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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 NOVEMBER 30, 1999
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
MERITAGE HOSPITALITY GROUP INC.
(Exact name of registrant as specified in its charter)
MICHIGAN 38-2730460
(State or other jurisdiction (I.R.S. Employer Identification Number)
of incorporation or organization)
40 PEARL STREET, N.W., SUITE 900
GRAND RAPIDS, MICHIGAN 49503
(Address of Principal Executive Offices) (Zip Code)
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
Common Shares, $0.01 par value American Stock Exchange
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. [ ]
As of January 31, 2000, there were 5,751,877 common shares of the Registrant
outstanding. The aggregate market value of the common shares held by
non-affiliates at that date was $7,746,687 based on the closing sales price on
the American Stock Exchange on that date.
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MERITAGE HOSPITALITY GROUP INC.
INDEX TO ANNUAL REPORT ON FORM 10-K
PART I PAGE
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Item 1 - Business 3
Item 2 - Properties 7
Item 3 - Legal Proceedings 8
Item 4 - Submission of Matters to Vote of Security-Holders 8
PART II
Item 5 - Market for Registrant's Common Equity and Related
Stockholder Matters 9
Item 6 - Selected Financial Data 10
Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Item 7A - Quantitative and Qualitative Disclosures About
Market Risk 24
Item 8 - Financial Statements and Supplementary Data 24
Item 9 - Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure 24
PART III
Item 10 - Directors and Executive Officers of the Registrant 25
Item 11 - Executive Compensation 27
Item 12 - Security Ownership of Certain Beneficial Owners
and Management 28
Item 13 - Certain Relationships and Related Transactions 28
PART IV
Item 14 - Exhibits, Financial Statement Schedules, and
Reports on Form 8-K 30
Certain statements contained in this report that are not historical
facts constitute forward-looking statements, within the meaning of the Private
Securities Litigation Reform Act of 1995, and are intended to be covered by the
safe harbors created by that Act. Reliance should not be placed on
forward-looking statements because they involve known and unknown risks,
uncertainties and other factors which may cause actual results, performance or
achievements to differ materially from those expressed or implied. Any
forward-looking statement speaks only as of the date made. The Company
undertakes no obligation to update any forward-looking statements to reflect
events or circumstances after the date on which they are made.
Statements concerning expected financial performance, on-going business
strategies and action which the Company 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. 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; severe weather;
changes in travel patterns; increases in food, labor and energy costs; the
availability and cost of suitable restaurant sites; the ability to finance
expansion; fluctuating interest rates; fluctuating insurance rates; the
availability of adequate employees; directives issued by the franchisor; the
general reputation of Wendy's restaurants; and the recurring need for renovation
and capital improvements. Also, the Company is subject to extensive government
regulations relating to, among other things, zoning, minimum wage, public health
certification, and the operation of its restaurants. Because the Company's
operations are concentrated in smaller urban areas of Michigan, a marked decline
in the Michigan economy could adversely affect its operations.
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PART I
ITEM 1. BUSINESS.
THE COMPANY
Meritage Hospitality Group Inc. is the nation's only publicly held
"Wendy's Old Fashioned Hamburgers" restaurant franchisee. The Company serves
more than six million customers annually through its operation of 29 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 "Wendy's" brand name. During the past year, Meritage has
opened four new Wendy's restaurants and has several additional Wendy's
restaurants currently under development. Its latest new store, which opened in
December 1999, was the first Wendy's restaurant completed pursuant to a
co-branding venture with Meijer, Inc., one of the nation's largest discount
retailers, whereby Meritage combines a full service Wendy's restaurant with a
Meijer convenience store and gas station facility.
The Company's primary growth strategy is to expand its Wendy's business
through the development of new restaurants within the Company's designated
market area, and through joint ventures and acquisitions inside and outside of
its designated market area. This plan includes developing and acquiring 20 to 30
additional Wendy's restaurants over the next five years, including up to ten new
restaurants constructed pursuant to the co-branding venture with Meijer.
Meritage was incorporated in 1986, and is currently engaged exclusively
in the quick-service restaurant business. The Company owns half of its
restaurant properties and leases the other half.
Meritage's principal executive office is located at 40 Pearl Street,
N.W., Suite 900, Grand Rapids, Michigan 49503. Its telephone number is (616)
776-2600 and its facsimile number is (616) 776-2776. The Company's 29 Wendy's
restaurants are owned or operated by Wendy's of Michigan, a Michigan limited
partnership that is owned by MHG Food Service Inc., a wholly-owned subsidiary of
Meritage. S & Q Management, LLC, a Michigan limited liability company owned by
Robert E. Schermer, Jr. and Ray E. Quada, is the sole general partner of Wendy's
of Michigan. 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, 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 comprises Meritage's
designated market area.
Menu
Each Wendy's restaurant offers a diverse menu containing a variety of
food items, featuring hamburgers, chicken sandwiches and pita 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, 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.
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Wendy's International maintains significant discretion over the menu items that
are offered in the Company's restaurants.
Restaurant Layout and Operations
The Company's restaurants typically range from 2,700 to 3,400 square
feet with a seating capacity 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 to drive-through customers accounted for
over half of the total restaurant sales in fiscal 1999.
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, 2.5% of
which is used to benefit all restaurants owned and franchised by Wendy's
International. The Wendy's National Advertising Program uses these moneys to
develop advertising and sales promotion materials and concepts to be implemented
nationally. The remainder of the fund 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
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 has not experienced any significant shortages of food,
equipment, fixtures or other products which 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.
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, and general operating procedures. The franchise agreements currently
in place expire in approximately 19 years. Subject to certain conditions, the
franchise agreements can be renewed for an additional 10 years.
The franchise agreements with Wendy's International provide, among
other things, that (i) a change in the operational control of Wendy's of
Michigan, (ii) the removal or resignation of S & Q
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Management as the sole general partner of Wendy's of Michigan, or (iii) the
removal or resignation of any guarantor of the Company's franchise agreements,
cannot occur without the prior consent of Wendy's International. In addition,
any proposed sale of the Wendy's business, interests or franchise rights is
subject to the consent of, and a 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
but such consent is not obtained, Meritage will not be able to proceed with its
plans which, in turn, could adversely effect 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 at fair market value.
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 royalty fees, Meritage is required to
pay Wendy's International a technical assistance fee upon the opening of a new
Wendy's restaurant. 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 the prohibition is waived by
Wendy's International in its sole and absolute discretion. 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.
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 1,200 people of which approximately 200
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. The Company believes that it fosters a
good working relationship with its employees.
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COMPETITION AND INDUSTRY CONDITIONS
The food service industry is one of the largest sectors of the nation's
economy, generating an estimated $320 billion of revenue in 1997, of which
one-third was attributable to the quick-service restaurant industry. The quick
service market experienced sales of an estimated $112 billion in 1998, with an
annual growth rate of approximately 5%. As a whole, the quick-service industry
has consistently grown for more than 20 years, and indications are that this
growth will continue. Historic changes in domestic lifestyles, favoring greater
convenience, has significantly impacted this trend. In addition, a burgeoning
household income, brought about by a strong national economy, has increased the
spending on food away from home. Because of these trends, competition in the
quick-service restaurant segment is, and can be expected to remain, intense.
Within the quick service market, the hamburger market segment contains
approximately half of the entire market (with the pizza, chicken, Mexican and
Asian market segments comprising the remainder). The segment is dominated by
McDonalds' (12,500 units), Burger King (8,000 units), Wendy's (5,000 units) and
Hardees (2,700 units), who collectively represent over 80% of the entire
segment.
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 and
new product development. These competitors have attempted to draw customer
traffic through a strategy of deeply discounting the price of their products.
However, neither Wendy's International nor the Company believe this is a
profitable long-term strategy. Both Wendy's International and the Company
believe that the competitive position of a Wendy's restaurant is enhanced by its
unique qualities such as the use of fresh ground beef, a diverse menu, food
prepared to order with a wide choice of condiments, promotional products and the
atmosphere and decor of its restaurants.
The following table compares the Company's average Wendy's restaurant
same store sales to the average sales of (i) the system-wide domestic Wendy's
restaurants (i.e. franchised and franchisor-owned), and (ii) the franchised
domestic Wendy's restaurants.
================ ======================== ========================= ==========================
FISCAL MERITAGE OPERATED SYSTEM-WIDE DOMESTIC FRANCHISED DOMESTIC
YEAR RESTAURANTS RESTAURANTS * RESTAURANTS *
---------------- ------------------------ ------------------------- --------------------------
1997 $1,063,000 $1,042,000 $1,017,000
---------------- ------------------------ ------------------------- --------------------------
1998 $1,080,000 $1,062,000 $1,031,000
---------------- ------------------------ ------------------------- --------------------------
1999 $1,134,000 $1,117,000 ** $1,080,000 **
================ ======================== ========================= ==========================
* Source: Wendy's International, Inc.
** Estimated figures
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 at Wendy's restaurants
currently operated by the Company. The Company's new developments would include
both freestanding and nontraditional (e.g. combination units being developed
under the joint venture with Meijer) Wendy's restaurants. Some new stores may
replace older and obsolete units that the Company has decided to close. Finally,
the Company will also explore other acquisitions or developments that would
complement its Wendy's business.
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The restaurant industry 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. During
fiscal 1999, food service revenue generated by quarter was as follows: first
quarter - 23%; second quarter - 25%; third quarter - 27%; and fourth quarter -
25%.
RISKS AND GOVERNMENTAL REGULATIONS
Meritage is subject to numerous risks 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; severe weather; changes in travel patterns;
increases in food, labor and energy costs; the availability and cost of suitable
restaurant sites; the ability to finance expansion; fluctuating interest rates;
fluctuating insurance rates; the availability of an adequate number of managers
and hourly-paid employees; directives issued by the franchisor, the general
reputation of Wendy's restaurants; and the recurring need for renovation and
capital improvements. Also, the Company is subject to extensive federal, state
and local government regulations relating to, among other things, zoning and the
operation of its restaurants. Congress increased the minimum wage to $5.15 per
hour in 1997. Further changes regarding minimum wage or other laws governing the
relationship with employees (e.g. overtime wage and health care coverage) 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 free-standing
restaurants are one-story brick buildings constructed on sites of approximately
40,000 square feet, with parking for approximately 50 vehicles. The restaurants,
which range from 2,700 to 3,400 square feet, 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 the Wendy's
restaurants being developed under the joint venture with Meijer are basically
the same except that the restaurant is connected to a 3,500 square foot
convenience store and gas station facility operated by Meijer.
Of the 29 Wendy's restaurants that the Company operates, it (i) owns
the land and buildings comprising 13 restaurants, (ii) leases the land and
buildings comprising 15 restaurants, and (iii) owns the building and leases the
land comprising one restaurant. The term of the leases (including options to
renew) range from 10 months to 30 years. The structures range from being brand
new to approximately 25 years old. The land and buildings owned by the Company
are subject to encumbrances described in "Financing and Encumbrances."
The Company leases approximately 4,600 square feet of office space
located at 40 Pearl Street, N.W., Suite 900, Grand Rapids, Michigan which serves
as the corporate headquarters and the registered office of the Company and its
subsidiaries. The Company also leases approximately 3,000 square feet of office
space located at 4613 West Main, Kalamazoo, Michigan 49006 as its operating
office.
The Company believes that its properties are adequately covered by
insurance.
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FINANCING AND ENCUMBRANCES
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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 of 13 Company-owned Wendy's
restaurants as well as the equipment and business value of certain of these
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 7.77% to 8.53%. The loan agreements contain financial covenants which
require the maintenance of certain coverage ratios. In addition to the coverage
ratio requirements, the loan covenants limit the amount of currently generated
operating cash flow that can be utilized to fund corporate level expenses.
In fiscal 1999, the Company also borrowed $1,261,000 from Fleet
Business Credit Corporation ("Fleet") to build and equip an additional Wendy's
restaurant. This long-term indebtedness is secured by the related real estate
and equipment. The Fleet loans require monthly payments of $11,932, and carry
fixed interest rates of 8.32% for a seven year equipment loan, and 8.7% on a
15-year real estate mortgage.
The Company presently holds a $3,750,000 forward commitment from Fleet
to provide additional financing for the construction and equipment associated
with the development of three new Wendy's restaurants, which the Company plans
to open in fiscal 2000. This indebtedness would be secured by the real estate
and equipment of the new restaurants. The fixed interest rate would be 220
points over similar term treasury rates for seven year equipment loans and real
estate mortgages with 15-year terms and 20-year amortizations. The Company is
under no obligation to utilize this commitment.
ITEM 3. LEGAL PROCEEDINGS.
The Company is involved in routine legal proceedings which are
incidental to its business. Except as described 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 which cover most legal proceedings brought against the
Company.
On January 31, 2000, the Company was served with a complaint from the
owners of six condominium units at the former Grand Harbor Yacht Club (T.E.
Beckering Enterprises et al. v. GHYC Inc. et al., Ottawa County (Michigan)
Circuit Court). The complaint seeks injunctive relief and unspecified monetary
damages associated with the sale of six condominium units in 1997 and 1998. All
assets of the former Grand Harbor Yacht Club, and all the rights and obligations
as the developer of the condominium project, were assigned to the purchaser of
the Grand Harbor Yacht Club in June 1998. The Company believes the case is
without merit and will vigorously defend against the lawsuit. Moreover, at the
time of the sale, the purchaser of the Grand Harbor Yacht Club agreed to
indemnify and hold the Company harmless against all such claims. Any potential
liability of the Company with respect to this matter will not, in the aggregate,
be material to the Company's financial condition or operations.
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 1999.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
MARKET INFORMATION
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Meritage's common shares have been listed on the American Stock
Exchange under the symbol "MHG" since September 24, 1999. Prior to that, its
common shares were quoted on the OTC Bulletin Board under the symbol "MHGI."
There was no established public trading market for the Company's common shares
prior to October 18, 1995.
The following table sets forth the high and low sales or bid prices for
the Company's common shares for the two most recent fiscal years. From December
1, 1997 through September 23, 1999, the table reflects the bid prices quoted on
the OTC Bulletin Board. From September 24 through November 30, 1999, the table
reflects the sales prices reported by the American Stock Exchange.
================================================ =========== ===========
HIGH LOW
------------------------------------------------ ----------- -----------
FISCAL YEAR ENDED NOVEMBER 30, 1998
------------------------------------------------ ----------- -----------
First Quarter $ 3.13 $ 1.00
------------------------------------------------ ----------- -----------
Second Quarter $ 2.00 $ 1.03
------------------------------------------------ ----------- -----------
Third Quarter $ 1.56 $ 1.06
------------------------------------------------ ----------- -----------
Fourth Quarter $ 1.63 $ 1.00
================================================ =========== ===========
================================================ =========== ===========
HIGH LOW
------------------------------------------------ ----------- -----------
FISCAL YEAR ENDED NOVEMBER 30, 1999
------------------------------------------------ ----------- -----------
First Quarter $ 2.00 $ 1.25
------------------------------------------------ ----------- -----------
Second Quarter $ 2.69 $ 1.50
------------------------------------------------ ----------- -----------
Third Quarter $ 3.13 $ 1.78
------------------------------------------------ ----------- -----------
Fourth Quarter $ 2.75 $ 1.94
================================================ =========== ===========
HOLDERS
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As of January 31, 2000, there were approximately 700 record holders of
the Company's common shares, which the Company believes represents approximately
1,200 beneficial holders.
DIVIDENDS
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No dividends on Meritage's common shares were paid in the two most
recent 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 2000.
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ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth the selected financial information of
the Company.
(In thousands except for per share information)
YEAR ENDED NOVEMBER 30,
--------------------------------------------------------------------
1999 1998 1997 1996 1995
(RESTATED)* (RESTATED)* (RESTATED)*
----------- ------------ ----------- ------------ -----------
SUMMARY OF OPERATIONS
- ---------------------
Continuing Operations
Total revenue $ 29,752 $ 27,044 $ 26,860 $ 2,099 $ --
Operating expenses 28,898 27,590 27,534 2,368 --
Operating income (loss) 854 (546) (674) (269) --
Earnings (loss) from continuing operations 322 (1,374) (1,935) 268 --
Discontinued Operations
Loss from operations -- (479) (1,058) (2,193) (2,049)
Gain on disposal of business segment 150 3,711 1,479 -- --
Net earnings (loss) 472 1,131 (1,691) (1,926) (2,049)
Preferred stock dividends 40 108 102 -- --
Net earnings (loss) on common shares 432 1,023 (1,793) (1,926) (2,049)
Earnings (loss) per common share - basic and diluted
Earnings (loss) from continuing operations $ 0.05 $ (0.30) $ (0.63) $ 0.09 $ --
Net earnings (loss) $ 0.08 $ 0.21 $ (0.56) $ (0.62) $ (1.13)
BALANCE SHEET DATA
- ------------------
Property & equipment $ 16,684 $ 13,183 $ 7,518 $ 7,652 $ --
Net assets of discontinued operations -- (594) 840 267 3,055
Total assets 25,201 24,964 13,814 14,891 3,055
Long-term obligations (1) 15,091 13,513 10,447 9,715 --
Stockholders' equity 5,883 5,434 30 2,021 3,055
Cash dividends declared per common share $ 0.00 $ 0.00 $ 0.00 $ 0.50 $ 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
consolidated financial statements beginning on page M-1 have been restated
for all periods presented to reflect the results of operations and net assets
of the lodging industry segment as discontinued operations. The selected
financial data above has also been restated to reflect the 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
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CONTINUING OPERATIONS
The following summarizes the results of continuing operations for the
years ended November 30, 1999, 1998 and 1997.
