SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-SB/A
(Amendment No. 2)
GENERAL FORM FOR REGISTRATION OF SECURITIES OF
SMALL BUSINESS ISSUERS
Under Section 12(b) or 12(g) of
The Securities Exchange Act of 1934
JRECK SUBS GROUP, INC.
Name of Small Business Issuer in its charter)
Colorado 84-1317674
(State or Other Jurisdiction (IRS Employer Identification No.)
of Incorporation or Organization)
2101 West State Road 434, Suite 100, Longwood, FL 32779 (Address of principal
executive offices) (Zip Code)
(407) 682-6363
(Issuer's Telephone Number)
Securities to be registered under Section 12(b) of the Act:
Title of each class Name of Each Exchange on which
to be so registered each class is to be registered
None None
Securities to be registered pursuant to section 12(g) of the Act:
Common Stock, no par value
(Title of Class)
<PAGE>
PART I
Item 1. Description of Business
Background
In the summer of 1969 five school teachers from the Carthage, New York
Central School System - named Jerry, Richard, Ellis, Charles and Keith - JRECK -
commenced a business of preparing and serving submarine style sandwiches from an
old school bus just outside of the main gate of Camp Drum. The business was
incorporated in 1974 in the State of New York under the name JRECK Subs, Inc.
In May, 1996 the Company concluded a reverse acquisition wherein all of
its capital stock was acquired by Circa Media, Inc., a Colorado corporation
formerly engaged in reproducing archival, public domain art and photographs in
digital form. Circa Media, Inc. was incorporated on July 19, 1995, and changed
its name to JRECK Subs Group, Inc. ("Company") on May 7, 1996. The former common
shareholders of JRECK Subs, Inc. received 5,000,000 shares of Common Stock of
the Company in the acquisition, or 56% of the outstanding shares, and the former
Series A Preferred Stockholders of Jreck Subs, Inc. received 700,000 shares of
Series A Preferred Stock. The former business of Circa Media, Inc. was
discontinued prior to May 1996. The historical information presented prior to
May 1997 is that of Jreck Subs, Inc.
The Company consists of JRECK Subs Group, Inc. and its wholly-owned
subsidiaries including JRECK
Subs, Inc., a New York corporation, Leovera, Inc. ("Leovera"), a Florida
corporation, Admiral Subs of Washington,
Inc. ("ASWI"), a Washington corporation, owners of Seawest Subshops, Inc.
("Seawest"), Little King, Inc. ("Little
King"), a Delaware corporation, Pastry Products Producers, LLC, a New York
limited liability company ("Pastry
Products"), SBK Franchise Systems, Inc. ("Sobik's"), a Florida corporation, Li'l
Dino Corporation ("Li'l Dino"), a
North Carolina corporation, and Admiral's Fleet, Inc. ("AFI"), a Washington
corporation and AFI's wholly-owned
subsidiaries, Richey Enterprises, Inc. ("Georgio's"), a Washington corporation
and Quality Franchise Systems, Inc.
("Mountain Mike's"), a Delaware corporation.
Company Operations
The Company is a multiple-concept franchisor. The Company began with
the JRECK Subs franchise which currently has 47 restaurants. JRECK Subs offers a
menu of high quality, fresh submarine sandwiches, soups and hot and cold side
order items as well as a full line of bagel offerings in selected franchise
locations based on the Lox, Stock & Bagel menu which certain proprietary rights
were acquired by the Company in 1990.
During 1997, the Company commenced a growth strategy through strategic
alliances and acquisitions which included the following:
C Hymie's Bagels, a 8 unit chain of company owned bagel shops in Tampa,
Florida along with a bakery;
C Seawest Subs, a 40 unit submarine sandwich chain primarily located in Seattle,
Washington;
C Little King, a 36 unit submarine sandwich chain primarily located in Nebraska;
C Georgio's, a 6 unit submarine sandwich chain primarily located in Seattle,
Washington;
C Mountain Mike's Pizza, a 78-unit pizza chain primarily located in northern and
central California;
C Sobik's Sandwich Shops, a 41-unit submarine sandwich chain primarily located
in the Orlando, Florida area;
C Li'l Dino, a 43-unit submarine sandwich chain primarily located in North
Carolina; and
C The completed acquisition of a 100% interest in Pastry Products
Producers, LLC which supplies the JRECK Subs restaurants with all of
their bakery products.
<PAGE>
JRECK Subs Menu and Stores
The Company's JRECK Subs franchises offer a menu of different submarine
sandwiches, as well as a full line of bagel offerings and additional breakfast
items in selected franchise locations based on the Lox, Stock & Bagel menu.
JRECK Subs' emphasis in the submarine sandwich business is to offer a wider
selection of menu items and higher quality ingredients (such as rib-eye steak)
cooked on the premises. The food preparation area is open to customer view to
engage customer interest and to showcase freshness and cleanliness. The food
preparation process is designed to deliver a completed food order within 60
seconds. Sandwich menu prices range from $2.50 to $5.00. In addition, JRECK Subs
offers a selection of soft drinks, on-premises baked cookies and deep fried
items such as french fries, mushrooms, and cheese sticks.
As of March 31, 1998 there were 47 JRECK Subs franchisees, all of which
are located in New York State. Each location is designed as a "dine in"
location, although a number of franchises have drive up windows as well. Located
in strip shopping centers, shopping malls, and free standing buildings,
restaurants generally range from 1,000 to 2,000 square feet in size with 1,400
to 1,500 square feet being typical. The typical JRECK Subs store is decorated
with wood, brass tables and chairs, and brass lamps with green shades to impart
a friendly and cozy atmosphere. The green and white color scheme of the JRECK
"Admiral" signage is carried throughout the interior.
As is typical in sandwich shops, a majority of store sales occur during
lunch and the remainder during the dinner hours. Dine in and take out (including
delivery) typically comprise 60% and 40% of sales, respectively.
Individual franchisees can elect to offer catering services or home delivery.
Each franchisee leases or owns store facilities. Neither the Company
nor any of its affiliates leases store premises to franchisees.
Franchise Program
As of March 31, 1998 the Company had approximately 299 restaurants of
which 288 are franchised locations. The Company obtains prospective franchisees
from its current and former employees, from referrals from existing franchisees
and from franchise shows.
The Company assists franchisees with selecting suitable locations by
the use of demographic and traffic pattern analysis, an analysis of the
proximity of business and community resources, and competition; advises on the
negotiation of lease terms and store design; assists with sourcing of food
product supply; and purchase of furniture and fixtures. The Company's experience
is that smaller towns with populations under 10,000 are prime locations for its
franchisees due to the lack of competition from larger fast food chains and the
high quality of its products. The Company has no formal policy with respect to
proximity of franchises, but deals with proximity issues on a case by case
basis. Certain franchisees are required to purchase all their baked goods from
the Company, such as submarine sandwich rolls. Bakery products for JRECK Subs
stores are supplied by the Company's bakeries in Watertown, New York and Tampa,
Florida to franchises in those states.
The Company intends to develop new franchise locations primarily
through existing franchisees. Management believes that the Company has a
national presence which it intends to strengthen by further developing each of
its regional concepts. The primary criteria considered by the Company in the
review and approval of franchisees are prior experience in operating restaurants
or other comparable businesses and capital available for investment.
Franchise fees in all franchising companies are to a large degree
competitively market driven. The Company intends to maintain franchise fees for
new franchised locations within industry norms of $10,000 to $12,500 for new
locations in the sandwich segment and $20,000 in the pizza segment. Franchise
fees are due upon execution of the Franchise agreement. The Company intends to
maintain royalty fees of 5% to 7% of sales for all new locations for each of its
brands on a going forward basis and advertising fees at 2% to 4% of sales. The
following table sets forth certain information regarding the Company's
franchises.
<PAGE>
<TABLE>
<CAPTION>
Franchised/ Avg. Years Avg. Royalty Avg. Royalty Price of
Licensed Left on on Existing on New New Selling New
Concept Units Contract Franchises Franchises Franchise Franchises
<S> <C> <C> <C> <C> <C>
JRECK Subs 47 9.2 4.3% 5.0% $10,000 Yes
Mountain 78 10.0 4.6% 5.0% $20,000(d) Yes
Mike's Pizza
Sobik's41 6.8 4.6% 5.0% $10,000(e) Yes
Sandwich
Shops
Li'l Dino 43 16.0 5.9% 7.0%(c) $12,500(f) Yes
Seawest Subs 40 6.5 5.0% 5.0% $10,000(g) Yes
Shops
Little King 25 9.9 4.9% 6.0% $12,000 Yes
Hymie's 8(a) N/A N/A N/A N/A No
Bagels
Georgio's 6(b) 8.5 4.0% 5.0% $10,000 Yes
</TABLE>
(a) All Hymie's units are operated under a license agreement.
(b) Three franchised and three operating under a license agreement.
[Totals 6.]
(c) Li'l Dino's receives 6% royalties from university locations.
(d) The initial franchise fee is reduced to $10,000 for existing franchise
owners acquiring another franchise.
(e) The initial franchise fee is reduced to $4,000 for existing franchise
owners acquiring another franchise and is $1,000 for a non-
traditional restaurant (i.e. convenience stores).
(f) The initial franchise fee is $5,000 for a non-traditional store.
(g) The
initial franchise fee is $2,500 for a regional developer.
The Company maintains a staff of operations personnel to train and
assist franchisees in opening new restaurants and to monitor the operations of
existing restaurants. These services are provided as part of the Company's
franchise program. New franchisees are required to complete a two-week training
program which consists of formal classroom training and in--restaurant training,
including human resources, accounting, purchasing and labor and food handling
laws. Upon the opening of a new franchised restaurant, Company representatives
are typically sent to the restaurant to assist the franchisee during the opening
period. These Company representatives work in the restaurant to monitor
compliance with the Company's standards and provide additional on-site training
of the franchisee's restaurant personnel.
The Company also provides development and construction support services
to its franchisees. Plans and specifications for the restaurants must be
approved by the Company before improvements begin. The Company's personnel
typically visit the facility during construction of leasehold improvements to
meet with the franchisee's site contractor and to verify that construction
standards are met.
To maintain uniformly high standards of appearance, service, food and
beverage quality, the Company has adopted policies and implemented a monitoring
program. Franchisees are required to adhere to the Company's specifications and
standards in connection with the selection and purchase of products used in the
operation of the restaurant. Detailed specifications are provided for the
products used, and franchisees must request the Company's approval for any
deviations. Except for submarine sandwich rolls, and other baked goods, the
Company does not generally sell equipment, supplies or products to its
franchisees. The various franchise agreements require franchisees to operate
their restaurants in accordance with the Company's requirements. Ongoing advice
and assistance is provided to franchisees in connection with the operation and
management of each restaurant.
Suppliers
In October 1997, the Company completed its acquisition of Pastry
Products in Watertown, New York. Pastry Products supplies the Company's JRECK
Subs franchises with all of its bakery products. Pastry Products sells
approximately 95% of its products to JRECK Subs franchises. The Company does not
believe that it would have
<PAGE>
difficulty in obtaining an alternate supplier to Pastry Products due to the
large number of alternate bakeries in New York State.
In connection with the Company's purchase of Hymie's Bagels, the
acquisition included a bakery which provides the bagels for all of the Hymie's
Bagel shops. The Company does not believe that it would have difficulty in
obtaining an alternate supplier to the Hymie's Bagels chain due to the large
number of alternate bakeries in Florida.
The Company's various franchisees obtain meat, cheese, vegetable and
paper products from several suppliers. Other than rolls used at the Company's
Little King and Seawest Subs restaurants, only fresh, never frozen, and Grade A
products are used.
Recent Acquisitions
In June 1997, the Company through its wholly owned subsidiary Leovera,
Inc. acquired all of the outstanding shares of Leovera, a company which operates
the Hymie's Bagel 8 unit chain and a bagel bakery in Tampa, Florida, for
$200,000 in cash and the issuance of 289,500 shares of the Company's Common
Stock. The Company added submarine sandwich counters to each location. In
connection with the acquisition, the Company entered in a five-year management
agreement with a principal of Leovera with an initial management fee of $85,000
for the first year. The management agreement was terminated in February 1998 for
$19,000.
In June 1997, the Company, through its ASWI subsidiary, acquired all of
the outstanding shares of Seawest Sub Shops, Inc., headquartered in Bellevue,
Washington. Seawest Subs has 40 franchised submarine sandwich shops. The
consideration included $150,000 in cash, the issuance of options to purchase
100,000 shares of the Company's common stock at a price of $.001 per share for
15 years (valued at $406,000) and the assumption of certain liabilities
personally guaranteed by the former president of Seawest Sub Shops, Inc. The
optionees have the right to require the Company to repurchase these shares at
the greater of their "fair market value" (defined to be the average of the high
and low sales prices on a public market) or $3.25 per share, without the prior
written agreement in any 3 month period but in no event more than 10,000 shares
without the prior written agreement in any 3 month period per month. The
optionees were also granted piggy back registration rights. The options become
exercisable on a cumulative basis at 25% on each of December 19, 1997, May 19,
1998, November 19, 1998 and May 19, 1999. In connection with this acquisition,
the Company entered into a noncompete agreement with the former president of
Seawest Sub which calls for monthly payments of $8,000 which commenced in June
1997 for a twelve month period.
In August 1997, the Company acquired all of the outstanding stock of
Little King, Inc., a 36-unit submarine shop including the assets of nine
corporately-owned restaurants. The consideration consisted of $50,000 cash, a
note for $100,000, 500,000 shares of the Company's common stock immediately
issued, 700,000 shares of the Company's common stock to be issued within 12
months plus 100,000 contingent shares based on Little King franchising revenues
or total revenues exceeding certain parameters for the year ending December 31,
1998. The acquisition also provided the principal of Little King an option to
repurchase Little King from the Company if the stock price of the Company is not
at least $1.50 per share on the second anniversary of the closing with the
repurchase based on the Company receiving back all of the Company's shares
issued, any funds invested by the Company into Little King and a fair market
value determination. The term of the acquisition also provided that in the event
the Company files bankruptcy within three years of the closing and the
bankruptcy is not dismissed within 90 days, the principal of Little King is
granted the first option to repurchase the Little King stock from the Company
for $25,000. In connection with the acquisition of Little King, the Company
entered into employment agreements with Sid Wertheim and Robert Wertheim to act
as president and vice-president of Little King respectively. Mr. Sid Wertheim's
employment agreement is for a seven-year period with an initial salary of
$54,000 subject to annual increases up to 20% based on operating performance.
Mr. Robert Wertheim's employment agreement is for a ten-year period with an
initial salary of $45,000 subject to annual increases up to 20% based on
operating performance.
In August 1997, the Company through its AFI subsidiary acquired all of
the outstanding stock of Richey Enterprises, Inc., a Washington corporation,
which franchises 6 Georgio's Sub shops. The consideration consisted of 93,794
shares of the Company's common stock and a stock price guarantee if any sale of
the Company's stock sold by the seller to a third party, is valued within 30
days after the anniversary of the date of the close of escrow
<PAGE>
at less than 80% of the price of the stock at the close of escrow. In connection
with the acquisition of Georgio's Sub, the Company entered into a
consulting/noncompete agreement with William and Colleen Richey which calls for
a sixty-day agreement with an initial fee of $10,000 and a monthly consulting
fee of $3,750. After the initial sixty-days, the agreement is subject to mutual
renewal on a month-to-month basis. The noncompete agreement is in effect during
the period of the consulting agreement and two years after any termination of
the consulting agreement.
In September 1997 the Company, through its AFI subsidiary acquired all
of the outstanding shares of Quality Franchise Systems, Inc., the franchisor of
Mountain Mike's Pizza, a 78-unit pizza chain located primarily in northern and
central California. The consideration consisted of 899,967 shares of the
Company's common stock, 120 shares of the Company's Series C preferred stock,
and options to purchase 32,204 shares of common stock valued at $23,000. In
addition, the shareholders of QFS received 150,000 additional shares of the
Company's common stock since the stock price did not exceed $3.50 for 21
consecutive days between October 1, 1997 and January 31, 1998. 500,000
additional shares are to be issued if the Mountain Mike's income from
franchising operations, as defined, exceed $500,000 for any consecutive
twelve-month period from October 1, 1997 to December 31, 1998.
