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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the quarterly period ended August 31, 2000.
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 No.)
of Incorporation or Organization)
40 PEARL STREET, N.W., SUITE 900
GRAND RAPIDS, MICHIGAN 49503
(Address of Principal Executive Offices) (Zip Code)
(616) 776-2600
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities and Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES [X] NO [ ]
As of October 9, 2000 there were 4,388,217 outstanding Common Shares, $.01 par
value.
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SAFE HARBOR STATEMENT
Certain statements contained in this report that are not historical
facts constitute forward-looking statements, within the meaning of the Private
Securities Litigation Reform Act of 1995, and are intended to be covered by the
safe harbors created by that Act. Reliance should not be placed on
forward-looking statements because they involve known and unknown risks,
uncertainties and other factors which may cause actual results, performance or
achievements to differ materially from those expressed or implied. Any
forward-looking statement speaks only as of the date made. The Company
undertakes no obligation to update any forward-looking statements to reflect
events or circumstances after the date on which they are made.
Statements concerning expected financial performance, on-going business
strategies and actions which the Company intends to pursue to achieve strategic
objectives constitute forward-looking information. Implementation of these
strategies and the achievement of such financial performance are subject to
numerous conditions, uncertainties and risk factors. Factors which could cause
actual performance to differ materially from these forward looking statements
include, without limitation, competition; changes in local and national economic
conditions; changes in consumer tastes and views about quick-service food;
severe weather; changes in travel patterns; increases in food, labor and energy
costs; the availability and cost of suitable restaurant sites; the ability to
finance expansion; fluctuating interest rates; fluctuating insurance rates; the
availability of adequate employees; directives issued by the franchisor; the
general reputation of Wendy's restaurants; and the recurring need for renovation
and capital improvements. Also, the Company is subject to extensive government
regulations relating to, among other things, zoning, minimum wage, public health
certification, and the operation of its restaurants. Because the Company's
operations are concentrated in smaller urban areas of Michigan, a marked decline
in the Michigan economy could adversely affect its operations.
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
The following unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not contain all the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation of
the financial position, results of operations, stockholders' equity and cash
flows of the Company have been included. For further information, please refer
to the consolidated financial statements and footnotes thereto included in the
Company's Annual Report on Form 10-K for the fiscal year ended November 30,
1999. The results of operations for the three and nine month periods ended
August 31, 2000 are not necessarily indicative of the results to be expected for
the full year.
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AUGUST 31, 2000 AND NOVEMBER 30, 1999
- --------------------------------------------------------------------------------
ASSETS
AUGUST 31,
2000 NOVEMBER 30,
(UNAUDITED) 1999
----------- ------------
CURRENT ASSETS
Cash and cash equivalents $ 1,045,882 $ 1,578,914
Receivables 85,282 81,239
Notes receivable, current portion - 475,000
Inventories 209,192 207,563
Prepaid expenses and other current assets 177,110 157,413
----------- -----------
Total current assets 1,517,466 2,500,129
PROPERTY, PLANT AND EQUIPMENT, NET 19,469,993 16,683,959
OTHER ASSETS
Goodwill, net of amortization of $471,434 and
$335,287, respectively 4,838,289 4,974,436
Franchise fees, net of amortization of $58,756
and $40,167, respectively 716,244 684,833
Financing costs, net of amortization of $33,147 and
and $17,808, respectively 366,911 318,385
Other assets 82,576 39,657
----------- -----------
Total other assets 6,004,020 6,017,311
----------- -----------
Total assets $26,991,479 $25,201,399
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SEE NOTES TO UNAUDITED FINANCIAL STATEMENTS.
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - CONTINUED
AUGUST 31, 2000 AND NOVEMBER 30, 1999
- --------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
AUGUST 31,
2000 NOVEMBER 30,
(UNAUDITED) 1999
----------- ------------
CURRENT LIABILITIES
Current portion of long-term obligations $ 529,455 $ 874,051
Current portion of obligations under capital lease 355,492 328,236
Trade accounts payable 1,317,891 1,245,679
Income taxes payable -- 5,000
Accrued liabilities 1,245,049 1,145,756
----------- -----------
Total current liabilities 3,447,887 3,598,722
LONG-TERM OBLIGATIONS 15,519,809 12,822,125
OBLIGATIONS UNDER CAPITAL LEASE 796,739 1,066,814
DEFERRED REVENUE 1,876,940 1,830,788
COMMITMENTS AND CONTINGENCIES -- --
STOCKHOLDERS' EQUITY
Preferred stock - $0.01 par value
shares authorized: 5,000,000; 200,000 designated
as Series A convertible cumulative preferred stock
shares issued and outstanding: 42,020 and 44,520, respectively
(liquidation value - $420,200 and $445,200, respectively) 420 445
Common stock - $0.01 par value
shares authorized: 30,000,000
shares issued: 5,793,825 and 5,752,677, respectively
shares outstanding: 5,778,865 and 5,751,877, respectively 57,788 57,519
Additional paid in capital 13,346,604 13,316,795
Note receivable from the sale of shares, net of valuation
allowance of $5,929,961 and $5,362,804, respectively (1,660,962) (1,660,962)
Accumulated deficit (6,393,746) (5,830,847)
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Total stockholders' equity 5,350,104 5,882,950
----------- -----------
Total liabilities and stockholders' equity $26,991,479 $25,201,399
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SEE NOTES TO UNAUDITED FINANCIAL STATEMENTS.