Statements of Operations
---------------------------------------------------------------------------
$ in Thousands % of Revenue
--------------------------------------- ---------------------------------
1999 1998 1997 1999 1998 1997
---------------------------------------------------------------------------
Food and beverage revenue $ 29,752 $ 27,044 $ 26,860 100.0% 100.0% 100.0%
Costs and expenses
Cost of food and beverages 8,557 7,752 7,720 28.8 28.7 28.7
Operating expenses 17,004 15,693 15,902 57.1 58.0 59.2
General and administrative
Restaurant operations 1,228 1,374 1,317 4.1 5.1 4.9
Corporate level expenses 670 1,692 1,525 2.3 6.2 5.7
Depreciation and amortization 1,283 1,079 1,070 4.3 4.0 4.0
Impairment of assets 156 -- -- 0.5 -- --
------------------------------------- -----------------------------------
Total costs and expenses 28,898 27,590 27,534 97.1 102.0 102.5
------------------------------------- -----------------------------------
Earnings (loss) from operations 854 (546) (674) 2.9 (2.0) (2.5)
Other income (expense)
Interest expense (1,314) (1,473) (1,440) (4.4) (5.5) (5.4)
Interest income 391 185 593 1.3 0.7 2.2
Other income -- 509 -- -- 1.9 --
Gain (loss) on disposal of assets 391 (25) (218) 1.3 (0.1) (0.8)
Minority interest -- 26 (196) -- 0.1 (0.7)
------------------------------------- -----------------------------------
Total other income (expense) (532) (778) (1,261) (1.8) (2.9) (4.7)
------------------------------------- -----------------------------------
Earnings (loss) from continuing
operations before income taxes 322 (1,324) (1,935) 1.1 (4.9) (7.2)
Income taxes - current -- 50 -- -- 0.2 --
------------------------------------- -----------------------------------
Earnings (loss) from continuing
operations $ 322 $ (1,374) $ (1,935) 1.1% (5.1%) (7.2%)
===================================== ===================================
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COMPARISON OF YEARS ENDED NOVEMBER 30, 1999 AND 1998
----------------------------------------------------
REVENUE
Revenue increased 10.0% from $27,044,000 in fiscal 1998 to $29,752,000
in fiscal 1999. Revenue in fiscal 1999 includes sales from three new restaurants
opened February 18, March 18 and June 24, respectively. Revenue from new
restaurants totaled $2,101,000 in fiscal 1999 accounting for 7.1% of the 10.0%
increase in revenue. Fiscal 1999 revenue was adversely impacted by the closing
of two restaurants during the year due to fire damage resulting in a combined
loss of approximately seven months of sales. Quarterly revenue on a per
restaurant basis for restaurants in operation during the same periods of fiscal
1999 and 1998 ("same store sales"), are set forth in the following table:
Average Net Sales Per Restaurant Unit
-------------------------------------
1999 1998 Increase % Increase
-------------- -------------- -------- ----------
Three months ended November 30 $ 287,161 $ 278,766 $ 8,395 3.0%
Three months ended August 31 301,321 293,119 8,202 2.8%
Three months ended May 31 287,449 267,263 20,186 7.6%
Three months ended February 28 258,065 240,925 17,140 7.1%
-------------- -------------- -----------
Year ended November 30 $ 1,133,996 $ 1,080,073 $ 53,923 5.0%
============== ============== ===========
The 5.0% (approximately $1,300,000) increase in same store sales in
fiscal 1999 was primarily attributable to (i) an increase in customer traffic
during late night hours (sales between the hours of 10:00 p.m. and midnight),
resulting in a $227,000 increase in late night sales in fiscal 1999 compared to
fiscal 1998, (ii) an increase in beverage selling prices and "combo" meal prices
in July 1999 combined with an increase in value menu prices on October 4, 1999
from $0.99 per item to $1.09 per item resulting in an increase in sales of
approximately $285,000, and (iii) increased "combo" transactions and upsizing
(the addition of a larger beverage and french fry to standard combo meals for an
additional thirty-nine cents). The increase in selling prices, combo
transactions and upsizing sales contributed to a 4.9% increase in average sales
per transaction in fiscal 1999 compared to fiscal 1998.
The Company's fiscal 1999 average sales on a per restaurant basis of
approximately $1,134,000 exceeded the average sales of both (i) Wendy's
system-wide domestic restaurants (i.e. franchised and franchisor-owned) which
were estimated to average approximately $1,117,000 per restaurant in 1999,
and (ii) Wendy's franchised domestic restaurants which were estimated to average
approximately $1,080,000 per restaurant in 1999.
COST OF FOOD AND BEVERAGES
Cost of food and beverages increased $805,000 in fiscal 1999 compared
to fiscal 1998 (from $7,752,000 to $8,557,000), which was the result of the
increase in revenue. As a percentage of revenue, cost of food and beverages was
28.8% in fiscal 1999 compared to 28.7% in fiscal 1998. Overall food costs
remained relatively constant in fiscal 1999 compared to fiscal 1998. Cost of
meat products, which represent approximately 40% of the Company's cost of food
and beverages, decreased slightly in fiscal 1999 compared to fiscal 1998. This
decrease was largely offset by an increase in the cost of dairy products. The
cost of food and beverage percentages of 28.8% in fiscal 1999 and 28.7% in
fiscal 1998 are in line with the Company's and Wendy's International's
guidelines.
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OPERATING EXPENSES
Operating expenses as a percentage of revenue decreased .9 percentage
points in fiscal 1999 compared to fiscal 1998 (from 58.0% of revenue in 1998 to
57.1% in 1999). The net decrease in operating expenses as a percentage of
revenue was primarily the result of reductions in rent expense and advertising
expense in excess of increased payroll costs. A detailed discussion follows:
- Rent Expense
Rent expense decreased $295,000 in fiscal 1999 compared to fiscal 1998.
As a percentage of revenue, rent expense decreased from 4.2% of revenue in
fiscal 1998 to 2.8% of revenue in fiscal 1999. The reduction in rent expense
resulted from the September 1998 purchase of five restaurants which were
previously leased. The Company has realized a corresponding increase in interest
expense and depreciation due to this purchase. The elimination of this rent
expense was slightly offset by increased rent at certain leased restaurants due
to increased sales volume at these restaurants in fiscal 1999 compared to fiscal
1998.
- Advertising Expense
Advertising expense decreased $121,000 in fiscal 1999 compared to
fiscal 1998. As a percentage of revenue, advertising expense decreased .9
percentage points, from 5.7% of revenue in fiscal 1998 to 4.8% of revenue in
fiscal 1999. The reduction in advertising costs in fiscal 1999 was primarily the
result of an increase in advertising rebates earned in 1999 compared to rebates
earned in 1998. The Company changed beverage suppliers in May 1998 (from
Coca-Cola to PepsiCo), and the new beverage contract with PepsiCo included
increased advertising funds. The Company also received a refund of approximately
$30,000 in fiscal 1999 from its local advertising cooperative due to an
overpayment related to the prior year's advertising commitment.
- Increased Payroll Costs
Payroll costs increased from 31.4% of revenue in fiscal 1998 to 33.1%
of revenue in fiscal 1999. The Company has continued to be affected by a tight
labor market and its effect on the availability and cost of labor. As a
percentage of revenue, restaurant crew labor costs increased 1.3 percentage
points (a 7.7% increase) in fiscal 1999 compared to fiscal 1998. This increase
was primarily the result of an increase in the average hourly rate of 6.3%. This
increase in hourly rate was partially due to an increase in overtime premium
wages, and additional hours required for positional training and operations
during the opening phase at the new restaurants opened in fiscal 1999. Payroll
taxes, training costs, and supervisors salaries also increased in fiscal 1999,
and employee health insurance costs increased from 1.7% of revenue in fiscal
1998 to 2.0% of revenue in fiscal 1999, as a result of increased premiums.
On a per restaurant basis, restaurant operating expenses increased from
an average of $628,000 per restaurant in fiscal 1998 to an average of $646,000
per restaurant in fiscal 1999, an increase of 2.9% compared to the 5.0% increase
in same store sales.
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14
GENERAL AND ADMINISTRATIVE
Restaurant Operations
General and administrative expenses for the restaurant operations in
fiscal 1998 included an annual administrative fee paid to the former general
partner of $160,000 compared to $7,700 in fiscal 1999. The general partner
administrative fee was eliminated in the first month of fiscal 1999 when a
change in the general partner occurred. Excluding the general partner
administrative fee, general and administrative expenses increased $5,000 for
fiscal 1999 compared to fiscal 1998 (from $1,215,000 to $1,220,000). As a
percentage of revenue, general and administrative expenses (excluding the
general partner administration fee) decreased from 4.5% of revenue in fiscal
1998 to 4.1% of revenue in fiscal 1999.
Corporate Level Expenses
Fiscal 1999 general and administrative expenses for corporate level
expenses decreased $1,022,000 (from $1,692,000 to $670,000), from 6.2% of
revenue to 2.3% of revenue. The decrease was primarily due to (i) a $454,000
reduction in legal expenses resulting from the recovery of $192,000 of legal
expenses from insurance proceeds in 1999, and higher legal costs in 1998 due to
then active litigation, (ii) a $392,000 decrease in salaries, bonuses and
related costs resulting from the elimination of several positions, (iii) a
$129,000 reduction in life insurance premiums, and (iv) a $37,000 reduction in
property and liability insurance. Offsetting these decreases was a $48,000
increase in public market expense due to a $30,000 application fee for
registration on the American Stock Exchange, and the engagement in fiscal 1999
of an investor relations firm at a cost of $25,000.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense increased $204,000 for fiscal
1999 compared to fiscal 1998 (from $1,079,000 in fiscal 1998 to $1,283,000 in
fiscal 1999). The increase in depreciation was primarily attributable to the
acquisition of five restaurants in September 1998 that were previously leased
and the addition of three new restaurants in 1999.
IMPAIRMENT OF ASSETS
During 1999, the Company determined that there was a permanent decline
in the market value of the property and equipment at one of the Company's
restaurants due to changes in local market conditions. In November 1999,
management decided that the lease for this restaurant would not be renewed. As a
result, the property and equipment owned by the Company at this location was
written down to the estimated fair market value resulting in an impairment loss
of $156,000.
INTEREST EXPENSE
Interest expense in fiscal 1999 and 1998 was $1,314,000 and $1,473,000,
respectively. Long-term obligations were restructured during the fourth quarter
of 1998 which resulted in a weighted average interest rate of approximately 9%
for fiscal 1999 compared to approximately 12.5% for fiscal 1998. All of the
Company's long-term obligations are now at fixed interest rates compared to
long-term obligations prior to the debt restructuring when the Company had both
fixed and variable interest rates.
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15
The impact on interest expense of this significant reduction in
interest rates more than offset the additional interest expense incurred due to
the Company's increase in long-term obligations. Long-term obligations have
increased from $9,400,000 as of August 31, 1998 (prior to the Company's debt
restructuring), to $15,100,000 as of November 30, 1999. The increase in
long-term obligations was due to borrowings of $10,100,000 in the fourth quarter
of 1998 of which $4,200,000 was used to acquire five restaurants that had been
previously leased by the Company. The remaining $5,900,000 was used to refinance
existing long-term obligations at a lower interest rate. During fiscal 1999, the
Company borrowed an additional $3,100,000 to finance the land and building for
three new restaurants opened during fiscal 1999 and to acquire land for a
restaurant currently under construction.
INTEREST INCOME
Interest income increased $206,000 for fiscal 1999 (from $185,000 in
1998 to $391,000 in 1999). Interest income for 1999 and 1998 was primarily the
result of interest earned on the notes receivable obtained in the sale of the
Thomas Edison Inn and the Grand Harbor Resort & Yacht Club.
GAIN ON DISPOSAL OF ASSETS
A gain on disposal of assets of $391,000 was recognized in fiscal
1999. The gain resulted from the sale of life insurance policies at a gain of
$200,000, and from the excess of insurance proceeds over the net book value of
fire damaged equipment totaling $191,000. The Company experienced two fires in
fiscal 1999. The first fire occurred April 15, 1999 and resulted in the closing
of the restaurant until October 1, 1999. Substantially all damaged property was
covered by insurance. The second fire occurred October 12, 1999. This restaurant
reopened on February 1, 2000 and it is expected that insurance will cover
substantially all of the costs to restore and equip the fire damaged restaurant.
COMPARISON OF YEARS ENDED NOVEMBER 30, 1998 AND 1997
----------------------------------------------------
REVENUE
Revenue increased 0.7% from $26,860,000 in fiscal 1997 to $27,044,000
in fiscal 1998. Same store sales (excluding the Company's restaurant that was
closed in August 1997) increased 1.6%. Although sales increased only slightly
for the year, average sales on a per restaurant basis of approximately
$1,080,000 exceeded the average sales of both (i) Wendy's system-wide domestic
restaurants (i.e. franchised and franchisor-owned) which averaged approximately
$1,062,000 per restaurant in 1998, and (ii) Wendy's franchised domestic
restaurants which averaged approximately $1,031,000 per restaurant in 1998.
Several product-related factors had a significant impact on the
Company's sales. In April 1997 the Company began phasing-out its hot SuperBar
offering, and in April 1998 the cold salad bars were removed from all
restaurants. The termination of these two product offerings was carried out at
the direction of Wendy's International. Lost sales resulting from the closure of
these two all-you-can-eat food bar concepts totaled $959,000 in fiscal 1998
compared to fiscal 1997. This reduction in sales, however, was offset by a
number of actions taken by the Company including:
-15-
16
- The introduction of the "Pita" sandwich product in April 1997 which
constituted 5.3% of total sales in fiscal 1998.
- The expansion of the Company's "Late Night" sales program from a
seasonal effort (typically beginning in April and ending in September)
to a year round sales program. Late night sales rose nearly 100%, from
approximately $473,000 in fiscal 1997 to approximately $941,000 in
fiscal 1998.
- Increased emphasis on Wendy's "Upsizing" program which began in April
1997. Upsize sales rose in fiscal 1998 to approximately $272,000 from
approximately $185,000 in fiscal 1997, an increase of 47%.
Sales in fiscal 1998 were also positively impacted by an overall
increase in "combo" sales and relatively mild winter weather conditions during
the first quarter of fiscal 1998 and November 1998. Sales during fiscal 1998
were negatively impacted by intense competition throughout the quick-service
industry including price discounting. The Company and Wendy's International
resisted engaging in deep price discounting, choosing instead to combat low
prices with "value menu" offerings and high quality, made-to-order products.
Weighted average price increases for fiscal 1998 were less than 1% compared to
fiscal 1997.
COST OF FOOD AND BEVERAGES
Cost of food and beverages increased $32,000 in fiscal 1998 compared to
fiscal 1997 (from $7,720,000 to $7,752,000), while revenue increased $184,000
for the same period. As a percentage of sales, cost of food and beverages was
28.7% for both fiscal 1998 and fiscal 1997. Beef prices remained relatively
stable since late 1996 and poultry prices were relatively low during early and
mid-1998. The elimination of the hot and cold SuperBar, which operated with
slightly higher than average food costs and waste, also contributed to steady
food costs. Stabilized management teams in the Company's restaurants, combined
with continued and consistent emphasis on food cost controls, contributed to
controlling waste and keeping the Company's cost of food and beverage percentage
in line with guidelines established by the Company and Wendy's International.
OPERATING EXPENSES
Restaurant operating expenses decreased $209,000, from $15,902,000 in
fiscal 1997 to $15,693,000 in fiscal 1998. As a percentage of revenue,
restaurant operating expenses decreased 1.2 percentage points in fiscal 1998
compared to fiscal 1997 (from 59.2% of revenue in 1997 to 58.0% of revenue in
1998). Advertising expense declined 0.4 percentage points as a result of Wendy's
International entering into a national advertising contract with Coca-Cola USA,
which reduced the Company's mandatory advertising contribution to the Wendy's
International national advertising program during the fourth quarter of 1998.
Rent expense decreased 0.5 percentage points in fiscal 1998 compared to fiscal
1997. This decrease resulted from the elimination of rent expense during the
final four months of the year associated with five of the Company's restaurants
whose real estate was purchased by the Company on September 1, 1998. Slight
decreases in food serving supplies, utilities, and training costs also
contributed to the decline in restaurant operating expenses.
-16-
17
Payroll costs remained stable in fiscal 1998 compared to fiscal 1997
despite (i) the continued pressure to increase hourly rates caused by an
extremely tight labor market, and (ii) the additional store managers hired in
late fiscal 1998 in preparation of new restaurant openings in early fiscal 1999.