In December 1997, the Company entered into an agreement to acquire SBK
Franchise Systems, Inc., franchiser of 41 Sobik's Sandwich Shops located
primarily in central Florida, from Interfoods of America, Inc. The purchase
price consisted of $100,000 in cash, a $500,000 note and 187,266 shares of the
Company's common stock. The Company is obligated to repurchase up to 34,453 of
the shares on an annual basis at a price of $2.67 per share upon request from
the prior owner.
In March 1998 the Company acquired the assets of Li'l Dino Corporation,
a 43-unit sandwich shop franchisor located in North Carolina. The purchase price
was 735,294 shares of common stock, and the assumption of approximately $400,000
in debt. The acquisition closed in March 1998 upon completion of a state
fairness hearing held in accordance with state securities laws to approve the
transactions as fair to Li'l Dino Corporation shareholders.
Competition
The fast food restaurant industry is highly competitive and can be
significantly affected by many factors, including changes in local, regional or
national economic conditions, changes in consumer tastes, consumer concerns
about the nutritional quality of quick-service food and increases in the number
of, and particular locations of, competing restaurants. Factors such as
inflation, increases in food, labor and energy costs, the availability and cost
of suitable sites, fluctuating interest and insurance rates, state and local
regulations and licensing requirements and the availability of an adequate
number of hourly paid employees can also adversely affect the fast food
restaurant industry. Multi-unit restaurant chains like the Company can also be
substantially adversely affected by publicity resulting from food quality,
illness, injury, or other health concerns. Major chains, which have
substantially greater financial resources and longer operating histories than
the Company, dominate the fast food restaurant industry. The Company competes
primarily on the basis of location, food quality and price. Changes in pricing
or other marketing strategies by these competitors can have an adverse impact on
the Company's sales, earnings and growth. There can be no assurance that the
Company will be able to compete effectively against its competitors. In
addition, with respect to the sale of franchises, the Company competes with many
franchisors of restaurants and other business concepts for qualified and
financially capable franchisees.
Regulation
The Company is subject to a variety of federal, state, and local laws
affecting the conduct of its business. Operating restaurants are subject to
various sanitation, health, fire and safety standards and restaurants under, or
proposed for construction, are subject to state and local building codes, zoning
restrictions and alcoholic beverage regulations. Difficulties in obtaining or
failure to obtain required licenses or approvals could delay or prevent the
development or opening of a new restaurant in a particular area. The Company is
also subject to the Federal Fair Labor Standards Act, which governs minimum
wages, overtime, working conditions and other matters, and the
<PAGE>
Americans with Disabilities Act, which became effective in January 1992. The
Company believes that it is in compliance with such laws, and that its
Restaurants have all applicable licenses as required by governmental
authorities.
The Company believes that it is in compliance with the applicable
federal and state laws concerning designated non-smoking and smoking areas in
its Company operated restaurants.
The Company is subject to regulations of the Federal Trade Commission
(the "FTC") and various states relating to disclosure and other requirements in
the sale of franchises and franchise operations. The FTC's regulations require
the Company to timely furnish prospective franchisees a franchise offering
circular containing prescribed information. Certain state laws also require
registration of the franchise offering with state authorities. Other states
regulate the franchise relationship, particularly concerning termination and
renewal of the franchise agreement. The Company believes that it is in
compliance with the applicable franchise disclosure and registration regulations
of the FTC and the various states that it operates in.
While the Company intends to comply with all federal, state and foreign
laws and regulations, there can be no assurance that it will continue to meet
the requirements of such laws and regulations, which, in turn, could result in a
withdrawal of approval to franchise in one or more jurisdictions. Any such loss
of approval may have a material adverse effect upon the Company's ability to
successfully market its franchises. Violations of franchising laws and/or state
laws and regulations regulating substantive aspects of doing business in a
particular state could subject the Company and its affiliates to rescission
offers, monetary damages, penalties, and/or injunctive proceedings. The state
laws and regulations concerning termination and non-renewal of franchisees are
not expected to have a material impact on the Company's operations. In addition,
under court decisions in certain states, absolute vicarious liability may be
imposed upon franchisors based upon claims, there can be no assurance that
existing or future franchise regulations will not have any adverse effect on the
Company's ability to expand its franchise program.
Business Strategy
The Company's business strategy is to increase its franchise revenue
base through continuing franchising of JRECK Subs shops and the affiliated
regional companies it has acquired. Each of these companies has a strong track
record of regional franchise brand recognition and long-term franchise operating
history in their respective markets.
The typical fast food customer frequents one franchise for the majority
of purchases but also relies on one or two additional concepts and a number of
specialty restaurants. Increasing sales and franchise revenues through existing
franchisees is generally more profitable than through new franchises because
they do not require significant additional financing expenses, training calls or
other additional administrative expenses.
The Company intends to continue to supplement internal growth with
strategic acquisitions of existing fast food franchisees. The strategic
acquisition of complementary brands which are proven revenue generators in their
established markets allows the Company to grow more rapidly at less cost than
would be possible through internal growth alone. The Company has the facilities
and the management to support a larger distribution operation, therefore it
believes that it can reduce the operating expenses of the acquired businesses as
well as use economies of scale to increase gross sales, franchise revenue,
market share, and net profits. The Company is currently seeking attractive fast
food franchise businesses to acquire, but there are no assurances that the
Company will be able to acquire an ongoing business at a favorable price or that
any such acquisition would ultimately be successful.
Employees
As of March 31, 1998, the Company had approximately 120 employees
consisting of 30 administrative employees, 70 employees in the Company's 11
corporate restaurants and 20 employees in bakery operations.
Trademarks
<PAGE>
The Company markets several products under the JRECK Subs, Seawest Sub
Shops, Little King, Li'l Dino's and Mountain Mike's Pizza labels in addition to
the Georgio's and Hymie's Bagel labels.
With respect to the "JRECK Subs" label, the Company has registered this
Mark on the Principal Register of the United States and Trademark Office ("PTO")
on October 14, 1975 (Registration No. 1,022,898) and the Company has filed all
required affidavits for, and has renewed, this Mark. On May 9, 1997, the Company
filed an application with the PTO for registration of one of its principal
trademarks, the "Admiral J" logo (Application 75/289578). As of September 30,
1997, the Company has yet to receive Principal Register federal registration for
the "Admiral J" logo.
The "Seawest Sub Shops" has registered trademarks, names, symbols and
designs on the Principal Register
of the PTO on the following: "Original Deli Taste Without The Cost Logo"
(Registration No. 1,675,510, dated
February 11, 1992), "Full Boat" (Registration No. 1,761,574, dated March 30,
1993), "Destroyer" (Registration No.
1,761,573, dated March 30, 1993), "Enough for two or just for you" (Registration
No. 1,764,733, dated April 13,
1993), "Seawest Sub Shops" (Registration No. 1,703,897, dated July 28, 1992),
"Substantially More:" (Registration
No. 1,772,028, dated May 18, 1993 and "Sub Shop" (and Design) (Registration No.
1,862,112, dated November 8,
1994). In addition the trade name "Seawest Sub Shops" is registered as a
service mark with the State of Washington,
under Registration Number 020443 as of March 29, 1991. The Company has also
registered in Canada its
"Submarine Design Logo" (TMA 407,629), dated February 5, 1993.
The "Little King" service mark and design was registered on the
Principal Register of the PTO on April 12, 1977 (Service Mark No. 1,063,555).
The service mark "Royal Treat" was registered on the Principal Register of the
PTO on October 29, 1991 (Service Mark No. 1,662,623). The service mark "Little
King B America's Greatest Hero" was registered in Nebraska on February 2, 1983.
The service mark "The Little King - Where a Sandwich is a Complete Meal" and
design was registered in Iowa on December 22, 1975 and in California on December
30, 1975.
All required affidavits of use and renewals have been filed.
The "Mountain Mike's" name, service mark and design was registered on
the Principal Register of the PTO on September 15, 1992 (Registration Nos.
1,716,962 and 1,716,963). The Company's new mark and design for "Mountain Mike's
Pizza" was registered on the Principal Register of the PTO on October 1, 1996
(Registration No. 2,004,536). The Company filed for registration the slogan
"Pizza the way it oughta be" on the PTO in September 1996 (Application No.
75/174377). The Company has been informed by the PTO of a potential conflict
between its slogan and the slogan "Pizza, the way Pizza was meant to be" used by
Godfather's Pizza. The Company and its trademark counsel are evaluating options
regarding the registration of this slogan. The slogan is still in use in the
Mountain Mike's Pizza system.
The "Li'l Dino" service mark was registered on the Principal Register
of the PTO on September 30, 1986 (Registration No. 1,411,762). The "Li'l Dino
Bagel Deli Grille" service mark and design was registered on the Principal
Register of the PTO on September 30, 1997 (Registration No. 2,101,316).
The "Sobik's Subs" service mark was registered on the Principal
Register of the PTO on August 12, 1997 (Registration No. 2,087,639).
Item 2. Management's Discussion and Analysis or Plan of Operation
Overview
The following discussion regarding the financial statements of the
Company should be read in conjunction with the financial statements and notes
thereto.
The following discussion and analysis contains forward-looking
statements involving risks and uncertainties that may cause the Company's actual
results to differ materially. Those risks and uncertainties include, but are not
limited to, economic, competitive, industry and market factors affecting the
operations, market products and prices of not only the company but also its
franchisees.
<PAGE>
The Company has evaluated the impact of year 2000 on its operations.
Currently the Company is updating all of its software to provide uniformity
among all of its recent acquisitions and provide management with timely
interaction about operations. The Company has been assured by vendors that the
new software takes into consideration the changes required by calendar year
2000. On this basis the Company believes that the onset of the year 2000 will
have no material impact on the Company, since the Company had already embarked
on a software modernization program, the remedying of the year 2000 problem
existing in old software will impose no significant additional cost on the
Company.
Three months ended March 31, 1998 compared to three months ended March 31, 1997.
Results of Operations
The results of operations for the three months ended March 31, 1998
reflect less than one month of operations from Li'l Dino.
The Company had a net loss of $845,041 for the three months ended March
31, 1998, compared to a net loss of $864,080 for the same period in 1997. The
decrease in the net loss is primarily the result from increased franchising
revenues of approximately $513,000 and sales from the Company's corporately
owned restaurants and bakeries of approximately $782,000 offset by cost of sales
related to the Company's corporately owned restaurants and bakeries of
approximately $309,000 and increased operating costs of approximately $906,000
from the Company's acquisitions of businesses in 1997. Other changes for the
three months ended March 31, 1998 included consulting costs associated with
expansion where stock was issued for these services with a value of
approximately $427,000, amortization and depreciation expense associated with
the Company's acquisitions of businesses in 1997 of approximately $195,000 and
interest expense of approximately $66,000 associated with debt assumed with the
Company's acquisitions. Expansion expenses were approximately $763,000 for the
same period in 1997.
The revenue of the Company increased $1,470,548 to $1,555,300 for the
three months ended March 31, 1998 from $84,651 for the same period in 1997. The
increase is primarily due to the acquisitions of businesses made during 1997
which included increased franchising related revenues of approximately $513,000
and sales from the Company's corporate restaurants and bakeries of approximately
$782,000.
Cost and operating expenses applicable to revenue increased $1,214,349
to $2,139,144 for the three months ended March 31, 1998 from $924,795 for the
same period in 1997. This increase is primarily due to the acquisitions of
businesses made during 1997 including cost of sales from the Company's corporate
restaurants and bakeries of approximately $309,000, additional depreciation and
amortization expense of approximately $199,000 and additional operating costs
from the acquired businesses of approximately $906,000.
Hymie's Bagels:
In June 1997, the Company acquired the stock of Leovera which licenses
eight Hymie's Bagels restaurants along with a bakery that principally produces
bagels. Sales for the three months ended March 31, 1998 totaled $89,282. Costs
and expenses applicable to revenue for the period amounted to $75,939.
Seawest Sub Shops:
In June 1997, the Company acquired the stock of Seawest Sub Shops, Inc.
Revenues for the three months ended March 31, 1998 totaled $75,182. Costs and
expenses applicable to revenue for the period were $69,948.
Amortization of goodwill and a non-compete agreement was $27,353.
<PAGE>
Little King:
Operations as the Little King subsidiary of the Company commenced on
September 1, 1997. Income for the three months ended March 31, 1998 was
$529,229. Costs and expenses applicable to revenue for the period were $548,769.
Depreciation and amortization of goodwill amounted to $57,252.
Georgio's:
Operations of the Georgio's subsidiary (through the Company's AFI
subsidiary) commenced in September 1997. Sales for the three months ended March
31, 1998 were $86,188. Costs and expenses applicable to revenue for the period
amounted to $86,331. Amortization of goodwill amounted to $4,848.
Mountain Mike's Pizza:
In September 1997, the Company, through its AFI subsidiary, acquired
Mountain Mike's Pizza. Operations commenced on October 1, 1997. Revenues for the
three months ended March 31, 1998 were $456,103. Costs and expenses applicable
to revenue for the period were $223,871. Net interest expense was $15,210 and
amortization of goodwill was $47,590.
Sobik's Subs:
On December 4, 1997, the Company purchased SBK Franchise Systems, Inc.,
the franchisor of Sobik's Subs. Revenues for the three months ended March 31,
1998 were $53,849. Costs and expenses applicable to revenue for the period were
$47,173. Amortization of goodwill was $14,079.
Pastry Products:
On October 28, 1997, the Company acquired the remaining 50% interest of
Pastry Products Producers, LLC. Pastry Products is a bakery operation which
primarily serves the Jreck restaurant franchisees. Sales for the three months
ended March 31, 1998 were $161,139. Costs and expenses applicable to sales for
the period were $208,563. Interest expense was $4,000 and depreciation and
amortization of goodwill was $17,380.
Li'l Dino:
In mid-March 1998, the Company acquired the assets of Li'l Dino
Corporation, the franchisor of Li'l Dino sandwich restaurants principally
located in North Carolina. Operations for the period since acquisition are not
considered material for the three months ended March 31, 1998.
Liquidity and Capital Resources
Working capital at March 31, 1998 was a deficit of $3,215,517 compared
with a deficit of $5,330,587 at December 31, 1997, a decrease in deficit of
$2,115,070. The decrease in deficit is primarily attributable to the Company's
issuance of $2,500,000 in Series D Preferred Stock. The net proceeds from this
offering were substantially used to pay down existing debt or to satisfy other
obligations.
The Company's primarily capital requirements are for repayment of
current loans payable including those to related parties of $1,606,006 and
accounts payable of $955,194. The Company's capital requirements are anticipated
to be funded through debt and/or equity financing. There is no assurance that
additional funding will be available, or that, if available, it can be obtained
on terms favorable to the Company. Failure to obtain such funding could
adversely affect the Company's financial condition.
Year ended December 31, 1997 compared to year ended December 31, 1996.
<PAGE>
The results of operations for the year ended December 31, 1997 reflect
six months of operations from Hymie's Bagels and Seawest Subs, four months each
from Little King Subs and Georgio's Subs, three months from Mountain Mike's
Pizza and one month from Sobik's Subs.
The Company had a net loss of $8,903,644 for the year ended December
31, 1997, compared to a net loss of $39,657 for the year ended December 31,
1996. The increase in the net loss is primarily the result of consulting costs
associated with acquisitions and equity financing of $4,492,664 and a loss of
$862,029 related to an early extinguishment of debt.
The revenue of the Company increased $2,017,721 or 362% to $2,575,459
for the year ended December 31, 1997 from $557,738 for the same period in 1996.
The increase is primarily due to the acquisitions of businesses made during 1997
which included increased franchising related revenues of approximately $688,000
and sales from the Company's corporate restaurants and bakeries of approximately
$1,350,000.
