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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 February 28, 1999.
OR
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the transition period from
___________________ to ____________________
Commission File Number: 0-17442
MERITAGE HOSPITALITY GROUP INC.
(Exact Name of Registrant as Specified in Its Charter)
MICHIGAN 38-2730460
(State or Other Jurisdiction (I.R.S. Employer Identification
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 March 25, 1999 there were 5,748,421 outstanding Common Shares, $.01 par
value.
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SAFE HARBOR STATEMENT
Certain statements contained in this report that are not historical facts
constitute forward-looking statements, within the meaning of the Private
Securities Litigation Reform Act of 1995, and are intended to be covered by the
safe harbors created by that Act. Reliance should not be placed on
forward-looking statements because they involve known and unknown risks,
uncertainties and other factors which may cause actual results, performance or
achievements to differ materially from those expressed or implied. Any
forward-looking statement speaks only as of the date made. The Company
undertakes no obligation to update any forward-looking statements to reflect
events or circumstances after the date on which they are made.
Statements concerning expected financial performance, on-going business
strategies and possible future action which the Company intends to pursue to
achieve strategic objectives constitute forward-looking information.
Implementation of these strategies and the achievement of such financial
performance are each subject to numerous conditions, uncertainties and risk
factors. Factors which could cause actual performance to differ materially from
these forward looking statements include, without limitation, competition;
changes in local and national economic conditions; changes in consumer tastes
and views about the nutritional quality of quick-service food; severe weather;
changes in travel patterns; increases in food, labor and energy costs; the
availability and cost of suitable restaurant sites; fluctuating insurance rates;
the availability of an adequate number of employees; the general reputation of
Wendy's restaurants; and the recurring need for renovation and capital
improvements. Also, the Wendy's restaurants are subject to extensive government
regulations relating to, among other things, zoning, minimum wage, public health
certification and food safety, and the operation of its restaurants. Because
Meritage's restaurant operations are concentrated in smaller urban areas of
Michigan, a marked decline in the Michigan economy could adversely affect
Meritage's operations.
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
The following unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not contain all the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation of
the financial position, results of operations, stockholders' equity and cash
flows of the Company have been included. For further information, please refer
to the consolidated financial statements and footnotes thereto included in the
Company's Annual Report on Form 10-K for the fiscal year ended November 30,
1998. The Company has restated its prior year consolidated statements of
operations and cash flows to present the operating results of the lodging group
business segment as a discontinued operation. The assets and liabilities of
these operations at February 28, 1999 and November 30, 1998 are reflected on the
balance sheet as a net liability (see Note B of the Company's financial
statements). The results of operations for the three month period ended February
28, 1999 are not necessarily indicative of the results to be expected for the
full year.
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
FEBRUARY 28, 1999 AND NOVEMBER 30, 1998
- ------------------------------------------------------------------------------------------------------------------------
ASSETS
FEBRUARY 28,
1999 NOVEMBER 30,
(UNAUDITED) 1998
----------- ----
CURRENT ASSETS
Cash and cash equivalents $ 1,081,619 $ 2,109,358
Receivables 71,571 70,974
Notes receivable, current portion 3,219,617 2,719,617
Inventories 163,659 165,156
Prepaid expenses and other current assets 72,922 90,796
------------- -------------
Total current assets 4,609,388 5,155,901
PROPERTY, PLANT AND EQUIPMENT, NET 14,783,968 13,182,940
OTHER ASSETS
Note receivable, net of current portion - 500,000
Goodwill, net of amortization of $199,140 and
$153,758, respectively 5,110,583 5,155,965
Franchise costs, net of amortization of $19,835 and
$17,806, respectively 655,165 632,194
Financing costs, net of amortization of $6,628 and
and $3,314, respectively 325,672 261,815
Deferred charges and other assets 59,354 75,431
------------- -------------
Total other assets 6,150,774 6,625,405
------------- -------------
Total assets $ 25,544,130 $ 24,964,246
============= =============
SEE NOTES TO UNAUDITED FINANCIAL STATEMENTS.
