E. Schermer, Jr. (Principal Executive Officer)
/s/ Robert E. Riley President and Director February 7, 2003
- --------------------------
Robert E. Riley
/s/ William D. Badgerow Controller (Principal February 7, 2003
- -------------------------- Financial & Accounting
William D. Badgerow Officer
/s/ James P. Bishop Director February 7, 2003
- --------------------------
James P. Bishop
/s/ Joseph L. Maggini Director February 7, 2003
- --------------------------
Joseph L. Maggini
/s/ Jerry L. Ruyan Director February 7, 2003
- --------------------------
Jerry L. Ruyan
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 annual report on Form 10-K of Meritage Hospitality Group Inc.;
2. Based on my knowledge, this annual 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 annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual 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 annual 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 annual 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 annual report (the "Evaluation Date"); and |
(c) |
Presented in this annual 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 annual 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: February 7, 2003 |
|
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 annual report on Form 10-K of Meritage Hospitality Group Inc.;
2. Based on my knowledge, this annual 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 annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual 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 annual 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 annual 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 annual report (the "Evaluation Date"); and |
(c) |
Presented in this annual 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 annual 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: February 7, 2003 |
|
Certification of Chief Executive Officer
Pursuant to 18 U.S.C.ss. 1350, as adopted pursuant to
ss. 906 of the Sarbanes-Oxley Act of 2002
In connection with the filing with the Securities and Exchange Commission of the Annual Report of Meritage Hospitality Group Inc. (the "Company") on Form 10-K for the period ending December 1, 2002 (the "Report"), I, Robert E Schermer, Jr., Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C.ss.1350, as adopted pursuant toss.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: February 7, 2003 |
|
Certification of Chief Financial Officer
Pursuant to 18 U.S.C.ss. 1350, as adopted pursuant to
ss. 906 of the Sarbanes-Oxley Act of 2002
In connection with the filing with the Securities and Exchange Commission of the Annual Report of Meritage Hospitality Group Inc. (the "Company") on Form 10-K for the period ending December 1, 2002 (the "Report"), I, William D. Badgerow, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss.1350, as adopted pursuant toss.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: February 7, 2003 |
|
Meritage Hospitality Group Inc. and Subsidiary Page
----
Report of Independent Certified Public Accountants .........................F-2
Financial Statements
Consolidated Balance Sheets.................................................F-3
Consolidated Statements of Operations.......................................F-5
Consolidated Statements of Stockholders’ Equity.............................F-6
Consolidated Statements of Cash Flows.......................................F-8
Notes to Consolidated Financial Statements .................................F-10
F-1
Board of Directors
Meritage Hospitality Group Inc.
We have audited the accompanying consolidated balance sheets of Meritage Hospitality Group Inc. (a Michigan corporation) and subsidiary as of December 1, 2002 and December 2, 2001, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 1, 2002. 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 auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Meritage Hospitality Group Inc. and subsidiary as of December 1, 2002 and December 2, 2001, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 1, 2002, in conformity with accounting principles generally accepted in the United States of America.
/s/ Grant Thornton LLP
Southfield, Michigan
December 19, 2002
(except for Note F, of which the date is January 31, 2003)
F-2
Meritage Hospitality Group Inc. and Subsidiary
Consolidated Balance Sheets
December 1, 2002 and December 2, 2001
ASSETS
December 1, December 2,
2002 2001
----------- -----------
Current Assets
Cash and cash equivalents $ 901,113 $ 1,663,900
Receivables 235,766 129,162
Inventories 208,197 202,708
Prepaid expenses and other current assets 161,189 201,885
----------- -----------
Total Current Assets 1,506,265 2,197,655
Property, Plant and Equipment, net 38,076,198 28,780,582
Other Assets
Note receivable 362,994 362,736
Assets held for sale 728,383 472,725
Goodwill, net of amortization of $879,874
and $698,345, respectively 4,429,849 4,611,378
Franchise costs, net of amortization of
$129,943 and $93,917, respectively 995,057 881,083
Financing costs, net of amortization of
$90,466 and $64,108, respectively 591,475 477,787
Deferred charges and other assets 65,423 96,889
----------- -----------
Total Other Assets 7,173,181 6,902,598
----------- -----------
Total Assets $46,755,644 $37,880,835
=========== ===========
F-3
Meritage Hospitality Group Inc. and Subsidiary
Consolidated Balance Sheets - Continued
December 1, 2002 and December 2, 2001
LIABILITIES AND STOCKHOLDERS’ EQUITY
December 1, December 2,
2002 2001
------------ ------------
Current Liabilities
Current portion of long-term obligations $ 1,141,281 $ 748,444
Current portion of obligations under
capital lease 341,993 306,305
Trade accounts payable 1,466,713 1,583,295
Income taxes payable -- 17,264
Accrued liabilities 1,733,840 1,575,278
---------- ----------
Total Current Liabilities 4,683,827 4,230,586
Long-Term Obligations 30,736,582 22,701,377
Obligations Under Capital Lease 60,749 402,742
Deferred Revenue 3,665,137 4,209,108
Commitments and Contingencies
(Notes H, I, K, O and P) -- --
Stockholders’ Equity
Preferred stock - $0.01 par value
shares authorized: 5,000,000; 200,000
shares 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: 5,900,351 and
5,878,413, respectively
shares outstanding:5,342,800 and
5,323,799, respectively 53,428 53,238
Additional paid in capital 13,584,800 13,534,302
Note receivable from sale of shares -- (538,900)
Accumulated deficit (6,029,174) (6,711,913)
---------- ----------
Total Stockholders’ Equity 7,609,349 6,337,022
---------- ----------
Total Liabilities and Stockholders’ Equity $ 46,755,644 $ 37,880,835
=========== ==========
The accompanying notes are an integral part of these financial statements.
