1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the quarterly period ended May 31, 1998.
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
of Incorporation or Organization) No.)
40 PEARL STREET, N.W., SUITE 900
GRAND RAPIDS, MICHIGAN 49503
(Address of Principal Executive (Zip Code)
Offices)
(616) 776-2600
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities and Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES [ X ] NO [ ]
As of July 13, 1998 there were 5,216,109 outstanding Common Shares, $.01 par
value.
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PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
The following unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not contain all the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
solely of normal recurring adjustments) considered necessary for a fair
presentation of the financial position, results of operations, stockholders'
equity and cash flows of the Company have been included. For further
information, please refer to the consolidated financial statements and footnotes
thereto included in the Company's Annual Report on Form 10-K for the fiscal year
ended November 30, 1997. The Company has restated its prior financial statements
to present the operating results of the lodging group business segment as a
discontinued operation. The assets and liabilities of these operations at May
31, 1998 and November 30, 1997 are reflected on the balance sheet as a net
current asset (see Note E of the Company's Financial Statements). The results of
operations for the three and six month periods ended May 31, 1998 are not
necessarily indicative of the results to be expected for the full year.
[REMAINDER OF PAGE LEFT BLANK INTENTIONALLY]
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MAY 31, 1998 AND NOVEMBER 30, 1997
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ASSETS
MAY 31, NOVEMBER 30,
1998 1997
(UNAUDITED) (RESTATED)
----------- -----------
CURRENT ASSETS
Cash and cash equivalents $ 1,631,741 $ 1,061,475
Receivables 157,193 258,282
Inventories 159,779 156,746
Deferred income taxes 22,000 22,000
Prepaid expenses and other current assets 140,150 156,028
Net assets of discontinued operations - Note E 201,758 539,107
----------- -----------
Total current assets 2,312,621 2,193,638
PROPERTY, PLANT AND EQUIPMENT, NET 8,734,145 7,518,007
OTHER ASSETS
Goodwill, net of amortization of $186,022 and
$2,278,454 respectively 5,207,451 3,586,177
Financing costs, net of amortization of $144,756 and
and $108,014 respectively 424,029 449,520
Sundry 722,318 190,398
----------- -----------
Total other assets 6,353,798 4,226,095
----------- -----------
Total assets $17,400,564 $13,937,740
=========== ===========
SEE NOTES TO UNAUDITED FINANCIAL STATEMENTS.
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4
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - CONTINUED
MAY 31, 1998 AND NOVEMBER 30, 1997
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LIABILITIES AND STOCKHOLDERS' EQUITY
MAY 31, NOVEMBER 30,
1998 1997
(UNAUDITED) (RESTATED)
----------- -----------
CURRENT LIABILITIES
Current portion of long-term debt $ 1,337,021 $ 1,077,552
Current portion of obligations under capital leases 279,066 264,372
Trade accounts payable 1,184,266 899,118
Accrued liabilities 1,327,007 837,230
------------ ------------
Total current liabilities 4,127,360 3,078,272
LONG-TERM DEBT 6,344,256 7,348,464
OBLIGATIONS UNDER CAPITAL LEASES 1,546,321 1,689,628
DEFERRED INCOME TAXES 190,000 190,000
DEFERRED REVENUE - NOTE D 2,090,000 --
MINORITY INTEREST -- 1,601,415
STOCKHOLDERS' EQUITY
Preferred stock - $0.01 par value; authorized 5,000,000 shares; 200,000
shares designated as Series A convertible cumulative preferred stock;
issued and outstanding 138,387 in 1998 and 1997 (liquidation
value - $1,383,870) 1,384 1,384
Common stock - $0.01 par value; authorized 30,000,000
shares; issued and outstanding 5,214,309 and 3,218,778
respectively 52,144 32,188
Additional paid in capital 17,538,208 12,982,295
Note receivable from the sale of shares (6,007,523) (5,700,645)
Accumulated deficit (8,481,586) (7,285,261)
------------ ------------
Total stockholders' equity 3,102,627 29,961
------------ ------------
Total liabilities and stockholders' equity $ 17,400,564 $ 13,937,740
============ ============
SEE NOTES TO UNAUDITED FINANCIAL STATEMENTS.
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5
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE SIX MONTH PERIODS ENDED MAY 31, 1998 AND 1997
(UNAUDITED)
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1997
1998 (RESTATED)
------------ ------------
FOOD AND BEVERAGE REVENUE $ 12,713,910 $ 12,949,739
COSTS AND EXPENSES
Cost of food and beverages 3,668,318 3,733,590
Operating expenses 7,629,492 7,843,174
General and administrative expenses 1,569,966 1,471,447
Depreciation and amortization 619,629 602,634
------------ ------------
Total costs and expenses 13,487,405 13,650,845
OPERATING LOSS (773,495) (701,106)
OTHER INCOME (EXPENSE)
Interest expense (740,757) (704,374)
Interest income 315,444 283,432
Other income 518,312 2,911
Minority interest 25,677 (35,946)
------------ ------------
118,676 (453,977)
------------ ------------
Loss from continuing operations (654,819) (1,155,083)
LOSS FROM DISCONTINUED OPERATIONS - NOTE E (479,232) (684,568)
------------ ------------
Net loss (1,134,051) (1,839,651)
DIVIDENDS ON PREFERRED STOCK 62,274 39,440
------------ ------------
NET LOSS ON COMMON SHARES $ (1,196,325) $ (1,879,091)
============ ============
BASIC AND DILUTED LOSS FROM CONTINUING OPERATIONS
PER COMMON SHARE $ (0.16) $ (0.37)
============ ============
BASIC AND DILUTED NET LOSS PER COMMON SHARE $ (0.27) $ (0.59)
============ ============
WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC AND DILUTED 4,414,859 3,212,097
============ ============
SEE NOTES TO UNAUDITED FINANCIAL STATEMENTS.