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - CONTINUED
FEBRUARY 28, 1999 AND NOVEMBER 30, 1998
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LIABILITIES AND STOCKHOLDERS' EQUITY
FEBRUARY 28,
1999 NOVEMBER 30,
(UNAUDITED) 1998
----------- ----
CURRENT LIABILITIES
Current portion of long-term debt $ 1,683,202 $ 1,199,458
Current portion of obligations under capital leases 302,654 294,577
Short-term borrowings 1,100,000 1,100,000
Trade accounts payable 1,028,049 727,199
Amount due related party - 245,260
Income taxes payable 5,000 50,000
Accrued liabilities 939,403 1,308,987
------------- -------------
Total current liabilities 5,058,308 4,925,481
LONG-TERM DEBT 11,533,664 10,623,946
OBLIGATIONS UNDER CAPITAL LEASES 1,314,768 1,395,049
DEFERRED REVENUE 1,925,185 1,992,026
NET LIABILITIES OF DISCONTINUED OPERATIONS 277,032 593,855
COMMITMENTS AND CONTINGENCIES - -
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,
44,520 shares (liquidation value - $445,200) 445 445
Common stock - $0.01 par value; authorized 30,000,000
shares; issued and outstanding, 5,742,586 shares 57,426 57,426
Additional paid in capital 13,299,467 13,299,467
Note receivable from sale of shares, net of
valuation allowance of $4,837,072 and
$4,666,755, respectively (1,660,962) (1,660,962)
Accumulated deficit (6,261,203) (6,262,487)
-------------- -------------
Total stockholders' equity 5,435,173 5,433,889
------------- -------------
Total liabilities and stockholders' equity $ 25,544,130 $ 24,964,246
============= =============
SEE NOTES TO UNAUDITED FINANCIAL STATEMENTS.
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTH PERIODS ENDED FEBRUARY 28, 1999 AND 1998
(UNAUDITED)
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1998
1999 (RESTATED)
----------- -------------
FOOD AND BEVERAGE REVENUE $ 6,493,030 $ 6,023,117
COSTS AND EXPENSES
Cost of food and beverages 1,891,113 1,727,125
Operating expenses 3,809,769 3,727,743
General and administrative expenses 510,107 918,401
Depreciation and amortization 297,996 309,813
----------- -----------
Total costs and expenses 6,508,985 6,683,082
----------- -----------
LOSS FROM OPERATIONS (15,955) (659,965)
OTHER INCOME (EXPENSE)
Interest expense (330,347) (370,053)
Interest income 130,168 156,350
Gain on sale of assets 156,635 --
Minority interest -- 25,677
----------- -----------
(43,544) (188,026)
----------- -----------
Loss from continuing operations (59,499) (847,991)
INCOME (LOSS) FROM DISCONTINUED OPERATIONS - NOTE B 70,800 (351,813)
----------- -----------
NET EARNINGS (LOSS) 11,301 (1,199,804)
DIVIDENDS ON PREFERRED STOCK 10,017 31,137
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NET EARNINGS (LOSS) ON COMMON SHARES $ 1,284 $(1,230,941)
=========== ===========
NET EARNINGS (LOSS) PER COMMON SHARE - BASIC AND DILUTED
Continuing operations $ (0.01) $ (0.23)
Discontinued operations 0.01 (0.09)
----------- -----------
Net earnings (loss) $ 0.00 $ (0.32)
=========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC AND DILUTED 5,742,586 3,810,574
=========== ===========
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, 1998 AND THE THREE MONTH PERIOD ENDED FEBRUARY 28, 1999
(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, 1997 $ 1,384 $ 32,188 $ 12,982,295 $ (5,700,645) $ (7,285,261) $ 29,961
Issuance of 1,999,935 shares of
common stock -- 19,999 4,561,155 -- -- 4,581,154
Conversion of 73,867 shares of
convertible preferred shares into
523,873 common shares (739) 5,239 (4,500) -- -- --
Cancellation of 20,000 shares of
convertible preferred stock (200) -- (199,800) -- -- (200,000)
Dividends paid - preferred stock -- -- -- -- (107,928) (107,928)
Recognition of interest income
on note receivable from sale
of shares -- -- 627,072 (627,072) -- --
Establishment of valuation allowance
on note receivable from sale
of shares -- -- (4,666,755) 4,666,755 -- --
Net earnings -- -- -- -- 1,130,702 1,130,702
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BALANCE AT NOVEMBER 30, 1998 445 57,426 13,299,467 (1,660,962) (6,262,487) 5,433,889
