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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.    20549

FORM 10-Q

(Mark One)

or

Commission File Number: 001-12319

MERITAGE HOSPITALITY GROUP INC.
(Exact Name of Registrant as Specified in Its Charter)

(616) 776-2600
(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X]                     No [  ]

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

As of June 28, 2005 there were 5,511,235 outstanding Common Shares, $.01 par value.

SAFE HARBOR STATEMENT

        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. Forward-looking statements may be identified by words such as “estimates,” “anticipates,” “projects,” “plans,” “expects,” “believes,” “should,” and similar expressions, and by the context in which they are used. Such statements are based only upon current expectations of the Company. Any forward-looking statement speaks only as of the date made. 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. 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, business strategies and action which Meritage intends to pursue to achieve its 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 the forward-looking statements. These include, without limitation: competition; changes in the national or local economy; changes in consumer tastes and eating habits; concerns about the nutritional quality of our restaurant menu items; concerns about consumption of beef or other menu items due to diseases including E. coli, hepatitis, and mad cow; promotions and price discounting by competitors; severe weather; changes in travel patterns; road construction; demographic trends; the cost of food, labor and energy; the availability and cost of suitable restaurant sites; delays in scheduled restaurant openings; the ability to finance expansion; interest rates; insurance costs; the availability of adequate managers and hourly-paid employees; directives issued by the franchisor regarding operations and menu pricing; the general reputation of Meritage’s and its franchisors’ restaurants; legal claims; and the recurring need for renovation and capital improvements. In addition, Meritage’s expansion into the casual dining restaurant segment as a franchisee of O’Charley’s subjects Meritage to additional risks including, without limitation, unanticipated expenses or difficulties in securing market acceptance of the O’Charley’s restaurant brand, the ability of our management and infrastructure to successfully implement the O’Charley’s development plan in Michigan, and our limited experience in the casual dining segment. Also, Meritage is subject to extensive government regulations relating to, among other things, zoning, public health, sanitation, alcoholic beverage control, environment, food preparation, minimum and overtime wages and tips, employment of minors, citizenship requirements, working conditions, and the operation of its restaurants. Because Meritage’s operations are concentrated in certain areas of Michigan, a marked decline in Michigan’s economy, or in the local economies where our restaurants are located, could adversely affect our operations.

PART I
FINANCIAL INFORMATION

Item 1.    Financial Statements.

        The following unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not contain all the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting solely of normal recurring adjustments) considered necessary for a fair presentation of the financial position, results of operations, stockholders’ equity and cash flows of Meritage have been included. For further information, please refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended November 28, 2004. The results of operations for the three and six month periods ended May 29, 2005 are not necessarily indicative of the results to be expected for the full year.

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Meritage Hospitality Group Inc. and Subsidiaries
Consolidated Balance Sheets
May 29, 2005 and November 28, 2004

ASSETS

See notes to unaudited financial statements.

3

Meritage Hospitality Group Inc. and Subsidiaries
Consolidated Balance Sheets — continued
May 29, 2005 and November 28, 2004

LIABILITIES AND STOCKHOLDERS’ EQUITY

See notes to unaudited financial statements.

4

Meritage Hospitality Group Inc. and Subsidiaries
Consolidated Statements of Operations
For the Six Months Ended May 29, 2005 and May 30, 2004
(Unaudited)

See notes to unaudited financial statements.

5

Meritage Hospitality Group Inc. and Subsidiaries
Consolidated Statements of Operations
For the Three Months Ended May 29, 2005 and May 30, 2004
(Unaudited)

See notes to unaudited financial statements.

6

Meritage Hospitality Group Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
For the Year Ended November 28, 2004 and the
Six months Ended May 29, 2005 (Unaudited)

See notes to unaudited financial statements.

7

Meritage Hospitality Group Inc. and Subsidiaries
Consolidated Statements of Cash Flows
For the Six Months Ended May 29, 2005 and May 30, 2004
(Unaudited)

8

Meritage Hospitality Group Inc. and Subsidiaries
Consolidated Statements of Cash Flows (Continued)
For the Six Months Ended May 29, 2005 and May 30, 2004
(Unaudited)

See notes to unaudited financial statements.

9

Meritage Hospitality Group Inc. and Subsidiaries
Notes to Unaudited Financial Statements
For the Six Months Ended May 29, 2005 and May 30, 2004

Note A — Earnings (Loss) Per Share

Basic earnings per share is computed by dividing earnings on common shares by the weighted average number of common shares outstanding during each period. Diluted earnings per share reflect per share amounts that would have resulted if dilutive potential common stock had been converted to common stock. For the three and six months ended May 29, 2005 and May 30, 2004, convertible preferred stock and exercisable stock options were not included in the computation of diluted earnings per share because the effect of converting preferred stock and exercising stock options would be antidilutive due to the net loss on common shares reported.