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6
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTH PERIODS ENDED MAY 31, 1998 AND 1997
(UNAUDITED)
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1997
1998 (RESTATED)
----------- -----------
FOOD AND BEVERAGE REVENUE $ 6,690,794 $ 7,119,495
COSTS AND EXPENSES
Cost of food and beverages 1,953,142 2,041,480
Operating expenses 3,882,603 4,118,216
General and administrative expenses 621,735 701,347
Depreciation and amortization 309,265 303,288
----------- -----------
Total costs and expenses 6,766,745 7,164,331
LOSS FROM OPERATIONS (75,951) (44,836)
OTHER INCOME (EXPENSE)
Interest expense (371,253) (367,732)
Interest income 158,989 142,330
Other income 518,239 185
Minority interest -- (138,298)
----------- -----------
305,975 (363,515)
----------- -----------
Earnings (loss) from continuing operations 230,024 (408,351)
LOSS FROM DISCONTINUED OPERATIONS - NOTE E (164,270) (106,365)
----------- -----------
Net earnings (loss) 65,754 (514,716)
DIVIDENDS ON PREFERRED STOCK 31,137 26,680
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NET EARNINGS (LOSS) ON COMMON SHARES $ 34,617 $ (541,396)
=========== ===========
BASIC AND DILUTED EARNINGS (LOSS) FROM CONTINUING
OPERATIONS PER COMMON SHARE $ 0.04 $ (0.14)
=========== ===========
BASIC AND DILUTED NET EARNINGS (LOSS) PER COMMON SHARE $ 0.01 (0.17)
=========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC AND DILUTED 5,006,008 3,214,447
=========== ===========
SEE NOTES TO UNAUDITED FINANCIAL STATEMENTS.
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED NOVEMBER 30, 1997 AND THE SIX MONTH PERIOD ENDED MAY 31, 1998
(UNAUDITED)
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SERIES A NOTE
CONVERTIBLE ADDITIONAL RECEIVABLE
PREFERRED COMMON PAID-IN SALE OF ACCUMULATED
STOCK STOCK CAPITAL SHARES DEFICIT TOTAL
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BALANCE AT DECEMBER 1, 1996 $1,084 $32,045 $12,616,727 $(5,135,716) $(5,492,697) $ 2,021,443
Issuance of 14,295 shares of
common stock -- 143 65,868 -- -- 66,011
Issuance of 30,000 shares of
preferred stock 300 -- 299,700 -- -- 300,000
Dividends paid - preferred stock -- -- -- -- (101,714) (101,714)
Recognition of interest income
on note receivable from sale
of shares -- -- -- (564,929) -- (564,929)
Net loss -- -- -- -- (1,690,850) (1,690,850)
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BALANCE AT NOVEMBER 30, 1997 1,384 32,188 12,982,295 (5,700,645) (7,285,261) 29,961
Issuance of 1,995,531 shares of
common stock -- 19,956 4,555,913 -- -- 4,575,869
Dividends paid - preferred stock -- -- -- -- (62,274)
(62,274)
Recognition of interest income
on note receivable from sale
of shares -- -- -- (306,878) -- (306,878)
Net loss -- -- -- -- (1,134,051) (1,134,051)
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BALANCE AT MAY 31, 1998 $1,384 $52,144 $17,538,208 $(6,007,523) $(8,481,586) $ 3,102,627
==============================================================================================
SEE NOTES TO UNAUDITED FINANCIAL STATEMENTS.
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTH PERIODS ENDED MAY 31, 1998 AND 1997
(UNAUDITED)
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1998 1997
------------ -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(1,134,051) $(1,839,651)
Adjustments to reconcile net loss to net cash used in operating
activities
Depreciation and amortization 957,281 1,077,568
Compensation and fees paid by issuance of common stock 2,809 58,834
Minority interest in net earnings of consolidated subsidiaries (25,677) 35,946
Interest income on note receivable from sale of shares (306,878) (276,467)
Interest expense refinanced as long-term debt 5,299 --
Increase in deferred revenue 2,090,000 --
Decrease (increase) in current and other assets 313,952 (137,540)
Increase in current liabilities 330,067 146,056
----------- -----------
Net cash provided by (used in) operating activities 2,232,802 (935,254)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property, plant and equipment (170,840) (471,925)
Proceeds from sale of hotel assets 3,601,063 --
Payment for acquisition of business (755,200) --
Increase in other assets (48,421) (109,021)
----------- -----------
Net cash provided by (used in) investing activities 2,626,602 (580,946)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term debt 75,000 750,000
Principal payments of long-term debt (4,176,586) (526,895)
Payments on obligations under capital leases (128,613) (110,780)
Proceeds from issuance of stock 3,335 300,000
Preferred dividends paid (62,274) (39,440)
----------- -----------
Net cash (used in) provided by financing activities (4,289,138) 372,885
----------- -----------
Net increase (decrease) in cash 570,266 (1,143,315)
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 1,061,475 2,265,497
----------- -----------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 1,631,741 $ 1,122,182
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SUPPLEMENTAL CASH FLOW INFORMATION - SEE NOTE A
SEE NOTES TO UNAUDITED FINANCIAL STATEMENTS.