F-4
Meritage Hospitality Group Inc. and Subsidiary
Consolidated Statements of Operations
Years Ended December 1, 2002, December 2, 2001, and November 30, 2000
2002 2001 2000
----------- ----------- ------------
Food and beverage revenue $45,952,990 $38,356,360 $33,104,982
Cost and expenses
Cost of food and beverages 11,695,390 10,634,688 9,587,701
Operating expenses 26,348,642 21,998,347 19,657,914
General and administrative
expenses 2,763,970 2,580,966 2,024,949
Depreciation and amortization 2,469,796 1,898,615 1,582,613
(Gain) loss on impairment
of assets - (463,952) 553,549
----------- ----------- ------------
Total cost and expenses 43,277,798 36,648,664 33,406,726
----------- ----------- ------------
Earnings (loss) from operations 2,675,192 1,707,696 (301,744)
Other income (expense)
Interest expense (1,981,855) (1,514,861) (1,360,986)
Interest income 99,961 105,708 98,004
Miscellaneous income 33,356 30,975 69,797
(Loss) gain on disposal of assets (134,347) 217,064 142,167
----------- ----------- ------------
Total other expense (1,982,885) (1,161,114) (1,051,018)
----------- ----------- ------------
Earnings (loss) before
income taxes 692,307 546,582 (1,352,762)
Income tax benefit (expense)
- current 17,000 (15,000) -
----------- ----------- ------------
Net earnings (loss) 709,307 531,582 (1,352,762)
Preferred stock dividends 26,568 26,568 33,318
----------- ----------- ------------
Net earnings (loss) on common shares $ 682,739 $ 505,014 $(1,386,080)
=========== =========== ===========
Earnings (loss) per common
share - basic $ .13 $ .10 $ (.25)
=========== =========== ===========
Earnings (loss) per common
share - diluted $ .12 $ .10 $ (.25)
=========== =========== ===========
Weighted average shares
outstanding - basic 5,332,134 5,236,149 5,489,710
=========== =========== ===========
Weighted average shares
outstanding - diluted 5,685,789 5,287,007 5,489,710
=========== =========== ===========
The accompanying notes are an integral part of these financial statements.
F-5
Meritage Hospitality Group Inc. and Subsidiary
Consolidated Statements of Stockholders’ Equity
Years Ended December 1, 2002, December 2, 2001, and November 30, 2000
Note
Series A Receivable
Convertible Additional From
Preferred Common Paid-In Sale of Accumulated
Stock Stock Capital Shares Deficit Total
--------- -------- ----------- ------------ ------------ -------------
Balance at
December 1, 1999 $445 $57,519 $13,316,795 $(1,660,962) $(5,830,847) $ 5,882,950
Issuance of 30,464 shares
of common stock -- 304 67,437 -- -- 67,741
Transfer of 15,000
shares of convertible
preferred shares for
80,001 common shares (150) 800 (650) -- -- --
Surrender of 1,392,858
common shares for
note receivable -- (13,929) (1,647,033) 1,660,962 -- --
Purchase of 14,600
shares of
common stock -- (146) (33,292) -- -- (33,438)
Preferred stock
dividends paid -- -- -- -- (33,318) (33,318)
Net loss -- -- -- -- (1,352,762) (1,352,762)
----- ------- ---------- ---------- ---------- ----------
Balance at November 30,
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
Purchase of 109,296
shares of
common stock -- (1,093) (237,296) -- -- (238,389)
Preferred stock
dividends paid -- -- -- -- (26,568) (26,568)
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
F-6
Meritage Hospitality Group Inc. and Subsidiary
Consolidated Statements of Stockholders’ Equity - Continued
Years Ended December 1, 2002, December 2, 2001, and November 30, 2000
Note
Series A Receivable
Convertible Additional From
Preferred Common Paid-In Sale of Accumulated
Stock Stock Capital Shares Deficit Total
----------- ------- ----------- ----------- ----------- ----------
Balance at
December 3, 2001 $295 $53,238 $13,534,302 $(538,900) $(6,711,913) $6,337,022
Payment received
on note
receivable
from sale of
common stock - - - 538,900 - 538,900
Issuance of
19,001 shares
of common
stock - 190 50,498 - - 50,688
Preferred stock
dividends paid - - - - (26,568) (26,568)
Net earnings - - - - 709,307 709,307
---- ------- ----------- --------- ----------- ---------
Balance at
December 1, 2002 $295 $53,428 $13,584,800 $ - $(6,029,174) $7,609,349
==== ======= =========== ========= =========== ==========
The accompanying notes are an integral part of these financial statements.