Note B – Stock Based Compensation

In December 2004, the FASB issued a revision of SFAS No. 123, Share Based Payment, (SFAS 123(R)), which supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. This statement focuses primarily on transactions in which an entity obtains employee services in exchange for share based payments. Under SFAS 123(R), an entity generally is required to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award, with such cost recognized over the applicable vesting period. In addition, SFAS 123(R) requires an entity to provide certain disclosures in order to assist in understanding the nature of share-based payment transactions and the effects of those transactions on the financial statements. The provisions of SFAS 123(R) are required to be applied as of the beginning of the first annual reporting period that begins after June 15, 2005. Accordingly, the Company is required to adopt the provisions of SFAS 123(R) at the beginning of fiscal 2006. The Company is evaluating the impact that the implementation guidance and revisions included in SFAS 123(R) will have on its consolidated statements.

The Company currently accounts for its stock based employee compensation plan under APB Opinion No. 25, Accounting for Stock issued to Employees. Under this method, which is acceptable through fiscal 2005, 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 loss and net loss per common share for the three and six months ended May 29, 2005 and May 30, 2004, would have been as follows:

Stock based employee compensation expense determined under the fair value based method in accordance with SFAS No. 123, has not been presented net of tax. To do so would create a deferred tax asset which would require an offsetting valuation allowance.

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Meritage Hospitality Group Inc. and Subsidiaries
Consolidated Statements of Cash Flows
For the Six Months Ended May 29, 2005 and May 30, 2004

Note C – Lease Commitments

The Company leases land and buildings used in operations under operating agreements, with remaining lease terms (including renewal options) ranging from three to thirty-nine years. The Company has certain leases that contain rent escalators. For these leases, rent expense is recognized in accordance with FASB Technical Bulletin 85-3 (Accounting for Operating Leases with Scheduled Rent Increases) using the straight line method over the term of the leases. Leasehold improvements are amortized over the shorter of their useful lives or the terms of the various leases. The Company includes renewal options in determining straight line rent and depreciation of leasehold improvements only when an economic compulsion to renew exists, such as when the Company owns a building subject to a ground lease.

In the first six months of 2005, the Company completed eight sale leaseback transactions involving Wendy’s restaurants. The Company collected $13,713,000 in proceeds from the transactions and used $8,315,000 of the proceeds to retire long-term obligations. The transactions resulted in deferred gains of $5,545,000 which will be recognized as a reduction in rent expense over the lease terms. Deferred gains of $78,000 and $133,000 were recognized as a reduction in rent expense in the three and six months ended May 29, 2005.

In February 2005, the SEC Office of the Chief Accountant issued a letter to clarify the staff’s interpretation regarding the accounting for operating leases under generally accepted accounting principles. Issues covered in this clarification include the amortization of leasehold improvements, rent holidays, and landlord/tenant incentives. The SEC staff believes that its positions are based upon existing accounting literature, and as such, any registrants who determine their accounting for leases in prior periods to be in error should issue a restatement of results from the correction of any such errors, if deemed significant. The Company has reevaluated its accounting for leases and determined that the impact of this clarification on its financial statements did not have a material impact on the Company’s financial statements in the current quarter or prior periods. Refer to Note G – Lease Commitments, provided in the Company’s 10-K report for the year ended November 28, 2004, for further information regarding the Company’s leases.

Note D – Guarantees, Commitments and Contingencies

In July 2004, the Company made a payment of $272,035, including interest and penalties, to the Michigan Department of Treasury (“Treasury”) related to a tax claim for years 1997 through 2001. After making this payment, the Company filed a claim against Treasury to recover the entire amount of the payment. The Company’s position is that the tax payment, which is related to fees that were paid to its franchisor, Wendy’s International, should be refunded because the fees at issue were incorrectly characterized as a “royalty” by Treasury, and therefore no tax is due from the Company related to these fees. The lawsuit is currently pending.

As of May 29, 2005, the Company has forward financing commitments totaling approximately $7,659,000 that it may, but is not required to, utilize to finance the land and building for future restaurants. The commitments are for real estate mortgages at interest rates defined in the loan commitments. The loan commitments allow the Company to select either a fixed or a variable interest rate. The commitments do not contractually obligate the Company to borrow on any of the commitments as such loans are made on a restaurant-by-restaurant basis.

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Meritage Hospitality Group Inc. and Subsidiaries
Notes to Unaudited Financial Statements
For the Six Months Ended May 29, 2005 and May 30, 2004

Note D – Guarantees, Commitments and Contingencies (continued)

The Company is party to several agreements executed in the ordinary course of business that provide for indemnification of third parties under specified circumstances. Generally, these agreements obligate the Company to indemnify the third parties only if certain events occur or claims are made, as these contingent events or claims are defined in each of these agreements. The Company is not currently aware of circumstances that would require it to perform its indemnification obligations under any of these agreements and, therefore, has not recorded a liability.

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 consolidated financial statements. The Company maintains various types of insurance standard to the industry which would cover most actions brought against the Company.

As of May 29, 2005, the Company had outstanding capital expenditure commitments related to new restaurant construction totaling approximately $267,000 which will be paid in the ordinary course of business.