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED FINANCIAL STATEMENTS
FOR THE SIX MONTH PERIODS ENDED MAY 31, 1998 AND 1997
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NOTE A - SUPPLEMENTAL CASH FLOW INFORMATION
1998 1997
----------- ---------
Cash paid for interest expense $ 1,243,666 $ 1,359,681
Schedule of non-cash investing and financing transactions
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 $ 3,748,187
Reduction of minority interest 1,575,738
Amount of cash payment (755,200)
-----------
1,992,359 common shares issued $ 4,568,725
===========
Acquisition of equipment
Cost of equipment $ 244,637
Equipment loan 244,637
-----------
Cash down payment for equipment $ --
===========
Increase in marina development costs
Increase in marina development costs $ 391,141
Long-term debt proceeds 200,000
-----------
Cash used in marina development costs $ 191,141
===========
NOTE B - EARNINGS PER SHARE
Beginning in fiscal 1998, the Company adopted Financial Accounting
Standards Number 128 - "Earnings Per Share". Prior year earnings per share
amounts reflect this new pronouncement.
Basic earnings per common share are computed by dividing net earnings
available to common shareholders by the weighted average number of common shares
outstanding during each period. Diluted earnings per share reflect per share
amounts that would have resulted if dilutive potential common stock had been
converted to common stock. As of May 31, 1998 and 1997, the Company had 138,387
shares of Series A Convertible Preferred Stock outstanding. Each share of
preferred stock is convertible into 1.43 shares of common stock. The convertible
preferred stock was not included in the computation of diluted earnings (loss)
per common share because the effect of conversion would be antidilutive.
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED FINANCIAL STATEMENTS - CONTINUED
FOR THE SIX MONTH PERIODS ENDED MAY 31, 1998 AND 1997
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NOTE C - ACQUISITION
In fiscal 1998, the Company acquired the remaining 46% of the now dissolved
Wendy's of West Michigan Limited Partnership (including assets acquired and
liabilities assumed) for $755,200 in cash and 1,992,359 common shares, which had
a value of $4,568,725. As a result, assets were recorded at their fair value (a
$3,748,187 increase) and minority interest was eliminated (a $1,575,738
reduction).
NOTE D - DEFERRED REVENUE
In April 1998, the Company entered into a long-term agreement with its
fountain beverage supplier. The agreement requires the Company to purchase
1,800,000 gallons of fountain beverage syrup from the supplier. In exchange, the
Company received $2,090,000 in marketing and conversion funds which, in
accordance with the terms of the agreement, will be recognized as income as the
gallons of fountain beverage syrup are purchased.
NOTE E - DISCONTINUED OPERATIONS
During the second quarter of 1998, the Company entered into agreements to
sell its two hotel properties resulting in the discontinuance of the Company's
lodging group business segment. The sale of the Grand Harbor Resort & Yacht Club
was closed on June 16, 1998, and the sale of the Thomas Edison Inn is scheduled
to close on September 1, 1998. As a result, effective May 31, 1998, the
Company's lodging group business segment is accounted for as discontinued
operations. Because the Company expects to realize a net gain from discontinued
operations and the disposal of the lodging group business segment, no losses
from discontinued operations will be recognized from June 1, 1998 through the
date of disposal of the assets. Instead, any losses from discontinued operations
will be deferred until the sale of the properties, at which time the anticipated
net gain will be recognized. Below is a schedule of the payment terms of the
hotel sales:
Grand
Harbor Resort Thomas Edison
& Yacht Club Inn
------------- -------------
Selling price (before selling costs) $4,500,000 $12,200,000
Promissory note held by Company 1,375,000 ----
---------- -----------
Cash portion of selling price $3,125,000 $12,200,000
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED FINANCIAL STATEMENTS - CONTINUED
FOR THE SIX MONTH PERIODS ENDED MAY 31, 1998 AND 1997
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NOTE E - DISCONTINUED OPERATIONS (CONTINUED)
As of May 31, 1998 and November 30, 1997, assets and liabilities of the
discontinued lodging group business segment included in the balance sheet are
summarized below:
May 31, November 30,
1998 1997
------------ ------------
Assets
Current assets $ 466,388 $ 4,199,733
Property, plant and equipment, net 11,128,630 11,461,306
Marina development costs 1,085,036 1,152,772
Other assets 710,822 710,824
Liabilities
Current liabilities (1,303,897) (4,959,561)
Long-term debt (11,885,221) (12,025,967)
------------ ------------
Net assets of discontinued operations $ 201,758 $ 539,107
============ ============
A summary of the results of operations of the discontinued operations for
the three and six month periods ended May 31, 1998 and 1997 is as follows:
1998 1997
------------ -----------
For the six month periods ended
May 31, 1998 and 1997
Revenues $ 4,224,973 $ 5,956,765
Costs and expenses 4,016,185 5,914,461
----------- -----------
Earnings from operations 208,788 42,304
Other income (expense), net (688,020) (726,872)
----------- -----------
Loss from discontinued operations $ (479,232) $ (684,568)
=========== ===========
1998 1997
------------ -----------
