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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, 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 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 __
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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 February 12, 2001, there were 5,420,638 common shares of the Registrant
outstanding. The aggregate market value of the common shares held by
non-affiliates at that date was $6,423,509 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 25
Item 8 - Financial Statements and Supplementary Data 25
Item 9 - Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure 25
PART III
Item 10 - Directors and Executive Officers of the Registrant 26
Item 11 - Executive Compensation 27
Item 12 - Security Ownership of Certain Beneficial Owners and Management 29
Item 13 - Certain Relationships and Related Transactions 29
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, fuel and energy costs; the
availability and cost of suitable restaurant sites; the ability to finance
expansion; fluctuating interest rates; fluctuating insurance rates; the
availability of adequate 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 Michigan's economy could adversely affect its operations.
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PART I
ITEM 1. BUSINESS.
THE COMPANY
Meritage Hospitality Group Inc. is the nation's only publicly traded
"Wendy's Old Fashioned Hamburgers" restaurant franchisee. The Company serves
more than six million customers annually through its operation of 33 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. In 2000, Meritage opened six new
Wendy's restaurants, and plans to open six to eight additional Wendy's
restaurants in fiscal 2001. Included in the new openings in 2000 were three
Wendy's restaurants developed 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 the development and/or acquisition of Wendy's
restaurants in other market areas. The Company's growth plan calls for
developing and acquiring 20 to 30 additional Wendy's restaurants over the next
five years.
Meritage was incorporated in 1986, and is currently engaged in the
quick-service restaurant business. The Company owns slightly more than half of
its restaurant properties and leases the remaining properties.
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, its facsimile number is (616) 776-2776, and its website address is
www.meritagehospitality.com. The Company's 33 Wendy's restaurants are owned
and/or operated by Wendy's of Michigan, a Michigan limited partnership that is
owned by a wholly-owned subsidiary of Meritage. For convenience, Meritage and
its subsidiaries are collectively referred to as "Meritage" or "the Company"
throughout this report.
OPERATIONS
Meritage's restaurants are located in the Michigan counties of Allegan,
Calhoun, Ionia, Kalamazoo, Kent, Muskegon, Newaygo, Ottawa and Van Buren. This
includes the metropolitan areas encompassing the cities of Grand Rapids,
Kalamazoo, Battle Creek, Muskegon and Holland. This geographical area comprises
Meritage's designated market area.
Menu
Each Wendy's restaurant offers a diverse menu containing a variety of
food items featuring hamburgers and chicken 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. Wendy's International maintains significant
discretion over the menu items that are offered in the Company's restaurants.
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Restaurant Layout and Operation
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 2000.
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 funds to
develop advertising and sales promotion materials and concepts to be implemented
nationally. The remainder of the funds must be used on local advertising. The
Company typically spends local advertising dollars in support of national
television advertising, local television and radio advertising print media,
local promotions and community goodwill projects. The Company expects that the
amount of the fund used to benefit all restaurants owned and franchised by
Wendy's International will be increased to 3% effective 2002.
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 that are necessary to restaurant
operations. While no such shortages are anticipated, the Company believes that
alternate suppliers are available if any shortage were to occur.
Relationship with Wendy's International
Meritage operates its restaurants pursuant to various agreements
(including one franchise agreement for each restaurant) with Wendy's
International. These agreements grant privileges such as the right to utilize
Wendy's International's trademarks, service marks, designs and other proprietary
rights (such as "Wendy's" and "Wendy's Old Fashioned Hamburgers") in connection
with the operation of its Wendy's restaurants. These agreements also impose
requirements regarding the preparation and quality of food products, the level
of service, capital improvements, and general operating procedures. The
franchise agreements currently in place expire in approximately 17 years.
However, subject to certain conditions, the Company can renew the franchise
agreements for an additional 10 years.
The franchise agreements with Wendy's International provide, among
other things, that a change in the operational control of Wendy's of Michigan,
or the removal of a guarantor of the franchise agreements, cannot occur without
the prior consent of Wendy's International. In addition, any proposed sale of
the Wendy's business, 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 and such consent is not
obtained, Meritage will not be able to proceed
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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.
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 new
Wendy's restaurants. Meritage is permitted to develop new Wendy's restaurants
and convert competitive units located in its designated market area subject to
the standard expandability criteria and site standards of Wendy's International.
Meritage is prohibited from acquiring or developing new Wendy's restaurants
outside of its designated market area unless Wendy's International, in its sole
discretion, consents. 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 1,300 people of which approximately 250
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.
COMPETITION AND INDUSTRY CONDITIONS
The food service industry is one of the largest sectors of the nation's
economy, generating an estimated $380 billion of revenue in 2000, of which
approximately 30% was attributable to the quick-service restaurant industry. The
quick service market experienced sales of an estimated $107 billion in 2000,
with an annual growth rate of approximately 4.5%. As a whole, the quick-service
restaurant industry has consistently grown for more than 20 years, and
indications are that this growth will continue, but at a somewhat slower rate
than in recent years. Historic changes in domestic lifestyles, favoring greater
convenience, have significantly impacted this trend. Consumers are looking for
convenient, quick and high quality meals that can be picked-up on their way home
from work. In addition, burgeoning household incomes, fueled by a strong
national economy and multiple-worker households, has increased dollars spent on
food served outside of the home. As a result of these trends, competition in the
quick-service restaurant segment is, and can be expected to remain, intense.
Additional competition from grocery and convenience stores, and full service
restaurants, has also picked-up in recent years. It is estimated that 57% of
full-service restaurant operators experienced increased take-out ordering in the
past two years.
Because of the strong economy and tight labor market, difficulty in
hiring qualified hourly-employees has been, and will continue to be, the top
operational challenge. Quick service restaurants are
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forced to focus not only on consumer satisfaction, but also on employee
satisfaction to reduce turnover. This has led to enhanced wages and incentive
awards, and a heightened emphasis on marketing to attract new employees and
training programs to retain existing employees.
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
McDonald's (13,000 units), Burger King (8,500 units) and Wendy's (5,500 units),
who collectively represent approximately 70% 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.
Neither Wendy's International nor the Company believes this is a profitable
long-term strategy. Rather, both 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 an emphasis on quality
and taste, 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) all system-wide domestic Wendy's
restaurants (i.e. franchised and franchisor-owned), and (ii) all franchised
domestic Wendy's restaurants.
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FISCAL YEAR MERITAGE OPERATED SYSTEM-WIDE DOMESTIC FRANCHISED DOMESTIC
RESTAURANTS RESTAURANTS * RESTAURANTS *
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1998 $1,080,000 $1,062,000 $1,031,000
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1999 $1,132,000 $1,138,000 $1,102,000
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2000 $1,106,000 $1,167,000 $1,130,000
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* Source: Wendy's International, Inc.
The Company intends to achieve growth by (i) developing new Wendy's
restaurants in its existing market, (ii) developing and/or acquiring Wendy's
restaurants in other markets, and (iii) increasing sales at Wendy's restaurants
currently operated by the Company. The Company's new developments would include
both freestanding and nontraditional (e.g. restaurants joined with other
concepts such as a convenience store and gas station facility) Wendy's
restaurants. Some new stores may replace older and outdated 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.
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 2000, food service revenue generated by quarter was as follows: first
quarter - 23%; second quarter - 25%; third quarter - 26%; and fourth quarter -
26%.
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, fuel and energy costs; the availability and cost of
suitable restaurant sites; the ability to finance expansion; fluctuating
interest rates; fluctuating insurance rates; the availability of an adequate
number of managers and hourly-paid employees; directives issued by the
franchisor; the
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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,
restaurant operation, and minimum wage. Last year, the U.S. House of
Representatives approved a $1.00 per hour increase in the minimum wage. However,
the U.S. Senate had not voted on the matter when its session ended. Changes
regarding minimum wage or other laws governing the Company's relationship with
its employees (e.g. overtime wages, health care coverage, employment of minors,
etc.) could have an adverse effect on the Company's operations.
The Company's restaurants are also subject to public health
certification regarding the preparation and sale of food. The Company believes
its operations would be adversely affected if these permits were terminated. The
Company does not anticipate, however, that its permits will be terminated.
ITEM 2. PROPERTIES.
Each Wendy's restaurant is built to specifications provided by Wendy's
International as to its exterior style and interior decor. Typical freestanding
restaurants are one-story brick buildings constructed on sites of approximately
40,000 square feet, with parking for 50 to 70 vehicles. The restaurants, which
range from 2,700 to 3,400 square feet, 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
constructed under the combination store concept are basically the same except
that the restaurants are connected to a 3,500 square foot convenience store and
gas station facility.
Of the 33 Wendy's restaurants that the Company operates, it (i) owns
the land and buildings comprising 17 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 16 months to 30 years. The structures range from being brand
new to approximately 26 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 leased approximately 3,000 square feet of
office space in Kalamazoo, Michigan as its operating office. In February 2001,
the Company entered into a new office lease for approximately 7,500 square feet
located at 1971 East Beltline, N.E., Suite 200, Grand Rapids, Michigan, a few
hundred feet from one of the Company's newly opened restaurants. This facility,
which is equipped with a training facility, will serve as the new corporate and
operating offices. Accordingly, the Company has terminated the Kalamazoo lease
effective February 28, 2001, and will not renew the current Grand Rapids office
lease when it expires later this year.
The Company believes that its properties are adequately covered by
insurance.
FINANCING AND ENCUMBRANCES
In fiscal 1998 and 1999, the Company borrowed $11,740,000 from Captec
Financial Group, Inc. ("Captec") to purchase existing Wendy's restaurants,
refinance existing restaurant indebtedness, and build new restaurants. This
long-term indebtedness is secured by the real estate and equipment of 13
Company-owned Wendy's restaurants. The Captec loans have terms ranging from
fifteen to twenty years, require monthly payments of $99,980, and carry fixed
interest rates that range from 7.77% to 8.53%. The loan agreements contain
financial covenants that 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.
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In fiscal 1999 and 2000, the Company borrowed $5,213,000 from Fleet
Business Credit Corporation ("Fleet") to build and equip four Wendy's
restaurants. This long-term indebtedness is secured by the related real estate
and equipment. The Fleet loans require monthly payments of $47,000, and carry
fixed interest rates ranging from 8.05% to 8.5%.