Cost of Sales and operating expenses applicable to revenue increased
$3,895,110 or 935% to $4,311,597 for the year ended December 31, 1997 from
$416,488 for the same period in 1996. This increase is primarily due to the
acquisitions of businesses made during the year including cost of sales from the
Company's corporate restaurants and bakeries of $552,941, additional
depreciation and amortization expense of approximately $507,000 and additional
operating costs from the acquired businesses of approximately $1,725,000.
Consulting costs and investor relations were $4,492,664 for the year
ended December 31, 1997 and resulted from the Company's acquisition and capital
raising activities. Included in the costs of $4,492,664 were $3,301,302 of
valuation related to options for 2,275,000 shares of the Company's common stock.
Hymie's Bagels:
In June 1997, the Company acquired the stock of Leovera which owned
eight Hymie's Bagels along with a bakery that principally produces bagels. Sales
for the five months ended December 31, 1997 totaled $373,295. Costs and expenses
applicable to revenue for the period amounted to $581,003 and the Company
recognized a goodwill impairment charge of $993,820.
Seawest Sub Shops:
In June 1997, the Company acquired the stock of Seawest Sub Shops, Inc.
Revenues for the six months ended December 31, 1997 totaled $288,471. Costs and
expenses applicable to revenue for the period were $291,482. Amortization of
goodwill was $22,371 and amortization of a non-compete agreement was $83,667.
Little King:
Operations as the Little King subsidiary of the Company commenced on
September 1, 1997. Income for the four months ended December 31, 1997 was
$648,499. Costs and expenses applicable to revenue for the period were $812,554.
Amortization of goodwill amounted to $76,337.
Georgio's:
Operations of the Georgio's subsidiary (through the Company's AFI
subsidiary) commenced in September 1997. Sales for the four months ended
December 31, 1997 were $144,685. Costs and expenses applicable to revenue for
the period amounted to $164,898. Amortization of goodwill amounted to $6,465.
Mountain Mike's Pizza:
In September 1997, the Company, through its AFI subsidiary, acquired
Mountain Mike's Pizza. Operations commenced on October 1, 1997 and revenues for
the three months ended December 31, 1997 were $462,524. Costs and expenses
applicable to revenue for the period were $242,342. Net interest expense was
$18,830 and amortization of goodwill was $49,365.
<PAGE>
Sobik's Subs:
On December 4, 1997, the Company purchased SBK Franchise Systems, Inc.,
the franchisor of Sobik's Subs. Revenues for the period from December 4, 1997 to
December 31, 1997 were $17,840. Costs and expenses applicable to revenue for the
period were $65,439. Amortization of goodwill was $4,693.
Pastry Products:
On October 28, 1997, the Company acquired the remaining 50% interest of
Pastry Products Producers, LLC. Pastry Products is a bakery operation which
primarily serves the Jreck restaurant franchisees. Sales for the two months
ended December 31, 1997 were $102,989. Costs and expenses applicable to sales
for the period were $145,168. Interest expense was $11,431 and amortization of
goodwill was $9,412.
Liquidity and Capital Resources
Working capital at December 31, 1997 was a deficit of $5,330,587
compared with a deficit of $541,873 at December 31, 1996, an increase of
$4,788,714. The increase is primary attributable to debt assumed or originated
with the Company's acquisitions during 1997 of $3,736,831, a liability to issue
700,000 shares of the Company's common stock related to the Company's Little
King acquisition valued at $2,143,750 and a liability to issue 150,000 shares of
the Company's common stock related to the Company's Quality Franchise Systems,
Inc. acquisition valued at $440,625.
During 1997, the Company raised approximately $1,310,000 in cash from
the sale of stock and the exercise of stock options of which $408,417 was
expended in conjunction with its acquisitions of businesses.
During 1997, the Company acquired Hymie's Bagels, Seawest Subs,
Georgio's Subs, Little King, Mountain Mike's Pizza, Sobik's Subs and the
remaining 50% of Pastry Products for an aggregate purchase price of $10,985,714.
The acquired businesses had an aggregate fair value of net assets acquired of a
deficit $1,473,957 which resulted in excess of cost over fair value of net
assets acquired of $13,061,671. For the year ended December 31, 1997,
amortization and depreciation expense was $506,742 and the net excess of cost
over fair value of net assets acquired was $11,521,526 at December 31, 1997.
Taking into account the acquisitions made by the Company through May 31, 1998,
amortization expenses are expected to be approximately $650,000 in fiscal 1998.
In January 1998, the Company issued $2,500,000 in Series D Preferred
Stock. The proceeds from this offering were substantially used to pay down
existing debt or to satisfy other obligations. The Company's primary capital
requirements are for repayment of current loans payable of $2,163,554 and
accounts payable of $1,020,101. The Company's capital requirements are
anticipated to be funded through debt and/or equity financing. There is no
assurance that additional funding will be available, or that, if available, it
can be obtained on terms favorable to the Company. Failure to obtain such
funding could adversely affect the Company's financial condition.
Item 3. Description of Property
The Company's corporate offices and Pastry Products bakery are located
in a 8,188 square foot facility in Watertown, New York which the Company
acquired in October 1997. Under the terms of the acquisition, the Company
assumed an existing note on the facility of $150,222 at 10% payable in 84 equal
installments of $2,494 beginning December 1, 1997.
The Company also leases corporate space for the operations of its
restaurant concepts through its subsidiaries. These leases generally are less
than two year leases, except for one lease in Omaha, Nebraska which expires in
2008 and calls for annual lease payments of $39,000. Total annual lease payments
for 1998 for these corporate leases are approximately $123,000.
The Company also leases the space for its 11 Little King corporate
restaurants.
Item 4. Security Ownership of Certain Beneficial Owners and Management
<PAGE>
The following table sets forth information relating to the beneficial
ownership of Company common stock by those persons beneficially holding more
than 5% of the Company's common stock, by the Company's directors and executive
officers, and by all of the Company's directors and executive officers as a
group as of August 3, 1998.
The address of each person is care of the Company unless noted.
<TABLE>
<CAPTION>
Percentage
Name of Number of of Outstanding
Stockholder Shares Owned(1) Common Stock
<S> <C> <C>
Christopher M. Swartz(2)(3)(4) 5,569,300 29.5%
Bradley L. Gordon 1,095,113 6.0%
Michael F. Cronin 500,000 2.8%
Eric T. Swartz -0- --
Kelly A. Swartz -0- --
Jeremiah J. Haley(5) 190,000 1.0%
All executive officers and
directors as a group (5 persons)(2)(3)(4) 7,354,413 39.0%
</TABLE>
(1) As used in this table, "beneficial ownership" means the sole or shared
power to vote, or to direct the voting of, a security, or the sole or
shared investment power with respect to a security (i.e., the power to
dispose of, or to direct the disposition of, a security). In addition,
for purposes of this table, a person is deemed, as of any date, to have
"beneficial ownership" of any security that such person has the right
to acquire within 60 days after such date.
(2) Includes 350,000 shares from the full conversion of Series B Preferred
Stock into the Company's Common
Stock in June 1998.
(3) Includes 3,344,300 shares of common stock owned by Tri-Emp Enterprises,
Inc. Mr. Christopher M. Swartz is President and the sole shareholder of
Tri-Emp Enterprises, Inc and as such is deemed to have beneficial
ownership of the shares of the Company's stock owned by Tri-Emp
Enterprises, Inc.
(4) Includes 2,000,000 shares subject to options currently exercisable by
Mr. Christopher M. Swartz and 225,000 shares subject to options
currently exercisable by Tri-Emp Enterprises, Inc.
(5) Mr. Haley owns 25,000 shares of Common Stock and 165,000 shares of
Common Stock from his conversion of 150,000 shares of the Series A
Preferred Stock into the Company's Common Stock in June 1998.
<PAGE>
Item 5. Directors, Executive Officers, Promoters and Control Persons
The members of the Board of Directors of the Company serve until the
next annual meeting of stockholders, or until their successors have been
elected. The officers serve at the pleasure of the Board of Directors.
Information as to the directors, executive officers and key employees of the
Company is as follows.
Name Age Office
Christopher M. Swartz 26 Chairman, President and Chief
Executive Officer
Bradley L. Gordon 45 Chief Operating Officer and Director
Eric T. Swartz 29 Secretary and Director
Michael F. Cronin 42 Chief Financial Officer
Kelly A. Swartz 27 Director
Jeremiah J. Haley 59 Director
Gary E. Rowe 44 Controller
Christopher M. Swartz has been President, Chief Executive Officer, and
Chairman of the Company since
April 1996 and of JRECK Subs, Inc. since September 1995. From 1992 to September
1995, he was Director of
Operations of Lox, Stox & Bagels of Liverpool, Inc. Prior to 1992 Mr. Swartz
was a student at Syracuse University
where his concentration was in the field of management. Mr. Swartz is a magna
cum laude graduate of Syracuse
University who grew up in the subs business. He has worked in construction,
building sub shops and has managed
sub shops. He is the second generation of his family involved with JRECK. Mr.
Swartz is also the President of Tri-
Emp Enterprises, Inc. and the brother of Eric T. Swartz and Kelly A. Swartz.
Bradley L. Gordon has been Chief Operating Officer and Director of the
Company since September 1997. Prior to joining the Company, he was president
from September 1993 to September 1997 of Quality Franchise Systems, Inc.
("QFS"), the franchisor of Mountain Mike's Pizza, QFS's chief executive officer
since September 1992 and one of its directors since January 1993. Before joining
QFS, he held various positions at Pace Membership Warehouse, Inc. in Denver,
Colorado beginning in November 1983, including executive vice president - sales,
senior vice-president-operations and vice president-human resources.
Eric T. Swartz has been a Director and Secretary of the Company since
April 1996. He was awarded his
J.D. degree from Syracuse University College of Law and his Bachelor's Degree
from Syracuse University. He has
been a partner in the Swartz Law Firm, P.C. from October 1993 to the present.
From September 1992 to May 1993
he was associated with the law firm of Pease & Willer, which he joined after hi
graduation from law school in
1992. Mr. Swartz is the brother of Christopher M. Swartz and Kelly A. Swartz.
Michael F. Cronin has been Chief Financial Officer of the Company since
February 1998. He is a Certified Public Accountant who has managed his own
practice since February 1985 specializing in SEC audits and business and tax
planning. He has been licensed in New York State for 16 years. Mr. Cronin, a
graduate of St. John Fisher College, began his career in public accounting in
Rochester, NY in 1979. From 1979 to 1985 Mr. Cronin was employed as Staff
Accountant and Partner in a regional public accounting firm in upstate New York.
Prior to attending college. Mr. Cronin served for three years in the United
States Marine Corps.
Kelly A. Swartz has been a Director of the Company since April 1996.
She is a graduate of the State University of New York, at Plattsburgh. Ms.
Swartz is an elementary school teacher at Apollo Elementary in Titusville,
Florida, where she has been employed since September, 1991. From May 1990 to
September 1991 she was employed in various capacities with JRECK Subs, Inc.,
including the management of several sub shops. Ms.
Swartz is the sister of Eric T. Swartz and Christopher M. Swartz.
Jeremiah J. Haley has been a Director of the Company since April 1996
He was one of the original
founders of JRECK Subs, Inc. (the "J" in the name JRECK stands for the first
letter of Mr. Haley's first name). Mr.
Haley has a B.S. degree from Mansfield State College in Mansfield, Pennsylvania.
He also holds a Master's degree
from the State University of New York at Cortland. Mr. Haley has been President
of Haley Enterprises, Inc., a
<PAGE>
JRECK Subs, Inc. franchisee, from 1975 to the present. He had also been a
teacher with the Carthage, New York
Central School District from 1965 until he retired in June 1993.
Gary Rowe has been the Corporate Controller since September 1993.
Prior to joining the Company, Mr.
Rowe was the controller of the quasi-independent New York State government
agency, the Development Authority
of the North Country. Mr. Rowe graduated from the State University of New York
at Albany in 1974 where he
received a Bachelor of Science Degree in accounting. Mr. Rowe is a Certified
Public Accountant.
<PAGE>
Item 6. Executive Compensation
The following table sets forth the cash compensation of the Company's
executive officers and directors during each of the last three fiscal years. The
remuneration described in the table does not include the cost to the Company of
benefits furnished to the named executive officers, including premiums for
health insurance and other benefits provided to such individual that are
extended in connection with the conduct of the Company's business. The value of
such benefits cannot be precisely determined, but the executive officers named
below did not receive other compensation in excess of the lesser of $25,000 or
10% of such officer's cash compensation.
<TABLE>
<CAPTION>
Summary Compensation Table
ANNUAL COMPENSATION LONG TERM COMPENSATION
Name and Other Annual Awards Payouts All
Principal Position Year Salary Bonus Compensation Other
RestrictedOptions/ LTIP
Stock ($)SARs(#) Payouts ($)
1997 115,393 0 0 0 0 0 0
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Christopher M. Swartz 1996 26,000 0 0 0 0 0 0
President and CEO
1995 0 0 0 0 0 0
1997 52,600 0 0 0
Gary E. Rowe 1996 46,350 0 0 0 0 0
Controller
1995 39,000 0 0 0 0 0
Bradley R. Gordon 1997(a) 37,500 0 0 0 0 0 0
Chief Operating
Officer
</TABLE>
(a) For the period October 1, 1997 to December 31, 1997.
The Company carries no officers and directors liability insurance or
disability insurance benefits. The Company maintains a $3,000,000 key man life
insurance policy on Mr. Christopher Swartz of which the Company is the
beneficiary. No executive officer or director is currently covered by an
employment agreement except for Bradley L. Gordon. Other than a 401(k) plan
maintained at the Mountain Mike's division of Admiral's Fleet, Inc., the Company
does not maintain any pension plan, profit sharing plan or similar retirement or
employee benefit plans.
Mr. Bradley L. Gordon joined the Company as chief operating officer in
September 1997. Under the terms of his three-year employment agreement
commencing, Mr. Gordon receives an initial annual compensation of $150,000
subject to annual increases consistent with other executives of the Company. If
the employment agreement is terminated by the Company, Mr. Gordon continues to
receive his base salary until the earlier of Mr. Gordon finding new employment
or twelve months after such termination date. Mr. Gordon was also granted a
right to purchase 500,000 shares of the Company's common stock at a price of
$3.00 per share which shares were issued in November 1997. The purchase price of
$1,500,000 was paid in the form of a promissory note to the Company which calls
for 9.5% with principal and interest due in September 2000. At any time prior to
September 2000, Mr.
<PAGE>
Gordon has the right to require the Company to repurchase the 500,000 shares as
consideration for the cancellation of the promissory note.
Directors currently receive no compensation for their duties as
directors. On December 29, 1997 the Company granted to Christopher Swartz an
option to purchase of 1,000,000 shares of the Company's common stock at $2.75
per share. The options are exercisable immediately and expire on December 29,
2000. No stock options have been issued to any other executive officers or
directors.
<TABLE>
<CAPTION>
Options Granted in Fiscal 1997
Percentage of
Total Options
Granted to
Options Employees in Exercise Expiration
Granted Fiscal 1997 Price Date
<S> <C> <C> <C> <C> <C>
Christopher Swartz 1,000,000 100% $ 2.75 December 29, 2000
</TABLE>
The following table contains information concerning the exercise of
stock options and employment related options and information in unexercised
stock options held as of December 31, 1997 by the named executive officers:
<TABLE>
<CAPTION>
Option Exercises and Year-end Value Table
Value of Unexercised
In-the-Money Options
Number of Unexercised at
Shares Options & Warrants December 31, 1997
Acquired on Value
Exercise Realized(1) Exercisable NonExercisable Exercisable(2)
<S> <C> <C> <C> <C> <C> <C>
Christopher Swartz -0- $ -0- 1,000,000 0 -0-
</TABLE>
(1) Market Value at time of exercise less exercise price.
(2) The closing sale price of the Common Stock at December 31, 1997 was $2
9/16. Value equals the difference between market value and exercise
price, and is $0 at December 31, 1997 since the exercise price was
higher than market value.
Item 7. Certain Relationships and Related Transactions
Conflicts of Interest
Kalin Enterprises, Inc. ("Kalin") is the franchisee for five JRECK Subs
restaurants. Mr. Christopher Swartz
is a 25% shareholder and an officer of Kalin.