Dividends paid - preferred stock -- -- -- -- (10,017) (10,017)
Recognition of interest income
on note receivable from sale
of shares -- -- 170,317 (170,317) -- --
Increase in valuation
allowance on note receivable
from sale of shares -- -- (170,317) 170,317 -- --
Net earnings -- -- -- -- 11,301 11,301
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BALANCE AT FEBRUARY 28, 1999 $ 445 $ 57,426 $ 13,299,467 $ (1,660,962) $ (6,261,203) $ 5,435,173
===========================================================================================
SEE NOTES TO UNAUDITED FINANCIAL STATEMENTS.
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTH PERIODS ENDED FEBRUARY 28, 1999 AND 1998
(UNAUDITED)
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1998
1999 (RESTATED)
----------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net earnings (loss) $ 11,301 $(1,199,804)
Adjustments to reconcile net earnings (loss) to net
cash used in operating activities
Depreciation and amortization 297,996 293,175
Compensation and fees paid by issuance of common stock -- 1,691
Minority interest in net loss of consolidated subsidiaries -- (25,677)
Interest income on note receivable from sale of shares -- (153,439)
Interest expense refinanced as long-term debt -- 5,299
Decrease (increase) in cash value of life insurance 9,656 (8,884)
Decrease in deferred revenue (66,841) --
Decrease in current assets 18,774 77,737
Decrease in net (liabilities) assets of discontinued operations (316,822) 128,054
(Decrease) increase in current liabilities (358,994) 709,224
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Net cash used in operating activities (404,930) (172,624)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property, plant and equipment (1,841,879) (90,675)
Payment for franchise agreement (25,000) --
Increase in other assets -- (77,376)
----------- -----------
Net cash used in investing activities (1,866,879) (168,051)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term debt 1,489,499 475,000
Payment of financing costs (67,171) --
Principal payments of long-term debt (96,037) (224,094)
Payments on obligations under capital leases (72,204) (63,437)
Proceeds from issuance of stock -- 2,325
Preferred dividends paid (10,017) (31,137)
----------- -----------
Net cash provided by financing activities 1,244,070 158,657
----------- -----------
Net decrease in cash (1,027,739) (182,018)
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 2,109,358 1,061,475
----------- -----------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 1,081,619 $ 879,457
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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 THREE MONTH PERIODS ENDED FEBRUARY 28, 1999 AND 1998
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NOTE A - SUPPLEMENTAL CASH FLOW INFORMATION
1998
1999 (RESTATED)
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Cash paid for interest expense $ 330,346 $ 293,200
========== =========
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 $2,744,387
Reduction of minority interest 1,575,738
---------
1,772,359 common shares issued $4,320,125
==========
NOTE B - DISCONTINUED OPERATIONS
Effective May 31, 1998, the Company began accounting for its lodging
business segment as discontinued operations. As of February 28, 1999 and
November 30, 1998, assets and liabilities of the discontinued lodging business
segment included in the balance sheet are summarized below:
FEBRUARY 28, NOVEMBER 30
1999 1998
----------- ------------
Assets
Current assets $ 6,645 $ 13,264
Other assets 16,511 16,511
Liabilities
Current liabilities (300,188) (623,630)
--------- ---------
Net liabilities of discontinued operations $(277,032) $(593,855)
========= =========
A summary of the results of operations of the discontinued operations for
the three month periods ended February 28, 1999 and 1998 is as follows:
For the three months ended February 28, 1999 1998
------------- ------------
Revenues $ -- $ 2,040,298
Costs and expenses -- 2,044,467