The stability in payroll expenses was primarily attributable to decreased store
management turnover. On a per restaurant basis (excluding the restaurant that
was closed in August 1997), restaurant operating expenses increased from an
average of approximately $625,000 per restaurant in fiscal 1997 to an average of
approximately $628,000 per restaurant in fiscal 1998, an increase of 0.5%
compared to the 1.6% increase in same store sales.
GENERAL AND ADMINISTRATIVE
Restaurant Operations
Restaurant general and administrative expenses increased $57,000 in
fiscal 1998 compared to fiscal 1997 (from $1,317,000 to $1,374,000). As a
percentage of revenue, general and administrative expenses increased from 4.9%
of revenue in fiscal 1997 to 5.1% of revenue in fiscal 1998. An increase in the
Michigan Single Business Tax of $80,000 (0.3 percentage points as a percentage
of revenue), recruiting costs (due to a shortage of managerial candidates), and
office expense were the primary reasons for this increase. These increases were
largely offset by a decrease in legal and professional fees of approximately
$115,000 (0.4 percentage points) in fiscal 1998 compared to fiscal 1997. Legal
and professional fees were unusually high in 1997 due to the former general
partner's attempts to sell, and the subsequent dissolution of, the former
Wendy's of West Michigan Limited Partnership.
Corporate Level Expenses
Corporate general and administrative expenses increased $167,000 in
fiscal 1998 compared to fiscal 1997 (from $1,525,000 to $1,692,000). The
increase in corporate general and administrative expenses was due to (i) an
increase in payroll costs of approximately $131,000 caused primarily by
severance costs associated with the discontinuance of the lodging business
segment which resulted in a reduction in executive level positions, and (ii) an
increase in legal fees of approximately $102,000 caused by the prolonged
litigation brought by the former general partner of the now dissolved Wendy's of
West Michigan Limited Partnership. These increases were offset by reductions in
accounting and other professional fees, office expense, public market expense,
promotional costs, and travel and entertainment.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization increased only slightly, from $1,070,000
in fiscal 1997 to $1,079,000 in fiscal 1998. As a percentage of sales,
depreciation was 4.0% in both fiscal 1998 and 1997.
INTEREST EXPENSE
Interest expense increased $33,000 in fiscal 1998 compared to fiscal
1997 (from $1,440,000 in fiscal 1997 to $1,473,000 in fiscal 1998). The increase
in interest expense was primarily due to interest expense incurred on additional
borrowings of $4,200,000 in September 1998 to acquire the real estate of five
restaurants which had previously been leased to the Company.
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18
INTEREST INCOME
Interest income decreased $408,000 in fiscal 1998 compared to fiscal
1997 (from $593,000 in fiscal 1997 to $185,000 in fiscal 1998). The decrease in
interest income was due to the non-recognition of any interest income in fiscal
1998 on the Company's note receivable from the sale of stock, compared to the
recognition of $565,000 of interest income in fiscal 1997. During the second
quarter of 1998, the Company determined that a valuation allowance was
appropriate due to the longer term price trend of the stock, which serves as
collateral for the note receivable. Because of the decrease in the value of the
collateral securing the note receivable, a valuation allowance of $4,667,000 was
made to adjust the note receivable to its estimated realizable value if the
shares of common stock securing the note were sold and the proceeds were applied
to the note receivable. As detailed in the Company's Statement of Stockholders'
Equity, the valuation allowance has no net effect on the Company's total
stockholders' equity.
Interest income in fiscal 1998 includes interest income from the notes
receivable from the sale of the Company's hotel properties of $142,000, and
interest income from cash and cash equivalents of $42,000.
OTHER INCOME
Other income of $509,000 in fiscal 1998 consisted primarily of income
from the forfeiture of an earnest deposit in the amount of $500,000 on a
contract to sell one of the Company's hotel properties.
LOSS ON DISPOSAL OF ASSETS
In fiscal 1998, the Company incurred a loss on the disposal of assets
of $25,000 compared to a loss on disposal of assets of $218,000 in fiscal 1997.
The fiscal 1998 loss was the result of the write-off of the franchise fee
regarding a Wendy's restaurant that was closed in 1997 which was determined to
be non-transferable to a new store in fiscal 1998. The fiscal 1997 loss was due
to the closing of the same restaurant and the decision not to extend the lease
on the restaurant building.
INCOME TAXES - CURRENT
In fiscal 1998, the Company incurred a current income tax expense and
current income tax liability of $50,000. Although no regular income tax
liability was incurred for fiscal 1998 because of the use of net operating loss
carryforwards, for alternative minimum tax purposes, the amount of alternative
tax net operating loss deduction is limited to 90% of alternative minimum
taxable income. This limitation resulted in fiscal year 1998 alternative minimum
tax of $50,000.
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DISCONTINUED OPERATIONS - LODGING GROUP
During the second quarter of 1998, the Company entered into agreements
to sell its remaining hotel properties. This resulted in the Company accounting
for its lodging business segment as a discontinued operation as of May 31, 1998.
Below is a summary of the lodging group's operating results for the years ended
November 30, 1998 and 1997, as well as a summary of the sale transactions for
all three of the Company's former hotel properties:
RESULTS OF OPERATIONS
---------------------
FOR THE YEARS ENDED NOVEMBER 30,
---------------------------------
1998 1997
--------------- ---------------
Revenues $ 6,358,126 $ 14,034,053
Costs and expenses 6,206,192 13,555,900
---------------- --------------
Earnings from operations 151,934 478,153
Other expense (791,166) (1,550,721)
---------------- ---------------
Loss from discontinued operations
before federal income taxes $ (639,232) $ (1,072,568)
================ ===============
A summary of the three sale transactions is as follows:
Grand Harbor
Resort
Thomas Edison Inn & Yacht Club St. Clair Inn
----------------- ------------ -------------
Date of sale September 1, 1998 June 15, 1998 November 30, 1997
Selling price (before selling costs) $ 12,200,000 $ 4,500,000 $ 3,800,000
Promissory note held by Company 2,000,000 1,375,000 --
------------------ ---------------- ------------------
Cash portion of selling price $ 10,200,000 $ 3,125,000 $ 3,800,000
================== ================ ==================
Gain on sale of assets $ 3,273,893 $ 583,164 $ 1,479,095
Loss from operations from measure-
ment date (May 31, 1998) to date
of disposal 109,800 35,893 --
------------------ ---------------- ------------------
Gain on disposal of discontinued
operations 3,164,093 547,271 1,479,095
Extraordinary charges (includes
loan prepayment penalty and
write-off of deferred finance costs) 548,395 178,777 177,291
------------------ ---------------- ------------------
Impact on equity $ 2,615,698 $ 368,494 $ 1,301,804
================== ================ ==================
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20
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Cash Flows - Year Ended November 30, 1999
Cash and cash equivalents ("cash") decreased $530,000, from $2,109,000
as of November 30, 1998 to $1,579,000 as of November 30, 1999. The decrease in
cash was the result of the following:
Net cash provided by operating activities $ 3,697,000
Net cash used in investing activities (4,594,000)
Net cash provided by financing activities 367,000
-----------------
Net decrease in cash $ (530,000)
==================
Net cash provided by operating activities increased $401,000, from
$3,296,000 in fiscal 1998 to $3,697,000 in fiscal 1999. Four significant
activities accounted for the majority of the increase. First, $2,745,000 was
collected on notes receivable related to the sale of the hotel properties during
fiscal 1999 compared to 1998 when the notes receivable in the amount of
$3,220,000 were recorded. Partially offsetting this increase was (i) a $650,000
decrease in net earnings, (ii) a net receipt of $2,168,000 of marketing and
conversion funds from the Company's beverage supplier in fiscal 1998, and (iii)
a $2,028,000 net change in cash from a decrease in net liabilities of
discontinued operations. In 1998, assets of discontinued operations were sold
generating cash compared to fiscal 1999 when liabilities of discontinued
operations were retired using cash.
Net cash used in investing activities decreased $1,252,000 in fiscal
1999 compared to fiscal 1998. The 1999 activity reflects an investment of
$4,593,000 into new restaurants ($4,189,000) and upgrades to existing
restaurants ($404,000, net of insurance proceeds of $671,000 which were used to
replace property damaged by fire). This compares to $5,788,000 invested in 1998
which included (i) a $4,200,000 purchase of real estate associated with five
Wendy's restaurants previously leased, (ii) a payment of $759,000 for the
remaining interest in the former Wendy's of West Michigan Limited Partnership,
and (iii) a $375,000 investment in real estate for future restaurants.
Net cash provided by financing activities decreased $3,231,000 in
fiscal 1999 compared to fiscal 1998. New debt incurred for the construction of
three new restaurants in fiscal 1999 was $3,116,000 compared to new debt of
$4,800,000, net of refinanced debt, in fiscal 1998, which was incurred primarily
for the purchase of five restaurants that had previously been leased.
Additionally, cash provided by financing activities in fiscal 1999 decreased due
to the repayment of $2,000,000 on short and long-term notes payable compared to
$1,499,000 of net proceeds from notes payable in 1998. These notes payable were
incurred when the Company sold participation interests in the notes receivable
resulting from the sale of the hotel properties. Scheduled principal payments
were reduced by approximately $1,000,000 in fiscal 1999 compared to fiscal 1998
due to the restructuring of the Company's long-term obligations.
Cash Flows - Year Ended November 30, 1998
Cash and cash equivalents ("cash") increased $1,048,000, from
$1,061,000 as of November 30, 1997 to $2,109,000 as of November 30, 1998. The
increase in cash was the result of the following:
Net cash provided by operating activities $ 3,296,000
Net cash used in investing activities (5,847,000)
Net cash provided by financing activities 3,599,000
-----------------
Net increase in cash $ 1,048,000
=================
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Net cash provided by operating activities increased $4,147,000, from a
negative $851,000 in fiscal 1997 to $3,296,000 in fiscal 1998. This increase was
due in large part to a $2,800,000 improvement in net income. The improvement was
also significantly impacted by the $2,198,000 receipt of marketing and
conversion funds received from the Company's beverage supplier (the advance has
been accounted for as deferred revenue - see Note K of the Company's Financial
Statements). Two other significant factors impacting net cash from operating
activities involved activities of discontinued operations. In fiscal 1998, net
liabilities of discontinued operations increased $1,434,000 resulting in an
increase in cash provided by operating activities compared to a decrease of
$573,000 in net liabilities in fiscal 1997 which used cash from operating
activities. Partially offsetting the above described activities (which all
contributed to an increase in net cash provided by operating activities) was
$3,220,000 of notes receivable which were recorded from the sale of the hotel
assets, thereby reducing net cash provided by operating activities in fiscal
1999.
Net cash used in investing activities increased $5,035,000, from
$812,000 in fiscal 1997 to $5,847,000 in fiscal 1998. The increase was primarily
due to $5,029,000 of property and equipment purchases which included a
$4,200,000 purchase of real estate associated with five Wendy's restaurants
previously leased, compared to $609,000 of equipment purchases in fiscal 1997
(an additional $244,000 of equipment purchases were made in fiscal 1997 and are
discussed in the schedule of non-cash investing activities). Also contributing
to the increase was a payment of $759,000 for the remaining interest of the
former Wendy's of West Michigan Limited Partnership in fiscal 1998 compared to
an investment of $182,000 for this acquisition in fiscal 1997.
Net cash provided by financing activities increased $3,140,000, from
$459,000 in fiscal 1997 to $3,599,000 in fiscal 1998. This increase was the
result of proceeds of long-term obligations and notes payable of $11,907,000 in
fiscal 1998 compared to $750,000 of new debt incurred in fiscal 1997. The
proceeds in fiscal 1998 were offset by principal payments of long-term
obligations and payments of capital lease obligations totaling $7,940,733, of
which approximately $6,600,000 represented payments related to debt
restructuring, and approximately $1,300,000 represented scheduled debt payments.
Scheduled debt payments of $270,000 were significantly less in fiscal 1997.
The Company was involved in two non-cash investing and financing
activities during the year. The transactions included (i) the issuance of
1,992,359 common shares in connection with the acquisition of the Wendy's
operations, and (ii) the assignment of the $1,375,000 note receivable described
in Note E of the Financial Statements in exchange for, among other things, the
cancellation of a $776,000 note payable and the cancellation of 20,000
convertible preferred shares.
Financial Condition
As of November 30, 1999, the Company's current liabilities exceeded its
current assets by $1,099,000 compared to November 30, 1998, when current assets
exceeded current liabilities by $230,000. Excluding the current portion of
occupancy related long-term obligations and capital leases, the Company's
current liabilities exceeded its current assets by $371,000 at November 30,
1999. At these dates the ratios of current assets to current liabilities were
.69:1 and 1.05:1, respectively. The above discussion regarding cash flows for
the year ended November 30, 1999 explains the decrease in cash as well as the
most significant reasons for the decrease in working capital. A significant
reason for the decline in working capital was the cash investment of
approximately $1,400,000 in new restaurants and upgrades at existing
restaurants.
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22
Liquidity issues facing the Company are a result of (i) the seasonal
cash flow tightening which occurs in the first quarter of the Company's fiscal
year, and (ii) the negative cash flow typically experienced by new stores during
the start-up phase of operations.
Seasonal cash flow tightening in the first quarter is typically due to
a slowing of sales, which can be compounded by adverse winter weather
conditions. The negative cash flow that typically occurs during the first fiscal
quarter will be heightened during fiscal 2000 due to lower than expected sales
in December. Additionally, the Company has seen labor costs increase
significantly and has been able to pass only a small portion of these cost
increases on to customers in the form of increased prices. However, the Company
believes that cash reserves will be sufficient to cover the negative cash flow
during this period and that the Company will experience a return to positive
cash flow in the second quarter.
In order to better manage the cash flow requirements that are generated
during a new store start-up period, the Company is limiting new store openings
to only one store during the first fiscal quarter and anticipates that the
majority of the remaining new store openings will occur during the second and
third quarters. This timing of store openings will allow the Company to better
manage the cash requirements that are typical during the first six months of new
store operations.
Capital resources are needed to fund both new restaurant construction
and capital improvements at existing restaurants. The Company's plans to open
nine new restaurants during fiscal 2000, of which five will require an
investment in real estate and equipment, and four will require an investment
only in equipment as the real estate will be leased. It is anticipated that
approximately $5,000,000 of a total $7,000,000 investment will be funded by
mortgage and equipment financing. The Company has a $3,750,000 forward
commitment for debt financing for three new restaurants and has received
multiple proposals to obtain additional debt financing to purchase both the
equipment and real estate for the remaining new restaurants. The Company
anticipates financing one new Wendy's restaurant by utilizing $1,050,000 of the
forward commitment for a restaurant currently under construction with an
anticipated opening in March 2000. The 15 year mortgage (20 year amortization)
and 7 year equipment loan will carry fixed interest rates equal to 2.2% over the
then current same term treasury rates. Based on current treasury rates, the rate
would be approximately 9.1%. Other financing proposals contain similar terms.
The Company is currently seeking equity financing to fund the planned expansion.
The ability to successfully complete the development of four of the nine new
restaurants that are planned to be opened in fiscal 2000 is dependent on the
Company's ability to raise the required equity financing.
Capital investment into existing restaurants is estimated at $500,000
during fiscal 2000. It is anticipated that the capital resources for this
investment will be a combination of internally generated cash and financing that
is available under Wendy's International preferred lender programs.
The Company's various loan agreements contain loan covenants requiring
the maintenance of certain financial ratios including:
- Fixed Charge Coverage Ratio ("FCCR") of 1.2:1 for the Wendy's
operation as a whole;
- FCCR of 1.2:1 for the Wendy's restaurants that are subject to a real
estate mortgage;
- FCCR of 1.4:1 for the Wendy's restaurants that are subject to both a
real estate mortgage and a business value loan; and
- a restriction against using operating cash flow from the Wendy's
business to fund corporate level expenses if such funding would cause
the FCCR to be less than 1.2:1.
-22-
23
At November 30, 1999, the Company was in compliance with these covenants.
The Company's loan agreements restrict the amount of currently
generated operating cash flow from the Wendy's operation that may be utilized to
fund corporate level expenses. These requirements were met during 1999 and the
Company anticipates that these requirements will be met in the upcoming year.
In light of these operational and investment cash flow management
challenges, the Company plans to meet its current obligations over the next
twelve months by:
- Utilizing cash balances in excess of $1,500,000.
- Using operating cash generated from existing Wendy's restaurants,
which was in excess of $900,000 in fiscal 1999.
- Exploring the acquisition of an equipment and a working capital line
of credit.
- Exploring the financing of certain of the planned capital expenditures
as opposed to paying cash, specifically with respect to planned
renovations at the existing Wendy's restaurants.
- Exploring the financing of equipment packages for certain of the new
restaurants as opposed to making a cash investment.
- Reducing or deferring the capital expenditures described above.
There can be no assurances, however, that the Company will be able to
complete the above activities or that completion would yield the results
expected. Also, a note receivable described in Note E of the Financial
Statements totaling $475,000 has been assigned with recourse. To the extent that
note is not paid by its maker, the Company would be obligated to make the
payment to the assignee upon completion of its collection efforts. Although the
Company believes that the collateral is sufficient to cover the remaining
obligations on the note, there is no assurance that the Company would be able to
effect such a realization when payment on the note would ultimately be due to
the assignee, and no assurances that the amounts recovered would be sufficient
to cover amounts due the assignee. In such circumstances, the Company would be
required to secure necessary funds through borrowings or other means.