Tri-Emp Enterprises, Inc. borrowed $445,000 from 20 investors secured
by 445,000 shares of Tri-Emp
Enterprises, Inc. Common Stock. Tri-Emp Enterprises, Inc. loaned the $445,000
loan proceeds to the Company.
On October 8, 1997 the Company issued 495,000 shares of common stock to the 20
noteholders in full satisfaction
of the amounts owed by Tri-Emp Enterprises, Inc.
The Company issued options to purchase 375,000 shares of common stock
to Gulf Atlantic Publishing Inc. on January 6, 1997, exercisable at $.75 per
share. On November 17, 1997 Gulf Atlantic assigned options to purchase 225,000
of these shares to Tri-Emp Enterprises, Inc. in conjunction with the purchase
from Tri-Emp Enterprises, Inc.
of 225,000 shares by Gulf Atlantic.
<PAGE>
In fiscal 1997, the Company wrote off a note receivable of $104,141
from Mr. Tom Swartz, a family
member of Mr. Christopher Swartz.
In February, 1998 the Company converted $277,404 in notes payable owed
to Sid Wertheim into 112,783 shares of common stock.
Mr. Jeremiah Haley, a director, received 175,000 shares of Series A
Preferred Stock in exchange for his shares of Jreck Subs, Inc. Series A
Preferred Stock on May 6, 1996. Mr. Haley was elected to the Board of Directors
pursuant to the right of holders of Series A Preferred Stock to elect one member
of the Board of Directors. Pursuant to the dividend rights of holders of Series
A Preferred Stock, Mr. Haley received $15,750 in dividends on his shares in
fiscal 1997. In July 1997, Mr. Haley converted 25,000 shares of Series A
Preferred Stock into 25,000 shares of Company Common Stock. In June 1998, Mr.
Haley converted the balance of 150,000 shares of Series A Preferred Stock into
165,000 shares of Company Common Stock.
Mr. Christopher Swartz, chairman and the Company's president and chief
executive officer, received (through Tri-Emp Enterprises, a company of which he
is the sole shareholder) 5,000,000 shares of Company Common Stock in exchange
for all of the Common Stock of Jreck Subs, Inc. on May 6, 1996. Mr. Swartz also
received 350,000 shares of Series B Preferred Stock for 50% of Pastry Products
Producers LLC. Mr. Swartz was elected to the Board of Directors pursuant to the
right of holders of Series B Preferred Stock to elect one member of the Board of
Directors. In June 1998, Mr. Swartz converted all 350,000 shares of Series B
Preferred Stock into 350,000 shares of Company Common Stock.
Mr. Bradley Gordon, director and the Company's chief operating officer,
purchased 500,000 shares of the Company's common stock for $1,500,000. The
Company received a promissory note from Mr. Gordon with interest at 10% per
annum with principal and interest due in September 2000. At any time prior to
September 2000, Mr. Gordon has the right to require the Company to repurchase
the 500,000 shares as consideration for the cancellation of the promissory note.
Mr. R.T. Silberman, a shareholder of the Company, purchased 300,000
shares of the Company's common
stock for $900,000. The Company received a promissory note from Mr. Silberman
with interest at 9.5% per annum
with principal and interest due in September 2000. At any time prior to
September 2000, Mr. Silberman has the right
to require the Company to repurchase the 300,000 shares as consideration for the
cancellation of the promissory note.
In connection with the acquisition of Little King, Inc., the Company
provided Mr. Sid Wertheim, the principal of Little King an option to repurchase
Little King from the Company if the stock price of the Company is not at least
$1.50 per share on the second anniversary of the closing with the repurchase
based on the Company receiving back all of the Company's shares issued, any
funds invested by the Company into Little King and a fair market value
determination. The term of the acquisition also provided that in the event the
Company files bankruptcy within three years of the closing and the bankruptcy is
not dismissed within 90 days, Mr. Wertheim of Little King is granted the first
option to repurchase the Little King stock from the Company for $25,000. The
agreement also provided the selling shareholders of Little King, Inc. with full
piggyback registration rights in the event the Company decides to register any
of its stock. The agreement also provides that in the event the Company
completes a secondary offering of its common stock on or prior to March 31,
1998, the Company will invest an amount equal to 4% of the proceeds the Company
receives for the development of the Little King concept. Mr. Sid Wertheim also
has an agreement with Tri-Emp Enterprises, Inc. ("Tri-Emp"). Tri-Emp is
controlled by Mr. Christopher Swartz, chairman, president and chief executive
officer of the Company. Under this agreement, if Tri-Emp receives an offer to
purchase its controlling interest during the first three years after the
Company's acquisition of Little King, Inc., Tri-Emp will obtain an acceptable
stock sale for Mr. Sid Wertheim. If Mr. Sid Wertheim receives an offer for a
substantial of all of his stock position, he shall grant Tri-Emp or its designee
a first option to make such purchase. The option shall be on the same terms and
conditions as a third party bona fide purchaser.
In connection with the Company's acquisition of Seawest Sub Shop, Inc.,
the Company issued options to purchase 100,000 shares of the Company's common
stock at a price of $.001 per share for 15 years (valued at $406,000) and the
assumption of certain liabilities personally guaranteed by the former president
of Seawest Sub. The optionees have the right to require the Company to
repurchase these shares at the greater of their "fair market
<PAGE>
value" (defined to be the average of the high and low sales prices on a public
market) or $3.25 per share, but in no event more than 10,000 shares per month.
The optionees were also granted piggy back registration rights. The options
become exercisable on a cumulative basis at 25% on each of December 19, 1997,
May 19, 1998, November 19, 1998 and May 19, 1999.
In connection with the Company's acquisition of SBK Franchise Systems,
Inc. on December 4, 1997, the Company issued 187,266 shares of its Common Stock
to Interfoods of America, Inc. ("IFA"). Commencing six months after the closing
and continuing every six months thereafter until June 2000, IFA shall have the
non-cumulative right to require the Company, to the extent legally permissible,
to repurchase one-fifth (1/5) of the Common shares issued to IFA in
consideration of the repayment of $100,000. In May 1998, the Company was
notified by IFA of its exercise of the right to have the Company repurchase
one-fifth of the shares on July 5, 1998.
Item 8. Description of Securities
Common Stock
The Company's Articles of Incorporation authorize the issuance of
50,000,000 shares of common stock, no par value per share, of which 16,637,271
shares were outstanding as of June 5, 1998. Holders of shares of common stock
are entitled to one vote for each share on all matters to be voted on by the
stockholders. Holders of common stock have no cumulative voting rights. Holders
of shares of common stock are entitled to share ratably in dividends, if any, as
may be declared, from time to time, by the Board of Directors in its discretion,
from funds legally available therefor, after dividends are first paid on Series
C Preferred Stock and Series D Preferred Stock. Pursuant to the Colorado
Business Corporations Act, dividends may be paid out of shareholder equity after
deductions for the liquidation preference for outstanding preferred stock. In
the event of a liquidation, dissolution or winding up of the Company, the
holders of shares of common stock are entitled to share pro rata all assets
remaining after payment in full of all liabilities. Holders of common stock have
no preemptive rights to purchase the Company's common stock. There are no
conversion rights or redemption or sinking fund provisions with respect to the
common stock. All of the outstanding shares of common stock are fully paid and
non-assessable except for 500,000 shares of the Company's common stock issued to
Mr. Bradley Gordon and 300,000 shares of the Company's common stock issued to
Mr. R.T. Silberman.
Penny Stock Regulations - Restrictions on Marketability
The Securities and Exchange Commission (the "Commission") has adopted
regulations which generally define "penny stock" to be any equity security that
has a market price (as defined) less than $5.00 per share or an exercise price
of less than $5.00 per share, subject to certain exceptions. The Company's
securities may be covered by the penny stock rules, which impose additional
sales practice requirements on broker-dealers who sell such securities to
persons other than established customers and accredited investors (generally
institutions with assets in excess of $5,000,000 or individuals with net worth
in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 jointly
with their spouse). For transactions covered by the rule, the broker-dealers
must make a special suitability determination for the purchase and receive the
purchaser's written agreement of the transaction prior to the sale.
Consequently, the rule may affect the ability of broker-dealers to sell the
Company's securities and also may affect the ability of purchasers to sell their
shares in the secondary market.
Preferred Stock
The Company is authorized to issue 5,000,000 shares of preferred stock,
no par value per share (the "Preferred Stock"). The Preferred Stock may be
issued from time to time in one or more classes or series, each class or series
of which shall have the voting rights, designations, preferences and relative
rights as fixed by resolution of the Company's Board of Directors, without the
consent or approval of the Company's shareholders. The Preferred Stock may rank
senior to the Common Stock as to dividend rights, liquidation preferences, or
both, and may have extraordinary or limited voting rights. There are currently 0
shares of Series A Voting Nonredeemable Cumulative Convertible Preferred Stock
(the "Series A Preferred Stock") 0 shares of Series B Voting Nonredeemable
Convertible Preferred Stock (the "Series B Preferred Stock"), 120 shares of
Series C Non-voting Nonredeemable Convertible
<PAGE>
Preferred Stock (the "Series C Preferred Stock") outstanding and 2,500 shares of
Series D Non-voting Nonredeemable Convertible Preferred Stock (the "Series D
Preferred Stock") outstanding.
The following table summarizes the principal terms of the Preferred
Stocks.
<TABLE>
<CAPTION>
Number of Annual Common Stock
Series Shares Authorized Dividends Cumulative Liquidation Conversion Voting/Election
& Capital Account Per Share Dividends Preference Formula Rights
# Shares Amount
<S> <C> <C> <C> <C> <C>
A 0 $0 $0.09 Yes Senior To All 1:1 1 Non-Cumulative
Equity Vote Per Share
B 0 0 $0.00 No Senior To All 1:1 1 Non-Cumulative
Only If/When But "A" Preferred Vote Per Share
Declared
C 120 120,000 $130.00 Yes Senior To All 1:133.23 None
But "A+B" Preferred
D 2,500 2,500,000 $80.00 Yes Senior Only $1,000 divided by None
Common Stock (65% of market
Value of Common
</TABLE>
Series A Preferred Stock
The Company is authorized to issue 700,000 shares of Series A Preferred
Stock, all of which are issued and none of which are outstanding after the
conversion of 100,000 shares of the Series A Preferred Stock to Common Stock in
July 1997 and 600,000 shares of the Series A Preferred Stock to Common Stock in
June 1998. The relative rights, preferences and limitations of the Series A
Preferred Stock are as follows.
Voting. The holders of Series A Preferred Stock were entitled to one
non-cumulative vote per share on all
matter on which shareholders may vote at all meetings of shareholders. In
addition, such holders as a group are
entitled to elect one director to the Company's Board of Directors. Mr.
Jeremiah Haley is the current director
holding this position.
Dividends. The holders of the Series A Preferred Stock were entitled to
a cumulative annual dividend of $.09 per share payable weekly out of funds
legally available therefor, which dividend shall have preference as to all other
dividends paid or declared by the Company. Such dividend shall be cumulative and
shall be paid in advance of any dividend paid to holders of Common Stock, Series
B Preferred Stock or Series C Preferred Stock.
Liquidation. The Series A Preferred Stock had a liquidation preference
over all classes of common stock and the Series B Preferred Stock and the Series
C Preferred Stock, and Series D Preferred Stock together with the amount of any
unpaid dividends thereon, in the event of any dissolution, liquidation, or
winding up of the Company. If, upon any such dissolution, liquidation, or
winding up of the Company, the assets of the Company is distributable to the
holders of the Series A Preferred Stock shall be insufficient to permit payment
in full of the preferential amount aforesaid, then the entire assets of the
Company shall be distributed ratably among the holders of the Series A Preferred
Stock according to the respective number of shares of Series A Preferred Stock
held by them.
Series B Preferred Stock
The Company is authorized to issue 350,000 shares of Series B Preferred
Stock, all of which are issued and none of which are outstanding and were owned
by the Company's president and chief executive officer. In June 1998, all
350,000 shares of Series B Preferred Stock was converted to Company Common
Stock. The relative rights, preferences and limitations of the Series B
Preferred Stock are as follows.
Voting. The holders of Series B Preferred Stock were entitled to one
non-cumulative vote per share on all
matters on which stockholders may vote at all meetings of shareholders. In
addition, such holders as a group are
<PAGE>
entitled to elect one director to the Company's Board of Directors. Mr. Swartz
is the current designee of the holders
of the Series B Preferred Stock.
Dividends. The holders of the Series B Preferred Stock were entitled
to dividends only if and when
declared by the Company.
Liquidation. The Series B Preferred Stock had a liquidation preference
over all classes of common stock and the Series C Preferred Stock and Series D
Preferred Stock, but not Series A Preferred Stock, together with the amount of
any unpaid dividends thereon, in the event of any dissolution, liquidation, or
winding up of the Company. If, upon any such dissolution, liquidation, or
winding up of the Company, the assets of the Company is distributable to the
holders of the Series B Preferred Stock shall be insufficient to permit payment
in full of the preferential amount aforesaid, then the entire assets of the
Company, after payment of the holders of the Series A Preferred Stock, shall be
distributed ratably among the holders of the Series B Preferred Stock according
to the respective number of shares of Series B Preferred Stock held by them.
Right to Convert. Each holder of Series B Preferred Stock may, only at
the discretion of the Board of Directors of the Company and upon surrender to
the Company of the certificate therefor at the principal office of the Company
or at such other place as the Company shall designate, convert all of such
holder's Series B Preferred Stock into shares of Common Stock at the rate of one
share of Series B Preferred Stock for one share of Common Stock (the "Series B
Conversion Ratio"). In the event of either an increase or decrease in the number
of the shares of the Company's Common Stock as a result of a stock dividend,
stock split, recapitalization, combination, or reclassification, the Series B
Conversion Ratio shall be equitably adjusted.
Series C Preferred Stock
The Company is authorized to issue 120 shares of Series C Preferred
Stock, all of which were issued in connection with the Company's acquisition of
QFS. The relative rights, preferences and limitations of the Series C Preferred
Stock are as follows.
Voting. The holders of Series C Preferred Stock are not entitled to
any vote on all matters on which
stockholders may vote at all meetings of shareholders.
Dividends. The holders of the Series C Preferred Stock are entitled to
a cumulative annual dividend of $130 per share payable out of funds legally
available therefor, which dividend shall be subordinate to all other dividends
on the Series A and Series B Preferred Stock.
Liquidation. The Series C Preferred Stock has a liquidation preference
over all classes of common stock, but not to the Series A Preferred Stock and
Series B Preferred Stock, as to $120,000, together with the amount of any unpaid
dividends thereon, in the event of any dissolution, liquidation, or winding up
of the Company. If, upon any such dissolution, liquidation, or winding up of the
Company, the assets of the Company is distributable to the holders of the Series
C Preferred Stock shall be insufficient to permit payment in full of the
preferential amount aforesaid, then the entire assets of the Company, after
payment of the holders of the Series A Preferred Stock and Series B Preferred
Stock, shall be distributed ratably among the holders of the Series C Preferred
Stock according to the respective number of shares of Series C Preferred Stock
held by them.
Right to Convert. Each holder of Series C Preferred Stock may and upon
surrender to the Company of the certificate therefor at the principal office of
the Company or at such other place as the Company shall designate, convert all
of such holder's Series C Preferred Stock into shares of Common Stock at the
rate of 133.23 shares of the Company's Common Stock for each share of Series C
Preferred Stock (the "Series C Conversion Ratio"). In the event of either an
increase or decrease in the number of the shares of the Company's Common Stock
as a result of a stock dividend, stock split, recapitalization, combination, or
reclassification, the Series C Conversion Ratio shall be equitably adjusted.
Series D Preferred Stock
<PAGE>
The Company is authorized to issue 2,500 shares of Series D Preferred
Stock, all of which were issued in January 1998 for $1,000 per share. The
relative rights, preferences and limitations of the Series D Preferred Stock are
as follows:
Voting. The holders of Series D Preferred Stock have no voting rights
on matters for which stockholder
may generally vote.