For the three month periods ended
May 31, 1998 and 1997
Revenues $ 2,184,674 $ 3,071,227
Costs and expenses 2,008,674 2,813,590
----------- -----------
Earnings from operations 176,000 257,637
Other income (expense), net (340,270) (364,002)
----------- -----------
Loss from discontinued operations $ (164,270) $ (106,365)
=========== ===========
NOTE F - SUBSEQUENT EVENT
On June 16, 1998, the Company closed on the sale of substantially all of
the assets of its wholly- owned subsidiaries, Grand Harbor Resort Inc. and Grand
Harbor Yacht Club Inc. The sale included real and personal property comprising
the hotel, restaurant and 47 condominium marina slips located at the Grand
Harbor Resort & Yacht Club. The assets were sold for $4,500,000 of which
$3,125,000 was paid in cash and $1,375,000 was in the form of a secured
promissory note requiring monthly payments of interest only at 10.8% through
June 15, 1999. On June 16, 1999, the remaining unpaid principal will be due
provided, however, that if the principal balance is $500,000 or less on that
date, the payments of interest only may continue for an additional six months at
which time any remaining unpaid principal will be due.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
RESULTS OF OPERATIONS
FOOD SERVICE GROUP
The Company's food service group consists of its operation of 25 "Wendy's Old
Fashioned Hamburgers" restaurants (under franchise agreements with Wendy's
International) throughout Western and Southern Michigan. Due to the discontinued
lodging group operations, the food service group's results of operations for the
three and six month periods ended May 31, 1998, and May 31, 1997 as restated,
also include expenses related to the Meritage Hospitality Group corporate office
and are summarized in the following table:
Statement of Operations
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Three month periods ended May 31, Six month periods ended May 31,
--------------------------------- -------------------------------
$ (000's) % of Revenue $ (000's) % of Revenue
--------- ------------ --------- ------------
1998 1997 1998 1997 1998 1997 1998 1997
------------- ------------- ------------- ------------
Food and beverage revenue $ 6,691 $ 7,119 100.0% 100.0% $12,714 $ 12,950 100.0% 100.0%
Costs and expenses
Cost of food and beverages 1,953 2,042 29.2 28.7 3,668 3,734 28.9 28.8
Operating expenses 3,883 4,118 58.0 57.8 7,629 7,843 60.0 60.5
General and administrative
expenses 622 701 9.3 9.8 1,570 1,471 12.3 11.4
Depreciation and amortization 309 303 4.6 4.3 620 603 4.9 4.7
---------------- --------------- ---------------- -------------
Total costs and expenses 6,767 7,164 101.1 100.6 13,487 13,651 106.1 105.4
Loss from operations (76) (45) (1.1) (0.6) (773) (704) (6.1) (5.4)
Other income (expense)
Interest expense (371) (367) (5.6) (5.2) (741) (701) (5.8) (5.4)
Interest income 159 142 2.4 2.0 315 283 2.5 2.2
Other income 518 0 7.7 0.0 518 3 4.0 0.0
Minority interest ---- (138) ---- (1.9) 26 (36) 0.2 (0.3)
---------------- --------------- ---------------- ------------
306 (363) 4.5 (5.1) 118 (454) 0.9 (3.5)
---------------- --------------- ---------------- ------------
Earnings (loss) from
continuing operations $ 230 $ (408) 3.4% (5.7%) $ (655) $(1,155) (5.2%) (8.9%)
================= ================ ================= =============
REVENUE
Food and beverage revenue decreased $428,000 or 6.0% for the three months
ended May 31, 1998 compared to the same period of 1997. For the six months ended
May 31, 1998, food and beverage revenue decreased $236,000 or 1.9% compared to
the same period of 1997. Food and beverage revenues in 1997 include revenue from
an under-performing restaurant which was closed in August 1997. Food and
beverage revenue on a per restaurant basis for restaurants in operation during
both the first and second quarters of 1998 and 1997 are set forth in the
following table:
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Average Net Sales Per Restaurant Unit
-------------------------------------
Increase % Increase
1998 1997 (Decrease) (Decrease)
---- ---- ---------- ----------
Three months ended May 31 $267,632 $281,324 $(13,692) (4.9%)
Three months ended February 28 240,925 230,797 10,128 4.4%
-------- -------- --------
Six months ended May 31 $508,557 $512,121 $ (3,564) (0.7%)
======== ======== ========
The 4.4% increase in same store sales in the first quarter of 1998 was primarily
attributable to the relatively mild winter weather conditions experienced in the
first quarter of 1998 compared to the first quarter of 1997. Same store sales
for the three months ended May 31, 1998 decreased 4.9%. Nearly 3% of the sales
decrease was the result of a decrease in pita sandwich sales which were
introduced in April 1997. The introduction of the pita sandwich was extremely
successful and helped contribute to a record sales month in May 1997. Sales
during the first half of 1998 have also been negatively impacted by competitive
intrusion which has effected several restaurants in the Company's market area
combined with intense competition throughout the quick-service industry
including price discounting. The Company and Wendy's International have
continued to resist engaging in deep price discounting, choosing instead to
combat low prices of its competitors with the Value Menu offerings and high
quality, made-to-order products. Weighted average price increases for the six
months ended May 31, 1998 were less than 1% compared to the same period of 1997.