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE NINE MONTH PERIODS ENDED AUGUST 31,
(UNAUDITED)
- --------------------------------------------------------------------------------
2000 1999
----------- -----------
FOOD AND BEVERAGE REVENUE $24,201,286 $22,003,792
COSTS AND EXPENSES
Cost of food and beverages 7,065,037 6,357,974
Operating expenses 14,359,773 12,720,471
General and administrative expenses 1,484,533 1,304,856
Depreciation and amortization 1,139,808 952,987
----------- -----------
Total costs and expenses 24,049,151 21,336,288
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EARNINGS FROM OPERATIONS 152,135 667,504
OTHER INCOME (EXPENSE)
Interest expense (983,337) (1,006,170)
Interest income 86,811 354,392
Other income 66,000 --
Gain on disposal of assets 142,167 297,227
----------- -----------
Total other expense (688,359) (354,551)
----------- -----------
Earnings (loss) from continuing operations (536,224) 312,953
EARNINGS FROM DISCONTINUED OPERATIONS -- 70,800
----------- -----------
Net earnings (loss) (536,224) 383,753
DIVIDENDS ON PREFERRED STOCK 26,675 30,051
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NET EARNINGS (LOSS) ON COMMON SHARES $ (562,899) $ 353,702
=========== ===========
NET EARNINGS (LOSS) PER COMMON SHARE - BASIC AND DILUTED
Continuing operations $ (0.10) $ 0.05
Discontinued operations -- 0.01
----------- -----------
Net earnings (loss) $ (0.10) $ 0.06
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WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC 5,754,089 5,746,905
=========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED 5,754,089 5,767,049
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SEE NOTES TO UNAUDITED FINANCIAL STATEMENTS.
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTH PERIODS ENDED AUGUST 31,
(UNAUDITED)
- --------------------------------------------------------------------------------
2000 1999
---------- ----------
FOOD AND BEVERAGE REVENUE $8,833,729 $7,983,256
COSTS AND EXPENSES
Cost of food and beverages 2,643,443 2,287,957
Operating expenses 5,282,724 4,526,050
General and administrative expenses 474,199 458,345
Depreciation and amortization 410,503 330,138
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Total costs and expenses 8,810,869 7,602,490
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EARNINGS FROM OPERATIONS 22,860 380,766
OTHER INCOME (EXPENSE)
Interest expense (339,927) (336,822)
Interest income 12,272 104,802
Gain on disposal of assets 95,000 --
---------- ----------
Total other expense (232,655) (232,020)
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Net earnings (loss) (209,795) 148,746
DIVIDENDS ON PREFERRED STOCK 6,641 10,017
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NET EARNINGS (LOSS) ON COMMON SHARES $ (216,436) $ 138,729
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NET EARNINGS (LOSS) PER COMMON SHARE - BASIC AND DILUTED $ (0.04) $ 0.02
========== ==========
WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC 5,769,699 5,750,631
========== ==========
WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED 5,769,699 5,796,223
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SEE NOTES TO UNAUDITED FINANCIAL STATEMENTS.
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED NOVEMBER 30, 1999
AND THE NINE MONTH PERIOD ENDED AUGUST 31, 2000 (UNAUDITED)
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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
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BALANCE AT NOVEMBER 30, 1999 445 57,519 13,316,795 (1,660,962) (5,830,847) 5,882,950
Issuance of 28,254 shares of
common stock -- 282 63,209 -- -- 63,491
Conversion of 2,500 shares of
preferred stock for 13,334
shares of common stock (25) 133 (108) -- -- --
Dividends paid - preferred stock -- -- -- -- (26,675) (26,675)
Recognition of interest income on
note receivable from sale of shares -- -- 567,156 (567,156) -- --
Increase in valuation allowance on
note receivable from sale of shares -- -- (567,156) 567,156 -- --
Purchase of 14,600 shares of
common stock -- (146) (33,292) -- -- (33,438)
Net loss -- -- -- -- (536,224) (536,224)
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BALANCE AT AUGUST 31, 2000 $420 $57,788 $13,346,604 $(1,660,962) $(6,393,746) $5,350,104
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SEE NOTES TO UNAUDITED FINANCIAL STATEMENTS.