Dividends. The holders of the Series D Preferred Stock are entitled to
a cumulative annual dividend of $80 per share payable out of funds legally
available therefor or in Common Stock.
Right to Convert. Each holder of Series D Preferred Stock may and upon
surrender to the Company of the certificate therefor at the principal office of
the Company or at such other place as the Company shall designate, convert all
of such holder's Series D Preferred Stock into shares of Common Stock at the
lower of (a) 65% of the closing bid, price averaged over the 5 trading days
before the date of conversion, or (b) $1.96875. In the event of either an
increase or decrease in the number of the shares of the Company's Common Stock
as a result of a stock dividend, stock split, recapitalization, combination, or
reclassification, the Series D Conversion Ratio shall be equitably adjusted.
Shares Eligible for Future Sale
Of the outstanding shares of the Company, all but 2,466,595 shares are
subject to resale restrictions and, unless registered under the Securities Act
of 1933 (the "Act) or exempted under another provision of the Act, will be
ineligible for sale in the public market until one year from their issuance,
following which sales may be made under Rule 144.
In general, under Rule 144, as currently in effect, a person (or
persons whose shares are aggregated) who has beneficially owned shares privately
acquired or indirectly from the Company or from an affiliate, for at least one
year, or who is an affiliate, is entitled to sell within any three-month period,
a number of such shares that do not exceed the greater of 1% of the then
outstanding shares of the Company's Common Stock (approximately 167,000 shares)
or the average weekly trading volume in the Company's Common Stock during the
four calendar weeks immediately preceding such sale. Sales under Rule 144 are
also subject to certain manner of sale provisions, notice requirements and the
availability of current public information about the Company. A person (or
persons whose shares are aggregated) who is not deemed to have been an affiliate
at any time during the 90 days preceding a sale, and who has beneficially owned
shares for at least two years, is entitled to sell all such shares under Rule
144 without regard to the volume limitations, current public information
requirements, manner of sale provisions or notice requirements.
Sales of substantial amounts of the Common Stock of the Company in the
public market could adversely affect prevailing market prices.
<PAGE>
PART II
Item 1. Market Price of and Dividends on the Registrant's Common Equity and
Other Shareholder Matters
(a) Market Information
The Company's Common Stock has been listed on the Electronic
Bulletin Board sponsored by the National Association of Securities Dealers, Inc.
since October, 1996. The prices reported reflect inter-dealer prices and are
without adjustments for retail markups, markdowns or commissions, and may not
necessarily represent actual transactions.
Quarter Ended
Bid Price
High Low
December 31, 1996 3 7/8 1 1/4
March 31, 1997 4 1/8 1 3/4
June 30, 1997 8 1/4 3 1/4
September 30, 1997 4 1/8 3
December 31, 1997 3 7/16 2 1/8
March 31, 1998 3 1/8 1 13/16
(b) Holders
As of June 4, 1998, there were approximately 1,700 record
holders of the Company's common
stock.
(c) Dividends
The Company has not paid any dividends on its common stock.
The Company currently intends to retain any earnings for use in its business,
and therefore does not anticipate paying cash dividends to holders of common
stock holders in the foreseeable future. Holders of Series A Convertible
Preferred Stock are entitled to annual cash dividends of $.09 per share. Holder
of Series C Convertible Preferred Stock are entitled to annual cash dividends of
$130.00 per share. Holders of Series D convertible Preferred Stock are entitled
to annual cash dividends of $80.00 per share. Pursuant to the Company's Articles
of Incorporation, holders of Common Stock are not entitled to receive dividends
unless dividends have been paid for prior calendar years and paid and set aside
for the then current calendar year on the Series A, Series C and Series D
Preferred Stock. The Company is under no other contractual restrictions on the
payment of dividends.
Item 2. Legal Proceedings
Not applicable.
Item 3. Changes in and Disagreements with Accountants.
Not applicable.
Item 4. Recent Sales of Unregistered Securities
<PAGE>
On May 6, 1996, the Company issued the following securities in exchange
for all of the capital stock of JRECK Subs, Inc.:
<TABLE>
<CAPTION>
Company JRECK Subs, Inc.
<S> <C> <C>
Securities Issued Securities Exchanged
5,000,000 8,000,000 shares of
shares of common stock common stock
700,000 shares of 700,000 shares of
Series A Preferred Series A Preferred
</TABLE>
In addition, the Company issued 350,000 shares of Series B Preferred
for 50% of the Common Stock of Pastry Products Producers, LLC. The sales were
made in compliance with Section 4(2) of the Securities Act of 1933. As a
condition to each of the above sales, the purchaser consented to a placement of
a restrictive legend on the certificate representing the securities.
In May 1996 the Company issued 1,100,000 restricted shares for $11,000
cash to seven persons. No underwriter was involved and the holders agreed that a
restrictive legend would be placed upon the certificates representing the
Shares. The Company believes that this transaction was exempt under Section 4(2)
of the Act as a transaction not involving a public offering.
From May 1996 to December, 1996 the Company issued 1,536,000 shares of
Common Stock in an offering under Rule 504 of Regulation D to approximately 70
purchasers. Net proceeds of the offering were $648,150. No underwriter was
involved.
In December 1996, the Company issued 45,000 shares to Gerharz
Equipment, Inc. for the cancellation of a debt of approximately $90,533.
In January 1997, the Company issued 415,095 shares of common stock in
an offering under Rule 504 of Regulation D to Corporate Relations Group and
Olympus Capital, Inc. Net proceeds of the offering were $220,000.
No underwriter was involved.
On February 28, 1997 the Company issued 94,650 shares valued at $2.4938
per share to four individuals for marketing services.
In February 1997, the Company issued 230,000 shares of common stock to
two individuals in connection with the purchase of bakery equipment located in
Missouri.
In April 1997, the Company issued 39,118 shares of common stock to
approximately 400 shareholders of Western Fast Food. The shares were issued
without consideration in satisfaction of a moral obligation of the Company and
its principals. Western Fast Food had been organized by Company affiliates to
develop the Company's franchise concepts but had been unsuccessful.
On May 23, 1997, the Company issued options to purchase 180,000 shares
at $.50 per shares to the Deegan Group in connection with obtaining a $180,000
loan. 60,000 shares were issued upon partial exercise of this option on November
21, 1997.
On July 10, 1997 Corporate Relations Group, exercised a total of
300,000 options to purchase Common Stock at $.75 per share.
On July 30, 1997 the Company issued 55,000 shares to two individuals
for operations consulting valued at $3.8125 per share. On August 7, 1997 the
Company issued 1,951 shares to Mark McKinnon, an employee, valued at $3.6875 per
share, and on August 18, 1997 issued 2,759 shares to another employee, Brick
Brunton, valued at $3.7500 per share.
<PAGE>
On September 17, 1997 the Company issued 75,000 shares to Olympus
Capital, Inc. for financial consulting services valued at $229,286.
Between June 19, 1997 and August 5, 1997 the Company issued, 289,500
and 67,500 shares of the Company's common stock, respectively, to approximately
20 individuals in connection with the acquisition of Hymie's Bagel chain.
On July 8, 1997, Messrs. Jeremiah Haley (a director) Charles Lehman,
Douglas Nichols and Keith Waltz, shareholders of the Company's Series A
Preferred Stock, converted an aggregate of 100,000 shares of Series A preferred
shares into 100,000 shares of the Company's common stock.
On October, 1997, the Company issued 495,000 shares of its common stock
to twenty individuals for the full satisfaction of debt of $445,000.
In August 1997, the Company acquired all of the outstanding shares of
Richey Enterprises, Inc. (Georgio's Subs) for 93,794 shares of its common stock.
On November 6, 1997 the Company issued 61,111 shares of Common Stock to
three persons for cash of $2.25 per share, and issued 25,000 shares to a fourth
individual for $2.00 per share.
On August 25, 1997 the Company issued 48,000 shares to Corporate
Relations Group in an offering under Rule 504 at a price of $1.00 per share.
On December 31, 1997 the Company issued 138,889 shares to Messrs.
Naddaff and Youngman for cash of $180,000 and warrants to purchase up to
1,250,000 shares of the Company's common stock for consulting and fundraising
services valued at $1,883,000.
In September 1997, the Company acquired all of the outstanding shares
of Little King, Inc. by the initial issuance of 500,000 shares of its common
stock.
On October 8, 1997 the Company acquired all of the outstanding shares
of Quality Franchise Systems, Inc. (Mountain Mike's Pizza) by the issuance of
120 shares of the Company's Series C preferred stock and 899,967 shares of the
Company's common stock.
On October 27, 1997, the Company issued 262,500 shares of its common
stock to three persons for the acquisition of the 50% of the capital stock of
Pastry Products not already owned by it.
On December 4, 1997 the Company issued 187,266 shares of its common
stock to Interfoods of America, Inc. to acquire SBK Franchise Systems, Inc., the
franchisor of Sobik's sandwich restaurants.
In November 1997, the Company issued 60,000 shares of its common stock
in consideration with obtaining a $250,000 loan.
In November 1997, the Company issued 800,000 shares of its common stock
to two individuals for total consideration of $2,400,000 paid in the form of
promissory notes with interest at 9.5% with interest and principal due in
September 2000. At any time prior to September 2000, these individuals may
require the Company to repurchase the 800,000 shares as consideration for the
cancellation of the notes.
On March 26, 1998 the Company issued 150,003 shares to shareholders of
Quality Franchise Systems of a price of $2.9375 per share as part of the
contingent share issuance agreed to at the time of acquiring QFS in 1997. On the
same day 52,631 shares were issued to three shareholders of Seawest Corporation
in connection with the acquisition of Seawest Subs. On May 18, 1998, 735,294
shares were issued to approximately 30 persons in connection with the
acquisition of Li'l Dino Corporation. The transaction was approved at a state
fairness hearing in March 1998 and was exempt from registration under section
3(a)(10) of the Securities Act of 1933. On April 29, 1998, 112,793 shares were
issued to the Wertheim family for satisfaction of $277,404 of Little King debt.
<PAGE>
On February 9, 1998 25,000 shares were issued upon exercise of options
at $.01 per share; the options had been issued to in connection with the
acquisition of Seawest Subs. On February 9, 1998 the Company issued 11,550
shares of common stock to its franchising attorney for services of $30,319. On
March 16, 1998 the Company issued 9,400 shares to one individual for services
valued at $22,913 and 50,000 shares to another individual for services rendered
valued at $121,875.
On May 27, 1998 the Company issued 115,000 shares to one individual for
consulting services valued at $251,563.
<TABLE>
<CAPTION>
Date Name Number Exercise Price Purpose
---- ---- ------ -------------- -------
<S> <C> <C> <C>
Jan. 6, 1997 Gulf Atlantic Publishing 375,000 $.75 Services
Apr. 2, 1997 Corporate Relations Group 150,000 .75 Services
Sept. 15, 1997 Corporate Relations Group 100,000 2.81 Services
Sept. 15, 1997 Corporate Relations Group 100,000 3.37 Services
Sept. 15, 1997 Corporate Relations Group 100,000 3.93 Services
Sept. 12, 1997 Olympus Capital, Inc. 100,000 2.75 Services
Sept. 12, 1997 Olympus Capital, Inc. 100,000 3.50 Services
Dec. 17, 1997 Naddoff & Youngman 375,000 1.92 Services
Dec. 17, 1997 Naddoff & Youngman 375,000 2.56 Services
Dec. 17, 1997 Naddoff & Youngman 375,000 3.20 Services
Dec. 17, 1997 Naddoff & Youngman 125,000 3.84 Services
Dec. 27, 1997 Christopher Swartz 1,000,000 2.75 Employee
Compensation
May 23, 1997 Rudolf 60,000 .50 Deferred loan costs
May 23, 1997 Larcomb 60,000 .50 Deferred loan costs
May 23, 1997 Deegan 60,000 .50 Deferred loan costs
June 30, 1997 H. Day 100,000 .01 Acquisition of
Seawest Sub
Sept. 30, 1997 Spelman & Co. 18,704 3.08 Acquisition of
______ Quality Franchise
Systems, Inc.
Sept. 30, 1997 AB Laffer, VA Canto & Assoc. 13,500 3.08 Acquisition of
______ Quality Franchise
Systems, Inc.
Oct. 27, 1997 R. Longley & P. Traux 37,500 *
</TABLE>
* 50% of mean of bid and ask on date of exercise.
On August 3, 1998 the Company issued 500,000 shares to Bradley L.
Gordon, and Michael Cronin and 300,000 shares to Richard Silverman for
consideration of $1.3125 per share (the closing sales price of the Common Stock
on that dat) paid in the form of promissory notes with interest at 9.5% with
interest and principal due in August 2001. At any time prior to August 2001,
these individuals may require the Company to repurchase the 1,300,000 shares as
consideration for the cancellation of the notes.
Except for sales noted as made under Rule 504, the above sales were
made in compliance with Section 4(2) of the Securities Act of 1933. There were
no public solicitations. As a condition to each of the above sales, the
purchaser made representations as to its investment sophistication and consented
to a placement of a restrictive legend on the certificate representing the
securities.
Item 5. Indemnification of Directors and Officers
As permitted under the Colorado General Corporation Law, directors and
officers are not liable to the Company or its stockholders for monetary damages
arising from a breach of their fiduciary duty of care as directors. Such
provisions do not, however, relieve liability for breach of a director's duty of
loyalty to the Company or its
<PAGE>
stockholders, liability for acts or omissions not in good faith or involving
intentional misconduct or knowing violations of law, liability for transactions
in which the director derived an improper personal benefit or liability for the
payment of a dividend in violation of Colorado law. Further, the provisions do
not relieve a director's liability for violation of, or otherwise relieve the
Company or its directors from the necessity of complying with, federal or state
securities laws or affect the availability of equitable remedies such as
injunctive relief or recision. However, as a practical matter, equitable
remedies may not be available in all situations and, there may be instances in
which no effective remedy is available or can be timely obtained.
At present, there is no pending litigation or proceeding involving a
director, officer, employee or agent of the Company where indemnification will
be required or permitted. The Company is not aware of any threatened litigation
or proceeding that may result in a claim for indemnification by any director or
officer.
PART F/S
Financial Statements
The following financial statements are included herein.
JRECK Subs Group, Inc.
Independent Auditors' Report
Consolidated Balance Sheet at December 31, 1997
Consolidated Statement of Operations for the Year Ended December 31,
1997 Consolidated Statement of Cash Flows for the Year Ended December
31, 1997 Consolidated Statement of Changes in Stockholders' Equity
Notes to Consolidated Financial Statements
Consolidated Balance Sheet at March 31, 1998
Consolidated Statement of Operations for the three months Ended March
31, 1998 and 1997 Consolidated Statement of Cash Flows for the three
months Ended March 31, 1998 and 1997 Consolidated Statement of Changes
in Stockholders' Equity Notes to Interim Financial Statements
Independent Auditors' Report
Consolidated Balance Sheet at December 31, 1997, December 31, 1996 and
1995
Consolidated Statement of Operations for the Nine Months ended
September 30, 1997 and 1996 and for the Years Ended December 31, 1996
and 1995
Consolidated Statement of Cash Flows for the Nine Months ended
September 30, 1997 and 1996 and for the Years Ended December 31, 1996
and 1995 Consolidated Statement of Changes in Stockholders' Equity
Notes to Consolidated Financial Statements
L'il Dino Corporation
Independent Auditors' Report
Balance Sheet at October 31, 1997
Statement of Loss and Retained Deficit for the year ended October 31,
1997 Statement of Cash Flows for the year ended October 31, 1997 Notes
to Financial Statements
Pastry Products Producers, LLC
Balance Sheet at June 30, 1997 and December 31, 1996
<PAGE>
Statements of Operations and Stockholders' Equity for the Six Months
ended June 30, 1997 and 1996 and for the Years Ended December 31, 1996
and 1995 Statement of Cash Flows for the Six Months ended June 30, 1997
and 1996 and for the Years Ended December 31, 1996 and 1995 Notes to
Financial Statements
Seawest Sub Shops, Inc.