----------- -----------
Earnings from operations -- (4,169)
Other income (expense), net -- (347,644)
----------- -----------
Loss from operations of discontinued operations -- (351,813)
Gain on disposal of discontinued operations (70,800) --
----------- -----------
Net income (loss) from discontinued operations $ 70,800 $ (351,813)
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
RESULTS OF OPERATIONS
CONTINUING OPERATIONS
The Company's continuing operations consists of 27 "Wendy's Old Fashioned
Hamburgers" restaurants (under franchise agreements with Wendy's International)
throughout Western and Southern Michigan. Due to the discontinuance of the
lodging business segment, results of continuing operations for the three month
periods ended February 28, 1999 and 1998 (as restated), also include expenses
related to the Company's corporate office and are summarized in the following
table:
Statements of Operations
--------------------------------------------------------------
Three month periods ended February 28,
---------------------------------------------------------------
$ (000's) % of Revenue
-------------------------- ---------------------------
1999 1998 1999 1998
--------- --------- -------- ---------
Food and beverage revenue $ 6,493 $ 6,023 100.0% 100.0%
Costs and expenses
Cost of food and beverages 1,891 1,727 29.1 28.7
Operating expenses 3,810 3,728 58.7 61.9
General and administrative
Restaurant operations 277 347 4.3 5.8
Corporate level expenses 233 571 3.5 9.5
Depreciation and amortization 298 310 4.6 5.1
------- ------- ------- -------
Total costs and expenses 6,509 6,683 100.2 111.0
------- ------- ------- -------
Loss from operations (16) (660) (0.2) (11.0)
Other income (expense)
Interest expense (330) (370) (5.1) (6.1)
Interest income 130 156 2.0 2.6
Gain on sale on assets 157 -- 2.4 --
Minority interest -- 26 -- 0.4
------- ------- ------- -------
Total other income (expense) (43) (188) (0.7) (3.1)
------- ------- ------- -------
Loss from continuing operations $ (59) $ (848) (0.9%) (14.1%)
======= ======= ======= =======
REVENUE
Food and beverage revenue increased $470,000 or 7.8% for the three months
ended February 28, 1999 compared to the same period of 1998. Food and beverage
revenues in 1999 include $41,000 of revenue from a new restaurant which opened
February 18, 1999. Food and beverage revenue on a per restaurant basis for
restaurants in operation during both the three months ended February 28, 1999
and 1998 are set forth in the following table:
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Average Net Sales Per Restaurant Unit
-------------------------------------
1999 1998 Increase % Increase
----------- ----------- -------------- ------------
Three months ended February 28 $ 258,066 $ 240,925 $ 17,141 7.1%
The 7.1% increase in same store sales for the three months ended February
28, 1999 compared to the same period of 1998 was primarily due to the success of
two promotions (i) "late night" business - restaurants are now staying open
later on a year around basis which has resulted in sales growth of $113,000
during the late night period for the three months ended February 28, 1999, and
(ii) an increase of $447,000 in "combo" sales and "upsizing" (the addition of a
larger beverage or larger french fry to the standard combo meal for an
additional 39 cents). Same store sales were also enhanced by the relatively mild
winter weather conditions experienced in the first quarter of 1999. These sales
increases were offset by a $62,000 decrease in sales during the first quarter of
1999 compared to the same period of 1998 due to the termination of cold bar
sales in all of the Company's restaurants on April 1, 1998, carried out at the
direction of Wendy's International, Inc. Sales during the first three months of
1999 continued to be negatively impacted by 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. There were no increases in
the average price of menu items during the three month period ended February 28,
1999 compared to the same period of 1998.