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 new Wendy's restaurants. Indebtedness under this
commitment would be secured by the real estate and equipment of the new
restaurants. The fixed interest rate would be 260 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 that 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 proceedings will
not, in the aggregate, be material to the Company's financial condition or
operations. The Company maintains various types of insurance standard to the
industry that covers most legal proceedings brought against the Company.
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 2000.
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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. There was no established
public trading market for the Company's common shares prior to October 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, 1998 through September 23, 1999, the table reflects the bid prices quoted on
the OTC Bulletin Board. From September 24, 1999 through November 30, 2000, the
table reflects the closing sales prices reported by the American Stock Exchange.
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HIGH LOW
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FISCAL YEAR ENDED NOVEMBER 30, 1999
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First Quarter $ 2.00 $ 1.25
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Second Quarter $ 2.69 $ 1.50
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Third Quarter $ 3.13 $ 1.78
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Fourth Quarter $ 2.75 $ 1.94
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HIGH LOW
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FISCAL YEAR ENDED NOVEMBER 30, 2000
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First Quarter $ 2.88 $ 2.00
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Second Quarter $ 2.38 $ 1.88
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Third Quarter $ 2.31 $ 1.75
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Fourth Quarter $ 2.13 $ 1.88
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HOLDERS
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As of February 12, 2001, there were approximately 685 record holders of
the Company's common shares, which the Company believes represents approximately
1,200 beneficial holders.
DIVIDENDS
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Meritage paid no dividends on its common shares in the last two fiscal
years. Because the Company intends to reinvest excess cash into the development
of new Wendy's restaurants, it does not intend to pay any dividends on common
shares in fiscal 2001. In addition, certain of the Company's loan agreements
contain restrictions which may limit the Company's ability to declare a
dividend.
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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,
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2000 1999 1998 1997 1996
(RESTATED)* (RESTATED)*
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SUMMARY OF OPERATIONS
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Continuing operations
Total revenue $ 33,105 $ 29,752 $ 27,044 $ 26,860 $ 2,099
Operating expenses 33,407 28,898 27,590 27,534 2,368
Operating income (loss) (302) 854 (546) (674) (269)
Earnings (loss) from continuing operations (1,353) 322 (1,374) (1,935) 268
Discontinued operations
Loss from operations -- -- (479) (1,058) (2,193)
Gain on disposal of business segment -- 150 3,711 1,479 --
Net earnings (loss) (1,353) 472 1,131 (1,691) (1,926)
Preferred stock dividends 33 40 108 102 --
Net earnings (loss) on common shares (1,386) 432 1,023 (1,793) (1,926)
Earnings (loss) per common share - basic and diluted
Earnings (loss) from continuing operations $ (0.25) $ 0.05 $ (0.30) $ (0.63) $ 0.09
Net earnings (loss) $ (0.25) $ 0.08 $ 0.21 $ (0.56) $ (0.62)
BALANCE SHEET DATA
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Property & equipment $ 19,093 $ 16,684 $ 13,183 $ 7,518 $ 7,652
Net assets of discontinued operations -- -- (594) 840 267
Total assets 27,045 25,201 24,964 13,814 14,891
Long-term obligations (1) 18,224 15,091 13,513 10,447 9,715
Stockholders' equity 4,531 5,883 5,434 30 2,021
Cash dividends declared per common share $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 0.50
(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 selected
financial data above has been restated to reflect 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, 2000, 1999 and 1998.
Statements of Operations
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$ in Thousands % of Revenue
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2000 1999 1998 2000 1999 1998
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Food and beverage revenue $ 33,105 $ 29,752 $ 27,044 100.0% 100.0% 100.0%
Costs and expenses
Cost of food and beverages 9,588 8,557 7,752 29.0 28.8 28.7
Operating expenses 19,629 17,122 15,815 59.3 57.5 58.5
General and administrative
Restaurant operations 1,241 1,110 1,252 3.7 3.7 4.6
Corporate level expenses 813 670 1,692 2.5 2.3 6.2
Depreciation and amortization 1,401 1,101 892 4.2 3.7 3.3
Goodwill amortization 182 182 187 0.5 0.6 0.7
Impairment of assets 553 156 -- 1.7 0.5 --
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Total costs and expenses 33,407 28,898 27,590 100.9 97.1 102.0
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Earnings (loss) from operations (302) 854 (546) (0.9) 2.9 (2.0)
Other income (expense)
Interest expense (1,361) (1,314) (1,473) (4.1) (4.4) (5.5)
Interest income 98 391 185 0.3 1.3 0.7
Other income 70 -- 509 0.2 -- 1.9
Gain (loss) on disposal of assets 142 391 (25) 0.4 1.3 (0.1)
Minority interest -- -- 26 -- -- 0.1
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Total other income (expense) (1,051) (532) (778) (3.2) (1.8) (2.9)
---------------------------------- ----------------------------------
Earnings (loss) from continuing
operations before income taxes (1,353) 322 (1,324) (4.1) 1.1 (4.9)
Income taxes - current -- -- 50 -- -- 0.2
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Earnings (loss) from continuing
operations $ (1,353) $ 322 $ (1,374) (4.1)% 1.1% (5.1)%
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COMPARISON OF YEARS ENDED NOVEMBER 30, 2000 AND 1999
----------------------------------------------------
REVENUE
Revenue increased 11.3% (or $3,353,000) from $29,752,000 in fiscal 1999
to $33,105,000 in fiscal 2000. The increase in revenue was due primarily to
sales from new restaurants, which provided a net increase in sales of $3,847,000
in fiscal 2000. Revenue for fiscal 2000 was positively impacted by a net
increase in sales of $584,000 from restaurants that were only open for a portion
of 1999. Partially offsetting this positive impact was a reduction in revenue of
$418,000 in 2000 from two stores that the Company closed in the fourth quarter
of the year as part of its plan to improve the overall quality of its assets by
recycling outdated restaurants. Quarterly revenue on a per restaurant basis for
restaurants in operation during the same periods of fiscal 2000 and 1999 ("same
store sales"), are set forth in the following table:
Average Net Sales Per Restaurant Unit
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Increase Increase
2000 1999 (Decrease) (Decrease)%
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Three months ended November 30 $ 290,887 $ 290,298 $ 589 0.2%
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%)
-------------- -------------- ------------
Year ended November 30 $ 1,106,435 $ 1,131,728 $ (25,293) (2.2%)
============== ============== ============
The 2.2% (approximately $660,000) decrease in same store sales in
fiscal 2000 was primarily attributable to a decrease in customer traffic, which
was partially offset by an increase in the average customer ticket. Customer
traffic decreased by approximately 7% in fiscal 2000 compared to fiscal 1999.
The following factors have had an impact on the decrease in customer traffic (i)
temporary discontinuance of late night hours (sales between the hours of 10:00
p.m. and midnight) 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, (iv)
discontinuance of certain discount cards, and (v) heavy price discounting 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 "value menu" offerings and high
quality, made-to-order products. Higher sales resulting from selective menu
price increases and the continued trend of increased "combo" meal (a combined
purchase of a sandwich, French fry and beverage) transactions and upsizing (the
addition of a larger beverage and French fry to standard combo meals for an
additional thirty-nine cents) offset a portion of the decrease in sales volume,
resulting in an increase in the average customer ticket amount of approximately
5% for fiscal 2000 compared to fiscal 1999.
The Company's fiscal 2000 average sales on a per restaurant basis of
approximately $1,106,000 were comparable to the average sales of both (i)
Wendy's system-wide domestic restaurants (i.e. franchised and franchisor-owned)
which were estimated to average approximately $1,167,000 per restaurant in 2000,
and (ii) Wendy's franchised domestic restaurants which were estimated to average
approximately $1,130,000 per restaurant in 2000.
12
13
COST OF FOOD AND BEVERAGES
Cost of food and beverages increased $1,031,000 in fiscal 2000 compared
to fiscal 1999 (from $8,557,000 to $9,588,000), which was the result of the
increase in revenue. As a percentage of revenue, cost of food and beverages was
29.0% in fiscal 2000 compared to 28.8% in fiscal 1999. The 0.2 percentage point
increase in cost of food and beverages was due to an increase of approximately
8% in the average cost of beef in 2000 compared to the prior year. Beef
purchases represent approximately 22% of all food and beverage purchases. The
impact of this product cost increase was somewhat offset by increased menu
prices which were effective during certain periods of the year. The majority of
the Company's food and paper products are purchased under a purchase arrangement
established by Wendy's International. The cost of food and beverage percentages
of 29.0% in fiscal 2000 and 28.8% in fiscal 1999 are in line with guidelines of
the Company and Wendy's International.
OPERATING EXPENSES
Operating expenses as a percentage of revenue increased 1.8 percentage
points in fiscal 2000 compared to fiscal 1999 (from 57.5% of revenue in 1999 to
59.3% in 2000). The following table illustrates operating expense categories
with significant year-to-year fluctuations:
2000 1999 Increase
---- ---- --------
As a percentage of revenue:
Labor and related expenses 34.2 33.1 1.1
Occupancy expenses 9.1 8.9 0.2
Advertising expenses 5.0 4.8 0.2
Other operating expenses 3.5 3.2 0.3
Labor and Related Expenses
Restaurant crew and managerial labor costs increased 1.5 percentage
points as a percentage of revenue (a 5.9% increase) in 2000 compared to fiscal
year 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 result of the labor
market, the majority of the labor cost increase was due to an increase in the
average hourly rate of 6.4% combined with similar market related wage increases
for salaried restaurant employees. Partially offsetting the impact of the
increase in direct labor cost was a reduction in health insurance costs of 0.4
percentage points as a percent of revenue (a reduction of approximately 20% in
the cost of health insurance) due to the adoption of a new insurance plan.
Occupancy Expenses
Business insurance premium costs increased by 0.2 percentage points as
a percent of revenue in fiscal 2000 compared to fiscal 1999 (from $137,000 in
1999 to $212,000 in 2000). The majority of this increase was caused by an
increase in premiums beginning in July 2000 due largely to two fire damage
claims during the previous plan year. Also contributing to the increase in
occupancy expenses was an increase in property tax expense. The average property
tax expense per store increased by 2.9% in 2000 compared to 1999 due primarily
to the overall increase in property values resulting from the development of new
stores. Because the majority of occupancy expenses are fixed costs, occupancy
expenses as a percentage of revenue were also adversely impacted by the 2.2%
decrease in same store sales.