Independent Auditors' Report
Balance Sheets at June 30, 1997 and December 31, 1996
Statement of Operations for the Six Months ended June 30, 1997 and 1996
and for the Years Ended December 31, 1996 and 1995 Statement of Cash
Flows for the Six Months ended June 30, 1997 and 1996 and for the Years
Ended December 31, 1996 and 1995 Statement of Changes in Stockholders'
Equity Notes to Financial Statements
Quality Franchise Systems, Inc. and Subsidiary
Independent Auditor's Report
Consolidated Balance Sheets at September 30, 1997 and December 31, 1996
Consolidated Statement of Operations for the Nine and Three Months
ended September 30, 1997 and 1996 Consolidated Statement of Cash Flows
for the Nine Months ended September 30, 1997 and 1996 Notes to
Consolidated Financial Statements
PART III
The following exhibits required by Item 601 of Regulation S-B
are filed herewith:
Exhibit No. Document Description
2. Plan of purchase, sale, reorganization, arrangement,
liquidation or succession.
2.1 Agreement and Plan of Reorganization and Merger among
Jreck Subs Group, Inc.,
Admiral's Fleet, Inc. and Quality Franchise Systems,
Inc. ("Quality Agreement")
2.2 Amendment to Quality Agreement
2.3 Agreement between the Company and CHAI Enterprises,
Inc. ("Hymie's Bagel Chain")
2.4 Stock Option Grants to acquire Seawest Sub Shops, Inc.
3. Articles of Incorporation and Bylaws
3.1. Articles of Incorporation
3.2 Articles of Amendment changing corporate name
3.3 Articles of Amendment dated May 2, 1996 and filed
May 7, 1996
3.4 Certificate of Correction to Articles of Amendment
filed July 24, 1996.
3.5 Bylaws. To be filed by Amendment
10. Material Contracts
10.1 Jreck Franchise Agreement. To be filed by Amendment.
21 Subsidiaries of the Registrant
<PAGE>
SIGNATURES
In accordance with Section 12 of the Securities Exchange Act of 1934,
the Registrant has caused this registration statement to be signed on its behalf
by the undersigned, thereunto duly authorized.
Dated: August 10, 1998 JRECK SUBS GROUP, INC.
By: /s/ Christopher M. Swartz
President and Chief Executive Officer
29
<PAGE>
Report of Independent Certified Public Accountants
To the Board of Directors
JRECK Subs Group, Inc.
Longwood, Florida
We have audited the accompanying consolidated balance sheet of JRECK Subs Group,
Inc. as of December 31, 1997 and the related consolidated statements of
operations, stockholders' equity and cash flows for the year then ended. 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 audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also included
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of JRECK Subs Group,
Inc. at December 31, 1997, and the results of their operations and their cash
flows for the year then ended in conformity with generally accepted accounting
principles.
BDO Seidman, LLP
Orlando, Florida
May 8, 1998, except for Note 12 d),
which is as of June 30, 1998
F-1
<PAGE>
<TABLE>
<CAPTION>
Jreck Subs Group, Inc.
Consolidated Balance Sheet
December 31,
1997
Assets
Current:
<S> <C>
Cash and cash equivalents $ 427,420
Accounts receivable - trade, net of allowance for
doubtful accounts of $199,228 (Note 7) 391,567
Current portion of notes receivable 168,560
Prepaid expenses (Note 2) 730,811
Total current assets 1,718,358
Notes receivable 173,704
Property, plant and equipment, net (notes 3 and 7) 1,930,990
Goodwill, net of accumulated amortization of $1,190,184 (Note 4) 11,521,526
Other assets:
Covenants note to compete, net of accumulated
amortization of $89,223 (Note 4) 512,777
Prepaid interest, net (Note 9) 597,760
Other 34,097
Total assets $ 16,489,212
</TABLE>
See accompanying summary of accounting policies and notes to
consolidated financial statements.
F-2
<PAGE>
<TABLE>
<CAPTION>
Jreck Subs Group, Inc.
Consolidated Balance Sheet
December 31,
1997
Liabilities and Stockholders' Equity
Current liabilities:
<S> <C> <C>
Current portion of long-term debt (Note 7) $ 2,163,554
Current portion of notes payable to related parties (Note 6) 434,785
Accounts payable 1,020,101
Accrued liabilities (Note 5) 1,196,130
Liability to issue common stock (Note 4) 2,234,375
Total current liabilities 7,048,945
Long-term debt, less current portion (Note 7) 1,619,115
Notes payable to related parties, less current portion(Note 6) 323,032
Total liabilities 8,991,092
Redeemable common stock (Note 4) 500,000
Commitments and contingencies (Note 8)
Stockholders' equity (Notes 4, 9 and 13):
Series A Convertible Preferred Stock, $2 par value,
700,000 shares authorized, 600,000 issued and outstanding 1,200,000
Series B Convertible Preferred Stock, $2 par value,
350,000 shares authorized, issued and outstanding 700,000
Series C Convertible Preferred Stock, no par value,
120 shares authorized, issued and outstanding 120,000 Series D
Convertible Preferred Stock, 2,500 shares authorized,
none issued and outstanding --
Common Stock, no par value, shares authorized
50,000,000; 14.365.600 issued and outstanding 17,729,478
Accumulated deficit (10,351,358)
Less: Stock subscription receivable (2,400,000)
Total stockholders equity 6,998,120
Total liabilities and stockholders' equity $ 16,489,212
</TABLE>
See accompanying summary of accounting policies and notes to
consolidated financial statements.
F-3
<PAGE>
<TABLE>
<CAPTION>
Jreck Subs Group, Inc.
Consolidated Statement of Operations
Year Ended
December 31,
1997
Revenues:
<S> <C>
Retail sales $ 1,310,205
Franchise revenues 1,265,254
2,575,459
Operating costs and expenses:
Cost of sales 552,940
Operating expenses 3,758,657
Consulting and investor relations 4,492,664
Goodwill writedown (Note 4) 993,820
9,798,081
Operating loss (7,222,622)
Other income (expense):
Interest, net (484,769)
Other 55,733
Loss before income taxes and extraordinary item (7,651,658)
Income tax expense (Note 10) (389,957)
Loss before extraordinary item (8,041,615)
Extraordinary loss - early extinguishment of debt (Note 13) (862,029)
Net loss (8,041,615)
Preferred Stock dividends (57,506)
Net loss applicable to common stock $ (8,961,150)
Weighted average number of common shares outstanding 10,807,267
Net loss per common share - basic and diluted:
Loss before extraordinary item $ (.74)
Extraordinary item (.08)
Net loss per share $ (.82)
</TABLE>
See accompanying summary of accounting policies and notes to
consolidated financial statements.
F-4
<PAGE>
<TABLE>
<CAPTION>
Jreck Subs Group, Inc.
Consolidated Statement of Stockholders' Equity
Common Preferred Class A Preferred Class B Preferred Class CSubscriptionAccumulated Total
Shares Amount Shares Amount Shares Amount Shares Amount Notes Deficit Equity
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1,
1997 8,781,000$-- 700,000 $1,400,000 350,000 $700,000 -- $-- $-- $ (1,390,208) $709,792
Conversion of preferred Class
A to common stock 100,000 200,000 (100,000) (200,000) -- -- -- -- -- -- --
Common stock issued for
acquisitions 2,045,761 6,531,339 -- -- -- -- 120 120,000 -- -- 6,651,339
Options issued in connection
with acquisitions -- 508,000 -- -- -- -- -- -- -- -- 508,000
Stock issued for equipment 230,000 424,003 -- -- -- -- -- -- -- -- 424,003
Conversion of debt to equity 445,000 1,307,029 -- -- -- -- -- -- - -- 1,307,029
Stock issued for payment of
interest 50,000 146,857 -- -- -- -- -- -- -- -- 146,857
Other stock sales 1,077,213 1,055,500 -- -- -- -- -- -- -- -- 1,055,500
Stock sold for subscription
notes receivable 800,000 2,400,000 -- -- -- -- -- -- (2,400,000) -- --
Stock issued for services 229,360 805,048 -- -- -- -- -- -- -- 805,048
Exercise of options 360,000 255,000 -- -- -- -- -- -- -- 255,000
Issuance of options and
warrants for services -- 3,301,302 -- -- -- -- -- -- -- 3,301,302
Stock and options issued in
connection with debt 60,000 795,400 -- -- -- -- -- -- -- -- 795,400
Preferred stock dividend -- -- -- -- -- -- -- -- -- (57,506) (57,506)
Net loss -- -- -- -- -- -- -- -- -- (8,903,644)(8,903,644)
Balance, December
31, 1997 14,178,334 $17,729,478 600,000$1,200,000 350,000 $700,000 120$120,000 $(2,400,000) $(10,351,358) $6,998,120
</TABLE>
See accompanying summary of accounting policies and notes to
consolidated financial statements.
F-5
<PAGE>
<TABLE>
<CAPTION>
Jreck Subs Group, Inc.
Consolidated Statement of Cash Flows
Year Ended
December 31,
1997
Cash flows from operating activities:
<S> <C>
Net loss $ (8,903,644)
Adjustments to reconcile net loss to net cash used:
Amortization and depreciation 506,742
Writedown and goodwill 993,820
Bad debts 166,831
Gain on disposal of equipment (2,365)
Stock issued for interest expense 146,857
Stock and stock options issued as consideration for consulting
and investor relations expense 4,038,249
Extraordinary loss resulting from issuance of stock on retirement of debt 862,029
Charge off of offering costs and deferred loan costs 67,267
Other (36,595)
Changes in assets and liabilities, net of assets and liabilities acquired:
Increase in accounts receivable (48,274)
Increase in prepaid expenses (21,774)
Decrease in deferred tax asset 387,846
Increase in accounts payable 366,879
Increase in accrued liabilities 204,494
Net cash used in operating activities (1,273,638) Cash flows from investing
activities:
Purchase of property and equipment (49,726)
Net cash paid in connection with acquisitions (408,417)
Note receivable considered worthless 104,141
Advances made on notes receivable (246,497)
Payments from notes receivable 86,982
Net cash provided by (used in) investing activities (513,517) Cash flows from
financing activities:
Proceeds from the sale of common stock 1,055,500
Proceeds from exercise of stock options 255,000
Proceeds from long-term debt 840,758
Payments on long-term debt (652,096)
Proceeds from related party notes payable 792,748
Payments on related party notes payable (124,703)
Net cash provided by financing activities 2,167,207
Net increase in cash and cash equivalents 380,052
Cash and cash equivalents, beginning of year 47,368
Cash and cash equivalents, end of year $ 427,420
</TABLE>
See accompanying summary of accounting policies and notes to
consolidated financial statements.
F-6
<PAGE>
Jreck Subs Group, Inc.
Summary of Accounting Policies
Principles of Consolidation:
The consolidated financial statements include the accounts of JRECK Subs
Group, Inc. and its wholly-owned subsidiaries ("the Company"). All significant
intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates:
The preparation of financial statement in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statement and the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from the estimates.
Cash and Cash Equivalents
For financial presentation purposes, the Company considers those short-term
highly liquid investments with original maturities of three months or less to be
cash and cash equivalents.
Property and Equipment
Property and equipment are stated at cost. Depreciation expense is provided
using the straight-line method for financial statement purposes and accelerated
methods for federal income tax purposes over the estimated useful lives of the
various assets, generally 5 to 40 years.
Intangible Assets
Goodwill
Goodwill represents the excess of cost over the fair value of net assets
acquired and is being amortized on a straight-line method over 20 years. The
realizability of goodwill is evaluated periodically for impairment events or if
changes in circumstances indicate a possible inability to recover the carrying
amount. When any such impairment exists, the related assets are written down to
fair value.
Covenants Not to Compete
Covenants not to compete are amortized straight-line over the estimated
useful lives, ranging from three to six years.
Revenue Recognition
Continuing franchise fee revenue is recognized as earned. Franchise fee
revenue from an individual franchise sale is recognized when all material
services or conditions relating to the sale have been substantially performed.
Revenues from company-owned stores are recognized when received.
F-7
<PAGE>
Jreck Subs Group, Inc.
Summary of Accounting Policies
Stock-Based Compensation
Stock-based compensation is accounted for by using the intrinsic value
based method in accordance with Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25"). The company has adopted
Statements of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation," ("SFAS No. 123") which allows companies to either
continue to account for stock-based compensation to employees, or to adopt a
fair value based method of accounting. The Company has continued with its
current method of accounting in accordance with APB 25 for employees, but has
made the required pro forma disclosures in accordance with SFAS No. 123.
Fair Value of Financial Instruments
Statement of Financial Accounting Standards No. 107, "Disclosures about
Fair Value of Financial Instruments," requires disclosure of fair value
information about financial instruments. Fair value estimates discussed herein
are based upon certain market assumptions and pertinent information available to
management as of December 31, 1997.
The respective carrying value of certain on-balance-sheet financial
instruments approximated their fair values. These financial instruments include
cash and equivalents, trade receivables, accounts payable and accrued expenses.
Fair values were assumed to approximated carrying values for these financial
instruments since they are short term in nature and their carrying amounts
approximate fair values or they are receivable or payable on demand. The fair
value of the Company's notes payable is estimated based upon the quoted market
prices for the same or similar issues or on the current rates offered to the
Company for debt of the same remaining maturities. The carrying value
approximates the fair value of the notes payable.
Net Loss Per Common Share
Effective December 31, 1997, the company has adopted the provisions of
Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS
No. 128"). SFAS No. 128 replaces the previously reported primary and fully
diluted earnings per share with basic and diluted earnings per share. Unlike
primary earnings per share, basic earnings per share exclude any dilutive
effects of options, warrants and convertible securities. Diluted earnings per
share are computed similarly to fully diluted earnings per share. The Company's
calculation for basic and fully diluted earnings per share is the same as the
Company has a loss, and the impact of potential common shares is antidilutive.
Potential common shares include 1,996,000 stock options, 1,250,000 warrants and
965,986 shares underlying the convertible preferred stock. All loss per share
amounts for all periods presented have been restated to conform to the
requirements of SFAS No. 128.
Income Taxes
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes," which
requires recognition of estimated income taxes payable or refundable on income
tax returns for the current year and for the estimated future tax effect
attributable to
F-8
<PAGE>
Jreck Subs Group, Inc.
Summary of Accounting Policies
temporary difference and carryforwards. Measurement of deferred income tax is
based on enacted income tax assets being reduced by available tax benefits not
expected to be realized.
Impairment of Long-Lived Assets
The Company adopted Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of," (SFAS No. 121") during 1997. SFAS No. 121 requires impairment
losses to be recorded on long-lived assets used in operations and goodwill when
indicators of impairment are present and the undiscounted cash flows estimated
to be generated by those assets are less than the assets' carrying amount.
Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
No. 130"), and No. 131, "Disclosure about Segments of an Enterprise and Related
Information" ("SFAS No. 131"). SFAS 130 establishes standards for reporting and
displaying comprehensive income, its components and accumulated balances. SFAS
131 establishes standards for the way that public companies report information
about operating segments in annual financial statements and requires reporting
of selected information about operating segments in interim financial statements
issued to the public. Both SFAS 130 and SFAS 131 are effective for periods
beginning after December 15, 1997. The Company has not determined the impact
that the adoption of these new accounting standards will have on its future
financial statements and disclosures.
In June 1998, the Financial Accounting Standards Board issued SFAS 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133").
SFAS 133 requires companies to recognize all derivatives contracts as either
assets or liabilities in the balance sheet and to measure them at fair value. If
certain conditions are met, a derivative may be specifically designated as a
hedge, the objective of which is to match the timing of gain or loss recognition
on the hedging derivative with the recognition of (i) the changes in the fair
value of the hedged asset or liability that are attributable to the hedged risk
or (ii) the earnings effect of the hedged forecasted transaction. For a
derivative not designated as a hedging instrument, the fain or loss is
recognized in income in the period of change. SFAS 133 is effective for all
fiscal quarters or fiscal years beginning after June 15, 1999.
Historically, the Company has not entered into derivatives contracts to
hedge existing risks or for speculative purposes. Accordingly, the Company does
not expect adoption of the new standard on January 1, 2000 to affect its
financial statements.