COST OF FOOD AND BEVERAGES
Cost of food and beverages as a percentage of food and beverage revenue
was 29.1% for the three months ended February 28, 1999 compared to 28.7% for the
three months ended February 28, 1998. The increase in food cost percentage was
primarily attributable to an increase in the cost of chicken products of
approximately 12% in the first quarter of 1999 compared to the same period of
1998 (from an average of $2.02 per pound in the first quarter of 1998 to an
average of $2.26 per pound in the first quarter of 1999). Continued and
consistent emphasis on food cost controls contributed to containment of other
food and beverage costs.
OPERATING EXPENSES
Operating expenses decreased 3.2 percentage points for the three months
ended February 28, 1999 compared to the same period of 1998 (from 61.9% of
revenue in 1998 to 58.7% of revenue in 1999). The decrease was due to the
combination of (i) decreased rent expense, (ii) reduced advertising costs, and
(iii) increased payroll costs.
- - Rent expense for the quarter decreased $97,000 when compared to the same
period of 1998. This 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 and
depreciation expense due to this purchase.
- - Advertising costs decreased $90,000, from $381,000 in the first quarter
of 1998 to $291,000 for the same period of 1999. Approximately $49,000 of
the decrease in advertising costs resulted from an agreement between
Wendy's International and Coca-Cola USA whereby the national advertising
fee paid to Wendy's International was reduced by .75% of sales for the
quarter. The Company also
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received a $30,000 credit from its local advertising co-op resulting from
excess funding in 1998. Additionally, the Company realized a $38,000
increase in advertising reimbursements under its current contract with
Pepsi-Cola Company compared to reimbursements under its previous contract
with Coca-Cola. Due to the increased sales volume, these decreases were
slightly offset by an increase in advertising costs which are primarily
based on a percentage of sales.
- - Payroll and related costs increased from $2,002,000 (33.2% of revenue)
for the first quarter of 1998 to $2,211,000 (34.0% of revenue) for the
same period of 1999. The increase was primarily due to a 4.7% increase in
the average hourly pay rate, from an average of $5.95 per hour for the
first quarter of 1998 compared to $6.23 per hour for the first quarter of
1999. This increase was compounded by an 18% increase in health insurance
costs (approximately $30,000). Labor costs were also negatively impacted
by higher than normal labor costs due to start-up salary and training
costs related to the Company's two new stores opened in February and
March of 1999.
GENERAL AND ADMINISTRATIVE
Restaurant Operations
General and administrative expenses decreased $70,000 for the three
months ended February 28, 1999 compared to the same period of 1998 (from
$347,000 to $277,000). As a percentage of revenue, general and administrative
expenses decreased from 5.8% of revenue for the three months ended February 28,
1998 to 4.3% of revenue for the same period of 1999. Approximately $32,000 of
this decrease was due to the elimination of the general partner administrative
fee effective December 16, 1998. Additionally, professional fees were reduced by
approximately $23,000, and travel and entertainment costs decreased
approximately $13,000.
Corporate Level Expenses
Corporate level expenses decreased $338,000, from $571,000 in the first
quarter of 1998 to $233,000 for the same period of 1999. This 59% decrease was
primarily due to (i) a $113,000 decrease in salaries and bonuses associated with
the discontinuance of the lodging business segment and a reduction in executive
level and other positions, (ii) a $188,000 decrease in legal expenses which were
unusually high in the first quarter of 1998 due to the litigation brought by the
former general partner of the now dissolved Wendy's of West Michigan Limited
Partnership, and (iii) a $47,000 decrease in life insurance expense as certain
of the policies were sold during the first quarter of 1999.
INTEREST EXPENSE
Interest expense for the first quarter of 1999 and 1998 was $330,000 and
$370,000, respectively. Long-term debt was restructured during the fourth
quarter of 1998 which resulted in a weighted average interest rate of
approximately 9.0% for the first quarter of 1999 compared to approximately
13.75% for the first quarter of 1998. This significant reduction in average
interest rates more than offset the Company's increase in long-term debt and was
the primary reason for the decline in interest expense.