12

Meritage Hospitality Group Inc. and Subsidiaries
Notes to Unaudited Financial Statements
For the Six Months Ended May 29, 2005 and May 30, 2004

Note E – Segment Reporting

The Company operates exclusively in the food service industry and has determined that its reportable segments are those based on the Company’s methods of internal reporting and management structure. The Company currently operates 48 Wendy’s restaurants in Western and Southern Michigan in the quick-service restaurant industry. The operation of the Wendy’s restaurants comprises the Company’s Wendy’s of Michigan Business Segment. The Company also operates three O’Charley’s restaurants and will be developing additional O’Charley’s restaurants throughout the state of Michigan. The operation of the O’Charley’s restaurants comprises the Company’s O’Charley’s of Michigan Business Segment. There were no material amounts of revenues or transfers among reportable segments. The following table presents information on reportable segments for the three and six months ended May 29, 2005 and May 30, 2004 (in thousands):

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Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations.

Overview

        Through its operation of 48 Wendy’s restaurants in Western and Southern Michigan, Meritage is the nation’s only publicly traded Wendy’s franchisee. These restaurants operate in the intensely competitive quick-service restaurant industry, and are located in close proximity to their principal quick-service restaurant competitors (e.g. McDonald’s, Burger King and Taco Bell) which 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. Wendy’s competes by offering a diverse menu, quality food prepared to order, pleasant and speedy service, and a pleasant atmosphere in its restaurants. It also competes by offering unique qualities such as the use of fresh ground beef.

        New Wendy’s store growth has slowed in the past two years as Meritage has essentially completed the development of Wendy’s restaurants in the West Michigan market. Also significant is the fact that Meritage completed ten sale and leaseback transactions from November 2004 through May 2005 involving some of its Wendy’s restaurants. The Company is using the proceeds to pay down long-term debt, increase cash on hand and help fund its new restaurant development efforts. The Company may enter into additional sale and leaseback transactions during the remainder of fiscal 2005.

        The Company is also the nation’s first and only publicly traded O’Charley’s franchisee, holding the exclusive right to develop O’Charley’s restaurants in Michigan. In August 2004, the Company opened its first O’Charley’s restaurant in Grand Rapids. The second O’Charley’s restaurant was opened in February 2005 and a third opened in May 2005, both in the metropolitan Detroit area. Two additional restaurants are planned in fiscal 2005 including one presently under construction which is expected to open in August 2005. O’Charley’s Inc. is the operator and franchisor of the O’Charley’s casual service restaurant system that operates more than 220 restaurants in 16 states in the Southeast and Midwest. O’Charley’s is best known for the freshness and homemade quality of its food, featuring specialty items such as hand-cut and aged steaks, freshly baked yeast rolls and fresh cut salads with special recipe salad dressings.  Meritage’s development agreement calls for the development of a minimum of 15 O’Charley’s restaurants by July of 2010. A successful rollout of the O’Charley’s concept in Michigan could provide a significant increase in the Company’s future earnings and cash flow.

Results of Operations

Wendy’s of Michigan Business Segment

        At May 29, 2005, the Company operated 48 Wendy’s restaurants in the quick-service restaurant industry that constitutes Meritage’s Wendy’s of Michigan Business Segment. For comparative purposes, corporate level general and administrative expenses have been included in the discussion of the Wendy’s of Michigan Business Segment.

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Wendy's of Michigan Business Segment (continued)

Results of operations for the three and six months ended May 29, 2005 and May 30, 2004 are summarized in the following table:

Revenue

        Food and beverage revenue declined 6.5% and 3.1% for the three and six months of fiscal 2005 compared to the same periods last year. The decreases were the result of lower same store sales during the periods. Additionally, sales from two new stores not in operation a year ago ($554,000 and $1,061,000 for the respective periods) were partially offset by a sales loss of $253,000 and $543,000 for the three and six months ended May 29, 2005, respectively, due to the permanent closing of two stores in fiscal 2004. Average customer traffic declined 8.7% and 5.1% for the three and six months ended May 29, 2005. Average customer ticket was flat for the three and six months ended May 29, 2005, compared to the same periods a year ago. Average food and beverage revenue for stores in full operation during the first two quarters of 2005 and 2004 (“same store sales”) is set forth in the following table:

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        The decrease in same store sales was attributable to (i) strong comparable sales in the first two quarters of 2004 when same store sales increased 10.9% and 11.2% respectively over the first two quarters of 2003, (ii) the allegation that a finger was found in a chili purchased at a California Wendy’s store (later proved to be false), (iii) increased competition, (iv) a slow economic recovery in West Michigan (unemployment remains among the highest in the nation), (v) the effects of historically high gasoline prices on customers, and (vi) lower than expected sales of nationally advertised menu items. In an effort to improve customer traffic and sales, Wendy’s International introduced a new Strategic Plan in May 2005 consisting of, among other things, “Value Choices Menu” enhancements and a new advertising campaign entitled “Do What Tastes Right.” Management cautions that the negative sales trend could continue into the third quarter as it remains difficult to accurately forecast how competitor discounting, menu price adjustments, consumer spending trends, the economic climate in West Michigan and the other factors noted above will affect the Company’s future revenue.