13
14
Advertising Expenses
Advertising expense increased $239,000 from $1,428,000 in fiscal 1999
to $1,667,000 in fiscal 2000. This represented a 0.2 percentage point increase
as a percentage of revenue, from 4.8% in 1999 to 5.0% in 2000. The increase was
primarily the result of the combination of (i) an increase in the cost of kids'
meal premiums, and (ii) costs incurred due to participation in a special
promotion sponsored by the Company's beverage supplier, both of which were
partially offset by a reduction in food giveaway costs as the Company began
discontinuing its participation in certain discount programs during fiscal 2000.
Other Operating Expenses
Total other operating expenses on a per restaurant basis increased 5.7%
in fiscal 2000 compared to fiscal 1999 (from approximately $36,000 per
restaurant in fiscal 1999 to $38,000 per restaurant in fiscal 2000). Increases
in cleaning and trash pickup costs, along with an increase in office supplies,
accounted for the majority of the increase in other operating expenses. The
increase in cleaning costs was largely due to the subcontracting of window
cleaning beginning in late 1999. New store pre-opening costs had the most
significant impact on the increase in trash pickup costs and office supplies.
GENERAL AND ADMINISTRATIVE
Restaurant Operations
General and administrative expenses increased $131,000 for fiscal 2000
compared to fiscal 1999 (from $1,110,000 to $1,241,000). As a percentage of
revenue, general and administrative expenses were 3.7% of revenue in both fiscal
1999 and in fiscal 2000. The increase in general and administrative expenses in
2000 was primarily due to increased payroll costs related to the Company's new
store growth over the past two years including supervisory, marketing,
accounting and administrative personnel added to support the additional
activities related to new store openings and operations. Also contributing to
the increase in restaurant general and administrative costs was an increase in
transportation costs, which was largely offset by a reduction in Michigan single
business tax.
Corporate Level Expenses
General and administrative expenses for corporate level expenses
increased $143,000 for fiscal 2000 compared to fiscal 1999 (from $670,000 to
$813,000), from 2.3% of revenue in 1999 to 2.5% of revenue in 2000. The increase
was primarily due to 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 an increase in computer system
development fees related to the new financial reporting system. Excluding the
$192,000 non-recurring reduction in legal costs in 1999, corporate level general
and administrative expenses decreased $49,000 in fiscal 2000 compared to fiscal
1999. Reductions in business insurance premiums due primarily to a change in
carriers, and a reduction in executive compensation due to the award of no
management incentive compensation, accounted for the majority of this decrease.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense increased $300,000 for fiscal
2000 compared to fiscal 1999 (from $1,101,000 in fiscal 1999 to $1,401,000 in
fiscal 2000). Amortization expense, which increased approximately $22,000,
related to (i) new loan costs and franchisee fees incurred for new restaurant
development and (ii) new loan costs incurred on the newly obtained line of
credit. Depreciation expense increased $278,000 in 2000 compared to 1999, which
resulted primarily from depreciation on capital expenditures related to new
stores ($178,000) and capital improvements made to existing restaurants.
14
15
IMPAIRMENT OF ASSETS
In fiscal 2000, the Company closed one restaurant and listed another
for sale due to the opening of a new restaurant in the same market area. The
property and equipment owned by the Company at these locations were written down
to their estimated fair market value resulting in an impairment loss in 2000 of
$553,549. 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, thus 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 in
fiscal 1999.
INTEREST EXPENSE
Interest expense in fiscal 2000 and 1999 was $1,361,000 and $1,314,000,
respectively. The net increase of $47,000 for fiscal 2000 was due to a
combination of an increase of $150,000 of interest expense resulting primarily
from $4.4 million of additional debt incurred in fiscal 2000 to finance the
development of new restaurants and an increase of $126,000 of interest expense
representing a full year of interest on the $3.1 million of additional debt
incurred in 1999 for the development of new restaurants. These interest expense
increases were partially offset by a decrease of $198,000 in interest expense
related to the notes payable issued by the Company in connection with the notes
receivable from the sale of the hotel properties and interest reductions
resulting from decreases in the principal balances of certain long-term debt and
obligations under capital leases. Nearly all of the Company's long-term debt is
at fixed interest rates.
INTEREST INCOME
Interest income decreased $293,000 for fiscal 2000 (from $391,000 in
1999 to $98,000 in 2000). Interest income for 1999 was primarily the result of
interest earned on the notes receivable obtained in the sale of the hotel
properties which were paid in full in August 1999 and April 2000, resulting in a
significant decrease in interest income in fiscal 2000 compared to fiscal 1999.
GAIN ON DISPOSAL OF ASSETS
In fiscal 2000, a gain on disposal of assets of $142,000 was
recognized. Of this gain, $95,000 was the result of the sale of vacant land. The
remaining $47,000 was a non-cash gain recorded due to the excess of insurance
proceeds over the net book value of equipment damaged by fire at one of the
Company's restaurants. In fiscal 1999, a gain on disposal of assets of $391,000
was recognized. 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.
15
16
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 for 1999 included sales from three new restaurants which
opened in February, March and June, respectively. Revenue from new restaurants
totaled $2,101,000 in 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 1999 compared to 1998,
(ii) an increase in beverage selling prices and "combo" meal prices in July 1999
combined with an increase in value menu prices in October 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 an increase of approximately 5.0% increase in
average customer ticket in fiscal 1999 compared to fiscal 1998.
The Company's fiscal 1999 average sales on a per restaurant basis of
approximately $1,134,000 were comparable to the average sales of both (i)
Wendy's system-wide domestic restaurants (i.e. franchised and franchisor-owned)
which were $1,138,000 per restaurant in 1999, and (ii) Wendy's franchised
domestic restaurants which were $1,102,000 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 1999 compared to 28.7% in 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 compared to 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 were in line with
the Company's and Wendy's International's guidelines.
16
17
OPERATING EXPENSES
Operating expenses as a percentage of revenue decreased 1.0 percentage
points in fiscal 1999 compared to fiscal 1998 (from 58.5% of revenue in 1998 to
57.5% 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 1998
to 2.8% of revenue in 1999. The reduction in rent expense resulted from the
September 1998 purchase of five restaurants which were previously leased. The
Company 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 Expenses
Advertising expense decreased $121,000 in fiscal 1999 compared to
fiscal 1998. As a percentage of revenue, advertising expense decreased 0.9
percentage points, from 5.7% of revenue in 1998 to 4.8% of revenue in 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 Expenses
Payroll costs increased from 31.4% of revenue in fiscal 1998 to 33.1%
of revenue in fiscal 1999. A tight labor market, and its effect on the
availability and cost of labor, was the primary reason for the increase in
payroll costs. 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 new restaurants opened in fiscal
1999. Payroll taxes, training costs, and supervisors salaries also increased in
1999, and employee health insurance costs increased from 1.7% of revenue in 1998
to 2.0% of revenue in 1999, as a result of increased premiums.
On a per restaurant basis, restaurant operating expenses increased from
an average of $633,000 per restaurant in fiscal 1998 to an average of $651,000
per restaurant in fiscal 1999, an increase of 2.8% compared to the 5.0% increase
in same store sales.
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18
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 $10,000 in
1999 compared to 1998 (from $1,092,000 to $1,102,000). As a percentage of
revenue, general and administrative expenses (excluding the general partner
administration fee) decreased from 4.0% of revenue in fiscal 1998 to 3.7% 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 $209,000 for fiscal
1999 compared to fiscal 1998 (from $892,000 in fiscal 1998 to $1,101,000 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 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.
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 debt 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 debt 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 were previously leased by the Company. The
remaining $5,900,000 was used to refinance existing long-term debt at a lower
interest rate. During fiscal 1999, the Company borrowed an additional
18
19
$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 fires at two
of its restaurant locations in fiscal 1999. One fire occurred in April 1999 the
second fire occurred in October 1999. Substantially all damaged property was
covered by insurance.
19
20
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 year ended
November 30, 1998, as well as a summary of the sale transactions for the two
hotel properties sold in fiscal 1998:
Revenues $ 6,358,126
Costs and expenses 6,206,192
-------------
Earnings from operations 151,934
Other expense (791,166)
--------------
Loss from discontinued operations
before federal income taxes $ (639,232)
==============
A summary of the sale transactions for the two hotel properties sold in fiscal
1998 is as follows:
Grand Harbor
Thomas Edison Resort
Inn & Yacht Club
---------------- ---------------
Date of sale September 1, 1998 June 15, 1998
Selling price (before selling costs) $ 12,200,000 $ 4,500,000
Promissory note held by Company 2,000,000 1,375,000
---------------- ---------------
Cash portion of selling price $ 10,200,000 $ 3,125,000
================ ===============
Gain on sale of assets $ 3,273,893 $ 583,164
Loss from operations from measurement
date (May 31, 1998) to date
of disposal 109,800 35,893
---------------- ---------------
Gain on disposal of discontinued
operations 3,164,093 547,271
Extraordinary charges (includes loan
prepayment penalty and write-off of
deferred finance costs) 548,395 178,777
--------------- ---------------
Impact on equity $ 2,615,698 $ 368,494
================ ===============
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21
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Cash Flows - Year Ended November 30, 2000
Cash and cash equivalents ("cash") decreased $791,000, from $1,579,000
as of November 30, 1999 to $788,000 as of November 30, 2000. The decrease in
cash was the result of the following:
Net cash provided by operating activities $ 736,000
Net cash used in investing activities (4,556,000)
Net cash provided by financing activities 3,029,000
---------------
Net decrease in cash $ (791,000)
================
Net cash provided by operating activities decreased $217,000, from
$953,000 in fiscal 1999 to $736,000 in fiscal 2000. The decrease of $217,000 in
cash provided by operating activities in fiscal 2000 was significantly less than
the decrease in earnings of $1,824,000 in 2000 compared to 1999 partially due to
certain non-cash transactions in fiscal 2000 compared to fiscal 1999, including
(i) an increase of $299,000 in depreciation and amortization expense, (ii) an
increase of $397,000 in charges related to impairment of assets, and (iii) a
reduction in the amount of non-cash gains from the replacement of restaurant
assets damaged by fire (paid for by insurance proceeds) of $144,000. The impact
on cash provided by operating activities in 2000 was also affected by a
reduction in cash used to satisfy certain obligations during fiscal 1999 which
was not repeated in fiscal 2000, including (i) obligations related to
discontinued operations ($594,000), and (ii) amounts due to the former general
partner of the Wendy's partnership ($245,000).