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTH PERIODS ENDED AUGUST 31,
(UNAUDITED)
- --------------------------------------------------------------------------------
2000 1999
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net earnings (loss) $ (536,224) $ 383,753
Adjustments to reconcile net earnings (loss) to net cash
provided by operating activities
Depreciation and amortization 1,139,808 952,987
Compensation and fees paid by issuance of common stock 63,491 15,505
Gain on disposal of assets (142,167) (297,227)
Decrease in cash value of life insurance - 199,960
Increase (decrease) in deferred revenue 46,152 (220,257)
(Increase) decrease in current assets (25,369) (162,252)
Decrease in net liabilities of discontinued operations - (416,308)
Increase (decrease) in current liabilities 166,505 (344,814)
----------- -----------
Net cash provided by operating activities 712,196 111,347
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property, plant and equipment (3,879,819) (4,007,301)
Payment for franchise agreements (50,000) (50,000)
Proceeds from disposal of assets 276,500 200,000
Collection on notes receivable 475,000 2,744,617
Purchase of common stock (33,438) --
(Increase) decrease in other assets (53,200) 22,947
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Net cash used in investing activities (3,264,957) (1,089,737)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term obligations 3,181,887 2,972,422
Payment of financing costs (63,865) (68,106)
Principal payments on long-term obligations (353,799) (1,151,304)
Payments on obligations under capital lease (242,819) (217,918)
Payments on notes payable (475,000) (1,100,000)
Preferred dividends paid (26,675) (30,051)
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Net cash provided by financing activities 2,019,729 405,043
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Net decrease in cash (533,032) (573,347)
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 1,578,914 2,109,358
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CASH AND CASH EQUIVALENTS - END OF PERIOD $ 1,045,882 $ 1,536,011
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SUPPLEMENTAL CASH FLOW INFORMATION - SEE NOTE A
SEE NOTES TO UNAUDITED FINANCIAL STATEMENTS.
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED FINANCIAL STATEMENTS
FOR THE NINE MONTH PERIODS ENDED AUGUST 31, 2000 AND 1999
- --------------------------------------------------------------------------------
NOTE A - SUPPLEMENTAL CASH FLOW INFORMATION
2000 1999
-------- ----------
Cash paid for interest expense $986,441 $1,099,534
Cash paid for income taxes $ 5,736 $ 45,000
NOTE B - EARNINGS (LOSS) PER SHARE
Basic earnings per share is computed by dividing earnings on common shares by
the weighted average number of common shares outstanding during each period.
Diluted earnings per share reflect per share amounts that would have resulted if
dilutive potential common stock had been converted to common stock.
The following table reconciles the numerators and denominators used to calculate
basic and diluted earnings per share for the three and nine month periods ended
August 31, 2000 and 1999:
THREE MONTHS ENDED AUGUST 31, NINE MONTHS ENDED AUGUST 31,
----------------------------- ----------------------------
2000 1999 2000 1999
---------- ---------- ---------- ----------
Numerators
Earnings (loss) from continuing operations $ (209,795) $ 148,746 $ (536,224) $ 312,953
Less preferred stock dividends 6,641 10,017 26,675 30,051
---------- ---------- ---------- ----------
Earnings (loss) on common shares -
basic and diluted $ (216,436) $ 138,729 $ (562,899) $ 282,902
========== ========== ========== ==========
Denominators
Weighted average common shares
outstanding - basic 5,769,699 5,750,631 5,754,089 5,746,905
Effect of dilutive securities
Stock options -- 45,592 -- 20,144
---------- ---------- ---------- ----------
Weighted average common shares
outstanding - diluted 5,769,699 5,796,223 5,754,089 5,767,049
========== ========== ========== ==========
For the three and nine months ended August 31, 2000 and 1999, convertible
preferred stock was not included in the computation of diluted earnings per
share because the effect of conversion would be antidilutive. For the three and
nine months ended August 31, 2000, stock options were not included in the
computation of diluted earnings per share because the exercise of stock options
would be antidilutive.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
RESULTS OF OPERATIONS
Results of continuing operations for the three and nine month periods
ended August 31, 2000 and August 31, 1999 are summarized in the following
tables:
Statements of Operations
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Three month periods ended August 31, Nine month periods ended August 31,
------------------------------------ -----------------------------------
$ (000's) % of Revenue $ (000's) % of Revenue
--------------- -------------- ---------------- -------------
2000 1999 2000 1999 2000 1999 2000 1999
--------------- -------------- ---------------- -------------
Food and beverage revenue $8,834 $7,983 100.0% 100.0% $24,201 $22,004 100.0% 100.0%
Costs and expenses
Cost of food and beverages 2,643 2,288 29.9 28.7 7,065 6,358 29.2 28.9
Operating expenses 5,283 4,526 59.8 56.7 14,359 12,720 59.4 57.8
General and administrative