Cost of Food and Beverages

        Cost of food and beverages, compared to the same periods last year, increased 1.8% in the second quarter of 2005, and 3.3% for the six month period ended May 29, 2005. These increases were primarily due to continued increases in beef costs which were approximately 14% and 8% higher for the three and six months ended May 29, 2005, respectively, compared to the same periods of 2004 (beef purchases represented approximately 23% and 24% of all food purchases during these respective periods). The increases were partially offset by an increase in the rebate earned from beverage suppliers. Where it maintains control, the Company has been successful in controlling food costs. However, Meritage has little control over certain areas of its food costs as many products are purchased under contracts negotiated by Wendy’s International. In May 2005, Wendy’s International changed the “Super Value Menu” to the “Value Choices Menu,” adjusted suggested menu pricing, and added new menu items; all of which are intended to mitigate the increases in food and beverage costs as a percentage of sales going forward.

Operating Expenses

        Operating expenses for the second quarter of 2005 increased 4.3% as a percentage of revenue over the second quarter of 2004. For the six months ended May 29, 2005, as a percentage of revenue, operating expenses were 3.7% higher than the same period last year. The following table presents the expense categories that comprise operating expenses:

        The increase in labor and related expenses as a percentage of revenue for the three and six months ended May 29, 2005 was primarily the result of increased hourly and management labor costs coupled with increased health care costs. Store management labor increased 0.9% and 0.6%, respectively, as modest increases in actual wages paid were magnified by the decline in sales. Store management labor is predominately a fixed cost. Hourly wages increased 0.7% and 0.6%, respectively, as certain of our restaurants were at minimum staffing levels and were unable to further reduce labor as sales declined. In May 2005, the Company restructured Wendy’s management to reduce expenses while still maintaining high quality store level execution.

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        As a percentage of revenue, the 2.7 and 2.3 percentage point increase in occupancy expenses for the three and six months ended May 29, 2005 was primarily due to increases in rent expense of 2.0% and 1.8%, respectively. This increase reflects the impact of the sale and leaseback of ten Wendy’s restaurants between November 2004 and May 2005. See the related discussion regarding decreases in depreciation expense and interest expense below (i.e., depreciation and interest expense are replaced by rent expense). The remainder of the increase as a percentage of revenue is attributable to the decline in same store sales as occupancy costs are largely fixed.

        The increase in other operating expenses as a percentage of revenue was primarily due to an increase in credit card fees as a greater percentage of sales were paid for via credit cards.

General and Administrative

        Restaurant level general and administrative expenses declined $47,000 and $44,000, respectively, for the three and six months ended May 29, 2005, as a result of reduced restaurant site development expenses and employee bonuses. Corporate level general and administrative expenses in the three and six months ended May 29, 2005 were $86,000 and $94,000 higher than the comparable periods of 2004. Increases were caused by (i) the addition of a Chief Financial Officer position in April 2005, (ii) contracted accounting services that did not exist in the comparable period of 2004, and (iii) increased accounting, auditing and legal fees. The significant increase in single business tax expense for the six months ended May 29, 2005 was attributable to the tax on the gain of approximately $5.8 million associated with the sale and leaseback transactions. These transactions also resulted in an investment tax credit recapture. Under generally accepted accounting principles, these gains from sale leaseback transactions are deferred and recognized as a reduction in rent expense over the terms of the leases.

Depreciation and Amortization

        Depreciation and amortization expense decreased by $93,000 and $171,000, respectively, for the three and six months ended May 29, 2005 as compared to 2004. The decrease was primarily due to (i) a decrease associated with the ten restaurants sold and leased back between November 2004 and May 2005 (depreciation replaced by rent), (ii) equipment acquired in the original purchase of 25 restaurants in 1998 that became fully depreciated in February 2005, and (iii) higher than normal depreciation in the first quarter of 2004 due to accelerated depreciation from two restaurants that were closed (one restaurant’s lease was not renewed and the other restaurant was demolished and rebuilt during the first quarter of 2004).

Interest Expense

        Interest expense for the three and six month periods ended May 29, 2005 decreased by $112,000 and $168,000, respectively, compared to the same periods in 2004. Interest expense related to the ten restaurants that were sold and leased back decreased $172,000 and $298,000 for the three and six month periods. This decrease was partially offset by additional interest expense related to borrowings associated with new restaurant development, and the conversion of certain variable interest rate loans to fixed rate loans in fiscal 2004 in anticipation of rising interest rates.

Debt Extinguishment Charges

        For the three and six months ended May 29, 2005, the Company retired $2,019,000 and $7,876,000, respectively, of long-term indebtedness in connection with the sale and leaseback of eight Wendy’s restaurant sites. The Company incurred $89,000 and $508,000, respectively, in the three and six months ended May 29, 2005 for prepayment penalties and the related write-off of the remaining unamortized financing costs associated with these loan payoffs.