Net cash used in investing activities increased $2,708,000 in fiscal
2000 compared to fiscal 1999. Fiscal 2000 activity reflects an investment of
$5,013,000 into both new restaurants ($4,425,000) and upgrades to existing
restaurants ($588,000, net of insurance proceeds of $195,000 which were used to
replace property damaged by fire). This compares to $4,593,000 invested in 1999
which included (i) $4,189,000 invested into new restaurants and (ii) upgrades to
existing restaurants of $404,000 (net of insurance proceeds of $671,000 which
were used to replace property damaged by fire). Also contributing significantly
to the increase in cash used in investing activities was the reduction of
$2,270,000 in cash collected on notes receivable in 2000 compared to 1999.
Net cash provided by financing activities increased $2,664,000 in
fiscal 2000 compared to fiscal 1999. This increase resulted from (i) new
borrowings totaling $4,420,000 in fiscal 2000 (primarily for the development of
new restaurants) compared to $3,116,000 of new borrowings in fiscal 1999, and
(ii) a reduction of $1,375,000 in principal payments on notes payable related to
notes receivable which were incurred from the sale of the hotel properties.
Scheduled principal payments on long-term obligations were approximately
$174,000 more in fiscal 2000 than in fiscal 1999.
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 $ 953,000
Net cash used in investing activities (1,848,000)
Net cash provided by financing activities 365,000
---------------
Net decrease in cash $ (530,000)
================
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22
Net cash provided by operating activities decreased $5,563,000, from
$6,516,000 in fiscal 1998 to $953,000 in fiscal 1999. The majority of the
decrease was due to (i) a $659,000 decrease in net earnings, (ii) a one-time 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 $7,219,000 in fiscal
1999 compared to fiscal 1998. Of the decrease, $5,965,000 was the result of an
increase in cash used in investing activities in 1998 due to the $3,220,000
issuance of notes receivable in 1998 in connection with the sale of the hotel
properties, compared to a decrease from payments received on these notes
receivable totaling $2,745,000 in fiscal 1999. The 1999 activity also 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 $5,813,000 invested
in 1998 which included (i) a $4,200,000 purchase of real estate associated with
five 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
$400,000 investment in the development of future restaurants.
Net cash provided by financing activities decreased $3,234,000 in
fiscal 1999 compared to fiscal 1998. New debt incurred for the construction of
three new restaurants in 1999 was $3,116,000 compared to new debt of $4,800,000,
net of refinanced debt, in 1998, which was incurred primarily for the purchase
of five restaurants that had previously been leased. Additionally, cash provided
by financing activities in 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.
Financial Condition
As of November 30, 2000, the Company's current liabilities exceeded its
current assets by $2,347,000 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 $1,307,000 at November 30,
2000. At these dates the ratios of current assets to current liabilities were
.35:1 and .69:1, respectively. A significant reason for the decline in working
capital was the cash investment of approximately $771,000 in new restaurants and
upgrades at existing restaurants in fiscal 2000. The above discussion regarding
cash flows for the year ended November 30, 2000 provides additional details of
the decrease in cash as well as the most significant reasons for the decrease in
working capital.
Cash flow from existing restaurants in fiscal 2000 was significantly
less than the Company has historically experienced. As a result, the Company is
beginning fiscal 2001 with less cash reserves than desired and at less than
historical levels. Liquidity issues currently facing the Company include (i)
seasonal cash flow tightening which occurs in the first quarter of the Company's
fiscal year, (ii) negative cash flow typically experienced by new stores during
the pre-opening and start-up phase of operations, and (iii) the need to
successfully execute management's plans to implement changes to operations so
that existing restaurants can exceed profit margins experienced in the past. The
Company anticipates using three different cash sources to meet operating cash
needs during the first quarter of the year. These sources include (i)
participating in advances and seasonal payment terms offered by the Company's
primary suppliers, (ii) using the Company's working capital line of credit, and
(iii) utilizing approximately $2,000,000 generated from the sale of common
stock.
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23
The resulting cash management activities can be discussed in two
primary areas: (i) operations of existing Wendy's restaurants and (ii)
investment into new Wendy's restaurants.
Cash flow from existing operations has declined over the past year due
to both increased operating costs and operational challenges resulting from the
Company's significant growth rate over the past two years. Previous management
of the Company developed only two new restaurants between 1988 and 1998. A new
management team that was assembled in 1998 began aggressively developing new
restaurants. In the past two years the Company has experienced a 32% increase in
number of restaurants. The Company has recognized the need to implement a number
of operational changes in order to effectively manage a growing and larger
company. These changes, which are being implemented during the first quarter of
fiscal 2001, are discussed in detail in the "Management Outlook" section. It is
anticipated that these initiatives will increase cash flow from existing
operations over the upcoming fiscal year.
Capital investment into existing restaurants is estimated at $1,000,000
during fiscal 2001. It is anticipated that the capital resources for this
investment will be a combination of internally generated cash from existing
operations and financing that is available under Wendy's International preferred
lender programs.
The Company plans to open six to eight new stores during fiscal 2001.
In order to minimize the impact of increased 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 with the remaining
stores opening throughout the balance of the fiscal year. The Company benchmarks
and monitors its pre-opening and start-up costs to insure that improved
efficiencies are being achieved.
The majority of the planned new restaurants for fiscal 2001 will
require an investment in real estate and equipment, and the remainder of the
planned new restaurants will require an investment in equipment only as the real
estate will be leased. It is anticipated that the new restaurants will require
an investment of up to $1.25 million for each new restaurant that is owned and
up to $275,000 for each new restaurant that is leased. It is expected that
$275,000 of equity will be invested in each new restaurant. Approximately $2
million of development equity was raised in the sale of common stock occurring
during the first quarter of fiscal 2001. Any remaining investment will be funded
through long-term financing. The Company has received 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
commenced construction on a new restaurant scheduled to open in March 2001. The
Company anticipates utilizing approximately $1,000,000 of the forward commitment
for this restaurant. The 15-year mortgage (20-year amortization) and 7-year
equipment loan will carry fixed interest rates equal to 2.6% over the then
current same term treasury rates. Based on current treasury rates, the rate
would be approximately 7.9%. Other financing commitment proposals contain
similar terms.
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;
- Leverage Ratio (Funded Debt: Earnings Before Interest, Taxes,
Depreciation and Amortization) not to exceed 6.0 : 1; 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.
23
24
At November 30, 2000, 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 2000, and the
Company anticipates that these requirements will be met in the upcoming year
through the use of (i) allowable cash flow from the Wendy's operations and (ii)
cash reserves.
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.
- Using operating cash generated from existing Wendy's restaurants.
- Borrowing on its $3.5 million line of credit. As of January 31,
2001, $1,050,000 was outstanding on the line with $2,450,000
available.
- Selling real estate currently listed for sale.
- Obtaining an advance of marketing funds from the Company's beverage
supplier.
- Working with vendors to obtain extended payment terms.
- 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.
- Reducing or deferring the capital expenditures described above.
- Investing the approximately $2 million of funds generated from the
sale of common stock which occurred in the first quarter of fiscal
2001.
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
- -----------------------------
The food service industry has been affected by the shortage of
management and hourly employees. Rising wage rates, due to this shortage, had a
negative impact on the Company's operating results in fiscal 2000. It is
expected that labor cost pressures will continue into fiscal 2001. Increases in
labor costs, along with periodic increases in food and other operating expenses
(including higher fuel and utility costs), 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. The Company instituted price increases equal to
about 8% during the fourth quarter of 2000, which are expected to produce
additional cash flow to offset increased operating costs.
MANAGEMENT'S OUTLOOK
- --------------------
During the fourth quarter of 2000, the Company was successful in
attracting a new president to the Company. Robert E. Riley brings many years of
retail management experience to the Company. Under the joint leadership of
Robert E. Schermer, Jr. and Mr. Riley, the Company has initiated a total
evaluation and reengineering of many of its administrative and operational
processes. The Company began implementing several operational changes that are
expected to increase cash flow. These changes include (i) adopting a more
objective profit-oriented incentive compensation plan for restaurant management,
(ii) creating special contests for crew members each quarter in order to involve
them more fully in striving to meet the Company's financial and operational
goals, (iii) realignment of key operational personnel into more productive and
profit-generating positions, (iv) increasing menu prices to better align the
Company's prices with its competitors and to absorb operating cost increases,
(v) consolidation of the Company's Grand Rapids and Kalamazoo offices into a new
office in Grand Rapids, (vi) establishing an in-house training center to improve
the quality and effectiveness of restaurant managers and to reduce turnover, and
(vii) implementing an aggressive capital improvement plan at existing
restaurants. These operational initiatives, along with an aggressive and
strategic growth plan, are the key elements of management's plans for fiscal
2001.
24
25
During the upcoming year, management will focus on stabilizing the
workforce at its restaurants. With a renewed emphasis on recruiting, management
intends to improve upon its hiring process. Through improved training programs
and working conditions, combined with a competitive compensation and incentive
pay plan, management expects to retain a greater percentage of its employees in
fiscal 2001 and beyond. Recent industry-wide surveys indicate that employee
recruitment and retention is the top operational challenge for quick-service
restaurant businesses in 2001. Retention and recruiting remain a key focus for
the Company.
Capital improvements will focus on two primary areas: renovation of
restaurant properties and the continued implementation of the Wendy's
system-wide program called "Service Excellence." The major thrust of Service
Excellence involves training employees to approach service in a new manner. With
the average age of the Company's restaurants at approximately 13 years, the
Company is targeting several of its older restaurants for a complete "face-lift"
which is expected to improve the overall dining experience for its customers.