COST OF FOOD AND BEVERAGES
Cost of food and beverages as a percentage of food and beverage revenue was
29.2% for the three months ended May 31, 1998 compared to 28.7% for the three
months ended May 31, 1997. Cost of food and beverages for the six months ended
May 31, 1998 was 28.9% compared to 28.8% for the same period of 1997. The .5
percentage point increase in cost of food and beverages for the second quarter
of 1998 was primarily due to a relatively low food and beverage cost of 28.7% in
the second quarter of 1997 due to high sales of pita sandwiches during their
introductory period in April and May of 1997. The pita sandwiches carry a
relatively lower food cost than most sandwich menu selections. Cost of food and
beverage percentages of 28.9% and 28.8% respectively for the six months ended
May 31, 1998 and 1997 are in line with the Company's and Wendy's International's
guidelines.
OPERATING EXPENSES
Operating expenses increased .2 percentage points for the three months
ended May 31, 1998 compared to the same period of 1997 (from 57.8% of revenue in
1997 to 58.0% in 1998). The increase for the second quarter was primarily a
function of the decrease in sales of 4.9% while certain fixed costs such as
property taxes and insurance were spread over reduced revenue. For the six
months ended May 31, 1998, operating expenses were reduced .5 percentage points
(from 60.5% of revenue in 1997 to 60.0% in 1998). Slight decreases in payroll
and utility costs produced the reduction in operating costs for the six months
ended May 31, 1998 compared to the same period of 1997.
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GENERAL AND ADMINISTRATIVE
General and administrative expenses decreased approximately $79,000 for the
three months ended May 31, 1998 compared to the same period of 1997 (from
$701,000 to $622,000). As a percentage of revenue, general and administrative
expenses decreased from 9.8% of revenue for the three months ended May 31, 1997
to 9.3% of revenue for the same period of 1998. For the six months ended May 31,
1998, general and administrative expenses increased approximately $99,000 (from
$1,471,00 to $1,570,000), from 11.4% of revenue to 12.3% of revenue. Increases
in administrative salaries and recruiting costs accounted for the increase in
general and administrative expenses for the six months ended May 31, 1998
compared to the same period of 1997. The decrease in general and administrative
expenses for the three months ended May 31, 1998 compared to the same period of
1997 was the result of a reduction in legal expenses and a refund of business
insurance premiums from a prior year.
INTEREST EXPENSE
Interest expense for the second quarter of 1998 and 1997 was $371,000 and
$367,000 respectively. Interest expense for the six months ended 1998 and 1997
was $741,000 and $704,000 respectively. The increases in interest expense were
due to additional borrowings in fiscal 1997 and an increase in interest rates.
See "Liquidity and Capital Resources" for details about the Company's long-term
debt.
INTEREST INCOME
Interest income increased $17,000 for the second quarter of 1998 compared
to the same period of 1997, and $32,000 for the six months ended May 31, 1998
compared to the six months ended May 31, 1997. The increase was attributable to
the increase in interest income from the note receivable from the sale of stock.
OTHER INCOME
Other income increased $518,000 for the three months ended May 31, 1998
compared to 1997. Other income increased $515,000 for the six months ended May
31, 1998 compared to the six months ended May 31, 1997. The increase in other
income was primarily due to the forfeiture of an earnest deposit in the amount
of $500,000 on a contract to sell one of the Company's hotel properties.
LODGING GROUP - DISCONTINUED OPERATIONS
During the second quarter of 1998 the Company entered into agreements to
sell its two hotel properties resulting in the discontinuance of the Company's
lodging group as of May 31, 1998. For details of the impact on the Company's
operating results see Note E of the Company's Financial Statements.
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LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS
Cash and cash equivalents ("cash") increased $571,000 from $1,061,000 as of
November 30, 1997 to $1,632,000 as of May 31, 1998. The increase in cash was the
result of the following:
Net cash provided by operating activities $ 2,233,000
Net cash provided by investing activities 2,627,000
Net cash used in financing activities (4,289,000)
-----------
Net increase in cash $ 571,000
==========
Net cash provided by operating activities of $2,233,000 was due to a net
loss before depreciation and amortization of $177,000 combined with the receipt
of $2,090,000 in marketing and conversion funds (deferred revenue) from the
Company's beverage supplier (see Note D of the Company's Financial Statements).
Other non-cash effects on net income and net cash provided by operating
activities totaled $320,000.