Restaurant operations 309 249 3.5 3.1 918 799 3.8 3.6
Corporate level expenses 165 209 1.9 2.6 567 506 2.3 2.3
Depreciation and amortization
Restaurant operations 345 271 3.9 3.4 952 776 3.9 3.6
Corporate level expenses 66 59 0.7 0.7 188 177 0.8 0.8
--------------- -------------- ---------------- -------------
Total costs and expenses 8,811 7,602 99.7 95.2 24,049 21,336 99.4 97.0
Earnings from operations 23 381 0.3 4.8 152 668 0.6 3.0
Other income (expense)
Interest expense (340) (337) (3.8) (4.2) (983) (1,006) (4.1) (4.6)
Interest income 12 105 0.1 1.3 87 354 0.4 1.6
Other income -- -- -- -- 66 -- 0.3 --
Gain on sale of assets 95 -- 1.0 -- 142 297 0.6 1.4
--------------- -------------- ---------------- -------------
Total other expense (233) (232) (2.7) (2.9) (688) (355) (2.8) (1.6)
--------------- -------------- ---------------- -------------
Earnings (loss) from
continuing operations $ (210) $ 149 (2.4)% 1.9% $ (536) $ 313 (2.2)% 1.4%
=============== ============== ================ =============
REVENUE
Food and beverage revenue increased $851,000 or 10.7% for the three
months ended August 31, 2000 compared to the same period of 1999. For the nine
months ended August 31, 2000, food and beverage revenue increased $2,197,000 or
10.0% compared to the same period of 1999. The increase in revenue was due
primarily to sales from new restaurants. New restaurants contributed $867,000
and $2,031,000 in new sales for the three and nine months ended August 31, 2000,
respectively. Revenue for the three and nine months ended August 31, 2000 was
positively impacted by a net increase in sales of $336,000 and $305,000
respectively from restaurants that were closed for a portion of fiscal years
1999 and 2000 due to fire damage. Food and beverage revenue decreased for
restaurants in operation during both the three and nine months ended August 31,
2000 and 1999 ("same store sales") as set forth in the following table:
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Average Net Sales Per Restaurant Unit
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2000 1999 Decrease Decrease
-------- -------- -------- --------
Three months ended August 31 $285,148 $298,427 $13,279 4.4%
Three months ended May 31 278,485 286,385 7,900 2.8%
Three months ended February 28 251,915 256,618 4,703 1.8%
-------- -------- -------
Nine months ended August 31 $815,548 $841,430 $25,882 3.1%
======== ======== =======
The decrease in same store sales for the three and nine months ended
August 31, 2000 was primarily attributable to decreased customer traffic of
approximately 4% and 8% respectively, compared to the same periods of 1999. The
following factors have had an impact on the decrease in customer traffic: (i)
temporary discontinuance of late night hours from December 1999 through March
2000, (ii) negative impact on "same-store" sales in certain market areas brought
about by the Company's new restaurant development, (iii) selective increased
menu pricing, and (iv) heavy price discounting and the use of toy promotions by
some of the Company's primary competitors. The Company and Wendy's International
continue to resist engaging in deep price discounting, choosing instead to
combat the low prices of its competitors with the "value menu" offerings and
high quality, made-to-order products. Increased sales resulting from selective
menu price increases and the continued trend of increased "combo" meal sales
offset a portion of the decrease in sales volume, resulting in an increase in
the average customer ticket amount of approximately 2% and 5% respectively for
the three and nine months ended August 31, 2000 compared to the same periods of
1999.
COST OF FOOD AND BEVERAGES
Cost of food and beverages as a percentage of revenue was 29.9% for the
three months ended August 31, 2000 compared to 28.7% for the three months ended
August 31, 1999. Cost of food and beverages as a percentage of revenue for the
nine months ended August 31, 2000 was 29.2% compared to 28.9% for the same
period of 1999. The 1.2 percentage point increase in cost of food and beverages
for the three months ended August 31, 2000 compared to the same period of 1999
was primarily due to (i) an increase of approximately 7% in the cost of beef as
compared to the prior year and (ii) an increase in the cost of product waste
which has increased 0.7 percentage points of revenue for the three months ended
August 31, 2000 compared to the same period of 1999. Changes in several in-store
management teams, which was due to new store growth, was the primary reason for
the increase in product waste. The 0.3 percentage point increase in the cost of
food and beverages for the nine months ended August 31, 2000, compared to the
same period of 1999, was primarily due to (i) an increase in the average cost of
beef of 12% over the prior year and (ii) an increase in the cost of product
waste. The impact of these two increases was tempered during the first six
months of the fiscal year due to retail price increases that were in effect
during that period but eliminated beginning June 2000. The majority of the
Company's product cost is a result of Wendy's International's purchasing
agreements. Cost of food and beverage percentages of 29.9% for the three months
ended August 31, 2000, and 29.2% for the nine months ended August 31, 2000, are
in line with guidelines established by the Company and Wendy's International.