Restaurant openings form the basis of the Company's growth strategy.
During fiscal 2001 the Company plans to open six to eight new 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 outdated units,
and replace such units with new, more efficient restaurants.
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.
25
26
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 February 12,
2001:
===================================== ==================================== =====================================
COMMON SHARES
BENEFICIALLY OWNED
------------------
NAME AND AGE (1) POSITION AMOUNT (2) PERCENTAGE
------------------------------------- ------------------------------------ ------------------- -----------------
Robert E. Schermer, Sr. (3) (4) Chairman of the Board of Directors 637,521 11.8%
65
------------------------------------- ------------------------------------ ------------------- -----------------
Robert E. Schermer, Jr. (3) (5) (6) Chief Executive Officer and 472,079 8.6%
42 Director
------------------------------------- ------------------------------------ ------------------- -----------------
Robert E. Riley (6) (7) President 525,200 9.6%
53
------------------------------------- ------------------------------------ ------------------- -----------------
Pauline M. Krywanski (6) Vice President, Treasurer and Chief 42,276 *
40 Financial Officer
------------------------------------- ------------------------------------ ------------------- -----------------
James R. Saalfeld (6) Vice President, Secretary and 29,606 *
33 General Counsel
------------------------------------- ------------------------------------ ------------------- -----------------
James P. Bishop (8) (9) Director 37,156 *
60
------------------------------------- ------------------------------------ ------------------- -----------------
Christopher P. Hendy (8) (9) Director 18,591 *
43
------------------------------------- ------------------------------------ ------------------- -----------------
Joseph L. Maggini (3) (8) (10) Director 422,090 7.8%
61
------------------------------------- ------------------------------------ ------------------- -----------------
Jerry L. Ruyan (9) Director 249,296 4.6%
54
------------------------------------- ------------------------------------ ------------------- -----------------
All Current Executive Officers and 2,433,815 43.7%
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 non-employee directors to acquire from 3,000 to
9,000 shares pursuant to the 1996 Directors' Share Option Plan.
(3) Executive Committee Member.
(4) Includes 4,000 shares held by Mr. Schermer, Sr.'s wife.
(5) Includes 3,850 shares held by Mr. Schermer, Jr. as a custodian for his
minor child.
(6) Includes options presently exercisable, or exercisable within 60 days, for
Mr. Schermer, Jr. of 56,041 shares, Mr. Riley of 25,000, Ms. Krywanski of
17,526 shares, and Mr. Saalfeld of 19,029 shares.
(7) Includes 7,500 shares held by a trust for the benefit of Mr. Riley's wife,
and 10,275 shares held by Mr. Riley's spouse in an IRA account.
(8) Compensation Committee Member.
(9) Audit Committee Member.
(10) Includes 1,100 shares held by Mr. Maggini's wife, and 1,000 shares held 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.
Robert E. Schermer, Jr. has been a director of the Company since
January 25, 1996. He has been Chief Executive Officer of the Company since
October 6, 1998. Mr. Schermer also served as President of the Company from
October 1998 until October 2000, Treasurer of the Company from January 1996
until September 1996, and Executive Vice President from January 1996 until
October 1998.
26
27
Robert E. Riley has been President of the Company since October 25,
2000. From 1984 until 1999, Mr. Riley was with Meijer Inc., a multi-billion
dollar supermarket and general merchandise retailer, where he held the position
of Senior Vice President, General Counsel and Secretary since 1986.
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 in the Midwest Region.
Ms. Krywanski is a CPA.
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 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 founding the company in 1974, Mr. Maggini has served as President
and Chairman of the Board of Magic Steel Corporation, a steel service center
located in Grand Rapids, Michigan.
Jerry L. Ruyan has been a director of the Company since October 24,
1996. 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
2000 all filing requirements were met except for Mr. Riley who untimely reported
a purchase of 1,500 common shares.
ITEM 11. EXECUTIVE COMPENSATION.
The following table sets forth information regarding compensation paid
by the Company to its Chief Executive Officer and executive officers or
significant employees earning in excess of $100,000 in fiscal 2000:
27
28
==================================================================================================================
SUMMARY COMPENSATION TABLE
- -------------------------------- ---------- ------------------------------ ---------------------------------------
ANNUAL COMPENSATION LONG-TERM COMPENSATION
SECURITIES UNDER- OTHER ANNUAL
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS LYING OPTIONS COMPENSATION
================================ ========== =============== ============== =================== ===================
Robert E. Schermer, Jr. 2000 $136,585 --- 20,205 ---
Chief Executive Officer 1999 $127,000 $27,782 50,000 ---
1998 $164,773 $25,000 45,000 ---
- -------------------------------- ---------- --------------- -------------- ------------------- -------------------
Ray E. Quada 2000 $93,353 --- --- $25,331(2)
Senior Vice President & Chief 1999 $122,470 $25,884 25,768 ---
Operating Officer 1998 $120,941 $36,649 12,500 ---
- -------------------------------- ---------- --------------- -------------- ------------------- -------------------
Pauline M. Krywanski 2000 $104,242 $5,000 --- ---
Vice President, Treasurer & 1999 $101,600 $22,225 24,496 ---
Chief Financial Officer 1998 $98,958 $10,000 10,000 ---
- -------------------------------- ---------- --------------- -------------- ------------------- -------------------
James R. Saalfeld 2000 $93,817 $5,000 --- ---
Vice President, General 1999 $91,440 $20,003 27,741 ---
Counsel & Secretary 1998 $87,917 $10,000 10,000 ---
================================ ========== =============== ============== =================== ===================
(1) Mr. Schermer, Jr. also received an annual automobile allowance.
(2) Mr. Quada passed away on August 27, 2000. One-time payments were made
associated with the funeral expenses and accrued employment benefits.
STOCK OPTIONS
The following tables contain information concerning the grant of stock
options to the executives and employees identified in the Summary Compensation
Table and the appreciation of such options:
===================================================================================================================
OPTION GRANTS IN FISCAL 2000
- -------------------------------------------------------------------------------------------------------------------
POTENTIAL REALIZABLE
VALUE AT
ASSUMED ANNUAL RATES OF
STOCK PRICE APPRECIATION
FOR
OPTION TERM
NUMBER OF % OF TOTAL EXERCISE
SECURITIES OPTIONS GRANTED PRICE
UNDERLYING TO EMPLOYEES IN ($ PER EXPIRATION
NAME OPTIONS GRANTED FISCAL 2000 SHARE) DATE 5% 10%
- ---------------------------- ---------------- --------------- ------------- ----------- ------------ --------------
Robert E. Schermer, Jr. 20,205 89 % $ 2.4375 12/1/2009 $ 30,978 $ 78,504
===================================================================================================================
- -------------------------------------------------------------------------------------------------------------------
FISCAL 2000 OPTION EXERCISES AND FISCAL YEAR-END OPTION VALUES
- -------------------------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE
OPTIONS AT FISCAL YEAR MONEY OPTIONS AT FISCAL
END YEAR END
SHARES ACQUIRED
NAME ON EXERCISE VALUE REALIZED EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
- --------------------------- --------------- ----------------- ------------------------- ---------------------------
Robert E. Schermer, Jr. --- --- 91,000/114,205 (1) $6,250/$25,000
- --------------------------- --------------- ----------------- ------------------------- ---------------------------
Ray E. Quada --- --- 10,154/28,114 (1) $868/$3,472
- --------------------------- --------------- ----------------- ------------------------- ---------------------------
Pauline M. Krywanski --- --- 14,898/29,598 (1) $1,041/$4,167
- --------------------------- --------------- ----------------- ------------------------- ---------------------------
James R. Saalfeld --- --- 29,549/35,692 (1) $1,649/$6,597
=========================== =============== ================= ========================= ===========================
(1) There is no value associated with a significant portion of the exercisable
options because the exercise price for these options is in excess of the
year-end share price.
28
29
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Other than certain of the Company's directors and officers as
identified in Item 10 herein, no other shareholders are known by the Company to
beneficially own 5% or more of the Company's outstanding common shares as of
February 12, 2001, except for Peter D. Wierenga who reported beneficial
ownership of 271,109 (5.0%). Mr. Wierenga's business address is reported in his
Schedule 13D as 3703 S. Division Ave., 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.
On November 30, 2000, Meritage sold 200,000 unregistered common shares
to the Company's newly appointed President, Robert E. Riley, in connection with
Mr. Riley's appointment as President. The shares were priced at $2.00 per share
which was the closing price of Meritage's common shares on the American Stock
Exchange on October 25, 2000, the date that Mr. Riley was appointed President.
The source of the common shares issued to Mr. Riley was treasury shares.
On February 9, 2001, Meritage completed the sale of 762,500
unregistered common shares to its officers and certain directors at $2.1556 per
share in a private placement. Cash proceeds of $1,104,745 and a 90-day
promissory note for $538,900 will be used for the continued development of its
Wendy's operations. The private placement was authorized by the Board of
Directors on January 22, 2001. The share price was computed by adding $0.0625 to
the average closing price of the common shares on the American Stock Exchange
for the ten trading days beginning on January 22, 2001. The source of the common
shares issued was treasury shares. The following directors and officers
participated in the private placement and acquired the common shares noted next
to their name: Director - James P. Bishop (10,000 shares); Director - Joseph L.
Maggini (230,000 shares); CEO & Director - Robert E. Schermer, Jr. (250,000
shares); President - Robert E. Riley (250,000 shares); Vice President &
Secretary - James R. Saalfeld (2,500 shares); and Vice President & Treasurer -
Pauline M. Krywanski (20,000 shares). Mr. Schermer's shares were purchased with
a 90-day recourse note to Meritage bearing interest at 8.0% per annum and
secured by 250,000 common shares.
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).
10.1 Sample Construction Loan Agreement with Captec Financial Group,
Inc. (4).
10.2 Sample Promissory Note with Captec Financial Group, Inc.
regarding real estate financing (4).
10.3 Sample Mortgage with Captec Financial Group, Inc. regarding real
estate financing (4).
10.4 Sample Promissory Note with Captec Financial Group, Inc.
regarding leasehold financing (4).
10.5 Sample Mortgage with Captec Financial Group, Inc. regarding
leasehold financing (4).