Net cash provided by investing activities of $2,627,000 was the result of
proceeds from the sale of the St. Clair Inn of $3,601,000. Cash provided from
the sale of this hotel asset was offset by the purchase of property and
equipment for $171,000 and the acquisition of the remaining 46% of the now
dissolved Wendy's of West Michigan Limited Partnership for $755,000. The
remaining use of cash increased other assets by $48,000.
Net cash used in financing activities of $4,289,000 was primarily the
result of payments of long-term debt of $4,177,000 in connection with the sale
of the St. Clair Inn, and a reduction in the long-term debt associated with the
Wendy's operations through the use of a portion of the beverage marketing and
conversion funds described above. In addition to the reduction of long-term
debt, principal payments reduced obligations under capital leases by $129,000.
Dividend payments on preferred stock of $62,000 for the six months ended May 31,
1998 accounted for the remaining cash used in financing activities. In March
1998, the Company received $75,000 in proceeds from long-term debt related to
the marina development at the Grand Harbor Yacht Club.
FINANCIAL CONDITION
As of May 31, 1998, the Company's current liabilities exceeded its current
assets by $1,815,000 compared to November 30, 1997 when current liabilities
exceeded current assets by $885,000. At these dates, the ratios of current
assets to current liabilities were 0.56:1 and 0.71:1 respectively. The
discussion above of cash flows for the six months ended May 31, 1998 explains
the increase in cash as well as the most significant reasons for the decrease in
working capital. The other significant items effecting working capital include
the receipt of $300,000 in earnest deposits on the sale of the Company's hotel
properties, and a $300,000 increase in the current portion of the Company's
second mortgage (Loan II) from November 30, 1997 to May 31, 1998.
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As of May 31, 1998, the Company's long-term debt consisted primarily of the
following:
1) $11,073,000 Loan I requiring monthly payments of $92,874, including
interest at 11.25%, through December 31, 2003 when the remaining unpaid
principal will be due.
2) $5,220,000 Loan II requiring monthly payments of $100,000, plus interest at
8% over the prime rate through June 2002. (A)
3) $825,000 Loan III (marina) requiring monthly payments of interest only at
11.25%. The $1.375 million note receivable from the sale of the Grand
Harbor Resort & Yacht Club serves as collateral for Loan III. Accordingly,
principal payments of $35,000 are required upon the sale of any condominium
units. Any remaining outstanding balance of principal and accrued interest
is due the earlier of the receipt of full payment of the note receivable or
September 1, 2000.
4) $1,599,000 revolving term loan requiring monthly payments of $43,313,
including interest at 1% over the prime rate, through February 2005 when
any remaining unpaid principal will be due. Under the revolving loan
agreement, the required monthly payments may be offset by additional
borrowings up to the unused available borrowings. The Company had $993,000
of available unused borrowings at May 31, 1998. The loan is secured by
substantially all of the assets used in the Company's Wendy's operation and
guaranteed by the Company.
5) $228,000 equipment note payable requiring monthly payments of $8,524,
including interest at 8.8%, through October 2000.
6) $776,000 note payable to the Company's Chairman of the Board of Directors.
The loan requires the Company to make monthly payments of interest only at
the prime rate plus 8% provided the Company is not in default under its
first and second mortgage long-term debt with its primary lender. Unpaid
principal and accrued interest must be paid 91 days after Loans I, II and
III are paid off.
(A) The Company's primary lender has deferred $50,000 of principal
payments due April 1, 1998 and May 1, 1998 until July 1, 1998.
The loan agreement with the Company's primary lender contains numerous
covenants regarding the maintenance of a prescribed amount of net worth, certain
financial ratios, and restrictions on certain common stock purchases, dividends,
additional indebtedness and executive compensation. At May 31, 1998, the Company
failed to meet certain of these covenants. However, a waiver has been obtained
through June 30, 1999.
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A summary of the financial covenants as well as the Company's compliance with
them is as follows:
COVENANT MAY 31, 1998 COVENANT
COVENANT DESCRIPTION REQUIREMENT ACTUAL CONDITION COMPLIANCE
Waiver obtained
through
Minimum Net Worth $8,000,000 $3,102,627 June 30,1999
Coverage Ratio -
Earnings before interest, taxes Waiver obtained
depreciation and amortization through
("EBITDA") of hotels : 1.75 : 1 .77 : 1 June 30, 1999
Debt Service
Coverage Ratio - Waiver obtained
EBITDA of hotels less capital through
expenditures : .70 : 1 .63 : 1 June 30, 1999
Debt Service
The following schedule details the financial covenant requirements
contained in the Company's loan agreement following the expiration of its
waiver:
Financial Covenant - Minimum Net Worth
August 31, 1999 - October 31, 1999 $9,250,000
November 30, 1999 - October 31, 2000 $10,750,000
November 30, 2000 - October 31, 2001 $12,500,000
November 30, 2001 - October 31, 2002 $14,500,000
November 30, 2002 - October 31, 2003 $16,500,000
Financial Covenant - Coverage Ratio - EBITDA of Hotels : Debt Service
August 31, 1999 - August 31, 2000 1.9 : 1
November 30, 2000 2.0 : 1
February 28, 2001 2.1 : 1
May 31, 2001 2.2 : 1
August 31, 2001 2.3 : 1
Financial Covenant - Coverage Ratio - EBITDA of Hotels Less Capital
Expenditures : Debt Service
August 31, 1999 1.4 : 1
November 30, 1999 - February 28, 2001 1.6 : 1
May 31, 2001 - August 31, 2001 1.7 : 1
November 30, 2001 and thereafter 1.8 : 1
The Company has faced significant cash flow and liquidity issues due to
several factors, including (i) the high level of fixed costs required to operate
the hotel operations which cannot be reduced at the same rate that the revenues
decrease during the off-season, (ii) declining revenues at the hotel properties
due to increased competition in the geographic market and lower room rates at
competing limited service hotel properties, and (iii) carrying a high-interest
rate (prime plus 8%) Loan II with its primary lender for a longer
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period of time than was originally contemplated and, as such, carrying a higher
level of debt service than was planned. The Company anticipates, however, that
it will be able to meet its current obligations over the next twelve months by:
* Closing on the $4.5 million sale of the Grand Harbor Resort & Yacht Club on
June 16, 1998 for cash of $3.125 million and a note receivable of $1.375
million. The proceeds were used to reduce long- term debt by approximately
$2.4 million.