INFLATION AND CHANGING PRICES
- -----------------------------
The food service industry has been affected by the shortage of
management and hourly employees. Rising wage rates, due to this shortage, have
had a negative impact on the Company's operating results in fiscal 1999.
Increases in labor costs, along with periodic increases in food and other
operating expenses, are normally passed on to customers in the form of price
increases. However, highly competitive market conditions have minimized the
Company's ability to offset higher costs through price increases to its
customers.
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24
MANAGEMENT'S OUTLOOK
- --------------------
Continued reinvestment of capital into existing restaurants, and an
aggressive and strategic growth plan, are the key elements of management's
expectations for fiscal 2000. Accomplishing these goals will require long-term
operational planning, improved training and a heightened emphasis on recruitment
and labor retention programs.
During the upcoming year, management will focus on stabilizing the
workforce at its restaurants. With a renewed emphasis on recruiting, management
intends to hire the best available employees for its restaurants. Through
improved training programs and working conditions, combined with a competitive
compensation plan, management expects to retain a greater percentage of its
employees in fiscal 2000 and beyond. These efforts will benefit the Company by
reducing waste, expediting customer service and improving employee morale.
Capital improvements will focus on two primary areas, customer service
and the installation of labor saving devices. Wendy's International has
instituted a system-wide program called "Service Excellence." While the major
thrust of this program involves training employees to approach service in a new
manner, it also requires providing employees with new timing and labor saving
devices to expedite the flow of customers. During the first half of fiscal 2000,
the Company expects to implement the Service Excellence plan at all of its
locations. This plan will require significant expenditures for each unit, the
cost of which has been incorporated into the Company's budget.
Restaurant openings form the basis of the Company's growth strategy.
During fiscal 2000 the Company plans to open nine additional units. In addition,
the Company will continue to assess its existing units to determine whether it
is in the Company's best interest to close older and obsolete units, and replace
such units with new more efficient restaurants. For fiscal 2000, the Company has
decided to close and replace at least one, and as many as three, of its older
units. Any replacement units are included in the nine new restaurants that the
Company plans to open in fiscal 2000.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
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.
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25
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 31,
2000:
===================================== ==================================== =====================================
COMMON SHARES
BENEFICIALLY OWNED
------------------
NAME AND AGE (1) POSITION AMOUNT (2) PERCENTAGE
------------------------------------- ------------------------------------ ------------------- -----------------
Robert E. Schermer, Sr. (3) (4) (5) Chairman of the Board of Directors 499,153 8.7%
64
------------------------------------- ------------------------------------ ------------------- -----------------
Robert E. Schermer, Jr. (3) (6) (7) President, Chief Executive Officer 238,643 4.1%
41 and Director
------------------------------------- ------------------------------------ ------------------- -----------------
Ray E. Quada (6) Senior Vice President & Chief 28,389 *
55 Operating Officer
------------------------------------- ------------------------------------ ------------------- -----------------
Pauline M. Krywanski (6) Vice President, Treasurer & Chief 13,416 *
39 Financial Officer
------------------------------------- ------------------------------------ ------------------- -----------------
James R. Saalfeld (6) (8) Vice President, Secretary and 1,424,084 24.6%
32 General Counsel
------------------------------------- ------------------------------------ ------------------- -----------------
James P. Bishop (4) (9) Director 12,909 *
59
------------------------------------- ------------------------------------ ------------------- -----------------
Christopher P. Hendy (9) Director 13,114 *
42
------------------------------------- ------------------------------------ ------------------- -----------------
Joseph L. Maggini (3) (4) (10) Director 175,304 3.0%
60
------------------------------------- ------------------------------------ ------------------- -----------------
Jerry L. Ruyan (9) Director 242,296 4.2%
53
------------------------------------- ------------------------------------ ------------------- -----------------
All Current Executive Officers and 2,647,308 44.7%
Directors as a Group (9 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 all non-employee directors to acquire 6,000 or
8,000 shares pursuant to the 1996 Directors' Share Option Plan.
(3) Executive Committee Member
(4) Compensation Committee Member
(5) Includes 4,000 shares held directly by Mr. Schermer, Sr.'s wife.
(6) Includes options presently exercisable, or exercisable within 60 days, for
Mr. Schermer, Jr. of 82,000 shares, Mr. Quada of 6,389 shares, Ms.
Krywanski of 9,666 shares, and Mr. Saalfeld of 23,139 shares.
(7) Includes 2,900 shares held by Mr. Schermer, Jr. as a custodian for his
minor child.
(8) Includes 1,392,868 shares owned by CBH Capital Corp. but for which Mr.
Saalfeld holds a proxy to vote the shares. See Item 13.
(9) Audit Committee Member
(10) Includes 1,100 shares held directly by Mr. Maggini's wife, and 1,000 shares
held directly by Mr. Maggini's son.
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.
-25-
26
Robert E. Schermer, Jr. has been a director of the Company since
January 25, 1996. He has been President and Chief Executive Officer of the
Company since October 6, 1998. Mr. Schermer also served as Treasurer of the
Company from January 1996 until September 1996, and as Executive Vice President
from January 1996 until October 1998.
Ray E. Quada has been the Senior Vice President and Chief Operating
Officer of the Company since May 19, 1998. From 1990 through 1998, Mr. Quada was
the Chief Executive Officer of the previous owner of the Company's Wendy's
operations. From 1994 through 1997, Mr. Quada was a director of First Michigan
Bank.
Pauline M. Krywanski has been Vice President, Treasurer and Chief
Financial Officer of the Company since May 20, 1997. From 1988 to 1997, Ms.
Krywanski was with American Medical Response, a healthcare transportation
provider, where she was Director of Financial Operations for the Midwest Region.
Ms. Krywanski is a Certified Public Accountant.
James R. Saalfeld has been Vice President, Secretary and General
Counsel of the Company since March 20, 1996. 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.
Christopher P. Hendy has been a director of the Company since July 16,
1998. Since August 1996, Mr. Hendy has been a partner in Redwood Holdings, Inc.,
an investment/venture capital company located in Cincinnati, Ohio. Between 1991
and August, 1996, Mr. Hendy was the Vice President Manager - Asset Based Lending
with Fifth Third Bank. Mr. Hendy is also a director of Hemagen Diagnostics, Inc.
(HMGN: NAS), a manufacturer of medical diagnostic test kits, and Schonstedt
Instrument Company, a manufacturer of magnetic field detecting and measuring
instruments.
Joseph L. Maggini has been a director of the Company since January 25,
1996. Since he founded it in 1974, Mr. Maggini has served as President and
Chairman of the Board of the 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. In October 1999, Mr. Ruyan was appointed Chairman and CEO of Hemagen
Diagnostics, Inc. Since 1995, Mr. Ruyan has been a partner in Redwood Holdings,
Inc. He is also a founder, and a former officer and director, of Meridian
Diagnostics, Inc., a producer of medical diagnostic products. In addition, Mr.
Ruyan is Chairman of the Board of Schonstedt Instrument Company, and a director
of Popmail.com (POPM:NAS), an Internet permission based marketing company.
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
1999 all filing requirements were met.
-26-
27
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:
==================================================================================================================
SUMMARY COMPENSATION TABLE
- -------------------------------- ---------- ------------------------------ ---------------------------------------
ANNUAL COMPENSATION LONG-TERM COMPENSATION
SECURITIES ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS UNDER-LYING COMPENSATION
OPTIONS
- -------------------------------- ---------- --------------- -------------- ------------------- -------------------
Robert E. Schermer, Jr. 1999 $ 127,000 $ 27,782 50,000 ---
President & Chief Executive 1998 $ 164,773 $ 25,000 45,000 ---
Officer 1997 $ 157,500 $ 17,500 45,000 ---
- -------------------------------- ---------- --------------- -------------- ------------------- -------------------
Ray E. Quada 1999 $ 122,470 $ 25,884 25,768 ---
Senior Vice President & Chief 1998 $ 120,941 $ 36,649 12,500 ---
Operating Officer 1997 $ 105,666 $ 20,707(1) --- ---
- -------------------------------- ---------- --------------- -------------- ------------------- -------------------
Pauline M. Krywanski 1999 $ 101,600 $ 22,225 24,496 ---
Vice President, Treasurer & 1998 $ 98,958 $ 20,000(2) 10,000 ---
Chief Financial Officer 1997 $ 59,564 $ 0 10,000 ---
- -------------------------------- ---------- --------------- -------------- ------------------- -------------------
James R. Saalfeld 1999 $ 91,440 $ 20,003 27,741 ---
Vice President, General 1998 $ 87,917 $ 20,000(2) 10,000 ---
Counsel & Secretary 1997 $ 80,000 $ 0 10,000 ---
================================ ========== =============== ============== =================== ===================
(1) Includes 2,000 shares of Meritage Common Stock which were valued at
$5.00 per share.
(2) Includes $10,000 for fiscal 1997 performance that was not approved and
paid until fiscal 1998.
STOCK OPTIONS
The following tables contain information concerning the grant of stock
options to the executives and employees identified in the Summary Compensation
Table and the appreciation of such options:
===================================================================================================================
OPTION GRANTS IN FISCAL 1999
- -------------------------------------------------------------------------------------------------------------------
POTENTIAL REALIZABLE
VALUE AT ASSUMED ANNUAL
RATES OF STOCK PRICE
APPRECIATION FOR OPTION
TERM
NUMBER OF % OF TOTAL
SECURITIES OPTIONS
UNDERLYING GRANTED TO EXERCISE EXPIRATION
NAME OPTIONS GRANTED EMPLOYEES IN PRICE ($ DATE 5% 10%
FISCAL 1999 PER SHARE)
- ---------------------------- ---------------- --------------- ------------- ----------- ------------ --------------
Robert E. Schermer, Jr. 50,000 31.0 % $ 1.50 2/16/2009 $47,175 $119,550
- ---------------------------- ---------------- --------------- ------------- ----------- ------------ --------------
Ray E. Quada 25,768 16.0 % (1) (1) $36,534 $92,583
- ---------------------------- ---------------- --------------- ------------- ----------- ------------ --------------
Pauline M. Krywanski 24,496 15.2 % (2) (2) $33,606 $85,163
- ---------------------------- ---------------- --------------- ------------- ----------- ------------ --------------
James R. Saalfeld 27,741 17.2 % (3) (3) $35,618 $90,263
============================ ================ =============== ============= =========== ============ ==============
(1) Mr. Quada received three separate option grants during fiscal 1999: (a)
6,944 shares with an exercise price of $1.50 and an expiration date of
2/16/09, (b) 7,059 shares with an exercise price of $2.69 and an expiration
date of 5/31/09, and (c) 11,765 shares with an exercise price of $2.4375
and an expiration date of 11/30/09.
-27-
28
(2) Ms. Krywanski received three separate option grants during fiscal 1999: (a)
8,333 shares with an exercise price of $1.50 and an expiration date of
2/16/09, (b) 6,061 shares with an exercise price of $2.69 and an expiration
date of 5/31/09, and (c) 10,102 shares with an exercise price of $2.4375
and an expiration date of 11/30/09.
(3) Mr. Saalfeld received three separate option grants during fiscal 1999: (a)
13,194 shares with an exercise price of $1.50 and an expiration date of
2/16/09, (b) 5,455 shares with an exercise price of $2.69 and an expiration
date of 5/31/09, and (c) 9,092 shares with an exercise price of $2.4375 and
an expiration date of 11/30/09.
===================================================================================================================
FISCAL 1999 OPTION EXERCISES AND FISCAL YEAR-END OPTION VALUES
- -------------------------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT
OPTIONS AT FISCAL YEAR FISCAL YEAR END
END
SHARES
ACQUIRED ON
NAME EXERCISE VALUE REALIZED EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
- --------------------------- --------------- ----------------- ------------------------- ---------------------------
Robert E. Schermer, Jr. --- --- 54,000/131,000 (1) $0/$46,875
- --------------------------- --------------- ----------------- ------------------------- ---------------------------
Ray E. Quada --- --- 2,500/35,768 (1) $0/$6,510
- --------------------------- --------------- ----------------- ------------------------- ---------------------------
Pauline M. Krywanski --- --- 6,000/38,496 (1) $0/$7,812
- --------------------------- --------------- ----------------- ------------------------- ---------------------------
James R. Saalfeld --- --- 16,500/48,741 (1) $0/$12,369
=========================== =============== ================= ========================= ===========================
(1) There is no value associated with the exercisable portion of the options
because the exercise price for these options was established at either
$3.50 or $7.00 per share, and the price of the stock at year end was less
than $3.50 per share.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following persons are the only shareholders known by the Company to
own beneficially 5% or more of its outstanding Common Shares as of January 31,
2000:
======================================== ================================================== =======================
NAME OF BENEFICIAL OWNER AMOUNT AND NATURE OF BENEFICIAL OWNERSHIP PERCENT OF CLASS
- ---------------------------------------- -------------------------------------------------- -----------------------
Robert E. Schermer, Sr. 499,153 (1) 8.7%
- ---------------------------------------- -------------------------------------------------- -----------------------
James R. Saalfeld 1,424,084 (2) 24.6%
======================================== ================================================== =======================
(1) Includes options for 8,000 common shares which are immediately exercisable
and 4,000 common shares owned by Mr. Schermer's wife.
(2) Includes options for 23,139 common shares which are either vested or
exercisable within 60 days, and 1,392,868 common shares which are owned by
CBH Capital Corp. but for which Mr. Saalfeld holds an irrevocable proxy to
vote the shares.
The business address of Mr. Schermer is 333 Bridge Street, N.W., Suite
1000, Grand Rapids, Michigan 49504. The business address of Mr. Saalfeld is 40
Pearl Street, N.W., Suite 900, Grand Rapids, Michigan 49503.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Management believes that the following transactions were on terms no
less favorable to the Company than those that could be obtained from
unaffiliated parties.
In October 1998, the Board of Directors authorized the Company to sell
participation interests (with recourse) in the $1,844,617 note payable received
from the sale of one of its former hotel properties. The Company sold $1,100,000
in total participation interests, including a $500,000 sale to Joseph L.
Maggini. Mr. Maggini entered into a participation agreement which contained the
same terms
-28-
29
as the agreements entered into with third parties that purchased interests. In
August 1999, the note was paid in full. Mr. Maggini's participation interest was
thereafter paid in full and fully discharged.
At November 30, 1999, CBH Capital Corp. (which is owned by former
executive officer and director Christopher B. Hewett) owed the Company
$9,750,000 pursuant to a secured, non-interest bearing note in the original
amount of $10,500,000 issued to the Company in payment for 1,500,000 common
shares issued in September 1995. The note was analyzed by Roney & Co. (now known
as Raymond James & Associates), a nationally recognized investment banking firm,
before delivering its fairness opinion regarding the transaction. The note and
corresponding pledge agreement were amended in February 1999, such that the
principal amount of the note is due and payable on the expiration of the note
(September 19, 2000), rather than in installment payments over a five year
period. This amendment was part of a larger settlement agreement between Mr.
Hewett, CBH Capital Corp. and the Company. Under the settlement agreement,
1,392,868 common shares owned of record by CBH Capital Corp. are held by the
Company as collateral pursuant to the note and pledge agreement, recovery of
which is the sole remedy in the event of a default. Also as part of the
settlement agreement, CBH Capital Corp. granted an option to the Company to
purchase the collateralized shares for $9,750,000 if CBH Capital Corp. obtains
the collateralized shares by making the full payment under the note. Also, Mr.
Hewett and CBH Capital Corp. entered into a voting agreement with James R.
Saalfeld (Vice President and Secretary of the Company), pursuant to which Mr.
Saalfeld received an irrevocable proxy from Mr. Hewett and CBH Capital Corp. to
vote the 1,392,868 common shares owned by CBH Capital Corp. These shares,
combined with the 8,077 common shares owned of record by Mr. Saalfeld, shall be
voted in accordance with the recommendation of the Company's Board of Directors
on all matters submitted to a vote of the Company's shareholders or, if the
Board fails to make a recommendation, as Mr. Saalfeld deems proper. To
facilitate these transactions, the Board (i) opted out of Chapter 7A of the
Michigan Business Corporation Act such that Chapter 7A did not apply to the
transactions, and (ii) amended the Company's Bylaws to temporarily opt out of
the Chapter 7B of the Michigan Business Corporation Act such that Chapter 7B
would not apply to any control share acquisitions involving the Company's common
shares between February 8, 1999 and February 11, 1999.
-29-
30
PART IV
ITEM 14. 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).
4.2 Subscription Agreement relating to issuance of Series A
Convertible Preferred Shares (3).
10.1 First Amended & Restated Secured Promissory Note and Stock
Pledge Agreement by and between the Company and CBH Capital
Corp. (4).
10.2 Second Amended & Restated Secured Promissory Note and Stock
Pledge Agreement by and between the Company and CBH
Capital Corp. (5).