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Gain on Sale of Non-Operating Property

        There were no sales of non-operating property in the first six months of 2005, compared to the same period of 2004 when the company realized a gain of $137,000 from the sale of an investment in non-operating property.

O’Charley’s of Michigan Business Segment

        At May 29, 2005, the Company operated three O’Charley’s restaurants in the casual dining restaurant industry that constitutes Meritage’s O’Charley’s of Michigan Business Segment. The first restaurant opened in August 2004, and as such, the Company had no operations in the first six months of 2004. Pursuant to a development agreement with its franchisor, O’Charley’s, Inc., Meritage is required to develop a minimum of 15 O’Charley’s restaurants in the State of Michigan over seven years. Results of operations for the three and six months ended May 29, 2005 are summarized below:

        O’Charley’s had no restaurants in operation during the three and six months ended May 30, 2004, but did incur $104,000 and $159,000 respectively in pre-opening costs during those periods.

        Results of operations for the three and six months ended May 29, 2005 reflect the immaturity of this business segment as it takes six months or more for each restaurant to reach initial maturity. Pre-opening costs include, but are not limited to (i) travel, meals and lodging, and payroll and related costs incurred in connection with the training of the management teams, (ii) travel-related costs of the O’Charley’s, Inc. new store training team, (iii) recruiting costs, and (iv) the cost of food giveaways during the periods prior to opening. New store pre-opening costs are estimated at approximately $200,000 per restaurant. The Company plans to open a total of four restaurants in fiscal 2005 (two are already in operation). Because of the pre-opening costs and operational inefficiencies that are normal in the initial months of a new store’s operation, a significant net loss before income taxes is expected from the O’Charley’s business segment in fiscal 2005. The Company is also operating with relatively high general and administrative expenses incurred to provide support for the growth planned in the O’Charley’s segment over the next several years.

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Consolidated Operations

Income Taxes

        The losses before income taxes of $928,000 and $2,732,000 for the three and six months ended May 29, 2005 resulted in cumulative losses in recent years. In accordance with SFAS No. 109, Accounting for Income Taxes, management assessed the realizability of its deferred tax assets and increased the Company’s valuation allowance for deferred income tax assets by $320,000 and $1,065,000, and was therefore unable to benefit from the losses incurred for the three and six months respectively. The increase in net deferred tax assets was primarily due to the gains on the sale and leaseback transactions completed during the first six months of 2005 which are deferred for financial reporting purposes but recognized for income taxes purposes. The Company recognized an income tax expense of $81,000 in the three months ended May 29, 2005, primarily related to AMT payments.

Liquidity and Capital Resources

Cash Flows

        Cash and cash equivalents (“cash”) increased $606,000, to $4,084,000 as of May 29, 2005, as set forth below:

        Net cash used in operating activities increased $2,956,000 from last year due primarily to a decrease in net earnings of $2,408,000 coupled with a $682,000 increase in the net change in current assets and liabilities. Total current liabilities declined $705,000 from November 28, 2004, due primarily to the timing of O’Charley’s restaurant construction and the repayment of $263,000 under the Company’s line of credit.

        Net cash used in investing activities increased $2,313,000 as a $150,000 decrease in payments for franchise agreements was more than offset by a $2,194,000 increase in purchases of property plant and equipment, a $190,000 reduction in proceeds from sale of non-operating property, and a $94,000 increase in the net change in deposits and other assets. During the second quarter, the Company purchased the land and building of a Wendy’s store which had been leased for $1,331,000.

        Net cash provided by financing activities increased $2,405,000. This increase was due to (i) $13,713,000 of proceeds from sale and leaseback transactions, (ii) an increase of $703,000 in proceeds from long-term obligations, and (iii) a reduction of $2,419,000 in purchases of common stock. This increase was largely offset by (i) an increase of $7,186,000 in principal payments on the line of credit, long-term obligations (primarily due to mortgages retired in connection with sale and leaseback transactions), and payments on capital leases, (ii) a reduction of $6,815,000 in the net proceeds from the issuance of common stock, preferred stock and warrants which primarily relates to the private equity offering in the first quarter of fiscal 2004, and (iii) an increase in dividends paid (both common and preferred) of $469,000 including a special dividend on common shares of $262,000 in January 2005.

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Financial Condition

        With only three O’Charley’s restaurants in operation, the Company’s operations are primarily in the quick-service restaurant industry. Due to the nature of the business and industry, the Company does not have significant trade receivables. Inventories are not significant due to the perishable nature of its products (primarily food items). As such, the Company’s working capital is typically negative. The current portion of long-term debt is a significant component of current liabilities.

        As of May 29, 2005, current liabilities exceeded current assets by $208,000 compared to November 28, 2004, when current liabilities exceeded current assets by $1,631,000. At these dates, the ratios of current assets to current liabilities were 0.97:1 and 0.77:1, respectively. The primary reason for the increases in cash and working capital was the net cash proceeds from the ten sale and leaseback transactions involving certain of our Wendy’s restaurants. Eight of these transactions were completed in the first six months of 2005. The cash flows discussion provides details of the increase in cash and the most significant reasons for the increase in working capital.