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INTEREST INCOME
Interest income decreased $26,000 for the first quarter of 1999 compared to
the same period of 1998, from $156,000 to $130,000. During the first quarter of
1998, the Company recognized $153,000 of non-cash interest income on the
Company's note receivable from the sale of stock. In the second quarter of 1998,
the Company discontinued its recognition of this interest income and reversed
the amount of year-to-date interest income recognized. This adjustment to
interest income was made as a result of the Company's determination that a
valuation allowance was appropriate due to the longer term price trend of the
stock, which serves as collateral for the note receivable. Because of the
decrease in the value of the collateral securing the note receivable, a
valuation allowance of $4,837,072 has been made to adjust the note receivable to
its estimated realizable value if the shares of common stock securing the note
were sold and the proceeds were applied to the note receivable. As detailed in
the Company's Statement of Stockholders' Equity, the valuation allowance has no
net effect on the Company's total stockholders' equity. The cash interest income
of $130,000 recognized in the first quarter of 1999 is 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, as well as from cash reserves.
GAIN ON SALE OF ASSETS
The Company recognized a gain on the sale of assets of $157,000 for the
three months ended February 28, 1999 compared to no such gains in 1998. The gain
on sale of assets was the result of the sale of life insurance policies during
the first quarter of 1999.
DISCONTINUED OPERATIONS - LODGING GROUP
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 business segment as of May 31, 1998. For details of the impact
on the Company's operating results see Note B of the Company's Financial
Statements.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS
Cash and cash equivalents ("cash") decreased $1,027,739 from $2,109,358
as of November 30, 1998 to $1,081,619 as of February 28, 1999. The decrease in
cash was the result of the following:
Net cash used in operating activities $ (404,930)
Net cash used in investing activities (1,866,879)
Net cash provided by financing activities 1,244,070
----------
Net decrease in cash $(1,027,739)
===========
Net cash used by operating activities decreased $232,000 for the three
months ended February 28, 1999 compared to the same period of 1998 despite an
increase in net income of $1,211,000. The decrease was due to a significant
reduction in current liabilities (other than current portions of long-term debt
and capital lease obligations) and a significant reduction in liabilities of
discontinued operations from November 30, 1998 to February 28, 1999, compared to
a significant increase in current liabilities for the corresponding period of
last year.
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Net cash used in investing activities increased $1,699,000 for the three
months ended February 28, 1999 compared to the same period of 1998. The increase
in cash used by investing activities was the result of the purchase of property
and equipment totaling $1,773,000 in connection with the development of two new
restaurants which opened in February and March of 1999, and the acquisition of
land for a third restaurant which is currently under construction.
Net cash provided by financing activities increased $1,085,000 for the
three months ended February 28, 1999 compared to the same period of 1998. The
increase in cash provided by financing activities was primarily the result of a
$1,015,000 increase in proceeds from long-term debt which were used to acquire
the assets described above related to new store development.
FINANCIAL CONDITION
As of February 28, 1999, the Company's current liabilities exceeded its
current assets by $448,920, compared to November 30, 1998 when current assets
exceeded current liabilities by $230,420. At these dates, the ratios of current
assets to current liabilities were 0.91:1 and 1.05:1, respectively. The above
discussion of cash flows for the three months ended February 28, 1999 explains
the decrease in cash as well as the most significant reasons for the decrease in
working capital.
As of February 28, 1999, the terms and balances of the Company's
long-term debt consisted primarily of the following:
- $8,613,000 mortgage notes payable requiring monthly payments
of $72,372, including interest at rates ranging from 7.77% to
8.15% through September and October 2018.
- $1,103,437 notes payable requiring monthly payments of $10,802
including interest at 8.15% through September 1, 2018.
- $1,250,187 construction notes payable requiring monthly
payments of interest only at rates ranging from 7.27% to 7.50%
through the completion of the building construction, at which
time a permanent mortgage note will be secured.
- $550,000 note payable due May 29, 1999 including accrued
interest at the bank's prime rate (currently 7.75%). This note
payable will be replaced with permanent long-term financing.