OPERATING EXPENSES
Operating expenses as a percentage of revenue increased 3.1 percentage
points for the three months ended August 31, 2000 compared to the same period of
1999 (from 56.7% in 1999 to 59.8% in 2000). For the nine months ended August 31,
2000, operating expenses increased 1.6 percentage points as a percentage
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of revenue (from 57.8% in 1999 to 59.4% in 2000). The following table
illustrates operating expense categories with significant year-to-year
fluctuations:
Three months ended August 31, Nine months ended August 31,
------------------------------- ----------------------------
2000 1999 Increase 2000 1999 Increase
---- ---- -------- ---- ---- --------
As a percentage of revenue:
Labor and related costs 33.6 32.0 1.6 34.7 32.9 1.8
Advertising expense 5.8 4.9 0.9 5.1 4.9 0.2
The increase in labor and related costs was primarily the result of an
increase in average hourly rate of 6.2% and 6.6%, respectively, for the three
and nine months ended August 31, 2000 compared to the same periods in the prior
year. The increase in advertising expense for the three and nine months ended
August 31, 2000, compared to the same periods in 1999, was due to increases in
the costs related to (i) kids meal premium giveaways, (ii) participation in a
promotion sponsored by the Company's beverage supplier, and (iii) the use of
gift certificates for both promotional purposes and customer relations.
GENERAL AND ADMINISTRATIVE
Restaurant Operations
General and administrative expenses for the restaurant operations
increased $60,000 for the three months ended August 31, 2000 compared to the
same period of 1999 (from $249,000 to $309,000), from 3.1% of revenue to 3.5% of
revenue. For the nine months ended August 31, 2000, general and administrative
expenses increased $119,000 (from $799,000 to $918,000) compared to the same
period in the prior year, representing 3.8% of revenue for the nine months ended
August 31, 2000 compared to 3.6% of revenue for the same period of 1999. The
increase in general and administrative expenses for the three and nine months
ended August 31, 2000 was primarily the result of increased labor and employee
benefit costs related to new restaurants, specifically additional supervisory
and marketing personnel.
Corporate Level Expenses
General and administrative expenses for corporate level expenses
decreased $44,000 (from $209,000 to $165,000), from 2.6% of revenue to 1.9% of
revenue for the three months ended August 31, 2000 compared to the same period
of 1999. The decrease was primarily due to a decrease in (i) public marketing
expenses resulting principally from the one-time AMEX registration fee recorded
during the third quarter of 1999, (ii) executive incentive compensation expense,
and (iii) professional fees of approximately $20,000 due to the completion of
activities related to the sale of the hotel properties.
For the nine months ended August 31, 2000, general and administrative
expenses increased $61,000 (from $506,000 to $567,000), compared to the same
period in the prior year. General and administrative expenses represented 2.3%
of revenue for both the nine months ended August 31, 2000 and August 31, 1999.
The increase was primarily due to (i) a non-recurring reduction in legal expense
of $192,000 in 1999 resulting primarily from the receipt of insurance proceeds
to cover legal fees incurred in previous litigation, and (ii) an increase in
computer system development fees related to the new financial reporting system.
This was partially offset by decreases in (i) business insurance premiums due
primarily to a change in carriers, (ii) public market expenses, and (iii)
executive incentive compensation expense.
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DEPRECIATION AND AMORTIZATION
Restaurant Operations
Depreciation and amortization expense increased $74,000 for the three
months ended August 31, 2000 and $176,000 for the nine months ended August 31,
2000, compared to the same periods of 1999. The increase in depreciation and
amortization expense for the three and nine months ended August 31, 2000 was
attributable to new restaurant development.
Corporate Level Expenses
Depreciation and amortization expense increased $7,000 for the three
months ended August 31, 2000 and $11,000 for the nine months ended August 31,
2000, compared to the same periods of 1999. The slight increase was due to the
purchase of a new financial reporting system. The corporate level depreciation
and amortization expense primarily represents the amortization of goodwill of
$45,000 and $136,000 for the three and nine months ended August 31, 2000 and
1999 resulting from the acquisition of the Wendy's business.
INTEREST EXPENSE
Interest expense for the third quarter of 2000 and 1999 was $340,000
and $337,000, respectively. Interest expense for the nine months ended August
31, 2000 and 1999 was $983,000 and $1,006,000, respectively. The slight increase
in interest expense for the three months ended August 31, 2000, compared to the
same period in the prior year, was due to a combination of (i) an increase of
$70,000 resulting primarily from additional debt incurred to finance the
development of new Wendy's restaurants, which was substantially offset by (ii) a
decrease of $67,000 of interest expense related to the notes payable issued by
the Company in connection with the notes receivable from the sale of the hotel
properties. The majority of these notes were retired during the latter part of
1999, and the entire amount was retired in April 2000. The net decrease in
interest expense of $23,000 for the nine months ended August 31, 2000, compared
to the same period in the prior year, was also due to a combination of (i) an
increase of $175,000 resulting primarily from additional debt incurred to
finance the development of new Wendy's restaurants, which was offset by (ii) a
decrease of $198,000 of interest expense related to the notes payable issued by
the Company in connection with the notes receivable from the sale of the hotel
properties. Nearly all of the Company's long-term debt is at fixed interest
rates.