        In fiscal 2004, cash generated from the Company’s Wendy’s operations was sufficient to meet obligations resulting from its Wendy’s operations and corporate level overhead including debt service and capital improvements. Based on our expected results in fiscal 2005, cash generated from our Wendy’s operations, combined with cash on hand at May 29, 2005, will be sufficient to meet obligations resulting from the Company’s Wendy’s operations and corporate level overhead including debt service and capital improvements. The Company recently completed a major store remodeling program such that all but one of the Company’s Wendy’s restaurants are no more than six years old or recently remodeled. As a result, capital expenditures for existing restaurants in fiscal 2005 are expected to be less than in recent fiscal years. Wendy’s fiscal 2005 operating cash flow will be negatively impacted by the sale and leaseback transactions because the rent expense under the new leases will exceed the debt service on the mortgages that were paid off. Furthermore, operating results for the first two quarters of 2005 are below results from the first two quarters of last year. It appears this trend will continue into the third quarter of 2005.

        The eight sale and leaseback transactions completed in the first two quarters of 2005 resulted in proceeds of approximately $13,713,000 which, after the retirement of the related mortgage debt and the associated prepayment penalties, netted Meritage approximately $5,395,000 in cash. These sale and leaseback transactions, combined with the sale and leaseback transactions in fiscal 2004, resulted in deferred gains of approximately $7,119,000 which are being amortized over the twenty year lease terms and accounted for as a reduction in rent expense on a straight line basis. The transactions completed in the first two quarters reduced our long-term obligations by $8,315,000 through the retirement of mortgage debt, and increased our total operating lease obligations by $21,527,000 (over the 20-year lease terms) of which $1,011,000 will be due within the next year. The Company has a tax net operating loss carryforward of approximately $3,210,000 at November 28, 2004 which will be used to offset a portion of the taxable gains resulting from these sales. The Company may enter into additional sale and leaseback transactions containing similar terms which, in the aggregate, could result in additional net proceeds of approximately $9,600,000. The Company anticipates that it would use approximately 60% of the pre-tax proceeds to pay off long-term debt, with remaining after tax net proceeds used for general corporate purposes including new restaurant development.

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        Subsequent to the end of the second quarter, the Company sold the land and building of a former restaurant site netting approximately $395,000 in proceeds. The Company also purchased non-operating surplus property for $300,000 which it is currently marketing. Management believes this property has a fair value greater than $300,000 and will be sold at a profit in the future.

        In January 2005, the Company paid a $0.05 per share special cash dividend to its common shareholders which totaled $262,000. The special dividend was paid from proceeds from the sale of non-operating surplus property in fiscal 2004.

        The Company has slowed its Wendy’s new store development in recent years as Meritage has essentially completed the development of Wendy’s restaurants in the West Michigan market. The Company opened three new restaurants in fiscal 2003, one new restaurant in fiscal 2004, and one new restaurant in the first quarter of fiscal 2005. It has no current plans to open additional Wendy’s restaurants in fiscal 2005. Meritage now operates 48 Wendy’s restaurants and any additional Wendy’s restaurants will depend primarily on the adequacy of new store sites. A new Wendy’s restaurant requires an investment in real estate and equipment. Investments average approximately $1.25 to $1.5 million per restaurant, of which Meritage typically invests $250,000 to $300,000 of equity with the remaining investment funded through long-term financing. Financing for future Wendy’s restaurants will be obtained on a restaurant-by-restaurant basis.

        Meritage’s loans and franchise agreements relating to its Wendy’s operations contain covenants requiring the maintenance of certain financial ratios including:

At May 29, 2005, Meritage was in compliance with these covenants.

        Meritage has three O’Charley’s restaurants in operation. Under its development agreement with O’Charley’s, Inc. Meritage is required to open a minimum of twelve additional restaurants by July 2010, one in 2005, two each in 2006 and 2007, three each in 2008 and 2009, and one in 2010. New O’Charley’s restaurants owned by Meritage require an investment in real estate and equipment. We estimate that the total cost to open all 15 O’Charley’s restaurants required under the development agreement will be approximately $39 to $50 million, or approximately $2.6 to $3.3 million per restaurant, with land and site development being the significant variables.

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        In the first six months of 2005, the Company borrowed $1,040,000 from Independent Bank, for the restaurant opened in August 2004 which is subject to a ground lease, and $1,441,000 for construction financing for an owned restaurant opened in May 2005. The Company can draw up to $559,000 of additional funds on this restaurant. These loans are variable rate loans with interest equal to the prime rate, have a 10-year term and 20-year amortization, and require monthly payments of principal and interest.