Risk and Uncertainties
The primary uncertainty which the Company faces is its ability to locate
knowledgeable franchises who also have the financial resources to successfully
operate the stores. In addition, the Company needs to be able to identify
appropriate locations for its new franchised stores. The company believes that
it has taken the steps necessary to minimize these risks.
F-9
<PAGE>
1. Nature of Organization
JRECK Subs Group, Inc., f/k/a/ Circa Media, Inc., (the "Company") was
organized on July 19, 1995. On May 7, 1996, the company acquired 100% of
JRECK Subs, Inc., a multi-concept franchisor of sandwich shops in the state
of New York. For financial reporting purposes, the acquisition was
accounted for as a reverse merger, whereby JRECK Subs, Inc. was deemed to
be the acquiring entity. During 1997, the Company acquired various other
franchisor companies located in various geographic locations throughout the
United States (see Note 4). The company's headquarters are located in
Longwood, Florida. The various franchise agreements are for terms ranging
from 10 to 15 years and contain various renewal options.
Currently, the company serves as the franchisor to approximately 288 stores
operating under various tradenames. Franchise arrangements include a
license to operate under the applicable tradename and generally provide for
the receipt of initial fees, as well as continuing service fees and
royalties based upon a percentage of sales. In addition, the Company offers
guidance and assistance to the franchisees in areas such as product
preparation, equipment purchasing, marketing, administrative support and
employee training. In addition, the company owns and operates approximately
11 of the franchised stores.
2. Prepaid Expenses
Prepaid expenses are comprised of the following at December 31, 1997:
<TABLE>
<CAPTION>
<S> <C>
Prepaid consulting fee $ 618,056
Other 112,755
$ 730,811
</TABLE>
3. Property and Equipment
<TABLE>
<CAPTION>
Property and equipment are summarized as follows:
1997
<S> <C>
Land and building $ 370,000
Machinery and equipment 1,707,064
Office and computer equipment 64,744
Vehicles 82,135
Leasehold improvements 41,457
2,265,400
Less accumulated depreciation (334,410)
Net property and equipment $ 1,930,990
</TABLE>
4. Acquisitions
During the year, the Company acquired seven entities through the
purchase of assets or stock. The acquisition have been accounted for
using the purchase method of accounting, and the results of the
F-10
<PAGE>
acquired businesses have been included in the consolidated financial
statements since the date of acquisition. The excess of the purchase
price over the fair values of the net assets acquired was $13,061,710
and has been recorded as goodwill, which is being amortized on a
straight-line basis over 20 years based on the expected future
undiscounted operating cash flows of the related businesses acquired.
Chai Enterprises, Inc.
On June 19, 1997, the company, through its wholly-owned
subsidiary, Leovera, Inc., acquired all of the bakery
equipment of Chai Enterprises, Inc. ("Chai"). Chai is the
franchisor of the Hymie's bagel restaurant chain located in
Tampa, Florida. The purchase price of the Chai assets
consisted of 289,500 shares of the Company's Common Stock,
valued at $4.598 per share ($1,331,156) and $200,000 cash.
The transaction was recorded as follows:
<TABLE>
<CAPTION>
<S> <C>
Total consideration paid $ 1,531,156
Less, fair value of assets acquired (537,336)
Excess cost of net assets acquired $ 993,830
</TABLE>
Seawest Sub Shops, Inc.
On June 30, 1997, the Company acquired all of the outstanding
shares of Seawest Sub Shops, Inc. ("Seawest"). Seawest is the
franchisor of sandwich restaurants in Seattle, Washington. The
purchase price of Seawest was $150,000 cash. In addition, the
Company entered into a noncompete agreement with the former
shareholder valued at $502,000. Consideration for the
agreement consisted of a $96,000 note payable and stock
options valued at $4.06 per share ($406,000).
<TABLE>
<CAPTION>
The transaction was recorded as follows:
<S> <C>
Total consideration paid $ 150,000
Less, fair value of assets acquired (231,281)
Liabilities assumed 976,106
Excess cost of net assets acquired $ 894,825
</TABLE>
As noted above, options were granted to purchase up to 100,000
shares of Company Common Stock to the prior owners of Seawest.
These options are exercisable at $.001 per share during an
18-month period between December 1997 and May 1999. Upon
requests of the prior owner of Seawest, the Company is
obligated to repurchase any exercised shares at the greater of
fair market value of $3.25 per share over a mutually agreeable
period of time which has not been determined. Subsequent to
year end, 25,000 options were exercised.
Richey Enterprises, Inc.
F-11
<PAGE>
On August 15, 1997, the Company acquired all of the
outstanding common stock of Richey Enterprises, Inc.
("Richey"). Richey was the franchisor of the Georgio's
sandwich restaurants located in Seattle Washington. The
purchase price of Richey consisted of 93,794 shares of the
Company's Common Stock, valued at $3.625 per share.
<TABLE>
<CAPTION>
The transaction was recorded as follows:
<S> <C>
Common stock issued in connection with acquisition $ 340,000
Less, fair value of assets acquired (95,174)
Liabilities assumed 143,057
Excess cost of net assets acquired $ 387,883
</TABLE>
The Company is obligated to reimburse the prior owners of
Richey if the fair market value of the Company's Common Stock
falls below 80% of its value on the original closing date.
This contingency takes effect only if the prior owners of
Richey transfer their shares to a third party during the first
30 days following the anniversary date of the closing.
Little King, Inc.
On August 31, 1997, the Company purchased the outstanding
share of Little King, Inc., a franchisor of sandwich
restaurants in Omaha, Nebraska. In addition to the purchase of
the Little King shares, the Company purchased certain assets
and assumed certain liabilities from a separate entity related
by common ownership to the previous Little King Owners. These
assets and liabilities represent company-owned stores. In
addition, the Company entered into a noncompete agreement with
the former shareholder valued at $100,000.
F-12
<PAGE>
The purchase price of Little King and the company-owned stores
was $3,825,000 as follows:
<TABLE>
<CAPTION>
<S> <C> <C>
500,000 shares of Company Common Stock $ 1,531,250
700 shares of Company Common Stock (to be issued within 12 months) 2,143,750
Cash paid 50,000
Note payable 100,000
Total acquisition price $ 3,825,000
</TABLE>
The 1,200,000 shares of Company Common Stock were valued at
$3.0625 per share.
<TABLE>
<CAPTION>
The transaction was recorded as follows:
<S> <C>
Total consideration paid $ 3,825,000
Less, fair value of assets acquired (475,470)
Liabilities assumed 1,230,675
Excess cost of net assets acquired $ 4,580,205
</TABLE>
Total consideration paid is subject to periodic adjustment
based on the difference between the market value of the
700,000 shares of the Company's stock at date of acquisition
until such time as the shares are issued. At December 31,
1997, goodwill and the liability to issue common stock
decreased by $350,000 due to a decline in market value of the
Company's stock. The obligation to issue the additional
700,000 shares is included in the "Liability to issue common
stock" on the accompanying consolidated balance sheet.
In addition to the consideration shown above, the Company is
contingently liable to the previous owners of Little King for
up to 100,000 shares of Company Common Stock. The issuance of
these shares is contingent upon Little King achieving $900,000
in continuing franchise fees or selling $400,000 of initial
franchise fees during 1998. No provision has been provided for
this contingency in the accompanying consolidated financial
statements.
In addition, the Company must provided the prior owners of
Little King the opportunity to repurchase Little King, based
on a fair market value, as defined, if the quoted closing
market price of Company Common Stock is less than $1.50 per
share on the second anniversary of the closing of the
acquisition.
F-13
<PAGE>
Quality Franchise Systems, Inc.
On September 30, 1997, the Company purchased all of the
outstanding shares of Quality Franchise Systems, Inc. ("QFS").
QFS is the franchisor of Mountain Mike's Pizza restaurants
located in Northern California through a newly created
wholly-owned subsidiary. The purchase price of QFS is
summarized as follows:
<TABLE>
<CAPTION>
<S> <C> <C>
Company Common Stock, 899,967 shares $ 2,643,653
Liability to issue common stock 440,625
Company Series "C" Preferred stock, 120 shares 120,000
Options for 32,204 shares of Company Common Stock 23,000
Total acquisition price $ 3,227,278
</TABLE>
The Company's Common Stock was valued at $2.9375 per share.
The Series "C" Preferred Stock is valued at its par value of
$1,000 per share. The value of the stock options were computed
using the market value at the date of grant.
<TABLE>
<CAPTION>
The transaction was recorded as follows:
<S> <C>
Total consideration paid $ 3,227,278
Less, fair value of assets acquired (325,406)
Liabilities assumed 1,047,261
Excess cost of net assets acquired $ 3,949,133
</TABLE>
The Company is contingently liable to the previous owners of
QFS for up to 650,000 shares of Company Common Stock as a
result of the following arrangements:
(1) A payment of up to an additional 500,000 shares based
on the 1998 earnings of the Mountain Mike's division,
as defined. Since this contingency is based on an
uncertain future event, no purchase price adjustment
was made in the accompanying financial statements.
(2) The contingency for the remaining 150,000 shares was
based on the market price performance of the
Company's Common Stock for the period of October 1,
1997 through January 31, 1998. Since the Company's
stock did not meet the required price levels, a
purchase price adjustment of $440,625 was made based
on the fair market value of the Company's stock at
the date of acquisition. In March 1998, the Company
issued these shares in satisfaction of the obligation
of this obligation.
F-14
<PAGE>
Pastry Product Producers, LLC
On October 28, 1997, the Company acquired the remaining 50%
interest of Pastry Product Producers, LLC ("Pastry"). Pastry
is a bakery operation which primarily serves the JRECK
restaurant franchisees. In 1996, the Company purchased a 50%
investment in Pastry and accounted for it under the equity
method. The balance sheet of Pastry as of December 31, 1997
and its results of operation for the period between the
acquisition date of the remaining 50% ownership and year end
has been consolidated in the accompanying financial
statements. The Company's share of operations prior to the
acquisition have been treated as a loss on equity investment
and classified as such in the statement of operations.
The carrying value of the original 50% of Pastry was $743,984,
consisting of 350,000 shares of $2 par Series "B" preferred
stock, plus $43,984 in subsidiary equity earnings. The
purchase price of the remaining 50% of Pastry is comprised of
the following:
<TABLE>
<CAPTION>
<S> <C> <C>
Company Common Stock, 262,5000 shares $ 658,594
Options for 37,500 shares of Company Common Stock 79,000
Other 48,000
Total acquisition price of remaining 50% share $ 785,594
</TABLE>
The Company's Common Stock was valued at $2.509 per share. The
value of the stock options were computed based upon the market
value at the date of grant.
The transaction was recorded as follows:
<TABLE>
<CAPTION>
<S> <C>
Total consideration paid $ 785,594
Carrying value of initial 50% investment 743,984
Less, fair value of assets acquired (669,738)
Liabilities assumed 269,697
Excess cost of net assets acquired $ 1,129,537
</TABLE>
SBK Franchise Systems, Inc.
On December 4, 1997, the company purchased the outstanding
shares of SBK Franchise Systems,
Inc. ("SBK"). SBK is the franchisor of the Sobik's sandwich
restaurant chain in Central Florida.
The purchase price of SBK consisted of a note payable for
$500,000, cash of $100,000 and 187,266 shares of the Company's
Common Stock valued at $2.8125 per share ($526,686).
The transaction was recorded as follows:
F-15
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
Total consideration paid $ 1,126,686
Less, fair value of assets acquired (90,342)
Liabilities assumed 89,963
Excess cost of net assets acquired $ 1,126,307
</TABLE>
The prior owners of SBK have the right to require the Company
to repurchase 187,266 shares at a purchase price of $2.67 per
share. The Company is only required to repurchase a maximum of
37,453 shares in any six-month period commencing six months
from the date of closing. The redeemable common stock purchase
obligation is noncumulative and expires June 2000.
Pro Forma Financial Information (Unaudited)
The following summarized unaudited pro forma consolidated
results of operation have been prepared as if the preceding
acquisitions occurred at the beginning of 1997 and includes
pro forma adjustments for interest, depreciation amortization:
<TABLE>
<CAPTION>
<S> <C>
Revenue $ 5,929,447
Net loss before extraordinary item $ (9,066,438)
Loss from extraordinary item, net of taxes $ (862,029)
Net loss $ (9,928,467)
EPS - Basic and diluted:
Net loss before extraordinary item $ (.73)
Net loss from extraordinary item, net of taxes $ (.07)
Net loss $ (.80)
Weighted average number of common shares outstanding 12,384,817
</TABLE>
The pro forma consolidated results do not purport to be
indicative of results that would have occurred had the
acquisitions been in effect for the periods presented, nor do
they purport to be indicative of the results that will be
obtained in the future.
At December 31, 1997, the Company recognized a goodwill
impairment charge of $993,820 related to the acquisition of
Chai Enterprises. In determining the amount of the impairment
charge, the Company developed its best estimate of the future
operating cash flows attributable to the assets purchased. In
the fourth quarter, the Company concluded that based on
current market conditions, including the reduction in the
number of franchises, the anticipated future cash flows
indicated the recoverability of the goodwill was not
reasonably. assured.
5. Accrued Liabilities
<TABLE>
<CAPTION>
Accrued liabilities are comprised of the following at December 31,
1997:
<S> <C>
Accrued consulting fees $ 550,000
F-16
<PAGE>
Deferred revenue 212,000
Accrued payroll and related 122,962
Other 311,168
$ 1,196,130
</TABLE>
6. Notes payable to Related Parties
<TABLE>
<CAPTION>
Notes payable to related parties consist of the following:
<S> <C>
Notes payable to stockholder bearing interest at 9% monthly
interest-only payments through January 1999, then monthly
payments of $3,121, including principal and interest through
its maturity in December 2008. The notes are unsecured.
$ 323,032
Note payable to stockholder, unsecured, bearing interest at 8%
payable in monthly interest-only payments until December 1998,
at which time all remaining unpaid interest plus principal is
due.
$ 334,785
Note payable to stockholder bearing interest at 10% principal
and accrued interest due upon demand. This note is unsecured.
$ 100,000
Total related party notes payable 757,817
Less current portion (434,785)
Long-term portion of related party notes payable $ 323,032
</TABLE>
Interest expense on the above related party debt totaled
$38,854 during 1997.
F-17
<PAGE>
7. Long Term Debt
<TABLE>
<CAPTION>
Long term debt consists of the following:
Year Ended December 31, 1997
Various uncollateralized notes payable, bearing interest at
rates between 8% and 12% per annum, maturing between March 1998
<S> <C>
and February 2002 $ 553,642
Convertible notes payable bearing interest at 12.75% per
annum, interest payable quarterly and principal due March
2000, collateralized by revenues generated from franchise
agreements,
convertible into Common Stock at $10.86 per share. 530,000
Note payable to former owner of acquired subsidiary bearing
interest at 7% per annum, interest payable monthly and
principal due in full in December 1998, collateralized by all
royalty
revenues generated by SBK, Inc. 500,000
Uncollateralized non-interest bearing debt assumed in
acquisition of Seawest, principal payable monthly in amounts
of $4,000 until
paid in full. 348,000
Commercial paper, bearing interest at 10.5% per annum, interest and
principal due September 1998, notes are uncollateralized. 283,630
FDIC promissory notes bearing interest at 10% per annum, accrued
interest and principal due on demand, notes are uncollateralized. 257,584
Uncollateralized notes payable, bearing interest at 15% per annum,
interest payable monthly and notes mature November 2004. 180,000
Uncollateralized note payable, net of unamortized original
issue discount of $73,200, bearing interest at 15% per annum,
interest
payable monthly with principal due in March 1998. 176,800
Uncollateralized note payable, bearing interest at 10% per
annum, payable in weekly principal and interest payments of
$1,750 until April 17, 1998, in which a balloon payment of
$139,408 is due. The Company is in the process of negotiating
a modification of the terms
of the debt. 155,523
Uncollateralized note payable, bearing interest at 10% per
annum, payable in monthly interest and principal payments of
$2,494 through
November 2004. 150,000
F-18
<PAGE>
Bank note payable, bearing interest at 10.75% per annum, principal
monthly in the amount of $500 plus accrued interest, collateralized
by equipment. 138,435
Bank note payable, bearing interest at 6.5% per annum,
interest payable monthly with principal balance due April
1998, guaranteed by
prior owner of Little Kings 135,000
Bank note payable, bearing interest at 10.5% per annum,
interest and principal payable monthly in the amount f $1,750
through February 2002 with a balloon payment of $107,444 due
March 2002, collateralized
by certain accounts receivable, inventory and fixed assets. 124,111
3,782,669
Less current portion (2,163,554)
Total long-term debt $ 1,619,115
</TABLE>
Interest expense on long-term debt during 1997 amounted to
$174,648.