F-7
Meritage Hospitality Group Inc. and Subsidiary
Consolidated Statements of Cash Flows
Years Ended December 1, 2002, December 2, 2001, and November 30, 2000
2002 2001 2000
------------ ------------ -------------
Cash Flows From Operating Activities
Net earnings (loss) $ 709,307 $ 531,582 $ (1,352,762)
Adjustments to reconcile net
earnings (loss) to net cash
provided by operating activities
Depreciation and amortization 2,469,796 1,898,615 1,582,613
Compensation paid by issuance
of common stock 28,000 34,478 38,991
Loss (gain) on disposal of assets 134,347 (217,064) (142,167)
(Gain) loss on impairment
of assets -- (463,952) 553,549
(Decrease) increase in deferred
revenue (543,971) 2,422,985 (88,305)
Decrease (increase) in current
assets
Receivables (106,604) (69,557) 21,634
Inventories (5,489) 25,315 (20,460)
Prepaid expenses and other
current assets 40,696 (34,517) (7,691)
Increase (decrease) in current
liabilities
Trade accounts payable (116,582) 206,953 130,663
Income taxes payable (17,264) 15,000 (2,736)
Accrued liabilities 158,562 406,570 22,952
----------- ----------- -----------
Net cash provided by
operating activities 2,750,798 4,756,408 736,281
Cash Flows From Investing Activities
Proceeds from disposal of assets 41,436 1,779,056 192,500
Proceeds from insurance - fire -- -- 84,000
Purchase of property, plant and
equipment (11,916,966) (11,418,474) (5,133,408)
Purchase of assets held for sale (5,658) (1,095,578) --
Payment for franchise agreement (150,000) (175,000) (75,000)
Collection on notes receivable -- -- 475,000
Decrease (increase) in deferred
charges and other assets 18,392 16,337 (99,200)
----------- ----------- -----------
Net cash used in
investing activities (12,012,796) (10,893,659) (4,556,108)
F-8
Meritage Hospitality Group Inc. and Subsidiary
Consolidated Statements of Cash Flows - Continued
Years Ended December 1, 2002, December 2, 2001, and November 30, 2000
2002 2001 2000
----------- ------------ -------------
Cash Flows From Financing
Activities
Proceeds from long-term
obligations $ 8,005,871 $ 6,441,453 $ 4,419,589
Proceeds from borrowings
on line of credit 3,295,238 2,650,000 --
Principal payments on
long-term obligations (791,996) (831,576) (483,321)
Payments on line of credit (2,081,071) (1,967,500) --
Payments of financing costs (157,546) (160,995) (66,366)
Payments on obligations
under capital lease (306,305) (357,767) (328,236)
Payments on notes payable -- -- (475,000)
Proceeds from issuance of
common stock 22,688 1,504,746 28,750
Purchase of common stock -- (238,389) (33,438)
Payment received on note
receivable 538,900 -- --
Preferred stock dividends paid (26,568) (26,568) (33,318)
--------- ------- ---------
Net cash provided by
financing activities 8,499,211 7,013,404 3,028,660
--------- ------- ---------
Net increase (decrease)
in cash (762,787) 876,153 (791,167)
Cash and cash equivalents
- beginning of year 1,663,900 787,747 1,578,914
--------- ------- ---------
Cash and cash equivalents
- end of year $ 901,113 $ 1,663,900 $ 787,747
=========== =========== ===========
Supplemental Cash Flow
Information
Cash paid for interest $ 1,956,000 $ 1,499,000 $ 1,358,000
Cash paid for income taxes $ -- $ -- $ 2,736
Schedule of Non-Cash Investing
and Financing Activities
Sale of impaired asset
Selling price of asset $ -- $ 400,000 $ --
Note receivable obtained
from buyer -- 365,000 --
--------- ------- ---------
Cash down payment received
from buyer $ -- $ 35,000 $ --
=========== =========== ===========
Issuance of 250,000 shares
of common stock in exchange
for note receivable $ -- $ 538,900 $ --
=========== =========== ===========
Transfer of 15,000 shares of
convertible preferred stock
into 80,001 shares of common
stock in 2000.