10.6 Sample Promissory Note with Captec Financial Group, Inc.
regarding business value financing (4).
10.7 Sample Security Agreement with Captec Financial Group, Inc.
regarding business value financing (4).
10.8 Sample Loan Agreement with Fleet Business Credit Corporation
(5).
10.9 Sample Promissory Note with Fleet Business Credit Corporation
(5).
10.10 Sample Mortgage with Fleet Business Credit Corporation (5).
10.11 Sample Guaranty with Fleet Business Credit Corporation (5).
10.12 Line of Credit, Term Loan & Security Agreement with Fleet
Business Credit Corporation (6).
10.13 Promissory Note for Line of Credit with Fleet Business Credit
Corporation (6).
30
31
10.14 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 (7).
10.15 Agreement and Consent dated August 7, 1998 between WM Limited
Partnership - 1998, Meritage Hospitality Group Inc., MHG Food
Service Inc., Meritage Capital Corp., MCC Food Service Inc.,
Robert E. Schermer, Jr., and Christopher B. Hewett (4).
10.16 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 (8).
10.17 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 (8).
10.18 Sample indemnification agreement for officers and directors of
the Company (9).
10.19 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 (5).
10.20 Promissory Note and Stock Pledge Agreement dated February 16,
2001 among Meritage Hospitality Group Inc., as lender, and
Robert E. Schermer, Jr., as borrower (10).
MANAGEMENT COMPENSATORY CONTRACTS
10.21 Amended 1996 Management Equity Incentive Plan (11).
10.22 Amended 1996 Directors' Share Option Plan (7).
10.23 1999 Directors' Compensation Plan (8).
----------------------------------
21 Subsidiaries of the Registrant (8).
23 Consent of Grant Thornton LLP (11).
31
32
Exhibits previously filed and incorporated by reference from:
(1) The Quarterly Report on Form 10-Q for the Company's fiscal quarter ended May 31, 2000.
(2) Report on Form 8-K for the Company filed on November 6, 2000.
(3) The Annual Report on Form 10-K for the Company's fiscal year ended November 30, 1996.
(4) The Quarterly Report on Form 10-Q for the Company's fiscal quarter ended August 31, 1998.
(5) The Quarterly Report on Form 10-Q for the Company's fiscal quarter ended May 31, 1999.
(6) The Quarterly Report on Form 10-Q for the Company's fiscal quarter ended August 31, 2000.
(7) The Quarterly Report on Form 10-Q for the Company's fiscal quarter ended May 31, 1997.
(8) The Annual Report on Form 10-K for the Company's fiscal year ended November 30, 1998.
(9) The Annual Report on Form 10-K for the Company's fiscal year ended November 30, 1997.
(10) Amendment No. 2 to Schedule 13-D filed by Robert E. Schermer, Jr. on
February 20, 2001.
(11) Filed herewith.
(b) Reports on Form 8-K.
-------------------
On November 6, 2000, the Company filed a report on Form 8-K under Item
5 announcing that the Board of Directors appointed Robert E. Riley as President
of the Company on October 25, 2000. It was reported that Mr. Riley will focus on
increasing the profitability of the Company's existing operations, and will fill
certain open functions brought about by the untimely death of Meritage's Senior
Vice President & Chief Operating Officer, Ray E. Quada, in August 2000.
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 15, 2001 By /s/ Robert E. Schermer, Jr.
----------------------------
Robert E. Schermer, Jr.
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 15, 2001
- ------------------------------------
Robert E. Schermer, Sr.
/s/ Robert E. Schermer, Jr. Chief Executive Officer and Director February 15, 2001
- ------------------------------------ (Principal Executive Officer)
Robert E. Schermer, Jr.
/s/ Pauline M. Krywanski Vice President, Treasurer and Chief February 15, 2001
- ------------------------------------ Financial Officer (Principal Financial
Pauline M. Krywanski & Accounting Officer)
/s/ James P. Bishop Director February 15, 2001
- ------------------------------------
James P. Bishop
/s/ Christopher P. Hendy Director February 15, 2001
- ------------------------------------
Christopher P. Hendy
/s/ Joseph L. Maggini Director February 15, 2001
- ------------------------------------
Joseph L. Maggini
/s/ Jerry L. Ruyan Director February 15, 2001
- ------------------------------------
Jerry L. Ruyan
33
34
INDEX TO FINANCIAL STATEMENTS
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES Page
----
Report of Independent Certified Public Accountants .................................................... F-2
FINANCIAL STATEMENTS
Consolidated Balance Sheets............................................................................ F-3
Consolidated Statements of Operations.................................................................. F-5
Consolidated Statements of Stockholders' Equity........................................................ F-7
Consolidated Statements of Cash Flows.................................................................. F-9
Notes to Consolidated Financial Statements ............................................................ F-12
SCHEDULES
Schedule II Valuation and Qualifying Accounts ......................................................... F-26
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, 2000 and 1999, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended November 30, 2000. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Meritage Hospitality
Group Inc. and subsidiaries as of November 30, 2000 and 1999 and the
consolidated results of their operations and their consolidated cash flows for
each of the three years in the period ended November 30, 2000, in conformity
with accounting principles generally accepted in the United States of America.
We also audited Schedule II for the years ended November 30, 2000, 1999 and
1998. In our opinion this schedule presents fairly, in all material respects,
the information required to be set forth therein.
Southfield, Michigan
December 22, 2000
F-2
36
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
NOVEMBER 30,
- --------------------------------------------------------------------------------
ASSETS
2000 1999
----------- -----------
CURRENT ASSETS
Cash and cash equivalents $ 787,747 $ 1,578,914
Receivables 59,605 81,239
Notes receivable, current portion -- 475,000
Inventories 228,023 207,563
Prepaid expenses and other current assets 165,104 157,413
----------- -----------
Total Current Assets 1,240,479 2,500,129
PROPERTY, PLANT AND EQUIPMENT, NET 19,092,780 16,683,959
OTHER ASSETS
Assets held for sale 704,350 --
Goodwill, net of amortization of $516,816 and
$335,287, respectively 4,792,907 4,974,436
Franchise costs, net of amortization of $65,375 and
$40,167, respectively 734,625 684,833
Financing costs, net of amortization of $47,379 and
$17,808, respectively 355,180 318,385
Deferred charges and other assets 124,907 39,657
----------- -----------
Total Other Assets 6,711,969 6,017,311
----------- -----------
Total Assets $27,045,228 $25,201,399
=========== ===========
F-3
37
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - CONTINUED
NOVEMBER 30,
================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
2000 1999
------------ ------------
CURRENT LIABILITIES
Current portion of long-term obligations $ 682,242 $ 874,051
Current portion of obligations under capital lease 357,768 328,236
Trade accounts payable 1,376,342 1,245,679
Income taxes payable 2,264 5,000
Accrued liabilities 1,168,708 1,145,756
------------ ------------
Total Current Liabilities 3,587,324 3,598,722
LONG-TERM OBLIGATIONS 16,475,202 12,822,125
OBLIGATIONS UNDER CAPITAL LEASE 709,046 1,066,814
DEFERRED REVENUE 1,742,483 1,830,788
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: 29,520 and 44,520,
respectively (liquidation value - $295,200 and
$445,200, respectively) 295 445
Common stock - $0.01 par value
shares authorized: 30,000,000
shares issued: 5,862,702 and 5,752,677, respectively
shares outstanding: 4,454,884 and
5,751,877, respectively 44,548 57,519
Additional paid in capital 11,703,257 13,316,795
Note receivable from sale of shares, net of valuation
allowance of $5,362,804 in 1999 -- (1,660,962)
Accumulated deficit (7,216,927) (5,830,847)
------------ ------------
Total Stockholders' Equity 4,531,173 5,882,950
------------ ------------
Total Liabilities and Stockholders' Equity $ 27,045,228 $ 25,201,399
============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-4
38
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED NOVEMBER 30,
- --------------------------------------------------------------------------------
2000 1999 1998
------------ ------------ ------------
Food and beverage revenue $ 33,104,982 $ 29,752,416 $ 27,043,954
Cost and expenses
Cost of food and beverages 9,587,701 8,556,960 7,752,187
Operating expenses 19,628,560 17,121,683 15,814,592
General and administrative expenses 2,054,303 1,780,173 2,944,756
Depreciation and amortization 1,582,613 1,283,343 1,078,539
Impairment of assets 553,549 156,150 --
------------ ------------ ------------
Total costs and expenses 33,406,726 28,898,309 27,590,074
------------ ------------ ------------
Earnings (loss) from operations (301,744) 854,107 (546,120)
Other income (expense)
Interest expense (1,360,986) (1,314,811) (1,473,019)
Interest income 98,004 390,701 184,614
Other income 69,797 -- 509,590
Gain (loss) on disposal of assets 142,167 391,571 (25,000)
Minority interest -- -- 25,677
------------ ------------ ------------
Total other expense (1,051,018) (532,539) (778,138)
------------ ------------ ------------
Earnings (loss) from continuing
operations before income taxes (1,352,762) 321,568 (1,324,258)
Income taxes - current -- -- 50,000
------------ ------------ ------------
Earnings (loss) from continuing operations (1,352,762) 321,568 (1,374,258)
Discontinued operations
Loss from operations (including
income tax benefit of $160,000 in 1998) -- -- (479,232)
Gain on disposal of discontinued operations -- 150,140 3,711,364
------------ ------------ ------------
Earnings from discontinued operations -- 150,140 3,232,132
------------ ------------ ------------
Earnings (loss) before extraordinary item (1,352,762) 471,708 1,857,874
Extraordinary item - loss on early extinguishment
of debt (no applicable federal income tax) -- -- 727,172
------------ ------------ ------------
Net earnings (loss) (1,352,762) 471,708 1,130,702
Preferred stock dividends 33,318 40,068 107,928
------------ ------------ ------------
Net earnings (loss) on common shares $ (1,386,080) $ 431,640 $ 1,022,774
============ ============ ============
F-5
39
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS - CONTINUED
YEARS ENDED NOVEMBER 30,
================================================================================
2000 1999 1998
------------- ------------- -------------
Earnings (loss) per common share - basic and diluted
Continuing operations $ (.25) $ .05 $ (.30)
Discontinued operations -- .03 .66
Extraordinary item -- -- (.15)
------------- ------------- -------------
Net earnings (loss) $ (.25) $ .08 $ .21
============= ============= =============
Weighted average shares outstanding - basic 5,489,710 5,748,288 4,932,738
============= ============= =============
Weighted average shares outstanding - diluted 5,489,710 5,774,337 4,932,738