INTEREST INCOME
Interest income decreased $93,000 for the third quarter (from $105,000
to $12,000), and $267,000 for the nine months ended August 31, 2000 (from
$354,000 to $87,000 in 1999). Interest income in fiscal 1999 was primarily
earned on the notes receivable obtained in the sale of hotel properties which
were paid in full in August 1999 and April 2000, resulting in a significant
decrease in interest income for both the three and nine months ended August 31,
2000.
OTHER INCOME
Other income of $66,000 for the nine months ended August 31, 2000
resulted from (i) $21,000 of insurance proceeds related to a property loss
incurred in 1998, and (ii) $45,000 received for a term extension on a note
receivable related to the prior sale of one of the Company's hotel properties.
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GAIN (LOSS) ON DISPOSAL OF ASSETS
A gain of $95,000 was recognized for the three months ended August 31,
2000 which resulted from the sale of real estate. A gain of $142,000 was
recognized for the nine months ended August 31, 2000 compared to a gain of
$297,000 during the same period in the prior year. In addition to the real
estate gain, a gain of $47,000 was recognized during the nine months ended
August 31, 2000 which was primarily due to the excess of insurance proceeds over
the net book value of fire damaged equipment. The gain of $297,000 recognized
for the nine months ended August 31, 1999 represented the sale of life insurance
policies ($200,000) and the excess of insurance proceeds over the net book value
of fire damaged equipment ($97,000).
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS
Cash and cash equivalents ("cash") decreased $533,000, from $1,579,000
as of November 30, 1999 to $1,046,000 as of August 31, 2000. The decrease in
cash was the result of the following:
Net cash provided by operating activities $ 712,000
Net cash used in investing activities (3,265,000)
Net cash provided by financing activities 2,020,000
-----------
Net decrease in cash $ (533,000)
===========
Net cash provided by operating activities increased $601,000 for the
nine months ended August 31, 2000 compared to the same period of 1999, despite a
decrease in net earnings of $920,000. The increase was due to (i) the $345,000
reduction of current liabilities during the nine months ended August 31, 1999
compared to an increase in current liabilities of $167,000 during the nine
months ended August 31, 2000, (ii) the payment of $416,000 of liabilities
related to discontinued operations during the nine months ended August 31, 1999
compared to no payments related to discontinued operations in the nine months
ended August 31, 2000, and (iii) the timing of the receipt of annual marketing
funds from the Company's beverage supplier.
Net cash used in investing activities increased $2,175,000 for the nine
months ended August 31, 2000 compared to the same period of 1999. The 2000
activity reflects an investment of $3,459,000 in three new restaurants which
opened in 2000 and the land for a two additional restaurants currently under
construction. This investment in new restaurants compares to the 1999 activity
which reflects an investment of $3,889,000 in three new restaurants opened in
1999 and the land for a fourth restaurant which was then under construction.
Offsetting the investment in new restaurants in 1999 was $2,745,000 of receipts
on notes receivable related to the sale of the Company's hotel properties
compared to $475,000 in 2000.
Net cash provided by financing activities increased $1,615,000 for the
nine months ended August 31, 2000 compared to the same period of 1999. The
increase was primarily the result of proceeds from long-term debt of $3,182,000
used to finance the investment in three new restaurants and the land for two
additional restaurants currently under construction, compared to $2,972,000 of
proceeds from long-term debt during the same period of 1999. The total cash
provided by financing activities was also impacted by a decrease in principal
payments on long-term debt and notes payable of $1,897,000 for the nine months
ended August 31, 2000 compared to the same period of 1999. In 1999, $2,000,000
of the payments were paid from proceeds from the note receivable described in
the previous paragraph and $251,000 represented
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scheduled principal payments, compared to the nine months ended August 31, 2000
in which $475,000 represented payments from proceeds from the note receivable
related to the previously discussed hotel sale and $354,000 represented
scheduled principal payments.
FINANCIAL CONDITION
As of August 31, 2000, the Company's current liabilities exceeded its
current assets by $1,930,000, compared to November 30, 1999 when current
liabilities exceeded current assets by $1,099,000. Excluding the current portion
of occupancy related long-term obligations and capital leases, the Company's
current liabilities exceeded its current assets by $1,045,000 as of August 31,
2000 and by $371,000 as of November 30, 1999. At these dates, the ratios of
current assets to current liabilities were 0.4:1 and 0.7:1 respectively. The
discussion regarding Cash Flows for the nine months ended August 31, 2000
explains the decrease in cash as well as the most significant reasons for the
decrease in working capital.
The cash management issues currently facing the Company can be
described in three areas: (i) operations of the Wendy's restaurants, (ii)
investment in new Wendy's restaurants, and (iii) continued control of corporate
level expenses.