10.3 Sample Construction Loan Agreement with Captec Financial
Group, Inc. (1).
10.4 Sample Promissory Note with Captec Financial Group, Inc.
regarding real estate financing (1).
10.5 Sample Mortgage with Captec Financial Group, Inc. regarding
real estate financing (1).
10.6 Sample Promissory Note with Captec Financial Group, Inc.
regarding leasehold financing (1).
10.7 Sample Mortgage with Captec Financial Group, Inc. regarding
leasehold financing (1).
10.8 Sample Promissory Note with Captec Financial Group, Inc.
regarding business value financing (1).
10.9 Sample Security Agreement with Captec Financial Group,
Inc. regarding business value financing (1).
-30-
31
10.10 Sample Loan Agreement with Fleet Business Credit Corporation
(6).
10.11 Sample Promissory Note with Fleet Business Credit Corporation
(6).
10.12 Sample Mortgage with Fleet Business Credit Corporation (6).
10.13 Sample Guaranty with Fleet Business Credit Corporation (6).
10.14 Promissory Note dated June 16, 1998 among Meritage
Hospitality Group Inc., as lender, and S.C. Land
Acquisitions, L.L.C., as borrower (7).
10.15 Promissory Note dated September 1, 1998 among Meritage
Hospitality Group Inc., as lender, and Reynolds/Ehinger
Enterprises, LLC, as borrower (8).
10.16 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).
10.17 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 (1).
10.18 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 (2).
10.19 Sample Loan Participation and Agency Agreement regarding sale
of participation interests in the Promissory Note dated
September 1, 1998 among Meritage Hospitality Group Inc., as
lender, and Reynolds/Ehinger Enterprises, LLC, as borrower
(2).
10.20 Sample indemnification agreement for officers and directors of
the Company (10).
10.21 Settlement Agreement dated February 8, 1998 among Meritage
Hospitality Group Inc., CBH Capital Corp. and Christopher B.
Hewett with Option Agreement, Voting Agreement and Irrevocable
Proxy attached as exhibits (5).
10.22 Amended Indemnification Agreement dated May 21, 1999 among
Meritage Hospitality Group Inc., MHG Food Service Inc., WM
Limited Partnership - 1998, S & Q Management, LLC, Robert E.
Schermer, Jr., and Ray E. Quada (6).
MANAGEMENT COMPENSATORY CONTRACTS
10.28 Amended 1996 Management Equity Incentive Plan (11).
10.29 Amended 1996 Directors' Share Option Plan (9).
-31-
32
10.30 1999 Directors' Compensation Plan (2).
----------------------------------
21 Subsidiaries of the Registrant (2).
23 Consent of Grant Thornton LLP (12).
27 Financial Data Schedule - Fiscal Year 1999 (12).
Exhibits previously filed and incorporated by reference from:
(1) The Quarterly Report on Form 10-Q for the Company's fiscal quarter
ended August 31, 1998.
(2) The Annual Report on Form 10-K for the Company's fiscal year ended
November 30, 1998.
(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-QSB for the Company's fiscal quarter
ended May 31, 1996.
(5) Amendment No. 12 to Schedule 13-D filed by Christopher B. Hewett and
CBH Capital Corp. on February 17, 1999.
(6) The Quarterly Report on Form 10-Q for the Company's fiscal quarter
ended May 31, 1999.
(7) The Report on Form 8-K for the Company filed on June 18, 1998.
(8) The Report on Form 8-K for the Company filed on September 9, 1998.
(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, 1997.
(11) The Quarterly Report on Form 10-Q for the Company's fiscal quarter
ended May 31, 1998.
(12) Filed herewith.
(b) Reports on Form 8-K.
-------------------
No reports on From 8-K were filed during the fourth quarter of
fiscal 1999.
-32-
33
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.
MERITAGE HOSPITALITY GROUP INC.
Dated: February 1, 2000 By /s/ Robert E. Schermer, Jr.
---------------------------------------
Robert E. Schermer, Jr.
President and Chief Executive Officer
(Principal Executive Officer)
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 of Directors February 1, 2000
- ------------------------------------
Robert E. Schermer, Sr.
/s/ Robert E. Schermer, Jr. President, Chief Executive Officer and February 1, 2000
- ------------------------------------ Director (Principal Executive Officer)
Robert E. Schermer, Jr.
/s/ Pauline M. Krywanski Vice President, Treasurer and Chief February 1, 2000
- ------------------------------------ Financial Officer (Principal Financial
Pauline M. Krywanski & Accounting Officer)
/s/ James P. Bishop Director February 3, 2000
- ------------------------------------
James P. Bishop
/s/ Christopher P. Hendy Director February 2, 2000
- ------------------------------------
Christopher P. Hendy
/s/ Joseph L. Maggini Director February 2, 2000
- ------------------------------------
Joseph L. Maggini
/s/ Jerry L. Ruyan Director February 3, 2000
- ------------------------------------
Jerry L. Ruyan
-33-
34
INDEX TO FINANCIAL STATEMENTS
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES Page
----
Report of Independent Certified Public Accountants .........................M-1
FINANCIAL STATEMENTS
Consolidated Balance Sheets.................................................M-2
Consolidated Statements of Operations.......................................M-4
Consolidated Statements of Stockholders' Equity.............................M-6
Consolidated Statements of Cash Flows.......................................M-8
Notes to Consolidated Financial Statements ................................M-11
SCHEDULES
Schedule I Condensed Financial Information of Registrant...................M-27
Schedule II Valuation and Qualifying Accounts .............................M-30
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP Page
----
Independent Auditors' Report ...............................................W-1
FINANCIAL STATEMENTS
Balance Sheets..............................................................W-2
Statements of Income........................................................W-4
Statements of Changes in Partners' Equity...................................W-6
Statements of Cash Flows....................................................W-7
Notes to Financial Statements ..............................................W-9
F-1
35
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Meritage Hospitality Group Inc.
We have audited the accompanying consolidated balance sheets of Meritage
Hospitality Group Inc. (a Michigan corporation) and subsidiaries as of November
30, 1999 and 1998, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended November 30, 1999. 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 did not audit the financial
statements of Wendy's of West Michigan Limited Partnership (the predecessor of
WM Limited Partnership - 1998), then a majority owned subsidiary, which
statements reflect total assets and revenues constituting 29 percent and 65
percent, respectively, of the related consolidated totals for November 30, 1997.
Those statements were audited by other auditors, whose report thereon has been
furnished to us and our opinion, insofar as it relates to the amounts included
for Wendy's of West Michigan Limited Partnership (the predecessor of WM Limited
Partnership - 1998), is based solely on the report of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. 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, based on our audits and the report of the other auditors, the
financial statements referred to above present fairly, in all material respects,
the consolidated financial position of Meritage Hospitality Group Inc. and
subsidiaries as of November 30, 1999 and 1998 and the consolidated results of
their operations and their consolidated cash flows for each of the three years
in the period ended November 30, 1999, in conformity with generally accepted
accounting principles.
We also audited Schedule I of Meritage Hospitality Group Inc. and Subsidiaries
as of and for the year ended November 30, 1997 and Schedule II for the years
ended November 30, 1999, 1998 and 1997. In our opinion these schedules present
fairly, in all material respects, the information required to be set forth
therein.
Southfield, Michigan
December 17, 1999
M-1
36
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
NOVEMBER 30,
- --------------------------------------------------------------------------------------------------------------------
ASSETS 1999 1998
---------- -----------
CURRENT ASSETS
Cash and cash equivalents $ 1,578,914 $ 2,109,358
Receivables 81,239 70,974
Notes receivable, current portion 475,000 2,719,617
Inventories 207,563 165,156
Prepaid expenses and other current assets 157,413 90,796
----------- -----------
Total Current Assets 2,500,129 5,155,901
PROPERTY, PLANT AND EQUIPMENT, NET 16,683,959 13,182,940
OTHER ASSETS
Note receivable, net of current portion -- 500,000
Goodwill, net of amortization of $335,287 and
$153,758, respectively 4,974,436 5,155,965
Franchise costs, net of amortization of $40,167 and
$17,806, respectively 684,833 632,194
Financing costs, net of amortization of $17,808 and
$3,314, respectively 318,385 261,815
Deferred charges and other assets 39,657 75,431
----------- -----------
Total Other Assets 6,017,311 6,625,405
----------- -----------
Total Assets $25,201,399 $24,964,246
=========== ===========
M-2
37
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - CONTINUED
NOVEMBER 30,
- ----------------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY 1999 1998
------------ ------------
CURRENT LIABILITIES
Current portion of long-term obligations $ 874,051 $ 1,199,458
Current portion of obligations under capital lease 328,236 294,577
Short-term borrowings -- 1,100,000
Trade accounts payable 1,245,679 727,199
Amount due related party -- 245,260
Income taxes payable 5,000 50,000
Accrued liabilities 1,145,756 1,308,987
------------ ------------
Total Current Liabilities 3,598,722 4,925,481
LONG-TERM OBLIGATIONS 12,822,125 10,623,946
OBLIGATIONS UNDER CAPITAL LEASE 1,066,814 1,395,049
DEFERRED REVENUE 1,830,788 1,992,026
NET LIABILITIES OF DISCONTINUED OPERATIONS -- 593,855
COMMITMENTS AND CONTINGENCIES (NOTES J, K, Q AND R) -- --
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: 44,520
(liquidation value - $445,200) 445 445
Common stock - $0.01 par value
shares authorized: 30,000,000
shares issued: 5,752,677 and 5,742,586
shares outstanding: 5,751,877 and 5,742,586 57,519 57,426
Additional paid in capital 13,316,795 13,299,467
Note receivable from sale of shares, net of valuation
allowance of $5,362,804 and $4,666,755 (1,660,962) (1,660,962)
Accumulated deficit (5,830,847) (6,262,487)
------------ ------------
Total Stockholders' Equity 5,882,950 5,433,889
------------ ------------
Total Liabilities and Stockholders' Equity $ 25,201,399 $ 24,964,246
============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
M-3
38
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED NOVEMBER 30,
- ------------------------------------------------------------------------------------------------------------------------------
1997
1999 1998 (RESTATED)
---------- ------------ ------------
Food and beverage revenue $ 29,752,416 $ 27,043,954 $ 26,860,546
Cost and expenses
Cost of food and beverages 8,556,960 7,752,187 7,720,307
Operating expenses 17,003,799 15,693,535 15,901,695
General and administrative expenses 1,898,057 3,065,813 2,842,030
Depreciation and amortization 1,283,343 1,078,539 1,070,017
Impairment of assets 156,150 -- --
------------ ------------ ------------
Total costs and expenses 28,898,309 27,590,074 27,534,049
------------ ------------ ------------
Earnings (loss) from operations 854,107 (546,120) (673,503)
Other income (expense)
Interest expense (1,314,811) (1,473,019) (1,440,192)
Interest income 390,701 184,614 592,850
Other income -- 509,590 --
Gain (loss) on disposal of assets 391,571 (25,000) (218,602)
Minority interest -- 25,677 (195,639)
------------ ------------ ------------
Total other expense (532,539) (778,138) (1,261,583)
------------ ------------ ------------
Earnings (loss) from continuing
operations before income taxes 321,568 (1,324,258) (1,935,086)
Income taxes - current -- 50,000 --
------------ ------------ ------------
Earnings (loss) from continuing operations 321,568 (1,374,258) (1,935,086)
Discontinued operations
Loss from operations (including
income tax benefit of $160,000 and
$15,000 in 1998 and 1997) -- (479,232) (1,057,568)
Gain on disposal of discontinued operations 150,140 3,711,364 1,479,095
------------ ------------ ------------
Earnings from discontinued operations 150,140 3,232,132 421,527
------------ ------------ ------------
Earnings (loss) before extraordinary item 471,708 1,857,874 (1,513,559)
Extraordinary item - loss on early extinguishment
of debt (no applicable federal income tax) -- 727,172 177,291
------------ ------------ ------------
Net earnings (loss) 471,708 1,130,702 (1,690,850)
Preferred stock dividends 40,068 107,928 101,714
------------ ------------ ------------
Net earnings (loss) on common shares $ 431,640 $ 1,022,774 $ (1,792,564)
============ ============ ============
M-4
39
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS - CONTINUED
YEARS ENDED NOVEMBER 30,
- -------------------------------------------------------------------------------------------------------------------
1997
1999 1998 (RESTATED)
------------ ------------- -------------
Earnings (loss) per common share - basic and diluted
Continuing operations $ .05 $ (.30) $ (.63)
Discontinued operations .03 .66 .13
Extraordinary item -- (.15) (.06)
------------- ------------- -------------
Net earnings (loss) $ .08 $ .21 $ (.56)
============= ============= =============
Weighted average shares outstanding - basic 5,748,288 4,932,738 3,214,836
============= ============= =============
Weighted average shares outstanding - diluted 5,774,337 4,932,738 3,214,836
============= ============= =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
M-5
40
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997
- -----------------------------------------------------------------------------------------------------------------------------------
SERIES A NOTE
CONVERTIBLE ADDITIONAL RECEIVABLE
PREFERRED COMMON PAID-IN SALE OF ACCUMULATED
STOCK STOCK CAPITAL SHARES DEFICIT TOTAL
----------- ----------- ------------ ------------ ------------ ------------
Balance at December 1, 1997 $ 1,084 $ 32,045 $ 12,616,727 $ (5,135,716) $ (5,492,697) $ 2,021,443
Issuance of 14,295 shares of common
stock -- 143 65,868 -- -- 66,011
Issuance of 30,000 shares of preferred
stock 300 -- 299,700 -- -- 300,000
Dividends paid - preferred stock -- -- -- -- (101,714) (101,714)
Recognition of interest income on note
receivable from sale of shares -- -- -- (564,929) -- (564,929)
Net loss -- -- -- -- (1,690,850) (1,690,850)
----------- ----------- ------------ ------------ ------------ ------------
Balance at November 30, 1997 1,384 32,188 12,982,295 (5,700,645) (7,285,261) 29,961
Issuance of 1,999,935 shares of common
stock -- 19,999 4,561,155 -- -- 4,581,154
Conversion of 73,867 shares of
convertible preferred shares into
523,873 common shares (739) 5,239 (4,500) -- -- --
Cancellation of 20,000 shares of
convertible preferred stock (200) (199,800) (200,000)
Dividends paid - preferred stock -- -- -- -- (107,928) (107,928)
Recognition of interest income on note
receivable from sale of shares -- -- 627,072 (627,072) -- --
Establishment of valuation allowance
on note receivable from sale
of shares -- -- (4,666,755) 4,666,755 -- --
Net earnings -- -- -- -- 1,130,702 1,130,702
----------- ----------- ------------ ------------ ------------ ------------
Balance at November 30, 1998 445 57,426 13,299,467 (1,660,962) (6,262,487) 5,433,889
M-6
41
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - CONTINUED
YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997
- ----------------------------------------------------------------------------------------------------------------------------------
SERIES A NOTE
CONVERTIBLE ADDITIONAL RECEIVABLE
PREFERRED COMMON PAID-IN SALE OF ACCUMULATED
STOCK STOCK CAPITAL SHARES DEFICIT TOTAL
----------- ----------- ------------ ------------ ------------ ------------
Balance at December 1, 1998 $ 445 $ 57,426 $ 13,299,467 $ (1,660,962) $ (6,262,487) $ 5,433,889
Issuance of 10,091 shares of common
stock -- 101 19,403 -- -- 19,504
Dividends paid - preferred stock -- -- -- -- (40,068) (40,068)
Recognition of interest income on note
receivable from sale of shares -- -- 696,049 (696,049) -- --
Increase in valuation allowance
on note receivable from sale
of shares -- -- (696,049) 696,049 -- --
Purchase of 800 shares of common stock -- (8) (2,075) -- -- (2,083)
Net earnings -- -- -- -- 471,708 471,708
----------- ----------- ------------ ------------ ------------ ------------
Balance at November 30, 1999 $ 445 $ 57,519 $ 13,316,795 $ (1,660,962) $ (5,830,847) $ 5,882,950
=========== =========== ============ ============ ============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
M-7
42
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED NOVEMBER 30,
- -----------------------------------------------------------------------------------------------------------------------------------
1997
1999 1998 (RESTATED)
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net earnings (loss) $ 471,708 $ 1,130,702 $(1,690,850)
Adjustments to reconcile net earnings (loss) to net
cash provided by operating activities
Extraordinary item-loss on early extinguishment
of debt from continuing operations -- 45,038 --
Depreciation and amortization 1,283,343 1,078,539 1,070,017
Compensation paid by issuance of preferred and
common stock 19,504 6,288 52,492
(Gain) loss on disposal of assets (391,571) 25,000 218,602
Impairment of assets 156,150 -- --
Minority interest in (loss) earnings of consolidated
subsidiaries -- (25,677) 195,639
Interest income on note receivable from sale of
shares -- -- (564,929)
Interest expense refinanced as long-term debt -- -- 240,310
Decrease (increase) in note receivable from sale
of assets 2,744,617 (3,219,617) --
Decrease (increase) in cash value of life insurance 222,903 (8,884) 185,207
(Decrease) increase in deferred revenue (161,238) 1,992,026 --
(Increase) decrease in current assets
Receivables (10,265) 187,308 (42,403)
Inventories (42,407) (8,410) 23,504
Prepaid expenses and other current assets (66,617) 65,232 (14,159)
Increase (decrease) in current liabilities
Trade accounts payable 518,480 (86,656) (27,057)
Amount due related party (245,260) 159,997 85,263
Income taxes payable (45,000) 50,000 --
Accrued liabilities (163,231) 471,757 (9,577)
(Decrease) increase in net (assets) liabilities
of discontinued operations (593,854) 1,433,841 (573,275)
----------- ----------- -----------
Net cash provided by (used in) operating
activities 3,697,262 3,296,484 (851,216)
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from insurance - fire 671,061 -- --
Purchase of property, plant and equipment (5,188,748) (5,029,283) (608,071)
Payment for franchise agreement (75,000) (25,000) --
Acquisition of business, net of cash acquired -- (758,632) (182,526)
Purchase of common stock (2,083) -- --
Increase in other assets -- (34,191) (21,106)
----------- ----------- -----------
Net cash used in investing activities (4,594,770) (5,847,106) (811,703)
M-8
43
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
YEARS ENDED NOVEMBER 30,
- -----------------------------------------------------------------------------------------------------------------------------------
1997
1999 1998 (RESTATED)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term obligations $ 3,115,542 $ 10,408,217 $ 750,000
Payment of financing costs (71,064) (265,129) --
Proceeds from note payable -- 1,498,934 --
Principal payments on long-term obligations (1,242,769) (7,676,361) (270,467)
Payments on obligations under capital lease (294,577) (264,372) (232,441)
Payments on notes payable (1,100,000) -- --
Proceeds from issuance of preferred and common
shares -- 5,144 313,519
Dividends paid (40,068) (107,928) (101,714)
------------ ------------ ------------
Net cash provided by financing activities 367,064 3,598,505 458,897
------------ ------------ ------------
Net (decrease) increase in cash (530,444) 1,047,883 (1,204,022)
Cash and cash equivalents - beginning of year 2,109,358 1,061,475 2,265,497
------------ ------------ ------------
Cash and cash equivalents - end of year $ 1,578,914 $ 2,109,358 $ 1,061,475
============ ============ ============
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest $ 1,319,123 $ 1,341,384 $ 1,370,969
Cash paid for income taxes 45,000 -- --
SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Acquisition of remaining 46% of Wendy's of West Michigan Limited Partnership,
including assets acquired and liabilities assumed
Fair value of tangible and intangible assets
acquired $ 3,751,619
Reduction of minority interest 1,575,738
Amount of cash payment (758,632)
------------
1,992,359 common shares issued $ 4,568,725
============
Assignment of note receivable
Amount of note receivable assigned $ 1,375,000
Cancellation of note payable (776,066)
Cancellation of 20,000 convertible preferred shares (200,000)
------------
Proceeds from note payable $ 398,934
============
M-9
44
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
YEARS ENDED NOVEMBER 30,
- -------------------------------------------------------------------------------------------------------------------------
1997
1999 1998 (RESTATED)
---------- --------- ---------
Conversion of 73,867 shares of convertible preferred
stock into 523,873 shares of common stock $ --
========
Acquisition of equipment
Cost of equipment $244,637
Equipment loan 244,637
--------
Cash down payment for equipment
$ --
========
Increase in long term debt due to three month moratorium
on interest and principal payments $240,310
========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
M-10
45
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
NOTE A - NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
The Company currently conducts its business in the quick-service restaurant
industry operating twenty-nine Wendy's Old Fashioned Hamburger restaurants under
franchise agreements with Wendy's International, Inc. All operations of the
Company are located in Michigan. The Company formerly conducted business in its
discontinued lodging industry segment which consisted of three full service
hotels. The hotels were sold during 1997 and 1998 (see Notes C and E).