============= ============= =============
F-6
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
40
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED NOVEMBER 30, 2000, 1999 AND 1998
- --------------------------------------------------------------------------------
SERIES A NOTE
CONVERTIBLE ADDITIONAL RECEIVABLE
PREFERRED COMMON PAID-IN SALE OF ACCUMULATED
STOCK STOCK CAPITAL SHARES DEFICIT TOTAL
---------- ------------ ------------ ------------ ------------ ------------
Balance at December 1, 1997 $ 1,384 $ 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 stock into
523,873 common shares (739) 5,239 (4,500) -- -- --
Cancellation of 20,000 shares of
convertible preferred stock (200) -- (199,800) -- -- (200,000)
Preferred dividends paid -- -- -- -- (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
Issuance of 10,091 shares of common
stock -- 101 19,403 -- -- 19,504
Preferred dividends paid -- -- -- -- (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
F-7
41
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - CONTINUED
YEARS ENDED NOVEMBER 30, 2000, 1999 AND 1998
- --------------------------------------------------------------------------------
SERIES A NOTE
CONVERTIBLE ADDITIONAL RECEIVABLE
PREFERRED COMMON PAID-IN SALE OF ACCUMULATED
STOCK STOCK CAPITAL SHARES DEFICIT TOTAL
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 1, 1999 $ 445 $ 57,519 $ 13,316,795 $ (1,660,962) $ (5,830,847) $ 5,882,950
Issuance of 30,464 shares of common
stock -- 304 67,437 -- -- 67,741
Transfer of 15,000 shares of
convertible preferred shares for
80,001 common shares (150) 800 (650) -- -- --
Preferred dividends paid -- -- -- -- (33,318) (33,318)
Surrender of 1,392,858 common
shares for note receivable -- (13,929) (1,647,033) 1,660,962 -- --
Purchase of 14,600 shares of
common stock -- (146) (33,292) -- -- (33,438)
Net loss -- -- -- -- (1,352,762) (1,352,762)
------------ ------------ ------------ ------------ ------------ ------------
Balance at November 30, 2000 $ 295 $ 44,548 $ 11,703,257 $ -- $ (7,216,927) $ 4,531,173
============ ============ ============ ============ ============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-8
42
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED NOVEMBER 30,
- --------------------------------------------------------------------------------
2000 1999 1998
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net earnings (loss) $(1,352,762) $ 471,708 $ 1,130,702
Adjustments to reconcile net earnings (loss) to net
cash provided by operating activities
Depreciation and amortization 1,582,613 1,283,343 1,078,539
Compensation paid by issuance of common stock 38,991 19,504 6,288
(Gain) loss on disposal of assets (142,167) (391,571) 25,000
Impairment of assets 553,549 156,150 --
Minority interest in loss of consolidated
subsidiaries -- -- (25,677)
Extraordinary item-loss on early extinguishment
of debt -- -- 45,038
Decrease (increase) in cash value of life insurance -- 222,903 (8,884)
(Decrease) increase in deferred revenue (88,305) (161,238) 1,992,026
Decrease (increase) in current assets
Receivables 21,634 (10,265) 187,308
Inventories (20,460) (42,407) (8,410)
Prepaid expenses and other current assets (7,691) (66,617) 65,232
Increase (decrease) in current liabilities
Trade accounts payable 130,663 518,480 (86,656)
Amount due related party -- (245,260) 159,997
Income taxes payable (2,736) (45,000) 50,000
Accrued liabilities 22,952 (163,231) 471,757
(Decrease) increase in net (assets) liabilities
of discontinued operations -- (593,854) 1,433,841
----------- ----------- -----------
Net cash provided by operating
activities 736,281 952,645 6,516,101
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from disposal of assets 192,500 -- --
Proceeds from insurance - fire 84,000 671,061 --
Purchase of property, plant and equipment (5,133,408) (5,188,748) (5,029,283)
Payment for franchise agreement (75,000) (75,000) (25,000)
Note receivable from sale of assets -- -- (3,219,617)
Collection on notes receivable 475,000 2,744,617 --
Acquisition of business, net of cash acquired -- -- (758,632)
Increase in other assets (99,200) -- (34,191)
----------- ----------- -----------
Net cash used in investing activities (4,556,108) (1,848,070) (9,066,723)
F-9
43
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
YEARS ENDED NOVEMBER 30,
- --------------------------------------------------------------------------------
2000 1999 1998
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term obligations $ 4,419,589 $ 3,115,542 $ 10,408,217
Payment of financing costs (66,366) (71,064) (265,129)
Proceeds from note payable -- -- 1,498,934
Principal payments on long-term obligations (483,321) (1,242,769) (7,676,361)
Payments on obligations under capital lease (328,236) (294,577) (264,372)
Payments on notes payable (475,000) (1,100,000) --
Proceeds from issuance of common shares 28,750 -- 5,144
Purchase of common stock (33,438) (2,083) --
Preferred dividends paid (33,318) (40,068) (107,928)
------------ ------------ ------------
Net cash provided by financing activities 3,028,660 364,981 3,598,505
------------ ------------ ------------
Net (decrease) increase in cash (791,167) (530,444) 1,047,883
Cash and cash equivalents - beginning of year 1,578,914 2,109,358 1,061,475
------------ ------------ ------------
Cash and cash equivalents - end of year $ 787,747 $ 1,578,914 $ 2,109,358
============ ============ ============
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest $ 1,358,177 $ 1,319,123 $ 1,341,384
Cash paid for income taxes $ 2,736 $ 45,000 $ --
SCHEDULE OF NON-CASH INVESTING AND
FINANCING ACTIVITIES
Transfer of 15,000 shares of convertible preferred
stock into 80,001 shares of common stock in 2000.
Conversion of 73,867 shares of convertible preferred
stock into 523,873 shares of common stock in 1998.
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
============
F-10
44
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
YEARS ENDED NOVEMBER 30,
- --------------------------------------------------------------------------------
2000 1999 1998
------------- -------------- -----------------
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
===============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-11
45
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 2000, 1999 AND 1998
- --------------------------------------------------------------------------------
NOTE A - NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
The Company currently conducts its business in the quick-service restaurant
industry operating thirty-two 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.
F-12
46
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 2000, 1999 AND 1998
- --------------------------------------------------------------------------------
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 certain of the Company's
restaurant locations due to changes in local market conditions. In 2000, the
Company closed one restaurant and listed another restaurant for sale due to the
opening of a new restaurant in the same market area. The property and equipment
owned by the Company at these locations were written down to estimated fair
market value resulting in an impairment loss in 2000 of $553,549. In 1999,
management decided that the lease for a certain 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 was approximately $1,667,000, $1,428,000, and
$1,553,000 for the years ended November 30, 2000, 1999 and 1998, 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.
F-13
47
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 2000, 1999 AND 1998
- --------------------------------------------------------------------------------
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, 2000, 1999
and 1998:
2000 1999 1998
---------------- ------------ ----------------
Numerators
Earnings (loss) from continuing
operations $ (1,352,762) $ 321,568 $ (1,374,258)
Less preferred stock dividends 33,318 40,068 107,928
---------------- ------------ ----------------
Earnings (loss) on common shares -
basic and diluted $ (1,386,080) $ 281,500 $ (1,482,186)
================ ============ ================
Denominators
Weighted average common shares
outstanding - basic 5,489,710 5,748,288 4,932,738
Effect of dilutive securities
Stock options - 26,049 -
---------------- ------------ ----------------
Weighted average common shares
outstanding - diluted 5,489,710 5,774,337 4,932,738
================ ============ ================
For 2000, 1999 and 1998, convertible preferred stock was not included in the
computation of diluted earnings per common share because the effect of
conversion would be antidilutive. For 2000 and 1998, exercisable stock options
were not included in the computation of diluted earnings per share because the
exercise of stock options would be antidilutive.
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.
F-14
48
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 2000, 1999 AND 1998
- --------------------------------------------------------------------------------
NOTE A - NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 1999 and 1998 financial statements have been reclassified
to conform to the 2000 presentation.
NOTE B - ACQUISITION
In 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 year ended November 30, 1998 as if 100% of the acquisition
had occurred at the beginning of the period 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 period
presented.
1998
--------------
Revenues $ 27,044,000
Net loss from
continuing operations $ (1,350,000)
Loss per share $ (.30)
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. As of November 30, 2000 and 1999, there were no assets or liabilities of
the discontinued lodging group business segment included in the balance sheet.
F-15
49
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 2000, 1999 AND 1998
- --------------------------------------------------------------------------------
NOTE C - DISCONTINUED OPERATIONS - SALE OF HOTEL ASSETS (CONTINUED)
The results of operations of the discontinued operations for the years ended
November 30, 2000, 1999 and 1998 are summarized below:
For years ended November 30, 2000 1999 1998
-------------- --------------- --------------
Revenues $ - $ - $ 6,358,126
Earnings from operations $ - $ - $ 151,934
Earnings from discontinued operations $ - $ 150,140 $ 3,232,132
NOTE D - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are summarized as follows at November 30:
2000 1999
------------------ --------------
Land and improvements $ 5,738,367 $ 4,512,961
Buildings and improvements 7,801,228 7,108,779
Furnishings and equipment 6,260,465 4,548,506
Leasehold improvements 1,100,793 1,024,422
Leased property/capital leases 983,292 983,292
Construction in progress 139,383 300,796
------------------ ------------------
22,023,528 18,478,756
Less accumulated depreciation and amortization (2,930,748) (1,794,797)
------------------ ------------------
$ 19,092,780 $ 16,683,959
================== ==================
Depreciation and amortization expense was approximately $1,332,000, $1,057,000,
and $853,000 for the years ended November 30, 2000, 1999 and 1998, respectively.