The accompanying notes are an integral part of these financial statements.
F-9
Meritage Hospitality Group Inc. and Subsidiary
Notes to Consolidated Financial Statements
Years Ended December 1, 2002, December 2, 2001, and November 30, 2000
Note A - Nature of Business and Significant Accounting Policies
The Company currently conducts its business in the quick-service restaurant industry operating 45 Wendy’s Old Fashioned Hamburgers restaurants under franchise agreements with Wendy’s International, Inc. All operations of the Company are located in Michigan.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, MHG Food Service Inc. All significant intercompany balances and transactions have been eliminated in consolidation.
Cash Equivalents
For purposes of the statement of cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.
Inventories
Inventories are stated at the lower of cost or market as determined by the first-in, first-out method. Inventories consist of restaurant food items, beverages and serving supplies.
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation is computed principally using the straight-line method based upon estimated useful lives ranging from 3 to 15 years for machinery and equipment and up to 30 years for property. Amortization of leasehold improvements is provided over the terms of the various leases.
Income Taxes
Income taxes are accounted for by using an asset and liability approach. Deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial basis and tax basis of assets and liabilities. 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.
Franchise Agreement Costs
Costs capitalized under the Company’s franchise agreements are amortized using the straight-line method over the terms of the individual franchise agreements including options to renew.
Financing Costs
Financing costs are amortized using the straight-line method over the terms of the various loan agreements.
F-10
Meritage Hospitality Group Inc. and Subsidiary
Notes to Consolidated Financial Statements - Continued
Years Ended December 1, 2002, December 2, 2001, and November 30, 2000
Note A - Nature of Business and Significant Accounting Policies (Continued)
Goodwill and Long-Lived Assets
The cost in excess of net assets acquired (goodwill) is amortized using the straight-line method over thirty years (the term of the franchise agreements including options to renew). The Company performs a review for impairment of goodwill and long-lived assets when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Undiscounted estimated future cash flows of an asset are compared with its carrying value, and if the cash flows are less than the carrying value, an impairment loss is recognized (see Recently Issued Accounting Standards under Note A). In 2002, there was no impact to the financial statements due to this review. However, in 2001 the Company recorded a gain on the sale of impaired assets of $463,952. This gain resulted from the sale of two restaurant buildings that were written down to estimated fair market value in 2000. In 2000, the Company closed one of these restaurants and listed the other restaurant for sale due to the opening of a new restaurant in the same market area. The property and equipment owned by the Company at these locations were written down to an estimated fair market value resulting in an impairment loss in 2000 of $553,549.
Obligations Under Capital Lease
Lease transactions relating to certain restaurant buildings are classified as capital leases. These assets have been capitalized and the related obligations recorded based on the present values of the minimum lease payments at the inception of the leases. Amounts capitalized are being amortized over the terms of the leases.
Advertising Costs and Other Franchise Fees
Fees due under the Company’s franchise agreements and advertising costs are based primarily on a percentage of monthly food and beverage revenue. These costs are charged to operations as incurred. Advertising expense was approximately $1,838,000, $1,521,000 and $1,667,000 for the years ended December 1, 2002, December 2, 2001, and November 30, 2000, respectively.
Credit Risk
The Company maintains cash deposits in excess of federally insured limits of $100,000.
Use of Estimates
The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, 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. Actual results could differ from those estimates.
Stock-Based Compensation
For stock options granted under the Company’s stock option plans (see Note N), the Company follows the provisions of Accounting Principles Board No. 25, Accounting for Stock Issued to Employees, and accordingly, recognizes no compensation expense for these option grants.
F-11
Meritage Hospitality Group Inc. and Subsidiary
Notes to Consolidated Financial Statements - Continued
Years Ended December 1, 2002, December 2, 2001, and November 30, 2000
Note A - Nature of Business and Significant Accounting Policies (Continued)
Recently Issued Accounting Standards
On July 20, 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting (“SFAS”) 141, Business Combinations, and SFAS 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 for the Company 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. |
The Company 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. The Company 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.
F-12
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.
Fair Value of Financial InstrumentsThe carrying amounts of the Company’s financial instruments which include cash and cash equivalents, receivables, notes receivable, trade accounts payable and long-term obligations, approximate their fair values.
Self-InsuranceThe Company is self-insured for health costs up to a certain stop loss level. The estimated liability is based upon a review by the Company and an independent broker of claims filed and claims incurred but not reported.
The Company has elected a 52/53 week fiscal period for tax and financial reporting purposes. The fiscal period ends on the Sunday closest to November 30. The three years in the period ended December 1, 2002 each contained 52 weeks.