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
the following wholly-owned subsidiaries:
Continuing operations:
MHG Food Service Inc.
Discontinued operations:
SC Inn Inc., TE Inn Inc., GHR Inc., and GHYC Inc.
All significant intercompany balances and transactions have been eliminated in
consolidation.
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 paper 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 30 years. 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. 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 FEES
Franchise fees for the Company's restaurant units are amortized using the
straight-line method over the terms of the individual franchise agreements
including options to renew.
M-11
46
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
NOTE A - NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FINANCING COSTS
Financing costs are amortized using the straight-line method over the terms of
the various loan agreements.
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. As a result of this review, it was determined that a permanent
decline in value below book value had occurred at one of the Company's
restaurant locations due to changes in local market conditions. In November
1999, management decided that the lease for this restaurant would not be
renewed. The property and equipment owned by the Company at this location were
written down to estimated fair market value resulting in an impairment loss in
1999 of $156,150.
OBLIGATIONS UNDER CAPITALIZED LEASE
Lease transactions relating to certain restaurant buildings and equipment are
classified as capital leases. These assets have been capitalized and the related
obligations recorded based on the fair market value of the assets at the
inception of the leases. Amounts capitalized are being amortized over the terms
of the leases.
FRANCHISE COSTS AND OTHER ADVERTISING COSTS
Royalties and advertising costs are based primarily on a percentage of monthly
sales. These costs and other advertising costs are charged to operations as
incurred. Advertising expense totaled $1,428,247, $1,553,193, and $1,638,409 for
the years ended November 30, 1999, 1998 and 1997, respectively.
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 and 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.
M-12
47
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
NOTE A - NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 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 November 30, 1999, 1998
and 1997:
1999 1998 1997
----------- ----------- -----------
Numerators
Earnings (loss) from continuing
operations $ 321,568 $(1,374,258) $(1,935,086)
Less preferred stock dividends 40,068 107,928 101,714
----------- ----------- -----------
Earnings (loss) on common shares - basic 281,500 (1,482,186) (2,036,800)
Effect of dilutive securities
Stock options -- -- --
----------- ----------- -----------
Earnings (loss) on common shares - diluted $ 281,500 $(1,482,186) $(2,036,800)
=========== =========== ===========
Denominators
Weighted average common shares
outstanding - basic 5,748,288 4,932,738 3,214,836
Effect of dilutive securities
Stock options 26,049 -- --
----------- ----------- -----------
Weighted average common shares
outstanding - diluted 5,774,337 4,932,738 3,214,836
=========== =========== ===========
For 1999, 1998 and 1997, convertible preferred stock was not included in the
computation of diluted earnings per common share because the effect of
conversion would be antidilutive. For 1998 and 1997, exercisable stock options
were not included in the computation of diluted earnings per share because the
option prices were greater than average quarterly market prices.
M-13
48
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
NOTE A - NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of the Company's financial instruments which include cash
and cash equivalents, receivables, notes receivable, accounts payable and
long-term obligations, approximate their fair values.
FINANCIAL STATEMENT PRESENTATION
Certain amounts in the 1998 and 1997 financial statements have been reclassified
to conform to the 1999 presentation.
NOTE B - ACQUISITION
In fiscal 1998, the Company purchased 46% of the partnership interest in the now
dissolved Wendy's of West Michigan Limited Partnership (the "Wendy's
Partnership"). The Company then transferred this interest to its wholly-owned
subsidiary, MHG Food Service Inc. This acquisition gave the Company 100%
ownership of the Wendy's Partnership. The acquisition was accounted for as a
purchase, and the total acquisition cost of $10,384,753, ($4,446,453 cash,
2,164,259 shares of common stock and 29,520 shares of preferred stock with a
total value of $5,938,300), was allocated to assets acquired and liabilities
assumed based upon estimates of their fair values. A total of $5,309,723,
representing the excess of the acquisition cost over the fair value of net
assets acquired, was allocated to goodwill.
The unaudited pro forma information below presents combined results of
operations for the years ended November 30, 1998 and 1997 as if 100% of the
acquisition had occurred at the beginning of the periods presented. The
unaudited pro forma information is not necessarily indicative of the results of
operations of the combined Company had the acquisition occurred at the beginning
of the periods presented.
1997
1998 (RESTATED)
------------ -----------
Revenues $ 27,044,000 $ 26,860,000
Net earnings (loss) from
continuing operations $ (1,350,000) $ (1,739,000)
Earnings (loss) per share $ (.30) $ (.57)
M-14
49
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
NOTE C - DISCONTINUED OPERATIONS - SALE OF HOTEL ASSETS
The Company sold substantially all the assets of its three full service hotels,
which were previously included in the lodging segment. As such, the Company
began reporting the lodging segment as discontinued operations effective May 31,
1998. The consolidated financial statements have been restated for 1997 to
reflect the results of operations and net assets of the lodging segment as
discontinued operations. As of November 30, 1999 and 1998, assets and
liabilities of the discontinued lodging group business segment included in the
balance sheet are summarized below:
NOVEMBER 30,
---------------------------------
1999 1998
---------------- -----------
Assets
Current assets $ -- $ 13,264
Other assets -- 16,511
Liabilities
Current liabilities -- (623,630)
--------------- ---------
Net liabilities of discontinued operations $ -- $(593,855)
=============== =========
The results of operations of the discontinued operations for the years ended
November 30, 1999, 1998 and 1997 are summarized below:
For years ended November 30, 1999 1998 1997
------------- ----------- -----------
Revenues $ -- $ 6,358,126 $14,034,053
Earnings from operations $ -- $ 151,934 $ 478,153
Earnings from discontinued operations $ 150,140 $ 3,232,132 $ 421,527
NOTE D - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are summarized as follows at November 30:
1999 1998
-------------- ------------
Land and improvements $ 4,512,961 $ 2,861,000
Buildings and improvements 7,108,779 5,515,359
Furnishings and equipment 4,548,506 3,547,990
Leasehold improvements 1,024,422 1,009,191
Leased property/capital leases 983,292 983,292
Construction in progress 300,796 75,390
------------ ------------
18,478,756 13,992,222
Less accumulated depreciation and amortization (1,794,797) (809,282)
------------ ------------
$ 16,683,959 $ 13,182,940
============ ============
Depreciation and amortization expense was approximately $1,057,000, $853,000,
and $768,000 for the years ended November 30, 1999, 1998 and 1997, respectively.
M-15
50
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
NOTE E - NOTES RECEIVABLE
Notes receivable consisted of the following at November 30:
1999 1998
---------- ----------
Mortgage note receivable (from sale of Grand Harbor Resort & Yacht Club),
collateralized by marina real estate, requiring monthly payments of interest
only at 10.8% through December 16, 1999 and 15.0% thereafter through
February 16, 2000 when the remaining balance is due. $ 475,000 $1,375,000
Mortgage note receivable (from sale of Thomas Edison Inn), collateralized by
land and the pledge of stock of an affiliate of the borrower, requiring monthly
payments of interest only at prime plus 8%. The note was paid in full in
August 1999. -- 1,844,617
---------- ----------
475,000 3,219,617
Less current portion 475,000 2,719,617
---------- ----------
$ -- $ 500,000
========== ==========
NOTE F - AMOUNTS DUE RELATED PARTIES AND RELATED PARTY TRANSACTIONS
The Company has entered into an agreement with the Company's Chairman of the
Board whereby the Company assigned a mortgage note receivable from the sale of
the Grand Harbor Resort & Yacht Club (see Notes C and E) to the Chairman in
exchange for (i) payment in full of a note payable to the Chairman ($776,000),
(ii) cancellation of $200,000 of preferred stock owned by the Chairman, and
(iii) a cash payment of $399,000. The payment terms, interest rate, and related
security are the same as the assigned note receivable (see Note E), which
include monthly payments of interest only at 10.8% through December 16, 1999 and
15.0% thereafter. In August 1999, a $900,000 payment was made on this obligation
reducing the outstanding balance to $475,000. The remaining balance is due
February 16, 2000. The Company indemnified the Chairman in the event of
nonpayment by the maker.
In 1998 the Company sold $1,100,000 of undivided interests in the $2,000,000
mortgage note received from the sale of the Thomas Edison Inn (see Notes C and
E). The participation agreements represented 59.6% of the outstanding note
balance, of which a 27.1% participation ($500,000) was sold to a member of the
Company's Board of Directors. The participation agreements required monthly
payments of interest only at prime plus 8% through August 1999 when the notes
were paid in full.
M-16
51
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
NOTE F - AMOUNTS DUE RELATED PARTIES AND RELATED PARTY TRANSACTIONS (CONTINUED)
The Wendy's Partnership incurred a management fee to its former general partner
in the amount of $7,671 in 1999 and $160,000 in 1998 and 1997.
NOTE G - ACCRUED LIABILITIES
Accrued liabilities consist of the following at November 30:
1999 1998
---------- ----------
Payroll and related payroll taxes $ 550,837 $ 787,394
Property taxes 255,667 238,953
Interest expense 88,257 78,201
Other expenses 250,995 204,439
---------- ----------
$1,145,756 $1,308,987
========== ==========
M-17
52
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
NOTE H - LONG-TERM OBLIGATIONS
Long-term obligations consist of the following at November 30:
1999 1998
----------- -----------
Mortgage notes payable, due in monthly
installments totaling $99,304 including
interest at fixed rates ranging from 7.8% to
8.7% maturing from October 1, 2018 through
November 30, 2019. (1) $11,769,353 $ 8,658,644
Notes payable, due in monthly installments of
$10,802 including interest at 8.15% through
September 1, 2013. (2) 1,073,236 1,113,588
Amount payable to the Chairman of the Board
and shareholder, due in monthly installments
of interest only at 10.8% through December
16, 1999 and 15.0% thereafter through
February 16, 2000 when the remaining
principal will be due (see Note F). (1) 475,000 1,375,000
Other notes payable, requiring monthly
payments aggregating $9,863 and $19,416,
respectively, subject to interest at rates
ranging from 7.5% to 8.8%. (2) 378,587 365,455
Construction note payable, due in monthly
installments of interest only. This note was
paid in full in June 1999. -- 310,717
----------- -----------
13,696,176 11,823,404
Less current portion 874,051 1,199,458
----------- -----------
$12,822,125 $10,623,946
=========== ===========
(1) The note is collateralized by certain real estate.
(2) The note is collateralized by certain equipment.
M-18
53
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
NOTE H - LONG-TERM OBLIGATIONS (CONTINUED)
Minimum principal payments on long-term obligations to maturity as of November
30, 1999 are as follows:
2000 $ 874,051
2001 407,905
2002 441,883
2003 478,622
2004 444,375
Thereafter 11,029,340
-----------
$13,696,176
===========
Loan covenants of the various loan agreements include requirements for
maintenance of certain financial ratios. At November 30, 1999 the Company was in
compliance.
NOTE I - INCOME TAXES
Deferred tax assets and liabilities at November 30, consist of the following:
1999 1998
Deferred tax assets: --------- ---------
Net operating loss carryforwards $ 29,000 $ 288,000
AMT credit carryforward 126,000 155,000
Allowance for doubtful accounts 450,000 213,000
Depreciation -- 16,000
Goodwill 25,000 11,000
Asset impairment 53,000 --
Accrued compensation -- 15,000
Accrued expenses 21,000 --
Contribution carryover 73,000 --
--------- ---------
777,000 698,000
Deferred tax liabilities
Property and equipment - cost basis (65,000) --
Depreciation (121,000) (26,000)
Amortization (14,000) (54,000)
Capital leases (29,000) (10,000)
--------- ---------
(229,000) (90,000)
Less valuation allowance (548,000) (608,000)
--------- ---------
Net deferred tax liability $ -- $ --
========= =========
The net operating loss carryforwards expire in 2011 - 2012.
M-19
54
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
NOTE I - INCOME TAXES (CONTINUED)
The income tax provision reconciled to the tax computed at the statutory federal
rate for continuing operations was as follows:
YEARS ENDED NOVEMBER 30,
---------------------------------------
(RESTATED)
1999 1998 1997
--------- --------- ---------
Tax expense (benefit) at statutory rates
applied to income before federal
income tax $ 109,000 $(450,000) $(657,600)
Effect of nondeductible items (67,000) 44,400 82,400
IRS adjustment to net operating loss -- -- 250,000
Other 18,000 21,600 (8,500)
Valuation allowance (60,000) 434,000 333,700
--------- --------- ---------
$ -- $ 50,000 $ --
========= ========= =========
NOTE J - LEASE COMMITMENTS
The Company leases land and buildings used in operations under operating
agreements, with remaining lease terms (including renewal options of up to
eleven years) ranging from one to thirty years. Included in the leases were five
with a real estate partnership related through common general partnership
ownership through May 19, 1997 at which time the former general partner was
removed.
Total lease expense (including taxes, insurance and maintenance when included in
rent) related to all operating leases and all percentage rentals is as follows:
YEARS ENDED NOVEMBER 30,
----------------------------------------
1999 1998 1997
---------- ---------- ----------
Leases with related parties
Minimum rentals $ -- $ -- $ 143,127
Percentage rentals -- -- 79,948
Other Leases
Minimum rentals 477,713 672,755 615,273
Percentage rentals 425,458 523,033 459,463
---------- ---------- ----------
$ 903,171 $1,195,788 $1,297,811
========== ========== ==========
M-20
55
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
NOTE J - LEASE COMMITMENTS (CONTINUED)
Certain restaurant leases (eight restaurant buildings, excluding land which is
accounted for as an operating lease) and equipment leases have been capitalized.