NOTE E - NOTES RECEIVABLE
Notes receivable consisted of the following at November 30:
2000 1999
-------- --------
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 1999 and 15.0% thereafter
through April 2000 when the remaining balance was
paid in full. $ -- $475,000
Less current portion -- 475,000
-------- --------
$ -- $ --
======== ========
F-16
50
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 2000, 1999 AND 1998
- --------------------------------------------------------------------------------
NOTE F - AMOUNTS DUE RELATED PARTIES AND RELATED PARTY TRANSACTIONS
The Company had 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 were the same as the assigned note receivable (see Note E), which
included monthly payments of interest only at 10.8% through December 1999 and
15.0% thereafter. In 1999, $900,000 was paid on this obligation reducing the
outstanding balance to $475,000. The note was paid in full in April 2000.
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). 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.
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.
NOTE G - ACCRUED LIABILITIES
Accrued liabilities consist of the following at November 30:
2000 1999
-------------------- -------------------
Payroll and related payroll taxes $ 525,704 $ 550,837
Property taxes 284,611 255,667
Interest expense 91,067 88,257
Other expenses 267,326 250,995
-------------------- -------------------
$ 1,168,708 $ 1,145,756
==================== ===================
F-17
51
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 2000, 1999 AND 1998
- --------------------------------------------------------------------------------
NOTE H - LONG-TERM OBLIGATIONS
Long-term obligations consist of the following at November 30:
2000 1999
----------- -----------
Mortgage notes payable, due in monthly installments
totaling $123,499 including interest at fixed rates
ranging from 7.8% to 8.7% maturing from October 2018
through November 2019. $14,003,840 $11,769,353
Notes payable, due in monthly installments of
$10,802 including interest at 8.15% through
September 2013. 1,029,470 1,073,236
Fixed rate equipment notes payable, requiring
monthly payments including interest aggregating
$24,119 and $9,863, respectively, subject to interest
at rates ranging from 8.02% to 9.54% maturing from
March 2002 through December 2007. 1,086,437 378,587
Variable rate equipment notes payable, requiring
monthly payments of principal increasing from
$6,906 to $11,241 over the term of the note plus
interest equal to the 7 year treasury rate plus 2.5%
maturing from January 2007 through December 2007. 720,197 --
Amount payable under $3.5 million revolving line of
credit, requiring monthly payments of interest only at
a variable interest rate equal to 30 day LIBOR plus
2.5% through July 2004 when any outstanding
principal is due. 317,500 --
Amount payable to the Chairman of the Board and
shareholder, due in monthly installments of interest
only at 10.8% through December 1999 and 15.0%
thereafter through April 2000 when the remaining
principal was paid in full (see Note F). -- 475,000
----------- -----------
17,157,444 13,696,176
Less current portion 682,242 874,051
----------- -----------
$16,475,202 $12,822,125
=========== ===========
Substantially all property, plant and equipment owned by the Company is pledged
as collateral for the outstanding long-term obligations.
F-18
52
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 2000, 1999 AND 1998
- --------------------------------------------------------------------------------
NOTE H - LONG-TERM OBLIGATIONS (CONTINUED)
Minimum principal payments on long-term obligations to maturity as of November
30, 2000 are as follows:
2001 $ 682,242
2002 706,226
2003 744,710
2004 1,043,353
2005 788,250
Thereafter 13,192,663
----------------
$ 17,157,444
================
Loan covenants of the various loan agreements include requirements for
maintenance of certain financial ratios. At November 30, 2000 the Company was in
compliance.
NOTE I - INCOME TAXES
Deferred tax assets and liabilities at November 30, consist of the following:
2000 1999
----------- -----------
Deferred tax assets:
Net operating loss carryforwards $ 1,295,000 $ 29,000
AMT credit carryforward 126,000 126,000
Interest income on note receivable -- 450,000
Goodwill 75,000 25,000
Asset impairment 235,000 53,000
Accrued compensation 12,000 --
Accrued expenses 6,000 21,000
Contribution carryover 73,000 73,000
----------- -----------
1,822,000 777,000
Deferred tax liabilities
Property and equipment - cost basis (81,000) (65,000)
Depreciation (227,000) (121,000)
Amortization (22,000) (14,000)
Capital leases (58,000) (29,000)
----------- -----------
(388,000) (229,000)
Less valuation allowance (1,434,000) (548,000)
----------- -----------
Net deferred tax liability $ -- $ --
=========== ===========
The net operating loss carryforwards expire through years ending in 2021.
F-19
53
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 2000, 1999 AND 1998
- --------------------------------------------------------------------------------
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,
-----------------------------------
2000 1999 1998
--------- --------- ---------
Tax expense (benefit) at statutory rates
applied to income before federal
income tax $(460,000) $ 109,000 $(450,000)
Permanent differences (420,000) (67,000) 44,400
Other (6,000) 18,000 21,600
Valuation allowance 886,000 (60,000) 434,000
--------- --------- ---------
$ -- $ -- $ 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
fifteen years) ranging from less than one year to thirty years.
Total lease expense (including taxes, insurance and maintenance when included in
rent) related to all operating leases and all percentage rentals was as follows:
YEARS ENDED NOVEMBER 30,
------------------------------------
2000 1999 1998
---------- ---------- ----------
Minimum rentals $ 557,879 $ 477,713 $ 672,755
Percentage rentals 424,474 425,458 523,033
---------- ---------- ----------
$ 982,353 $ 903,171 $1,195,788
========== ========== ==========
F-20
54
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 2000, 1999 AND 1998
- --------------------------------------------------------------------------------
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
------------------------ -------------- ---------------
2001 $ 457,344 $ 746,404
2002 369,575 713,296
2003 369,575 700,212
2004 30,798 540,409
2005 - 517,372
Thereafter - 3,602,436
-------------- ---------------
Total minimum lease obligations 1,227,292 $ 6,820,129
===============
Less amount representing interest imputed at
approximately 11% 160,478
--------------
Present value of minimum lease obligations $ 1,066,814
==============
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 $470,900
and $304,700, at November 30, 2000 and 1999, 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.
F-21
55
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 2000, 1999 AND 1998
- --------------------------------------------------------------------------------
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 $7.00 per share. The shares have a liquidation value of
$10.00 per share.
Under certain conditions relating to the market value of the Company's common
stock, the Company has the option to cause the preferred stock to be converted
into common stock.
NOTE 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, as amended, provided that CBHCC was not required to make
any payments to the Company from the date of the Note (September 19, 1995) until
September 19, 2000 when the remaining balance was due.
The Note was collateralized by the shares issued to CBHCC under the Agreement.
The Note was discounted at 11% and was 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 was recorded as of November 30, 1999.
In September 2000, CBHCC acknowledged that it could not pay the indebtedness.
The Company and CBHCC entered into a Collateral Surrender Agreement whereby the
shares were surrendered. The note receivable and the related valuation allowance
were written off and the shares were returned as treasury stock.
NOTE N - 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 O - 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 and
plan expenses paid by the Company totaled $3,400, $24,830, and $27,720 in 2000,
1999 and 1998, respectively.
F-22
56
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 2000, 1999 AND 1998
- --------------------------------------------------------------------------------
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.
F-23
57
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 2000, 1999 AND 1998
- --------------------------------------------------------------------------------
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, 1997 283,500 56,000
Granted during 1998 147,500 18,000
Forfeited during 1998 (178,500) -
---------- ----------
Outstanding at
November 30, 1998 252,500 $5.65 74,000 $5.31
===== =====
Granted during 1999 161,534 5,000
Forfeited during 1999 - (5,000)
---------- ----------
Outstanding at
November 30, 1999 414,034 $4.19 74,000 $5.35
===== =====
Granted during 2000 22,705 5,000
Forfeited during 2000 - -
---------- ----------
Outstanding at
November 30, 2000 436,739 $4.10 79,000 $5.51
========== ===== ========= =====
Exercisable at:
November 30, 1998 48,500 74,000
========== =========
November 30, 1999 97,500 74,000
========== =========
November 30, 2000 180,306 79,000
========== =========
Available for grant at:
November 30, 1998 472,500 46,000
========== =========
November 30, 1999 310,966 46,000
========== =========
November 30, 2000 288,261 41,000
========== =========
The Financial Accounting Standard Board has issued Statement No. 123,
"Accounting for Stock Based Compensation" ("SFAS No. 123"). The Statement
established a fair value method of accounting for employee stock options and
similar equity instruments such as warrants, and encourages all companies to
adopt that method of accounting for all of their stock compensation plans.
However, the statement allows companies to continue measuring compensation for
such plans using accounting guidance in place prior to SFAS No. 123. Companies
that elect to remain with the former method of accounting must make pro-forma
disclosures of net earnings and earnings per share as if the fair value method
provided for in SFAS No. 123 had been adopted.
F-24
58
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 2000, 1999 AND 1998
- --------------------------------------------------------------------------------
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 2000, 1999 and 1998: dividend yield of 0%, expected
volatility ranging from 60.6% - in 2000, 76.7% in 1999 and 82.6% in 1998,
risk-free interest rates ranging from 6.6% - 6.8% in 2000, 5.4% - 6.6% in 1999
and 4.8% - 5.8% in 1998 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,
------------------------
2000 1999 1998
---- ---- ----
Net earnings (loss)
As reported $ (1,352,762) $ 471,708 $ 1,130,702
Pro forma $ (1,399,969) $ 194,052 $ 955,272
Earnings (loss) per share
As reported $ (.25) $ .08 $ .21
Pro forma $ (.26) $ .03 $ .17
NOTE Q - COMMITMENTS AND CONTINGENCIES
As of November 30, 2000, 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 15 year real estate mortgages (20 year
amortization) and 7 year equipment loans at an interest rate equal to 2.6% over
the then current 10 year treasury rate for real estate and 2.5% over the five
year treasury rate for equipment. The Company has no obligation to utilize this
financing.
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.
F-25
59
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Additions
-------------------------------------------
Balance at
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:
2000 $ 548,000 $ -0- $ 886,000 * $ -0- $ 1,434,000
1999 608,000 -0- (60,000)* -0- 548,000
1998 970,000 -0- (362,000)* -0- 608,000
* Increase (decrease) to adjust allowance to the amount of net deferred taxes.
F-26