Earnings (Loss) Per Common ShareBasic earnings per share is computed by dividing earnings on common shares by the weighted average number of common shares outstanding during each year. 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 years ended December 1, 2002, December 2, 2001, and November 30, 2000:
2002 2001 2000
---- ---- ----
Numerators
Earnings (loss) from continuing
operations $ 709,307 $ 531,582 $(1,352,762)
Less preferred stock dividends 26,568 26,568 33,318
---------- ---------- -----------
Earnings (loss) on common shares -
basic and diluted $ 682,739 $ 505,014 $(1,386,080)
========== ========== ============
Denominators
Weighted average common shares
outstanding - basic 5,332,134 5,236,149 5,489,710
Effect of dilutive securities
Stock options 353,655 50,858 -
--------- --------- ----------
Weighted average common shares
outstanding - diluted 5,685,789 5,287,007 5,489,710
========= ========= =========
For 2002, 2001 and 2000, convertible preferred stock was not included in the computation of diluted earnings per common share because the effect of conversion would be antidilutive. For 2000, exercisable stock options were not included in the computation of diluted earnings per share because the exercise of stock options would be antidilutive.
Note B - Financial Statement PresentationCertain amounts in the 2001 and 2000 financial statements have been reclassified to conform to the 2002 presentation.
Property, plant and equipment are summarized as follows at December 1, 2002 and December 2, 2001:
2002 2001
---- ----
Land and improvements $14,791,974 $10,050,918
Buildings and improvements 15,777,169 12,129,702
Furnishings and equipment 10,237,452 8,419,624
Leasehold improvements 1,090,097 1,154,861
Leased property/capital leases 983,292 983,292
Construction in progress 1,584,649 444,544
----------- -----------
44,464,633 33,182,941
Less accumulated depreciation and amortization (6,388,435) (4,402,359)
------------ -----------
$38,076,198 $28,780,582
=========== ===========
Depreciation and amortization expense was approximately $2,196,000, $1,638,000, and $1,332,000 for the years ended December 1, 2002, December 2, 2001, and November 30, 2000, respectively.
Note D - Note ReceivableNote receivable consisted of the following at December 1, 2002 and December 2, 2001:
2002 2001
---- ----
Land contract receivable, collateralized by
land and building, requiring monthly payments
of $2,678 including interest at 8.0% from
March 2002 through February 2004, when the
remaining balance is due. $362,994 $365,000
Less current portion - 2,264
-------- --------
$362,994 $362,736
======== ========
Note E - Accrued Liabilities
Accrued liabilities consist of the following at December 1, 2002 and December 2, 2001:
2002 2001
---- ----
Payroll and related payroll taxes $ 920,511 $ 894,008
Property taxes 452,520 367,518
Interest expense 130,639 105,090
Other expenses 230,170 208,662
---------- ----------
$1,733,840 $1,575,278
========== ==========
Long-term obligations consist of the following at December 1, 2002 and December 2, 2001:
2002 2001
----------- -----------
Mortgage notes payable, due in monthly installments
totaling $241,859 including interest at fixed and
variable rates ranging from 3.99% to 8.70% (with
an average rate of 7.30%) maturing from October 2012
through November 2019. Certain of these notes are
partially guaranteed by an officer of the Company. $28,233,946 $19,267,717
Notes payable, due in monthly installments totaling
$10,802 including interest at 8.15% through
September 2013. 930,514 981,999
Fixed rate equipment notes payable, due in monthly
installments totaling $14,413 including interest
ranging from 8.02% to 8.39% maturing from June 2006
through December 2007. 619,553 736,793
Variable rate equipment notes payable, requiring
monthly payments of principal increasing from
$8,066 to $11,241 over the remaining terms of the
notes, plus interest equal to the 30 day commercial
paper plus 2.5% (total rate at December 1, 2002,
3.69%), maturing from January 2007 through December
2007. 544,704 636,242
Amount payable under $3.5 million revolving line of
credit, requiring monthly payments of interest only at
a variable interest rate equal to 30 day LIBOR plus 2.5%
(total rate at December 2, 2001, 3.94%) through December
2003, when any outstanding principal will be converted
to a term loan requiring 48 monthly installments of
principal and interest. 362,135 1,000,000
Construction loan payable, with interest accruing at a
variable interest rate equal to 30 day LIBOR plus 2.75%
(total rate at December 1, 2002, 4.19%) until conversion
to a permanent mortgage loan; the permanent mortgage
loan will require monthly installments of principal and
interest based on a 20 year amortization and a variable
interest rate equal 30 day LIBOR plus 2.55% at the time
of conversion. The loan will mature 10 years from the
time of conversion. 1,187,011 827,070
----------- -----------
31,877,863 23,449,821
Less current portion 1,141,281 748,444
----------- -----------
$30,736,582 $22,701,377
=========== ===========
Substantially all property, plant and equipment owned by the Company is pledged as collateral.