        The Company holds a $2,100,000 financing commitment from GE Capital to provide financing associated with the development of one O’Charley’s restaurant. The commitment requires a minimum 20% equity investment by Meritage of the total project costs. The Company can choose between fixed interest rates (3.11% plus the 10-year swap rate) or floating interest rates (3.05% over the 30-day LIBOR with an option to convert to a fixed rate during the first two years). The Company also holds a financing commitment from Irwin Financial Capital Corporation to loan up to $5,000,000 to construct and equip up to two O’Charley’s restaurants. This commitment requires a minimum 15% equity investment by Meritage of appraised premises value. The Company can choose between various fixed or variable interest rate options, terms, and amortization schedules that are similar to the Company’s other financing arrangements. The Company believes that financing available under these commitments will be sufficient for the Company’s O’Charley’s development in fiscal 2005 and into fiscal 2006.

        These commitments for O’Charley’s development do not contractually obligate the Company to borrow any or all of the loan commitment amounts as such loans are made on a restaurant-by-restaurant basis. In addition to owning restaurants subject to mortgages, the Company will occasionally lease the land and building of new O’Charley’s restaurants it develops.

        Meritage’s loans and franchise agreements relating to its O’Charley’s operations contain covenants requiring the maintenance of certain financial ratios (computed on a consolidated O’Charley’s/Wendy’s of Michigan operation level) including:

At May 29, 2005, Meritage was in compliance with these covenants.

        The Company maintains a $2.6 million credit facility with Standard Federal Bank consisting of (i) a $600,000 line of credit secured by inventory and equipment of seven leased Wendy’s restaurants, and certain other receivables (currently maturing on April 30, 2006), and (ii) a $2,000,000 revolving line of credit secured by real estate purchased with this facility (currently maturing on April 30, 2007). The facility requires monthly payments of interest only at Standard Federal’s prime rate plus 0.25%. As of May 29, 2005, there was no outstanding balance on this credit facility.

        In the first quarter of 2004, the Company completed a private equity offering which resulted in an increase in stockholders’ equity of approximately $4,750,000. The Company used offering proceeds to fund a portion of the construction and equipment for its first O’Charley’s restaurant which opened in August 2004, along with the related start-up and pre-opening costs associated with the O’Charley’s rollout in 2004. In addition, because the O’Charley’s business segment is not currently generating positive cash flow, offering proceeds were used for the $100,000 quarterly dividend payments on the Company’s Series B Convertible Preferred Stock, made in fiscal 2004 and 2005. The Company expects to use additional offering proceeds or net proceeds from the sale and leaseback transactions discussed above to make the remaining dividend payments in fiscal 2005.

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        Proceeds from the private equity offering and from the sale and leaseback transactions previously described are being used to finance equity contributions for the current O’Charley’s restaurant development. The Company expects to have five O’Charley’s restaurants open by the end of fiscal 2005. Thereafter, cash generated from these restaurants is expected to cover a portion of the equity contributions for the development of future O’Charley’s restaurants (e.g., 20% of the total costs under the GE Capital commitment). In addition to owning, the Company will also lease some of its O’Charley’s restaurants. For leased sites, the Company plans to own its equipment, although equipment financing (lease or debt) would be available from various lenders.

        Meritage’s expansion into the casual dining restaurant segment as a franchisee of O’Charley’s Inc. subjects Meritage to various business and financial risks including, without limitation, unanticipated expenses or difficulties in securing market acceptance of the O’Charley’s restaurant brand (there currently is no national advertising program utilized in Michigan), the ability of our management and infrastructure to successfully implement the O’Charley’s development plan in Michigan, and our limited experience in the casual dining segment. Failure or delay in completing the 15-store restaurant development agreement could have an adverse affect on the Company’s financial condition.

        As discussed above, cash on hand from the private equity offering and the sale and leaseback transactions, combined with proceeds from the financing commitments, will be used to fund the development of the O’Charley’s business over the next twelve months. Because the Wendy’s new store growth and remodeling program is substantially complete, Meritage believes that it will be able to meet Wendy’s and corporate overhead current obligations over the next twelve months with cash on hand and cash generated from operations. In addition, Meritage could use other sources to meet its current obligations over the next twelve months including:

        There can be no assurances, however, that Meritage will be able to complete the above activities or that completion would yield the expected results.

Critical Accounting Policies

        The Company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires management 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 consolidated financial statements and footnotes included in Meritage’s Annual Report on Form 10-K for the fiscal year ended November 28, 2004. Certain of these accounting policies are subject to judgments and uncertainties which may 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. The Company evaluates its estimates on an on-going basis. In the event estimates or assumptions prove to be different from actual results, adjustments are made in subsequent periods to reflect more current information. Management believes that any subsequent revisions to estimates used would not have a material effect on the financial condition or results of operations of the Company.

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Item 3.    Quantitative and Qualitative Disclosures About Market Risk.

        Because all of Meritage’s operations are in the United States, currency exposure is eliminated. All of Meritage’s debt is in U.S. dollars and approximately 75% of its debt is at fixed interest rates which limits financial instrument risk. Some of the Company’s variable rate mortgage loans contain provisions that permit the Company to convert to a fixed interest rate at certain periods during the loan term. During fiscal 2004, four of these loans were converted to fixed rate loans. These provisions 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 International utilizes various purchasing and pricing techniques in an effort to minimize volatility. Most of the Company’s O’Charley’s food purchases are made through the commissary operated by O’Charley’s Inc. These purchases can also be affected by fluctuating commodity prices. Presently, these purchases are not significant compared to the Company’s total food purchases.