- $1,375,000 obligation arising from the $1,375,000 note
receivable from the sale of the Grand Harbor Resort & Yacht
Club, which note receivable was assigned with recourse to the
Chairman of the Board as part of a separate transaction. Due
to the recourse nature of the obligation, it is accounted for
as a current portion of long-term debt in the Financial
Statements. The related note receivable is accounted for as a
current asset. Because the obligation was assigned with
recourse, to the extent the note receivable is not paid by the
maker, the Company would be required to make payment to the
assignee upon completion of its collection efforts.
- $325,242 equipment notes payable requiring monthly payments of
$8,126, including interest at rates ranging from 7.5% to 8.8%.
The 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;
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- FCCR of 1.2 : 1 for the Wendy's restaurants that are subject
to a real estate mortgage;
- FCCR of 1.4 : 1 for the Wendy's restaurants that are subject
to both a real estate mortgage and a business value loan; and
- a restriction against using operating cash flow from the
Wendy's business to fund corporate level expenses if such
funding would cause the FCCR to be less than 1.2 : 1.
At February 28, 1999, the Company was in compliance with these
covenants.
The cash flow management issues currently facing the Company can be
broken down into three areas: (i) operations of the Wendy's restaurants, (ii)
corporate level expenses, and (iii) investment in new restaurants.
Fiscal 1999 presents a new challenge as the Company is funding certain
pre-opening costs associated with the anticipated opening of four new
restaurants during the latter three quarters of this fiscal year. One of
these restaurants opened on March 18, 1999. The Company estimates capital
expenditures for the next twelve months at its existing Wendy's restaurants to
be approximately $500,000 for building improvements and furniture, fixtures and
equipment purchases.
The Company has invested approximately $2.5 million for the two new
Wendy's restaurants that opened in February and March 1999. It is estimated that
an additional investment of approximately $1,250,000 will be made for the real
estate of a third Wendy's restaurant expected to open in the third quarter of
fiscal 1999, and that operating leases will be entered into on the real estate
for two other new restaurants during the current fiscal year. The Company has
received forward commitments to fund the real estate at interest rates ranging
from 7.5% - 9.15% based on current interest rates. The Company anticipates
financing 90% of the cost of the real estate through the use of external
financing. Additionally, the Company estimates that an investment of $825,000
will be required for equipment packages and franchise fees associated with the
anticipated opening the remaining three new Wendy's restaurants during the
current fiscal year. It is anticipated that approximately $600,000 of this
equipment investment will be funded through the use of external financing. The
Company has received multiple equipment financing proposals at terms of five to
seven years with interest rates ranging from 7.3% - 8.0%.
Related to the two new restaurants that opened in February and March
1999, the Company has secured mortgage financing totaling $1,940,000, of which
$1,476,000 has been borrowed to date. When the final loan distributions are made
and the loan documents are finalized, the construction financing will be
converted to permanent 20-year mortgages which will carry a fixed interest rate
of 2.75% over the then current 10-year treasury rate. Based on current treasury
rates, the rate would be approximately 7.9%. The remaining available
construction draws of $464,000 are expected to fund the remaining construction
costs.
The Company's loan agreements restrict the amount of currently generated
operating cash flow from the Wendy's restaurants that may be utilized to fund
corporate level expenses. The Company anticipates that the corporate level
expenses will be funded primarily with cash flow from the Wendy's operations in
accordance with the loan covenants, as well as from cash proceeds generated from
non-operating activities. These activities include the sale of life insurance
policies, investment interest income, and the collection of certain notes
receivable. Corporate level expenses in fiscal 1999 are expected to be
significantly lower than in fiscal 1998. The Company has implemented a number of
significant general and administrative cost cutting measures to achieve these
cost reductions. However, there can no assurance that the Company will be able
to fully achieve its planned cost reductions, either as to dollar amount or
timing of the cost cutting measures.
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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 reserves in excess of $1,000,000.
- Using $900,000 of annual projected operating cash generated from
existing Wendy's restaurants.