Minimum principal payments on long-term obligations to maturity as of December 1, 2002 are as follows:
2003 $ 1,141,281
2004 1,342,236
2005 1,451,785
2006 1,558,310
2007 1,589,422
Thereafter 24,794,829
----------
$31,877,863
===========
Loan covenants of the various loan agreements include requirements for maintenance of certain financial ratios. At December 1, 2002 the Company was in compliance.
Note G - Income TaxesDeferred tax assets and liabilities at December 1, 2002 and December 2, 2001 consist of the following:
2002 2001
---- ----
Deferred tax assets:
Net operating loss carryforwards $1,444,000 $ 1,378,000
AMT credit carryforward 141,000 141,000
Goodwill 199,000 137,000
Asset impairment 22,000 11,000
Accrued compensation 11,000 11,000
Accrued expenses 3,000 5,000
Contribution carryover 73,000 73,000
--------- ---------
1,893,000 1,756,000
Deferred tax liabilities:
Property and equipment - cost basis (81,000) (81,000)
Depreciation (705,000) (231,000)
Amortization (43,000) (32,000)
Capital leases (144,000) (96,000)
Other (2,000) -
---------- ---------
(975,000) (440,000)
Less valuation allowance (918,000) (1,316,000)
---------- ------------
Net deferred tax liability $ - $ -
========== ============
The net operating loss carryforwards expire through years ending in 2022.
The income tax provision reconciled to the tax computed at the statutory federal rate for continuing operations was as follows for the years ended December 1, 2002, December 2, 2001, and November 30, 2000:
2002 2001 2000
---- ---- ----
Tax expense (benefit) at statutory rates
applied to income before federal
income tax $ 235,000 $ 186,000 $(460,000)
Permanent differences - 3,000 (420,000)
Other 146,000 (56,000) (6,000)
Valuation allowance (decrease) increase (398,000) (118,000) 886,000
-------- -------- -------
$ (17,000) $ 15,000 $ -
========= ========= =========
Note H - Lease Commitments
The Company leases land and buildings used in operations under operating agreements, with remaining lease terms including renewal options ranging from six to twenty-eight years.
Total lease expense (including taxes, insurance and maintenance when included in rent) related to all operating leases and all percentage rentals were as follows for the years ended December 1, 2002, December 2, 2001, and November 30, 2000:
2002 2001 2000
---- ---- ----
Minimum rentals $713,863 $758,307 $557,879
Percentage rentals 279,211 335,470 424,474
-------- ---------- --------
$993,074 $1,093,777 $982,353
======== ========== ========
Leases for eight restaurant buildings (excluding land which is accounted for as an operating lease) have been capitalized. Minimum future obligations under capital leases and noncancellable operating leases in effect are as follows:
Capital Operating
Years Ending Leases Leases
-------------- -------- ---------
2003 $369,575 $ 597,672
2004 61,596 437,449
2005 - 414,412
2006 - 414,412
2007 - 414,412
Thereafter - 2,904,783
-------- ----------
Total minimum lease obligations 431,171 $5,183,140
==========
Less amount representing interest
imputed at approximately 11% 28,429
--------
Present value of minimum lease
obligations $402,742
========
The present value of minimum lease obligations is reflected in the balance sheets as current and long-term obligations under capital lease.
Accumulated amortization of leased property under capital leases was $803,300 at December 1, 2002, and $637,100 at December 2, 2001.
In addition to minimum future obligations, percentage rentals may be paid under all restaurant leases on the basis of percentage of sales in excess of minimum prescribed amounts.
Note I - Deferred RevenueThe Company has entered into long-term agreements with its beverage suppliers. The agreements require the Company to purchase 1,948,000 gallons of fountain beverage syrup from the suppliers over the terms of the agreements. In exchange, the Company received $4,948,000 in marketing and conversion funds which, in accordance with the terms of the agreements, will be recognized as revenue as the gallons of fountain beverage syrup are purchased. At December 1, 2002 and December 2, 2001, 1,264,000 and 1,440,000 gallons, respectively, remained to be purchased under the agreements.
The Company previously designated a series of non-voting preferred stock. The shares have an annual dividend rate of $0.90 per share and the payment of the dividends is cumulative. The shares are convertible into common shares at the conversion price of $7.00 per share. The shares have a liquidation value of $10.00 per share.
Under certain conditions relating to the market value of the Company’s common stock, the Company has the option to cause the preferred stock to be converted into common stock.