        Based on the discussions above, Meritage does not make use of financial instruments to hedge commodity prices. While fluctuating commodity prices such as the cost of beef may impact the Company’s cost of food, Meritage retains some ability to adjust its menu pricing to offset these increases. However, highly competitive market conditions have limited the Company’s ability to fully offset higher beef and commodity costs through menu price increases.

Item 4.    Controls and Procedures.

        As of May 29, 2005, an evaluation was completed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and President, Chief Financial Officer and Treasurer, and General Counsel, as to the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that evaluation, the Company’s management concluded that the Company’s disclosure controls and procedures were effective as of May 29, 2005. Other than as noted below, there have been no changes to the Company’s internal control over financial reporting identified in connection with the evaluation required by Regulation 13a-15(d) that occurred during the first two fiscal quarters that has materially affected, or is reasonably likely to materially affect, Meritage’s internal control over financial reporting.

        In connection with the audit of, and the issuance of an unqualified report on, the consolidated financial statements for the year ended November 28, 2004, the Company’s auditors, Ernst & Young LLP, identified certain deficiencies in the design and operation of internal controls related to accounting, analysis and documentation of income taxes, which collectively represented a material weakness in internal control over financial reporting. In response, the Company implemented the following procedures in fiscal 2005:

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PART II
OTHER INFORMATION

Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds.

         (c)   The following table summarizes Meritage’s purchases of its common shares, par value $0.01 per share, for the quarter ending May 29, 2005:

Issuer Purchases of Equity Securities

(1)     In August 1999, the Board of Directors authorized the Company to repurchase from time to time, subject to capital availability, up to 200,000 shares of Meritage’s common stock through open market transactions or otherwise. This program was announced in November 1999. In February 2002, the Board authorized the repurchase of up to an additional 200,000 common shares under this program. The additional authorization of share purchases was announced in February 2002. There is no expiration date relating to this program, but the Board is permitted to rescind the program at any time.

Item 4.    Submission of Matters to a Vote of Security Holders.

        The 2005 Annual Meeting of Shareholders was held at Meritage’s offices in Grand Rapids, Michigan, at 9:00 a.m. on Tuesday, May 17, 2005. The Company solicited proxies for the matters brought before the shareholders pursuant to a definitive proxy statement that was filed with the Securities and Exchange Commission on April 11, 2005. 4,527,995 common shares were present in person or by proxy at the meeting, representing 85.2% of the total shares outstanding.

        The shareholders elected the following six members to the Company’s Board of Directors to serve until the 2006 Annual Meeting: James P. Bishop (4,516,591 shares in favor; 11,404 withheld), Stephen L. Gulis, Jr. (4,389,629 shares in favor; 138,366 withheld), Joseph L. Maggini (4,516,591 shares in favor; 11,404 withheld), Brian N. McMahon (4,516,591 shares in favor; 11,404 withheld), Robert E. Schermer, Sr. (4,516,481 shares in favor; 11,514 withheld) and Robert E. Schermer, Jr. (4,516,591 shares in favor; 11,404 withheld). Each director received no less than 96.9% of the total shares voted.

        The shareholders also adopted an amendment to the 2002 Management Equity Incentive Plan to increase the number of shares under the plan by 250,000 (from 750,000 to 1,000,000). The following are the results of the shares that voted: In Favor: 2,879,376 (63.6%); Opposed: 270,910; Abstentions: 140,484; Broker Non-Votes: 1,237,225.

        The shareholders also ratified the appointment of Ernst & Young LLP as the Company’s independent auditors for the fiscal year ending November 27, 2005. The following are the results of the vote: In Favor: 4,506,766; Opposed: 2,201; Abstentions: 19,028.

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Item 5.    Other Information.

        On May 17, 2005, the Board of Directors appointed the following officers of Meritage: Robert E. Schermer, Jr. – Chief Executive Officer and President; James R. Saalfeld – Vice President, General Counsel, Chief Administrative Officer and Corporate Secretary; Robert H. Potts – Vice President of Real Estate; Gary A. Rose – Vice President, Chief Financial Officer and Treasurer; and Roger L. Zingle – Chief Operating Officer. The positions of Chief Administrative Officer and Chief Operating Officer were newly created officer positions. Robert E. Schermer, Sr. was reappointed Chairman of the Board of Directors. The Board also reestablished the Executive, Audit, Compensation and Nominating & Corporate Governance Committees as standing committees of the Board of Directors.

        The Company opened its third O’Charley’s restaurant during the second fiscal quarter. This new restaurant is located in Chesterfield, Michigan. With the opening of the Chesterfield O’Charley’s restaurant, Meritage has a total of 51 restaurants in operation.

Item 6.    Exhibits.

    (a)        Exhibit List.

Exhibits filed herewith.

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SIGNATURES

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

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EXHIBIT INDEX