- Generating additional operating cash flow from restaurants opened in
fiscal 1999.
- Exploring the acquisition of a working capital line of credit.
- Collecting on the Company's notes receivable which are expected to
produce net proceeds of approximately $740,000.
- Exploring the financing of certain of the planned capital expenditures
and improvements as opposed to paying cash, specifically with respect
to the planned renovations at existing Wendy's restaurants.
- Exploring the financing of equipment packages for certain of the new
restaurants as opposed to making a cash investment.
- Reducing or deferring the capital expenditures described above.
There can be no assurances, however, that the Company will be able to
complete the above activities or that completion would yield the results
expected. Also, notes receivable totaling $3,219,617 have been assigned with
recourse. To the extent those notes are not paid by their makers, the Company
would be obligated to make the payments to the assignees upon completion of its
collection efforts. Collection efforts would include all attempts to foreclose
on collateral. Although the Company believes that the collateral is sufficient
to cover the remaining obligations on those notes, there is no assurance that
the Company would be able to effect such a realization when payments on the
notes would ultimately be due to the assignees, and no assurances that the
amounts recovered would be sufficient to cover amounts due those assignees. In
such circumstances, the Company would be required to secure necessary funds
through borrowings or other means.
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 three years. The
Company is completing its review of its computer hardware and software with the
assistance of the software designers to ensure that all significant software
applications are year 2000 compliant. 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. The critical
systems which are used to produce financial statements (general ledger module),
process purchases and cash disbursements (accounts payable module), and process
payroll have also been tested and are year 2000 compliant. However, the
Company's software used to compare actual product usage with planned product
usage is not year 2000 compliant. The Company plans to replace its product usage
software with software that is year 2000 compliant.
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The Company has estimated that necessary replacement or modification of
its hardware and software could cost from $75,000 to $150,000. 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 the review of its 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 exact
cost that may be required to ensure that all the critical computer systems are
year 2000 compliant.
Despite assurances from its various software vendors, the Company could
find that its critical computer systems are not year 2000 compliant or that it
experiences computer equipment failures. In such event, the Company's
contingency plan includes the following:
1) Point-of-Sale System - The Company would immediately begin to manually
(i) process its sales, (ii) monitor its inventory, and (iii) record
its labor expense. This manual system would remain in effect until
such time as the year 2000 issues are corrected or a substitute
computerized system is installed. It is possible, however, that if the
year 2000 issues can not be corrected, or a substitute system cannot
be installed within a short period of time, the Company's operations
could be adversely affected.
2) Financial Statements, Cash Disbursements and Payroll Systems - The
Company would initiate one or more of the following contingency plans
until the year 2000 issue can be corrected (i) manual processing, (ii)
utilization of an alternative software program on a "stop-gap" basis
until the system can be corrected, or (iii) contract with a third
party vendor to process payments, payroll and financial statements.
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PART II
OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibit List.
-------------
Exhibit No. Description of Document
- ----------- ----------------------------------------------------------------
10.1 Indemnification Agreement dated February 16, 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.
27.1 Financial Data Schedule - First Quarter 1999.
27.2 Financial Data Schedule - First Quarter 1998 (restated).
All Exhibits filed herewith.
(b) Reports on Form 8-K.
--------------------
No reports on Form 8-K were filed during the quarter for which
this report is filed.
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: March 25, 1999 MERITAGE HOSPITALITY GROUP INC.
By /s/ Robert E. Schermer, Jr.
------------------------------------------
Robert E. Schermer, Jr.
President and Chief Executive Officer
By /s/ Pauline M. Krywanski
-----------------------------------------
Pauline M. Krywanski
Vice President and Treasurer
(Chief Financial Officer)
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EXHIBIT INDEX
Exhibit No. Description of Document
- ----------- ----------------------------------------------------------------
10.1 Indemnification Agreement dated February 16, 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.
27.1 Financial Data Schedule - First Quarter 1999.
27.2 Financial Data Schedule - First Quarter 1998 (restated).
All Exhibits filed herewith.
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