The Company continued to utilize cash during the third quarter of
fiscal 2000 to fund pre-opening expenses at new restaurants and operating costs
during the initial months of new store operation which are typically higher than
operating costs of mature restaurants. Operating cash flow for the first nine
months of fiscal 2000 from existing stores has been less than anticipated and
less than has been experienced in the past due to (i) the continued increase in
the cost of labor at higher than anticipated rates because of a tight labor
market, (ii) the inability to reduce labor hours in relation to the decreased
customer traffic, (iii) increased product costs caused by significant increases
in beef prices and increased product waste costs, and (iv) the decrease in same
store sales and customer traffic as previously discussed. The impact of new
stores, as well as the negative cash flow from existing stores, has resulted in
a significant decline in working capital during the third quarter of 2000.
Working capital, exclusive of the current portion of occupancy related long-term
obligations and capital leases, has declined from a negative $371,000 at
November 30, 1999 and a negative $416,000 as of May 31, 2000, to a negative
$1,045,000 as of August 31, 2000. A discussion of the Company's plans for
meeting its current obligations in light of this declining cash flow trend
follows. The Company estimates capital expenditures for the next twelve months
at its existing Wendy's restaurants to be approximately $500,000 for building
improvements and furniture, fixtures and equipment purchases.
The Company has invested approximately $2.8 million for the development
of three new restaurants that opened in December 1999, March 2000 and June 2000,
and land for an additional restaurant which opened September 14, 2000. $2.5
million of this investment has been financed with mortgage and equipment
financing. The 15 year mortgages have fixed interest rates of 2.6% over ten year
treasury rates (approximately 8.3% based on current interest rates) and are
amortized over 20 years. The seven year equipment notes have interest rates
ranging from 8.25% to 9.25%.
The Company has entered into a financing agreement to provide an
additional $825,000 to finance the completion of the restaurant which opened on
September 14, 2000. Additionally, the Company plans to begin operations as a
tenant in two new restaurants during the remainder of the fiscal year, one of
which opened September 28, 2000 and the other which is expected to open in the
spring of 2001. The Company expects to enter into contracts to acquire real
estate for new restaurants that will be owned by the Company, and operating
leases covering restaurants that will be leased. The Company has received
forward
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commitments to finance the new restaurant development at similar terms to those
described above, and anticipates financing 90% of the cost of the real estate
and equipment through the use of external financing.
During July 2000, the Company obtained a $3.5 million revolving line of
credit facility. The line is secured by the equipment of eleven restaurants
operated under lease agreements. Monthly payments of interest only are required
at a rate equal to 2.5% over the 30 day LIBOR rate, with any outstanding
principal amount due in July 2004. As of August 31, 2000, the Company had
borrowed $317,500 on this line to purchase land for a future restaurant. The
Company expects to repay this financing when permanent mortgage financing is
obtained upon completion of this restaurant.
The Company closed a restaurant on August 29, 2000 and another
restaurant on September 12, 2000 due to the opening of new Wendy's restaurants
in the same trade areas. One restaurant, which was leased, ceased operations at
the end of its lease term. The furniture, fixtures and equipment of this
restaurant were written down to net realizable value in the fourth quarter of
1999. The second restaurant is owned by the Company and is currently listed for
sale. It is anticipated that this unit will be sold for a price near the
outstanding mortgage loan balance ($719,000 as of August 31, 2000). The property
and equipment of this restaurant had a net book value of approximately $683,000
as of August 31, 2000. If this unit is sold for less than its outstanding debt
plus costs incurred prior to its sale, the Company will have to fund any
shortfall out of current operating funds.
The various loan agreements with the Company's primary lenders (Captec
Financial Group "CFG" and Fleet Business Credit Corporation "FBCC") contain loan
covenants requiring the maintenance of certain financial ratios including:
o Fixed Charge Coverage Ratio ("FCCR") of 1.2 : 1 for the Wendy's
operation as a whole;
o FCCR of 1.2 : 1 for the Wendy's restaurants that are subject to a real
estate mortgage;
o FCCR of 1.4 : 1 for the Wendy's restaurants that are subject to both a
real estate mortgage and a business value loan;
o Leverage Ratio (Funded Debt : Earnings Before Interest, Taxes,
Depreciation and Amortization) not to exceed 6.0 : 1; and
o 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.
Covenant compliance is measured quarterly by FBCC and annually by CFG.
As of August 31, 2000, the Company was in compliance with the various financial
covenants. Additionally, 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. The Company anticipates that the
corporate level expenses will be funded primarily with cash flow from the
Wendy's operations in accordance with the loan covenants, as well as from cash
proceeds generated from non-operating activities. However, there can no
assurance that the Company will be able to realize non-operating proceeds either
as to dollar amount or timing. Approximately $161,000 of such non-operating
proceeds were received during the first nine months of the year.