* Exploring the sale of the $1.375 million promissory note received as a
result of the sale of the Grand Harbor Resort & Yacht Club. The proceeds
would be used to reduce high interest rate long-term debt and to provide
working capital.
* Closing on the sale of the Thomas Edison Inn for $12.2 million which is set
for September 1, 1998. The proceeds are projected to be used to reduce
long-term debt by approximately $10 million.
* Borrowing funds from the unused available revolving term loan, of which
approximately $993,000 were available as of May 31, 1998.
* Closing on the refinancing of the mortgage loan on the real estate
associated with the Wendy's operations and owned by the Company. This would
net the Company approximately $2,500,000 after closing costs and the
retirement of the underlying mortgage loans on the Wendy's properties. The
$2,500,000 would be used to pay down a portion of the Company's high
interest rate Loan II which would reduce the Company's annual debt service.
* Deferring the payment of the $160,000 annual general partner administrative
fee.
* Managing relationships with vendors to obtain an extension of the credit
terms.
* Using the $2,090,000 marketing and conversion funds received from the
Company's fountain beverage supplier to enhance marketing efforts and
assist in the reduction of long term debt.
* Exploring the financing options for certain of the planned capital
expenditures as opposed to using operating cash flow.
* Reducing or deferring capital expenditures.
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.
The Company's planned capital expenditures for the next twelve months are
approximately $600,000 for building improvements and furniture, fixtures and
equipment purchases at the Wendy's restaurants. The Company has signed a
commitment with Captec Financial Group, Inc. to finance (through debt or lease)
both the real estate and the furniture, fixtures and equipment for the
development of new Wendy's restaurants.
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INFLATION AND CHANGING PRICES
The Company has been affected by the increase in the minimum wage and the
availability of management and hourly employees. Increases in labor costs, along
with periodic increases in food and other operating expenses, are normally
passed on to customers in the form of price increases. However, highly
competitive market conditions have minimized the Company's ability to offset
higher costs through price increases to its customers.
COMPUTER SYSTEMS - YEAR 2000 IMPACT
The Company and its vendors have become increasingly reliant on computer
systems to process transactions and to provide relevant business information.
The majority of computer systems designed prior to the mid-1990's are
susceptible to a well publicized problem associated with an inability to process
date related information beginning with the year 2000. Almost all of the
Company's computer hardware was acquired within the past two years. The Company
is in the process of reviewing its computer hardware and software with the
assistance of the software designers to ensure that all significant software
applications are year 2000 compliant, and anticipates completing its review
during fiscal 1998. Based on the results of the review to date, the Company
believes that the point-of-sale system, which monitors all sales, inventory and
labor activity, is year 2000 compliant. However, the critical systems which are
used to (i) produce financial statements, (ii) process payroll, and (iii)
compare actual product usage with planned product usage are not year 2000
compliant. The Company has estimated that replacement or modification of those
systems will be necessary at a cost ranging from $100,000 to $300,000. However,
the Company can make no assurance that all year 2000 risks to the Company and to
its critical vendor systems can be identified and successfully negated through
modification or replacement of existing programs. The Company does not expect to
incur significant additional costs to complete its review of computer systems to
determine what measures are required to be year 2000 compliant. Pending the
final results of this review, the Company cannot determine the actual cost that
may be required to ensure that all the critical computer systems are year 2000
compliant.
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PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
As reported on the Form 8-K filed June 9, 1998 (see Item 6 below), legal
proceedings brought against the Company and its affiliates were dismissed with
prejudice on May 28, 1998.
ITEM 2. CHANGES IN SECURITIES.
On May 26 and 27, 1998, the Company issued 220,000 unregistered common
shares to the former general partner of the Wendy's of West Michigan Limited
Partnership and its seven shareholders in connection with the settlement of
litigation reported on the From 8-K filed June 9, 1998 (see Item 6 below). This
issuance was exempt from registration pursuant to Section 4(2) of the Securities
Act of 1933.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The 1998 Annual Meeting of Shareholders was held at the Thomas Edison Inn,
located at 500 Thomas Edison Parkway, Port Huron, Michigan, at 10:00 a.m. on
Tuesday, May 19, 1998, in accordance with the Company's Bylaws. The Company
solicited proxies for the matters brought before the shareholders pursuant to a
definitive proxy statement that was filed with the Securities and Exchange
Commission on April 14, 1998. 3,218,993 Common Shares were present in person or
by proxy at the meeting, representing 64.5% of the total shares outstanding.