Note K - Note Receivable from Sale of Shares (related party contingency)The Company had a note receivable from the Company’s Chief Executive Officer (“CEO) in the amount of $538,900. This note was received to facilitate his purchase of 250,000 shares of the Company’s common stock in a private placement in February 2001. The note was repaid in full including interest at 8.0% in February 2002. The proceeds received by the Company from the CEO to repay the note were from a bank loan obtained by the CEO, which is secured with the 250,000 shares as collateral. The Company has guaranteed the indebtedness of the CEO to the bank in the amount of $538,900. Under the terms of an indemnification agreement between the Company and the CEO, in the event that the Company becomes liable for this indebtedness, the Company would be subrogated to the bank’s rights and remedies. The indemnification agreement also provides that, if at any time during the term of the agreement the Company’s stock price closes below $3.00 per share for two consecutive trading days, the Company may order the CEO to repay the outstanding balance on the CEO’s bank loan. If the CEO fails to pay off the bank loan, the Company has the right, to pay off the CEO’s bank loan and take possession of the 250,000 shares securing the bank debt. In such event, the CEO agrees to pay any costs incurred by the Company in acquiring free and clear possession of the stock.
Note L - Employee Benefit PlansThe Company maintains a 401(k) plan that covers substantially all of its employees. Contributions to the plan may be made by plan participants through elective salary deductions and by the Company (which are at the Company’s discretion). Contributions to the plan and plan expenses paid by the Company totaled $5,484, $28,445 and $3,400 for the years ended December 1, 2002, December 2, 2001, and November 30, 2000, respectively.
Note M - Related PartyAn officer of the Company has provided personal guarantees to Wendy’s International to facilitate the granting of Wendy’s franchise agreements.
The 1996 Management Equity Incentive Plan, as amended, authorized 725,000 shares of common stock to be granted for options that may be issued under the plan. In May 2002 shareholders approved the 2002 Management Equity Incentive Plan authorizing 750,000 shares of common stock to be granted for options that may be issued under this plan. The Compensation Committee of the Board of Directors (which is comprised of independent directors) has the discretion to designate an option to be an incentive share option or a non-qualified share option. The Plans provide that the option price is not less than the fair market value of the common stock at the date of grant. Options granted under the Plans become exercisable pursuant to a vesting schedule adopted by the Compensation Committee which administers the Plan. Vesting schedules for options outstanding range from immediate to five years. Options granted under the Plans may have a term from one to ten years. For options outstanding at December 1, 2002, the range of exercise prices was $1.50 per share to $5.16 per share; the weighted average exercise price was $3.01 per share; and the weighted average remaining option term was approximately 8.2 years.
The 1996 Directors’ Share Option Plan (the “1996 Plan”) and the 2001 Directors’ Share Option Plan (the “2001 Plan”) provide for the non-discretionary grant of options to non-employee directors of the Company. The 1996 Plan terminated pursuant to its terms in 2001. However options granted under the 1996 Plan remain valid for the period of the respective option grants. The 2001 Plan, which became effective in May 2001, allows for the grant of additional options for a maximum of 120,000 shares. The 2001 Plan provides that the option price is the last closing sales price of the common stock on the date of grant. The 2001 Plan provides that each non-employee director, on the date such person becomes a non-employee director, will be granted options to purchase 5,000 shares of common stock. Provided that such person is still serving as a non-employee director, they will automatically be granted options to purchase 1,000 additional shares each year thereafter on the date of the Annual Shareholders’ Meeting and may, from time to time, be granted additional options on such terms and conditions as adopted by the Compensation Committee that administers the Plan. Options granted under the 2001 Plan have a term of ten years and vest immediately. For options outstanding under both plans at December 1, 2002, the range of exercise prices was $1.38 per share to $7.00 per share; the weighted average exercise price was $5.12 per share; and the weighted average remaining option term was approximately 4.9 years.
The following table summarizes the changes in the number of common shares under stock options granted pursuant to the preceding plans:
1996 and 2002 Management 1996 and 2001 Directors’
Equity Incentive Plan Share Option Plans
------------------------- -------------------------
Average Average
Shares Option Shares Option
Under Price Under Price
Option Per Share Option Per Share
--------- --------- -------- ---------
Outstanding at
December 1, 1999 414,034 $4.19 74,000 $5.35
Granted during 2000 22,705 $2.42 5,000 $2.25
------- ------
Outstanding at
November 30, 2000 436,739 $4.10 79,000 $5.51
Granted during 2001 430,000 $2.18 5,000 $2.17
Exercised during 2001 (8,471) $1.69 - -
Forfeited during 2001 (269,293) $5.70 (10,000) $6.63
-------- -------
Outstanding at
December 2, 2001 588,975 $2.30 74,000 $4.76
Granted during 2002 256,280 $4.63 5,000 $5.16
Exercised during 2002 (7,500) $3.03 (9,000) $2.15
Forfeited during 2002 (22,500) $3.03 - -
------- ------
Outstanding at
December 1, 2002 815,255 $3.01 70,000 $5.12
======= ======
Exercisable at:
November 30, 2000 180,306 $5.33 79,000 $5.51
======= ======
December 2, 2001 235,339 $2.41 74,000 $4.76
======= ======
December 1, 2002 428,215 $2.82 70,000 $5.12
======= =======
Available for grant at:
November 30, 2000 288,261 41,000
======= =======
December 2, 2001 127,554 115,000
======= =======
December 1, 2002 643,774 110,000
======= =======
The Financial Accounting Standard Board has issued Statement No. 123, “Accounting for Stock Based Compensation” (“SFAS No. 123”). The Statement established a fair value method of accounting for employee stock options and similar equity instruments such as warrants, and encourages all companies to adopt that method of accounting for all of their stock compensation plans. However, the statement allows companies to continue measuring compensation for such plans using accounting guidance in place prior to SFAS No. 123. Companies that elect to remain with the former method of accounting must make pro-forma disclosures of net earnings and earnings per share as if the fair value method provided for in SFAS No. 123 had been adopted.