As discussed above, the Company's cash flow situation is being
adversely affected by (i) declining trends in cash flow generated by operations,
and (ii) the negative cash flow during the third quarter, during which period
the operations have historically produced cash flow which was sufficient for
both then current cash needs and to build reserves needed for (a) the typically
slower winter months, (b) capital expenditures and (c) high start-up expenses of
the new restaurants. The Company anticipates that its liquidity concerns
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will continue and increase in intensity until such time as (i) cash flow from
operations improves to previously experienced levels, and (ii) the Company
either raises additional equity in accordance with its business plan to finance
construction and equipment costs of its new restaurants or slows its new store
growth pace. In light of these operational and investment cash management
issues, the Company plans to meet its current obligations over the next twelve
months by:
o Increasing selected retail menu prices, which is expected to result in
annual increases in revenue and operating profit of approximately
$750,000 based on current customer traffic.
o Attempting to reduce the operating costs, particularly through renewed
efforts to control labor related costs and food waste.
o Using operating cash generated from existing Wendy's restaurants.
o Borrowing on a $3.5 million revolving line of credit, of which $3.2
million is available. Availability is subject to certain loan covenant
restrictions.
o Exploring the financing of certain capital expenditures at existing
Wendy's restaurants.
o Participating in vendor financing programs for capital expenditures
required under the Service Excellence program.
o Utilizing equipment financing for certain of the Company's new
restaurants.
o Reducing or deferring investment in the capital expenditures for
existing restaurants.
o Working with vendors to obtain extended payment terms.
o Seeking additional equity capital from various business partners and
associates.
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.
INFLATION AND CHANGING PRICES
As discussed above, the Company has been affected by increased payroll
costs due to a tight labor market and its effect on the availability and cost of
management and hourly employees along with increased product purchase costs
(primarily beef costs). The Company anticipates that the tight labor market
conditions will continue into the near future. 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. Highly competitive market
conditions have minimized the Company's ability to offset higher costs through
price increases to its customers. However, the Company is implementing a general
price increase of approximately 4% beginning in October which will assist in
covering the increased labor and food costs.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not Applicable.
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PART II
OTHER INFORMATION
ITEM 5. OTHER INFORMATION.
On July 18, 2000, Meritage announced that it had engaged Ferris, Baker
Watts, Incorporated as the Company's exclusive financial advisor to assist with
financial transactions and the continued development and/or acquisition of
Wendy's restaurants. Ferris, Baker Watts is a full service investment banking
firm headquartered in Washington, D.C. that provides investment banking services
and research coverage to corporate clients in the restaurant and food service
industries.
On August 27, 2000, Meritage's Senior Vice President and Chief
Operating Officer, Ray E. Quada, 56, died unexpectedly from injuries sustain in
a motorcycle accident. Meritage's two Regional Directors of Operations, Alan
Pruitt and Jeff Neuhouser, continue to supervise the day-to-day operations and
report to Meritage's President, Robert E. Schermer, Jr.
On September 19, 2000, 1,392,858 issued and outstanding common shares
registered to CBH Capital Corp. were returned to the Issuer's treasury. These
shares, which were held as collateral in connection with a $9,750,000
non-interest bearing promissory note with Meritage dated September 1995, were
surrendered to Meritage as payment in full under the note when it was realized
that the note would otherwise be placed in default for nonpayment. The Company's
total issued and outstanding shares were reduced 24%, from 5,781,075 to
4,388,217. Significant effects of the event include a tax deduction for the
Company of $3.2 million, and an increase in book value per share of 32%, or
$0.29 per share. There was no effect to the Company's current earnings as no
interest income was recognized on the note.
The Company opened its 31st Wendy's restaurant during the third fiscal
quarter. The new restaurant is located at the intersection of Sprinkle Road and
Covington Road in Kalamazoo, Michigan.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibit List.
Exhibit No. Description of Document
- ----------- --------------------------------------------------------------
10.1 Line of Credit, Term Loan & Security Agreement with Fleet
Business Credit Corporation.
10.2 Promissory Note for Line of Credit with Fleet Business Credit
Corporation.
27 Financial Data Schedule.
- ---------------
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter for which
this report is filed.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: October 9, 2000 MERITAGE HOSPITALITY GROUP INC.
By /s/ Robert E. Schermer, Jr.
-----------------------------------------
Robert E. Schermer, Jr.
President and Chief Executive Officer
By /s/ Pauline M. Krywanski
-----------------------------------------
Pauline M. Krywanski
Vice President and Treasurer
(Chief Financial Officer)
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EXHIBIT INDEX
Exhibit No. Description of Document
- ----------- --------------------------------------------------------------
10.1 Line of Credit, Term Loan & Security Agreement with Fleet
Business Credit Corporation.
10.2 Promissory Note for Line of Credit with Fleet Business Credit
Corporation.
27 Financial Data Schedule.
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