Minimum future obligations under capital leases and noncancellable operating
leases in effect are as follows:
CAPITAL OPERATING
YEARS ENDING NOVEMBER 30, LEASES LEASES
------------------------ ---------- ----------
2000 $ 465,323 $ 519,030
2001 449,365 352,428
2002 369,575 322,841
2003 369,575 312,008
2004 30,798 152,205
Thereafter -- 997,680
---------- ----------
Total minimum lease obligations 1,684,636 $2,656,192
==========
Less amount representing interest
imputed at approximately 11% 294,586
----------
Present value of minimum lease
obligations $1,390,050
==========
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 $304,700,
and $138,500, at November 30, 1999 and 1998, respectively.
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 K - DEFERRED REVENUE
In April 1998, the Company entered into a long-term agreement with its beverage
supplier. The agreement requires the Company to purchase 1,878,000 gallons of
fountain beverage syrup from the supplier. In exchange, the Company received
$2,168,000 in marketing and conversion funds which, in accordance with the terms
of the agreement, will be recognized as revenue as the gallons of fountain
beverage syrup are purchased.
M-21
56
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
NOTE L - SERIES A CONVERTIBLE CUMULATIVE PREFERRED STOCK
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 $6.41 per share at November 30, 1999, increasing to $7.00
per share on December 15, 1999. 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 M - NOTE RECEIVABLE FROM SALE OF SHARES
On September 19, 1995, a stock purchase and sale agreement (Agreement) was
executed by and between the Company, its then principal stockholder, and CBH
Capital Corp. ("CBHCC") (formerly Meritage Capital Corp.). Under the agreement,
the Company sold 1,500,000 shares of previously authorized newly issued common
stock to CBHCC at a total price of $10,500,000. Upon execution of the agreement,
CBHCC gave the Company a non-interest bearing promissory note in the amount of
$10,500,000. The Note provides that CBHCC does not have to make any payments to
the Company from the date of the Note (September 19, 1995) until September 19,
2000 when the remaining balance is due.
The Note is collateralized by the shares issued to CBHCC under the Agreement.
The Note was discounted at 11% and is recorded as a reduction of stockholders'
equity. Due to the change in market value of the shares collateralizing the
loan, a valuation allowance of $5,362,804 and $4,666,755 was recorded as of
November 30, 1999 and 1998.
M-22
57
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
NOTE N - EMPLOYEE BENEFIT PLANS
The Company maintains a 401(k) profit sharing plan that covers substantially all
of its employees in the quick-service restaurant business. Contributions to the
plan may be made by the Company (which are discretionary) or by plan
participants through elective salary reductions. Contributions to the plan by
the Company totaled $24,830, $27,720, and $2,000 in 1999, 1998 and 1997,
respectively.
NOTE O - OTHER INCOME
Other income of $509,590 in 1998 consisted primarily of income from the
forfeiture of an earnest deposit in the amount of $500,000 on a contract to sell
one of the Company's hotel properties.
NOTE P - STOCK OPTION PLANS
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. The
Board of Directors has the discretion to designate an option to be an incentive
share option or a non-qualified share option. The plan provides that the option
price is not less than the fair market value of the common stock at the date of
grant. Unless the option agreement provides otherwise, options granted under the
plan become exercisable on a cumulative basis at the rate of 20 percent during
each of the second through sixth years after the date of grant. Options granted
under the plan may have a term of from one to ten years.
The 1996 Directors' Share Option Plan, as amended, provides for the
non-discretionary grant of options to non-employee directors of the Company to
purchase a combined maximum of 120,000 shares. The plan provides that the option
price is the fair market value of the common stock on the date of grant. The
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
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. Options
granted under the plan have a term of ten years.
M-23
58
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
NOTE P - STOCK OPTION PLANS (CONTINUED)
The following table summarizes the changes in the number of common shares under
stock options granted pursuant to the preceding plans:
1996 MANAGEMENT 1996 DIRECTORS'
EQUITY INCENTIVE PLAN STOCK OPTION PLAN
----------------------------------- ------------------------------
AVERAGE OPTION AVERAGE OPTION
SHARES UNDER PRICE SHARES UNDER PRICE
OPTIONS PER SHARE OPTIONS PER SHARE
----------------- --------------- -------------- --------------
Outstanding at
December 1, 1996 190,000 50,000
Granted during 1997 143,500 6,000
Forfeited during 1997 (35,000) -
------- ------
Outstanding at
November 30, 1997 298,500 $7.00 56,000 $4.00
Granted during 1998 147,500 ===== 18,000 =====
Forfeited during 1998 (178,500) -
------- ------
Outstanding at
November 30, 1998 267,500 $3.50 74,000 $1.40
Granted during 1999 161,534 ===== 5,000 =====
Forfeited during 1999 - (5,000)
------- ------
Outstanding at
November 30, 1999 429,034 $1.91 74,000 $2.00
======= ===== ====== =====
Exercisable at:
November 30, 1997 28,500 56,000
======= ======
November 30, 1998 48,500 74,000
======= ======
November 30, 1999 97,500 74,000
======= ======
Available for grant at:
November 30, 1997 176,500 64,000
======= ======
November 30, 1998 457,500 46,000
======= ======
November 30, 1999 295,966 46,000
======= ======
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.
M-24
59
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
NOTE P - STOCK OPTION PLANS (CONTINUED)
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 1999, 1998 and 1997: dividend yield of 0%, expected
volatility ranging from 75.3% - 78.0% in 1999, 81.6% - 83.6% in 1998 and 10.5% -
63.4% in 1997, risk-free interest rates ranging from 5.4% - 6.6% in 1999, 4.8% -
5.8% in 1998 and 6.2% - 7.0% in 1997 and expected life of ten years.
The Company has not adopted the 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.
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 earnings (loss) per share would
have been as follows:
YEARS ENDED NOVEMBER 30,
------------------------
1999 1998 1997
---------- ----------- ------------
Net earnings (loss)
As reported $ 471,708 $ 1,130,702 $(1,690,850)
Pro forma $ 194,052 $ 955,272 $(2,196,909)
Earnings (loss) per share
As reported $ .08 $ .21 $ (0.56)
Pro forma $ .03 $ .17 $ (0.72)
NOTE Q - COMMITMENTS AND CONTINGENCIES
The Company has a forward commitment in the amount of $3,750,000 to finance the
land, building and equipment for three additional restaurants. This commitment
is for 20 year real estate mortgages and 7 year equipment loans at an interest
rate equal to 2.2% over the then current same term treasury rate. The Company
has no obligation to utilize this financing.
M-25
60
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
NOTE Q - COMMITMENTS AND CONTINGENCIES (CONTINUED)
Uncertainty due to Year 2000 Issue - The Year 2000 Issue arises because many
computerized systems use two digits rather than four to identify a year.
Date-sensitive systems may recognize the year 2000 as 1900 or some other date,
resulting in errors when information using year 2000 dates is processed. In
addition, similar problems may arise in some systems which use certain dates in
1999 to represent something other than a date. The effects of the Year 2000
Issue may be experienced before, on, or after January 1, 2000, and, if not
addressed, the impact on operations and financial reporting may range from minor
errors to significant systems failure which could affect an entity's ability to
conduct normal business operations. It is not possible to be certain that all
aspects of the year 2000 Issue affecting the entity, including those related to
the efforts of customers, suppliers, or other third parties, will be fully
resolved.
NOTE R - LEGAL PROCEEDINGS
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.
M-26
61
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
MERITAGE HOSPITALITY GROUP INC.
CONDENSED BALANCE SHEET
NOVEMBER 30, 1997
ASSETS
Current assets:
Cash and cash equivalents $ 118,716
Receivable from sale of subsidiary's assets 3,187,782
Other current assets 29,025
------------
Total current assets 3,335,523
Property, plant and equipment, net 301,952
Investments in and advances to subsidiaries 17,455,533
Deferred income taxes 550,000
Other assets 402,281
------------
Total assets $ 22,045,289
============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Current Liabilities:
Current portion of long-term debt $ 4,438,776
Other current liabilities 377,532
------------
Total current liabilities 4,816,308
Deferred income taxes 740,000
Long-term debt 16,459,020
------------
Total liabilities 22,015,328
STOCKHOLDERS' EQUITY
Capital stock 7,315,222
Accumulated deficit (7,285,261)
------------
Total stockholders' equity 29,961
------------
Total liabilities and stockholders' equity $ 22,045,289
============
M-27
62
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
MERITAGE HOSPITALITY GROUP INC.
CONDENSED STATEMENT OF OPERATIONS
YEAR ENDED NOVEMBER 30, 1997
REVENUE
Equity in earnings of subsidiaries $ 2,595,397
Interest and dividend income 579,394
-----------
Total revenue 3,174,791
EXPENSES
General and administrative expenses 1,948,781
Depreciation and amortization 292,300
Interest expense 2,462,269
-----------
Total expenses 4,703,350
-----------
Loss before federal income tax (1,528,559)
Federal income tax benefit (15,000)
-----------
Loss before extraordinary item (1,513,559)
Extraordinary item - loss on early extinguishment
of debt (no applicable federal income tax) 177,291
-----------
Net loss (1,690,850)
Preferred stock dividends 101,714
-----------
Net loss on common shares $(1,792,564)
===========
M-28
63
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
MERITAGE HOSPITALITY GROUP INC.
CONDENSED STATEMENT OF CASH FLOWS
YEAR ENDED NOVEMBER 30, 1997
NET CASH USED IN OPERATING ACTIVITIES $(2,429,935)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property, plant and equipment (35,166)
Decrease in other assets 149,136
-----------
Net cash provided by investing activities 113,970
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term debt 750,000
Principal payments of long-term debt (295,328)
Proceeds from issuance of preferred and common shares 313,519
Dividends paid (101,714)
-----------
Net cash provided by financing activities 666,477
-----------
Net decrease in cash (1,649,488)
Cash and cash equivalents - beginning of year 1,768,204
-----------
Cash and cash equivalents - end of year $ 118,716
===========
M-29
64
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Additions
-----------------------------------
Balance at (1) (2)
beginning Charged to Charged to other Deductions- Balance at
Description of period Cost & Expenses accounts-describe describe end of period
- ----------------------------------------------------------------------------------------------
VALUATION ALLOWANCE FOR DEFERRED TAX ASSETS:
Year ended November 30:
1999 $608,000 -0- $ (60,000)* -0- $548,000
1998 970,000 -0- (362,000)* -0- 608,000
1997 729,000 -0- 241,000* -0- 970,000
* Increase (decrease) to adjust allowance to the amount of net deferred taxes.
M-30
65
INDEPENDENT AUDITORS' REPORT
To the Partners
Wendy's of West Michigan
Limited Partnership
Kalamazoo, Michigan
We have audited the accompanying balance sheets of Wendy's of West Michigan
Limited Partnership as of November 30, 1997 and 1996, and the related statements
of income, changes in partners' equity and cash flows for the year ended
November 30, 1997, eleven months ended November 30, 1996 and year ended December
31, 1995. These financial statements are the responsibility of the Partnership's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit 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 financial position of Wendy's of West Michigan
Limited Partnership at November 30, 1997 and 1996, and the results of its
operations and its cash flows for the year ended November 30, 1997, eleven
months ended November 30, 1996 and year ended December 31, 1995, in conformity
with generally accepted accounting principles.
January 9, 1998, except for Notes 6 and 7
which are as of January 30, 1998
W-1
66
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
BALANCE SHEETS
- --------------------------------------------------------------------------------
November 30, 1997 1996
- --------------------------------------------------------------------------------------------
ASSETS (Note 3)
CURRENT ASSETS
Cash $ 601,562 $ 394,066
Receivables, including amounts due from related parties 258,282 215,879
Inventories 156,746 180,250
Prepaid expenses 149,003 125,445
- --------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 1,165,593 915,640
- --------------------------------------------------------------------------------------------
PROPERTY AND EQUIPMENT
Land 749,000 749,000
Leasehold improvements 2,144,520 2,192,253
Buildings and improvements 2,398,127 2,398,127
Furnishings and equipment 4,893,418 4,296,289
Vehicles 79,734 79,734
Leased property under capital leases (Note 4) 2,825,338 2,825,338
- --------------------------------------------------------------------------------------------
13,090,137 12,540,741
Less accumulated depreciation and amortization 7,236,594 6,643,697
- --------------------------------------------------------------------------------------------
NET PROPERTY AND EQUIPMENT 5,853,543 5,897,044
- --------------------------------------------------------------------------------------------
OTHER ASSETS
Goodwill, net of amortization of $2,179,320
and $1,981,200 1,782,967 1,981,087
Franchise fees, net of amortization of $406,552
and $395,488 153,448 154,512
Other 70,130 127,404
- --------------------------------------------------------------------------------------------
TOTAL OTHER ASSETS 2,006,545 2,263,003
- --------------------------------------------------------------------------------------------
$ 9,025,681 $ 9,075,687
============================================================================================
W-2
67
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
BALANCE SHEETS
- --------------------------------------------------------------------------------
November 30, 1997 1996
- --------------------------------------------------------------------------------------------
LIABILITIES AND PARTNERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 591,773 $ 770,770
Accruals:
Salaries and wages 368,611 349,320
Taxes 258,854 267,698
Percentage rent 88,086 107,257
Other current liabilities, including amounts due to
related parties 51,492 38,546
Current maturities of long-term debt (Note 3) 126,294 -
Current maturities of obligations under capital leases
(Note 4) 264,372 232,442
- --------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 1,749,482 1,766,033
DEFERRED COMPENSATION (Note 2) - 61,444
OBLIGATIONS UNDER CAPITAL LEASES, less current
maturities (Note 4) 1,689,628 1,953,999
LONG-TERM DEBT, less current maturities (Note 3) 2,059,411 2,192,351
- --------------------------------------------------------------------------------------------
TOTAL LIABILITIES 5,498,521 5,973,827
- --------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES (Notes 1, 4, 5, 6 and 7)
PARTNERS' EQUITY (Note 1)
Limited Partners 3,551,822 3,130,775
General Partner (24,662) (28,915)
- --------------------------------------------------------------------------------------------
TOTAL PARTNERS' EQUITY 3,527,160 3,101,860
- --------------------------------------------------------------------------------------------
$ 9,025,681 $ 9,075,687
============================================================================================
See accompanying notes to financial statements.
W-3
68
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
STATEMENTS OF INCOME
- --------------------------------------------------------------------------------
Eleven
YEAR ENDED months ended Year ended
NOVEMBER 30, November 30, December 31,
1997 1996 1995
- ----------------------------------------------------------------------------------------------------------
NET SALES $ 26,860,546 $ 24,438,338 $ 25,364,596
COST OF SALES 7,672,613 7,222,691 7,390,886
- ----------------------------------------------------------------------------------------------------------
Gross profit 19,187,933 17,215,647 17,973,710
- ----------------------------------------------------------------------------------------------------------
EXPENSES (INCOME)
Restaurant operating costs, including amounts to
related parties:
Labor 7,547,115 6,747,046 6,962,082
Occupancy 2,785,973 2,555,026 2,526,139
Advertising 1,638,409 1,535,930 1,519,903
Food service supplies 1,075,263 1,008,536 1,087,791
Royalties 1,074,427 977,508 1,014,569
Other 2,058,380 1,838,291 1,988,597
- ----------------------------------------------------------------------------------------------------------
Total restaurant operating costs 16,179,567 14,662,337 15,099,081
General and administrative expenses, including
amounts to related parties 1,362,199 1,046,177 1,250,468
Depreciation and amortization 858,563 768,653 852,803
Interest expense 431,684 403,435 511,939
Loss on disposal of assets (Note 1) 218,601 25,453 1,097
Other income (287,981) (249,260) (236,309)
Insurance proceeds in excess of net book value
of fire damaged assets - - (32,377)
- ----------------------------------------------------------------------------------------------------------
Net expenses 18,762,633 16,656,795 17,446,702
- ----------------------------------------------------------------------------------------------------------
Income before extraordinary item 425,300 558,852 527,008
EXTRAORDINARY ITEM - loss on
extinguishment of debt - - (20,536)
- ----------------------------------------------------------------------------------------------------------
NET INCOME $ 425,300 $ 558,852 $ 506,472
==========================================================================================================
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69
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
STATEMENTS OF INCOME
- --------------------------------------------------------------------------------
Eleven
YEAR ENDED months ended Year ended
NOVEMBER 30, November 30, December 31,
1997 1996 1995
- ----------------------------------------------------------------------------------------------------------
Net income attributed to:
Limited Partners $421,047 $553,263 $501,407
General Partner 4,253 5,589 5,065
- ----------------------------------------------------------------------------------------------------------
$425,300 $558,852 $506,472
==========================================================================================================
Income before extraordinary item per unit of limited
partnership interest (1,256.8 units outstanding) $ 335.02 $ 440.22 $ 415.14
==========================================================================================================
Extraordinary item - loss on extinguishment of debt
per unit of limited partnership interest (1,256.8
units outstanding) $ - $ - $ (16.18)
==========================================================================================================
Net income per unit of limited partnership interest
(1,256.8 units outstanding) $ 335.02 $ 440.22 $ 398.96
==========================================================================================================
See accompanying notes to financial statements.