F-22
The fair value of each grant is estimated on the date of grant using the Black-Scholes option - pricing model with the following weighted average assumptions for grants in 2002, 2001 and 2000: dividend yield of 0%; expected volatility of 42.50% in 2002, 40.22% in 2001, and 60.6% in 2000; risk-free interest rates ranging from 5.63 - 5.64% in 2002, 5.2% - 5.6% in 2001, and 6.6% - 6.8% in 2000; and expected life of ten years.
The Company has not adopted the optional fair value accounting provisions of SFAS No. 123. Accordingly, SFAS No. 123 has no impact on the Company’s financial position or results of operations, since all options have been granted to employees and directors.
The Company accounts for the stock option plan under APB Opinion No. 25, “Accounting for Stock Issued to Employees.” No compensation costs have been recognized. Had compensation cost for the plans been determined based on the fair value of the options at the grant dates consistent with the method of SFAS No. 123, the Company’s net earnings (loss) and net earnings (loss) per common share would have been as follows for the years ended December 1, 2002, December 2, 2001, and November 30, 2000:
2002 2001 2000
---- ---- ----
Net earnings (loss)
As reported $709,307 $531,582 $(1,352,762)
Pro forma $ (2,732) $(29,118) $(1,399,969)
Net earnings (loss) per share
As reported $ 0.13 $ 0.10 $ (0.25)
Pro forma $(0.00) $ (0.01) $ (0.26)
As of December 1, 2002, the Company has forward commitments and financing proposals totaling $8,400,000 to finance the land and building for seven additional restaurants. The commitments are for 10-year real estate mortgages (20-year amortization) at variable interest rates equal to 2.55% over the 30 day LIBOR, or fixed interest rates equal to 2.26% - 2.61% over the then current 10 year treasury rate.
The Company is a 19% owner of a real estate development that is the lessor of one of the Company’s restaurants opened in 2001. As a 19% owner, the Company has guaranteed 19% of the outstanding loan balance of approximately $2.8 million. This loan was used to finance the acquisition and development of this real estate.
As of December 1, 2002, the Company has capital expenditure commitments outstanding related to new restaurants totaling approximately $850,000.
The Company is involved in certain routine legal proceedings which are incidental to its business. All of these proceedings arose in the ordinary course of the Company’s business and, in the opinion of the Company, any potential liability of the Company with respect to these legal actions will not, in the aggregate, be material to the Company’s financial condition or operations. The Company maintains various types of insurance standard to the industry which would cover most actions brought against the Company.
Note Q - Quarterly Financial Data (Unaudited)
First Second Third Fourth
Year ended December 1, 2002 Quarter Quarter Quarter Quarter
- --------------------------- ----------- ----------- ----------- -----------
Food and beverage revenue $10,437,712 $11,694,052 $12,427,270 $11,393,956
Cost of food and beverages 2,750,091 2,972,859 3,147,528 2,824,912
Operating expenses 6,084,465 6,570,615 6,995,203 6,698,359
Net earnings (loss) (137,939) 251,340 442,897 153,009
Basic earnings (loss)
per common share (0.03) 0.05 0.08 0.03
Diluted earnings (loss)
per common share (0.03) 0.04 0.08 0.03
First Second Third Fourth
Year ended December 2, 2001 Quarter Quarter Quarter Quarter
- --------------------------- ----------- ----------- ----------- -----------
Food and beverage revenue $ 8,206,244 $ 9,401,172 $10,325,627 $10,423,317
Cost of food and beverages 2,236,923 2,630,087 2,877,423 2,890,255
Operating expenses 4,945,054 5,306,401 5,791,278 5,955,614
Net earnings (loss) (405,125) 506,393 396,146 34,168
Basic and diluted earnings
(loss) per common share (0.08) 0.09 0.07 0.01