The shareholders elected the following seven members to the Company's Board
of Directors to serve until the 1999 Annual Meeting: Gary R. Garrabrant;
Christopher B. Hewett; David S. Lundeen; Joseph L. Maggini; Jerry L. Ruyan;
Robert E. Schermer Sr. and Robert E. Schermer, Jr. Each director received a
minimum of 2,994,957 (or 93%) of the total shares voted.
The shareholders also approved an amendment to the 1996 Management Equity
Incentive Plan increasing the number of Common Shares in the Plan by 175,000.
The following are the results of the shares that voted: In Favor: 2,467,686;
Opposed: 668,961; Abstentions: 79,446; Broker Non-Votes: 2,900.
ITEM 5. OTHER INFORMATION.
On May 19, 1998, the Board of Directors appointed the following officers of
the Company: Christopher B. Hewett - President and Chief Executive Officer;
Robert E. Schermer, Jr. - Executive Vice President; Pauline M. Krywanski - Vice
President, Treasurer and Chief Financial Officer; and James R. Saalfeld - Vice
President, General Counsel and Secretary. Robert E. Schermer, Sr. was
reappointed Chairman of the Board of Directors. In addition, Ray E. Quada was
appointed Senior Vice President and Chief Operating Officer on May 26, 1998. The
Board also reestablished the Executive, Audit, Compensation and Nominating
Committees as standing committees of the Board of Directors.
On May 27, 1998, the Company, through Wendy's of Michigan, entered into a
purchase agreement with Wendy's Real Estate Limited Partnership I (an unrelated
party) to buy, for $4,200,000, the real property comprising five of the Wendy's
restaurants currently operated by the Company. Assuming all conditions to
closing are satisfied, the purchase agreement is currently set to close on
August 25, 1998.
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On July 7, 1998, the Board of Directors took additional action in
accordance with its discussion at the February 26, 1998 Board Meeting to adopt
measures to protect the Company and its shareholders against potentially
disruptive and destructive actions that could be brought by dissident
shareholders and others. Specifically, the Board of Director amended the
Company's Bylaws to opt into Chapter 7B (being ss.ss. 790 through 799) of the
Michigan Business Corporation Act such that Chapter 7B shall apply to any
"control share acquisition" (as that term is defined by Chapter 7B) involving
the Company's common shares.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibit List.
Exhibit No. Description of Document
--------------------------------------------------------------
3.2 Restated and Amended Bylaws of Meritage Hospitality Group Inc.
MANAGEMENT COMPENSATORY CONTRACTS
10.12 Amended 1996 Management Equity Incentive Plan.
27 Financial Data Schedule.
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(b) Reports on Form 8-K.
On April 20, 1998, the Company filed a Form 8-K which reported
that the Company's wholly-owned subsidiary had entered into a
contract for the sale of real and personal property
comprising, among other things, the Thomas Edison Inn for a
price of $12,200,000, for which the Company received a
$250,000 non-refundable deposit.
On June 9, 1998, the Company filed a Form 8-K which reported
that all litigation brought by the former general partner of
the now dissolved Wendy's of West Michigan Limited Partnership
and its affiliates was dismissed with prejudice on May 28,
1998, following a settlement pursuant to which the former
general partner and its affiliates received $658,000 and
200,000 shares of the Company's common stock. The Company also
reported that it had entered into a contract on April 27, 1998
with Pepsi-Cola to convert the fountain beverages at its 25
Wendy's Old Fashioned Hamburgers restaurants from Coca-Cola to
Pepsi-Cola, and to buy 1,800,000 gallons of fountain beverage
syrup from Pepsi, in exchange for Pepsi paying $2,090,000 in
conversion and marketing fees and providing new fountain
beverage dispensing equipment at all of the 25 Wendy's
restaurants operated by the Company.
On June 18, 1998, the Company filed a Form 8-K to report that
the Company's wholly-owned subsidiaries sold certain real and
personal property, including the Grand Harbor Resort located
in Spring Lake, Michigan and 47 condominium slips of the Grand
Harbor Yacht Club, for $4,500,000 of which the Company
received $3,125,000 in cash and a $1,375,000 one-year secured
promissory note bearing 10.8% interest.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: July 13, 1998 MERITAGE HOSPITALITY GROUP INC.
By /s/ CHRISTOPHER B. HEWETT
-------------------------------------
Christopher B. Hewett
President and Chief Executive Officer
By /s/ PAULINE M. KRYWANSKI
-------------------------------------
Pauline M. Krywanski
Vice President and Treasurer
(Chief Financial Officer)
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EXHIBIT INDEX
Exhibit No. Description of Document
--------------------------------------------------------------
3.2 Restated and Amended Bylaws of Meritage Hospitality Group Inc.
MANAGEMENT COMPENSATORY CONTRACTS
10.12 Amended 1996 Management Equity Incentive Plan.
27 Financial Data Schedule.