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
STATEMENTS OF CHANGES IN PARTNERS' EQUITY
- --------------------------------------------------------------------------------
Limited General
Partners Partner Total
- ----------------------------------------------------------------------------
BALANCE, January 1, 1995 $ 2,955,865 $ (30,682) $ 2,925,183
Net income for the year 501,407 5,065 506,472
Distributions to partners (565,560) (5,713) (571,273)
- ----------------------------------------------------------------------------
BALANCE, December 31, 1995 2,891,712 (31,330) 2,860,382
Net income for the period 553,263 5,589 558,852
Distributions to partners (314,200) (3,174) (317,374)
- ----------------------------------------------------------------------------
BALANCE, November 30, 1996 3,130,775 (28,915) 3,101,860
Net income for the year 421,047 4,253 425,300
- ----------------------------------------------------------------------------
BALANCE, November 30, 1997 $ 3,551,822 $ (24,662) $ 3,527,160
============================================================================
See accompanying notes to financial statements.
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71
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
Eleven
YEAR ENDED months ended Year ended
NOVEMBER 30, November 30, December 31,
1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 425,300 $ 558,852 $ 506,472
Adjustments to reconcile net income to net cash
from operating activities:
Loan costs written off due to refinancing - - 20,536
Loan costs incurred due to refinancing - - (31,477)
Depreciation and amortization 858,563 768,653 852,803
Loss on disposal of property and equipment 218,601 25,453 1,097
Undepreciated cost of equipment destroyed
by fire - - 1,194
Decrease (increase) in cash value of
life insurance 61,444 (61,444) -
Increase (decrease) in deferred compensation (61,444) 61,444 -
Changes in operating assets and liabilities:
Receivables (42,403) (161,992) 13,681
Inventories 23,504 (34,443) 16,968
Prepaid expenses (23,558) 13,757 25,429
Accounts payable (178,997) (14,585) (8,681)
Accrued salaries and wages 19,291 44,276 21,391
Accrued taxes (8,844) (26,007) (35,821)
Accrued percentage rent (19,171) 27,441 (6,580)
Other current liabilities 12,946 (417) (11,234)
- -------------------------------------------------------------------------------------------------------
Net cash from operating activities 1,285,232 1,200,988 1,365,778
- -------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Proceeds from disposal of property and equipment - 5,449 122,500
Additions to property and equipment (572,906) (427,872) (471,092)
Payment of franchise fees (10,000) - (50,000)
Purchase of other assets (11,106) (8,784) -
- -------------------------------------------------------------------------------------------------------
Net cash for investing activities (594,012) (431,207) (398,592)
- -------------------------------------------------------------------------------------------------------
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
Eleven
YEAR ENDED months ended Year ended
NOVEMBER 30, November 30, December 31,
1997 1996 1995
- -------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Proceeds from long-term debt $ - $ - $ 2,022,499
Repayment of short-term notes payable - - (102,724)
Repayment of long-term debt (251,282) (307,989) (2,537,612)
Payments made on obligations under capital leases (232,442) (161,550) (142,920)
Distributions to partners -- (317,374) (571,273)
- -------------------------------------------------------------------------------------------------------
Net cash for financing activities (483,724) (786,913) (1,332,030)
- -------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH 207,496 (17,132) (364,844)
CASH, beginning of period 394,066 411,198 776,042
- -------------------------------------------------------------------------------------------------------
CASH, end of period $ 601,562 $ 394,066 $ 411,198
=======================================================================================================
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION
Cash paid for interest expense $ 437,014 $ 408,680 $ 499,673
=======================================================================================================
NONCASH INVESTING AND FINANCING TRANSACTIONS
Long-term debt incurred for purchase of
equipment $ 244,637 $ - $ -
Capital lease obligation incurred for use
of equipment - 379,591 -
Retirement of note payable - bank with new
revolving term note payable - bank - - 1,331,221
=======================================================================================================
See accompanying notes to financial statements.
W-8
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SUMMARY OF ORGANIZATION
SIGNIFICANT
ACCOUNTING Wendy's of West Michigan Limited Partnership
POLICIES (Partnership) is a Michigan limited partnership
organized on July 31, 1986. The Partnership presently
operates 25 Wendy's Old Fashioned Hamburger restaurants
in western Michigan under franchise agreements with
Wendy's International, Inc. In August 1997, the
Partnership closed one of its restaurants due to
continuing operating losses. As a result of this
restaurant closing and the Partnership not exercising
its option to extend its lease of the restaurant
building, the Partnership incurred a loss on disposal of
assets of $197,102.
Subject to the consent of the Limited Partners where
required by the Partnership Agreement, the General
Partner has the exclusive right to manage the
Partnership. The Limited Partners are not liable for
Partnership debts beyond the amount of their original
contributions and share of undistributed net profits.
The financial statements do not reflect assets the
partners may have outside their interests in the
partnership, nor any personal obligations, including
income taxes, of the individual partners.
The Partnership Agreement provides that the Limited
Partners (as a group) are to share in 99% of the
Partnership's net income or loss, except as discussed in
the following paragraph, and receive 99% of all cash
flow from operations as defined by the Partnership
Agreement.
The net profits of the Partnership arising from the sale
or other disposition, whether as a result of
foreclosure, condemnation or otherwise, of all or part
of the property, shall be allocated among the Partners
in accordance with the provisions of the Partnership
Agreement.
W-9
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
A Partnership administration fee is payable to the
General Partner equal to 2% of gross partnership
revenues from operations, as defined in the Partnership
Agreement. The General Partner has elected to reduce the
Partnership administration fee to the General Partner
from 2% of gross partnership revenues from operations to
$160,000, $146,667 and $160,000 for 1997, 1996 and 1995,
respectively.
The Partnership shall exist until December 31, 2026,
unless terminated sooner as provided in the Partnership
Agreement (see Note 7). A Limited Partner may, in
accordance with the agreement, assign his/her interest
in the Partnership by a properly executed and
acknowledged instrument, the terms of which are not
inconsistent with or contrary to the provisions of the
Partnership Agreement and are otherwise satisfactory to
the General Partner, subject to the approval of the
General Partner.
During the period ended November 30, 1996, MHG Food
Service Inc. (MHG), a wholly owned subsidiary of
Meritage Hospitality Group Inc. (Meritage), acquired
680.8 units of limited partnership interest,
representing approximately 54% of the outstanding
limited partner units. As a result, the Partnership
changed its fiscal year-end to November 30 to conform
with Meritage's fiscal year-end.
CONCENTRATION OF CREDIT RISK
Competition in the quick-service restaurant industry is
intense. Most of the Partnership's restaurants are in
close proximity to other quick-service restaurants which
compete on the basis of price, service and product
quality and variety. The General Partner believes that
the Partnership competes effectively in these areas.
W-10
75
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
USE OF ESTIMATES
The preparation of financial statements in conformity
with generally accepted accounting principles requires
management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the
date of the financial statements and the reported
amounts of revenues and expenses during the reporting
period. Actual results could differ from those
estimates.
INVENTORIES
Inventories are stated at the lower of cost (first-in,
first-out) or market. Inventories consist of restaurant
food items and food serving supplies.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Expenditures
for renewals and betterments which extend the originally
estimated economic life of assets are capitalized.
Expenditures for maintenance or repairs are charged to
expense when incurred. For financial reporting purposes,
depreciation is computed using the straight-line method
over the estimated economic lives of the assets. For tax
purposes, useful lives and methods are used as permitted
by the Internal Revenue Code. Amortization of leasehold
improvements is provided over the primary terms of the
various leases.
ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS
In 1995, the Partnership adopted Statement of Financial
Accounting Standards (SFAS) No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of. This statement requires that
long-lived assets and certain identifiable intangibles
to be held and used by an entity be
W-11
76
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an
asset may not be recoverable. This statement also
requires that long-lived assets and certain identifiable
intangibles to be disposed of be reported at the lower
of carrying amount or fair value less cost to sell. This
new accounting standard had no impact on the financial
statements.
OTHER ASSETS
Franchise fees for restaurant units are being amortized
over the terms of the individual restaurant franchise
agreements. Loan costs are being amortized over 120
months, the period of the loan. All amortization is
under the straight-line method.
The excess of cost over fair value of net assets
acquired (goodwill) is being amortized on the
straight-line method over 240 months. Amortization
expense for goodwill for the periods 1997, 1996 and 1995
amounted to $198,120, $181,610 and $198,120,
respectively. The Partnership evaluates the
recoverability of the goodwill whenever events or
changes in circumstances indicate that the carrying
amount of goodwill may not be recoverable and considers
whether the goodwill should be completely or partially
written off or the amortization period accelerated. The
Partnership assesses the recoverability of goodwill
based on undiscounted estimated future operating cash
flows. If the Partnership determines that the carrying
value of the goodwill has been impaired, the measurement
of the impairment will be based on discounted estimated
future operating cash flows.
FRANCHISE COSTS AND OTHER ADVERTISING COSTS
Royalties and national advertising costs are based on a
percentage of monthly sales. These costs and other
advertising costs are charged to operations as incurred.
W-12
77
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
CAPITALIZED LEASE OBLIGATIONS
Lease transactions relating to certain restaurant
buildings and equipment are classified as capital
leases. These assets have been capitalized and the
related obligations recorded based on the fair market
value of the assets at the inception of the leases.
Amounts capitalized are being amortized over the terms
of the leases.
INCOME TAXES
No provision for income taxes has been made in the
accompanying financial statements. A Partner's share of
the income or loss of the Partnership is includable in
the individual tax returns of the Partners.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of the Partnership's financial
instruments, consisting of cash, receivables, accounts
payable and long-term debt, approximate their fair
value.
2. DEFERRED The Partnership had a deferred compensation agreement
COMPENSATION with a key employee which provided for the payment of
$150,000 upon the completion of the five-year term of
the agreement in December 1998. The agreement was funded
by the Partnership through payment of premiums on a
split dollar life insurance contract. The agreement was
terminated in April 1997. Charges to operations related
to this agreement were $10,630, $27,913 and $25,295 for
1997, 1996 and 1995, respectively.
W-13
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
3. LONG-TERM DEBT Long-term debt at November 30, 1997 and 1996 consisted
of the following:
November 30, 1997 1996
----------------------------------------------------------------
Revolving term note payable - bank $2,037,111 $2,192,351
Equipment note payable 148,594 -
----------------------------------------------------------------
2,185,705 2,192,351
Less current maturities 126,294 -
----------------------------------------------------------------
Long-term debt, less
current maturities $2,059,411 $2,192,351
================================================================
The revolving term note payable - bank is secured by
substantially all assets of the Partnership and by the
unsecured corporate guaranty of Meritage. The loan
agreement requires monthly payments of $43,313,
including interest at 1% over prime (effectively 9.5% at
November 30, 1997) through February 2005 when any
remaining unpaid principal will be due. Under the
revolving loan agreement, the required monthly payments
described above may be offset by additional borrowings
up to the unused available borrowings. The total
available borrowings under the loan agreement were
$2,727,802 as of November 30, 1997. The total available
borrowings decrease monthly based on the original term
note amortization over 120 months. The loan agreement
also requires that the Partnership maintain certain cash
availability, financial ratios and a minimum tangible
net worth, as defined in the loan agreement, of
approximately $968,000. The Partnership was in
compliance with these covenants at November 30, 1997.
The loan agreement also requires that the Partnership
not exceed $400,000 of capital expenditures in any one
year. During 1997, the Partnership's capital
expenditures exceeded the covenant. The bank agreed to
waive the covenant for 1997.
W-14
79
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The equipment note payable is unsecured and requires
monthly payments of $11,290, including interest at 10%
through January 1999.
The following is a schedule by year of annual maturities
under the loan agreements:
Year ending November 30,
-----------------------------------------------
1998 $ 126,294
1999 22,300
2000 232,940
2001 375,677
2002 415,587
Later years 1,012,907
-----------------------------------------------
$ 2,185,705
===============================================
4. DESCRIPTION OF The Partnership leases land and buildings used in
LEASING operations under operating agreements, with remaining
ARRANGEMENTS lease terms (including renewal options of up to thirteen
(INCLUDING THOSE years) ranging from one to twenty-three years. Included
WITH AFFILIATED in the leases are five leases with parties related
PARTNERSHIP) through common ownership with the former general
partner. (See Note 6.)
W-15
80
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Total lease expense (including taxes, insurance and
maintenance when included in rent) related to all
operating leases and all percentage rentals is as
follows:
Period ended 1997 1996 1995
-------------------------------------------------------------------------
Leases with related parties:
Minimum rentals $ 143,127 $ 266,358 $ 230,848
Percentage rentals 79,948 168,370 150,867
Other leases:
Minimum rentals 583,365 403,613 414,539
Percentage rentals 459,463 275,993 309,228
-------------------------------------------------------------------------
$1,265,903 $1,114,334 $1,105,482
=========================================================================
Certain restaurant leases (eight restaurant buildings,
excluding land which is accounted for as an operating
lease) and equipment leases have been capitalized.
Minimum future obligations under capital leases and
noncancelable operating leases in effect are as follows:
Capital Operating
Year ending November 30, leases leases
----------------------------------------------------------------
1998 $ 465,323 $ 590,008
1999 465,323 445,516
2000 465,323 430,693
2001 449,365 409,622
2002 369,575 332,490
Later years 400,373 308,263
----------------------------------------------------------------
Total minimum lease obligations 2,615,282 $2,516,592
==========
Less amount representing interest
imputed at approximately 11% 661,282
--------------------------------------------------
Present value of minimum
lease obligations $1,954,000
==================================================
W-16
81
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The present value of minimum rental obligations is
reflected in the balance sheets as current and long-term
obligations under capital leases.
Accumulated amortization of leased property under
capital leases was $1,814,346 and $1,648,146 at November
30, 1997 and 1996, respectively.
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.
5. PROFIT-SHARING The Partnership maintains a 401(k) profit-sharing plan.
PLAN The plan covers substantially all employees of the
Partnership who are at least 21 years old and who have
completed at least one year of service (of at least
1,000 hours) with the Partnership. Contributions to the
plan may be made by the Partnership (which are purely
discretionary in nature) or by plan participants through
elective salary deductions. Contributions to the plan by
the Partnership for the periods ended 1997, 1996 and
1995, totaled $22,000, $30,721 and $12,000,
respectively.
6. LEGAL PROCEEDINGS On May 19, 1997, a majority limited interest of the
Partnership removed Wendy's West Michigan, Inc. as
general partner of the Partnership and appointed MCC
Food Service Inc. (MCC), an affiliate of Meritage, as
the substitute general partner. Approximately 180 unit
holders (from whom MHG Food Service Inc. (MHG) acquired
482.55 of its total partnership units) had previously
consented to the removal and substitution of the former
general partner. This action was carried out in
connection with MHG's prior acquisition of a controlling
interest in the Partnership. The former general partner
subsequently commenced a lawsuit against Meritage and
its affiliates seeking, among other things, (i) a
declaration that Wendy's West Michigan, Inc. is the
general partner of the Partnership, (ii) injunctive
relief in the form of a temporary restraining order or a
preliminary injunction which
W-17
82
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
would prohibit the defendants from participating in the
management of the Partnership, (iii) unspecified damages
for breach of contract, and (iv) unspecified damages for
various business torts and misrepresentation. The former
general partner's motion for a temporary restraining
order was denied on May 21, 1997. In September 1997, the
Partnership, Meritage and certain of its affiliates
filed claims against the former general partner and its
principal shareholders alleging (i) breach of contract,
(ii) violation of SEC Rule 10b-5, (iii) business
defamation, (iv) tortious interference, and (v) breach
of fiduciary duty. In January 1998, the former general
partner filed a motion to enjoin the dissolution of the
Partnership. The court denied this motion and the
Partnership was thereafter dissolved on January 30,
1998. Wendy's International, the franchisor, has
consented to MCC serving as the general partner of the
Partnership and to the dissolution of the Partnership.
Management believes there is no basis for the
Plaintiffs' claims but cannot at this time predict the
likely outcome of this litigation. It is management's
opinion that these proceedings are not expected to have
a material adverse effect on the Partnership's
operations or financial position.
7. DISSOLUTION OF Through the filing of Form S-4 with the Securities and
PARTNERSHIP Exchange Commission, which was effective on November 25,
1997, the holders of limited partnership units of the
Partnership were notified of the sale of all the assets
of the Partnership to a limited partnership affiliated
with Meritage and the subsequent dissolution of the
Partnership. As a result of the transaction, on January
30, 1998, the newly formed limited partnership acquired
all the assets and assumed all the liabilities of the
Partnership and succeeded to all business operations
that had been conducted by the Partnership. Upon
dissolution, Meritage common shares were distributed to
non-affiliated limited partners on the basis of that
number of Meritage common shares that had a value of
$7,500 per unit, based on the average high and low bid
price quoted on the OTC Bulletin Board for the 10
trading days preceding the date of dissolution ($2.4375
per share).
W-18