<TABLE>
<CAPTION>
The annual maturities of long-term debt and related party debt
for the five years subsequent to year end are as follows:
Long- Related
Term Party
Debt Debt Total
<S> <C> <C> <C> <C>
1998 $ 2,163,554 $ 434,785 $ 2,598,339
1999 192,683 39,636 232,319
2000 709,865 39,636 749,501
2001 216,533 39,636 256,169
2002 75,890 39,636 115,526
Thereafter 424,144 164,488 588,632
$ 3,782,669 $ 757,817 $ 4,540,486
</TABLE>
F-19
<PAGE>
8. Commitments and Contingencies
The Company leases office and store space under certain
operating leases which expire through 2008. Certain of these
leases have been entered into with a related party of the
Company. Total rent expenses for the year ended December 31,
1997 was $222,305, of which $114,740 was allocable to the
related party.
<TABLE>
<CAPTION>
Future annual minimum lease payments due under these operating
leases at December 31, 1997 are as follows:
Related Third
Party Party
Leases Leases Total
<S> <C> <C> <C> <C>
1998 $ 344,220 $ 98,616 $ 442,836
1999 185,820 83,616 269,436
2000 167,820 83,616 251,436
2001 167,820 26,916 194,736
2002 139,020 26,916 165,936
Thereafter 498,480 80,748 579,228
$ 1,503,180 $ 400,428 $ 1,903,608
</TABLE>
As mentioned in Note 4, certain of the acquisitions
consummated during 1997 contained provisions for contingent
payment of options or shares of Company Common Stock. In
addition to these contingencies, the company was also
contingently liable for certain consulting and investor
relation services to third party advisors. The following
summarizes the arrangements in which the Company is
contingently liable for consulting and investor relation
services.
In December 1997, the Company entered into an arrangement in
which it was to receive certain advisory services on capital
and earnings growth. As partial payment for these services,
the Company is contingently obligated to provide warrants for
up to 500,000 shares of Company Common Stock in the event the
Company either raises $10,000,000 or achieves a total store
level of 630 units within three years. The fair market value
of these options at date of issuance was recorded as prepaid
consulting expense of $512,500 as management believes the
Company will achieve the 630-store level through acquisitions.
During the year, the Company entered into an agreement to have
certain publishing services performed. The consideration for
these services includes an obligation for the cash payment of
$550,000 and options to purchase up to 300,000 shares of
Company Common Stock at exercise prices ranging from $2.81 to
$3.93 per share. The fair value of the options granted plus
the $550,000 were recorded as a consulting expense.
F-20
<PAGE>
Franchise Agreements
Under the terms of the various franchise agreements, the
franchises are obligated for the payment of the following fees
to the Company:
Franchise Fees
In accordance with the terms of the franchise
agreements, the Company receives an initial franchise
fee of $5,000 to $25,000.
Royalties
The Company receives royalties ranging from 3% to 5%
of gross sales from the franchisees' operations of
the restaurants.
Advertising Fund
The franchise agreements require the franchisees to
contribute to an advertising fund based upon 2% to 4%
of gross sales. The funds are maintained in separate
bank accounts, and their use is restricted solely for
advertising, marketing, and public relations programs
and materials to develop the goodwill and public
image of each of the respective franchises.
9. Stockholders' Equity
The following is a synopsis of significant transactions involving
Company Common and Preferred Stock.
(a) In 1996, the Company designated and issued 700,000 shares of
Series A voting nonredeemable cumulative convertible preferred
stock. The preferred stock is entitled to cumulative,
preferential dividends at a rate of $.09 per share and is
convertible into common stock at a conversion rate of one
share of common stock for each preferred share. The stock is
redeemable in liquidation at $2.00 per share. During 1997, the
holders of Series A preferred stock converted 100,000 shares
into 100,000 shares of common stock.
(b) In 1996, the Company designated and issued 350,000 shares of
Series B voting nonredeemable convertible preferred stock. The
Series B preferred stock is entitles to receive noncumulative
preferential dividends only when and as declared by the Board
of Directors and is convertible into common stock at a
conversion rate of one share of common stock for each
preferred share.
The stock is redeemable in liquidation at $2.00 per share.
(c) In September 1997, the Company designated and issued 120
shares of no par value Series C convertible preferred stock in
connection with the acquisition of Quality Franchise Systems,
Inc. The Series C preferred stock is entitled to cumulative
dividends at a rate of $32.50 per share per quarter and is
convertible into common stock ar a rate of 133.22 shares of
common stock for each preferred share with a face amount of
$1,000. The stock is redeemable at the option of the Company
or in liquidation at a rate of $1,000 per share.
F-21
<PAGE>
(d) In December 1997, the company designated 2,500 shares of
Series D convertible preferred stock. The Series D preferred
stock is entitled to cumulative dividends at a rate of 8% of
the face value per year and is convertible into common stock
at a rate of 65% of the average market price of the common
stock for five days immediately prior to the conversion date.
The stock is redeemable in liquidation at a rate of $1,300 per
share. As mentioned in Note 12 these shares were part of a
private placement offering which occurred in January 1998.
(e) During 1997, the Company acquired equipment valued at $424,003
in exchange for 230,000
restricted shares of common stock.
(f) As described further in Note 13, the Company issued 495,000
shares of its restricted shares of common stock.
(g) During 1997, the Company sold to accredited investors a total
of 1,077,213 shares of the Company's freely-traded common
stock at purchase prices ranging from $.53 to $2.25 per share
in private transactions exempt from registration under
applicable Federal securities laws. The Company collected
proceeds of $1,055,500 in connection with these transactions.
No offering costs were incurred as part of the transactions.
(h) As mentioned in Note 13, the Company sold to an officer and a
consultant 800,000 shares of restricted common stock for $3.00
per share (fair value) in exchange for subscription notes in
the amount of $2,400,000. The subscription notes bear interest
at 9.5% per annum and are due on or before September 2000. The
officer and the consultant also retain the right to require
the Company to repurchase the shares in exchange for
cancellation of the notes throughout the three year note
terms.
(i) During the year ended December 31, 1997, the company issued
229,360 shares of restricted
common stock, options to purchase 1,025,000 shares of common
stock at exercise prices ranging
from $.75 to #3.93, and warrants to purchase 1,250,000 shares
of common stock at exercise
prices ranging from $1.92 to $3.84 in connection with the
compensation of certain consultants.
The weighted average fair value of the warrants is $1.51.
The total expense recorded in
connection with the transactions amounted to $805,048 for the
common stock based upon the
market value at the date of issuance and $3,301,302 for the
options and warrants based upon the
market value at the date of grant.
(j) During May 1997, the company borrowed $180,000 from three
unrelated individuals and granted these individuals options to
purchase 180,000 shares of common stock at $.50 per share as
additional compensation for the loans. The stock options were
valued at $649,000 which represented the market value at the
date of grant. This amount was recorded as prepaid interest
and is being amortized as interest expense over seven years
based on the life of the loans.
During November 1997, the Company borrowed $250,000 from an
unrelated company and granted 60,000 shares of restricted
common stock. The common stock was valued at $146,400 based
upon the market value at the date of issuance and was recorded
as an original issue discount to be accredited over the life
of the loan.
F-22
<PAGE>
(k) During 1997, two consultants and a lender exercised their
options in exchange for 360,000 shares of Company Common
Stock. In connection with these transactions the Company
received cash proceeds of $225,000.
(l) In December 1997, the Board of Directors voted to retire all
outstanding shares of treasury stock. As a result of retiring
the treasury stock, the Company reclassified the outstanding
$1,600,000 balance to common stock.
The Company applies APB Opinion 25, "Accounting for Stock Issued to
Employees," and related interpretations in accounting for options
issued to employees. Accordingly, no compensation cost has been
recognized for options granted to employees at exercise prices which
equal or exceed the market price of the company's common stock at the
date of grant. Options granted at exercise prices below market prices
are recognized as compensation cost measured as the difference between
market price and exercise price at the date of grant.
SFAS No. 123 "Accounting for Stock-Based Compensation." requires the
Company to provide pro forma information regarding net income and
earnings per share as if compensation cost for the Company's employee
stock options had been determined in accordance with the fair value
based method prescribed in SFAS 123. The company estimates the fair
value of each stock option at the grant date by using the Black-Scholes
option-pricing model with the following weighted-average assumptions
used for grants in 1997; no dividend yield; an expected life of five
years; expected volatility of 64% and risk-free interest rate of 6.0%.
Under the accounting provisions of SFAS 123, the Company's net loss and
loss per share would have been reduced to the pro forma amounts
indicated below:
<TABLE>
<CAPTION>
1997
Net loss
<S> <C>
As reported $ (8,903,644)
Pro forma $(10,058,644)
Loss per share - basic and diluted
As reported $ (.82)
Pro forma $ (.93)
</TABLE>
A summary of the status of employee and nonemployee options as of
December 31, 1997 and changes during the year ended on those dates are presented
below:
<TABLE>
<CAPTION>
1997
Weighted
Average
Exercise
Shares Price
F-23
<PAGE>
<S> <C>
Balance at beginning of year -- $ --
Granted 2,374,704 2.11
Less, options exercised during year 360,000 .71
Less, options expired during year 18,704 3.08
Balance at end of year 1,996,000 2.36
Options exercisable at year end 1,996,000 $2.36
Weighted average fair value of options granted
during the year $1.62
</TABLE>
<TABLE>
<CAPTION>
The following table summarizes information about options under the plan
outstanding at December 31, 1997:
Options Outstanding Options Exercisable
Number Weighted-Average Number Weighted-
Range of Outstanding Remaining Weighted-Average Exercisable Average
Exercise Prices at Dec. 31, 1997 Contractual Life Exercise Price at Dec. 31, 1997 Exercise Price
<S> <C> <C> <C> <C> <C>
$.001 to 1.22 482,500 6.6 $ .57 482,500 $ .57
$2.75 to 3.93 1,513,500 2.6 2.93 1,513,500 2.93
1,996,000 3.5 $2.36 1,996,000 $2.36
</TABLE>
10. Income Taxes The components of net deferred income taxes consist of the
following:
<TABLE>
<CAPTION>
1997
Deferred income tax assets:
<S> <C>
Net operating loss carryforwards $ 1,470,000
Stock and stock options issued for services of debt 1,573,000
Other 50,000
Gross deferred income tax assets 3,093,000
Valuation allowance 3,093,000
Total deferred income tax assets $ --
The effect of deferred income tax liabilities are
nominal and have been netted with deferred tax assets
for financial statement disclosure purposes.
Unused net operating losses for income tax purposes,
expiring in various amounts from 2007 through 2011,
of approximately $3,870,000 are available at December
31, 1997 for carryforward against future year'
taxable income. Under Section 382 of the Internal
Revenue Code, the annual utilization of this loss may
be limited due to changes in ownership. A valuation
allowance has been offset against the tax benefit of
these losses in 1997 due to it being more likely than
not that the deferred income tax assets will not be
realized.
Income tax expense represents the change in the
estimated recoverability of the deferred tax asset.
</TABLE>
F-24
<PAGE>
11. Supplemental Cash Flow Information
Certain supplemental disclosure of cash flow information and noncash
investing and financing activities for the year ended December 31, 1997
is as follows:
<TABLE>
<CAPTION>
1997
Cash paid for interest during 1997 $ 144,283
<S> <C>
Issuance of common stock in exchange for subscription receivable 2,400,000
Capitalized franchise agreements were written off against deferred
revenue of the same value 2,294,041
Equipment classified as prepaid expense in 1996 was placed in service
in 1997 and reclassified to property and equipment 9,500
Equipment was purchased in exchange for common stock 424,003
Stock and stock options issued in exchange for consulting services 4,106,350
Stock issued to pay down related party notes payable ($445,000) and
record extraordinary loss ($862,029) 1,307,029
Stock and stock options issued in exchange for prepaid interest
($649,000) and original issue discount ($146,400) 795,400
Conversion of Class A preferred to Common Stock 200,000
Stock issued for payment of interest 146,857
Equipment valued at $47,635 was sold in exchange for note receivable 50,000
</TABLE>
In addition to the above non-cash items, the
following is a summary of non-cash transactions
entered into for the acquisitions listed in Note 4:
F-25
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
Common stock and stock options issued $ (7,539,339)
Preferred Stock issued (120,000)
Issuance of related party notes payable (100,000)
Issuance of long-term debt (596,000)
Original 50% equity investments in wholly-owned subsidiary (729,679)
Current year gain on equity investment (14,304)
Liability to issue common stock (2,234,375)
Miscellaneous accrued liability (48,000)
Total non-cash consideration paid (11,381,697)
Accounts receivable acquired 353,459
Prepaid expenses acquired 60,029
Notes receivable acquired 121,248
Property, plant and equipment acquired 1,644,402
Goodwill acquired 12,711,710
Other intangible assets acquired 636,097
Total non-cash acquisition of assets 15,526,945
Accounts payable assumed (643,821)
Accrued liabilities assumed (389,500)
Long-term debt assumed (2,268,739)
Related party notes payable assumed (434,771)
Total non-cash assumption of liabilities (3,736,831)
Net cash paid $ 408,417
</TABLE>
12. Subsequent Events
a) Private Placement
In January 1998, the Company completed a private
placement offering of Class D Convertible Preferred
Stock. An aggregate of 2,500 shares of this issuance
was sold for $2,500,000. The proceeds from this
offering were substantially used to pay down existing
long-term debt or to satisfy other obligations.
b) Debt Conversion
In February 1998, the Company converted $277,404 of
related party notes payable to 155,475 shares of
Company Common Stock. These shares had a fair market
value of $382,470 on the date of transfer.
F-26
<PAGE>
c) Acquisition
In March 1998, the Company acquired the assets of a
franchisor of sandwich restaurants located in North
Carolina. The acquisition price of this new entity
was approximately $2,400,000. To satisfy the purchase
price, the Company agreed to issue $2,000,000 of
Common Stock and assume approximately $400,000 of
debt. Upon completion of the acquisition, the Company
issued 735,294 shares of its Common Stock having a
market value of $2.72 per share.
d) Series A and B Convertible Preferred Stock
On June 30, 1998, the holders of the shares of Series
A and B convertible preferred stock converted the
remaining outstanding shares into 950,000 shares of
common stock.
13. Related Party Transactions
Significant related party transactions and balances
not previously disclosed are as follows:
During the year, the Company's major shareholder
incurred debt of $445,000 which was advanced directly
to the Company. This debt was collateralized by the
Shareholder's freely traded shares of Company Common
Stock. The debt of the stockholder was subsequently
satisfied by the Company through the issuance of
445,000 shares valued at $2.94 per share ($1,307,029)
of its own restricted Common Stock. These shares were
issued directly to the note holders in return for the
satisfaction of the original debt of the Company's
major shareholder. An extraordinary loss on the early
extinguishment of debt in the amount of $862,029 was
recorded as a result of this transaction. In
addition, 50,000 shares valued at $2.94 per share
($146,857) were issued, representing additional
interest expense in connection with the retirement of
debt.
The Company granted stock options for 1,800,000
shares of Common Stock to related parties during
1997. Options for 800,000 shares of Company Common
Stock were granted to the Chief Operating Officer and
a consultant. These options were exercised with a
note receivable for $2,400,000, which was classified
as a stock subscription receivable at year end. The
remaining options, granted to the President and Chief
Executive Officer, are exercisable at $2.75 per share
until December 2000. The President has yet to
exercise any portion of these options.
F-27
<PAGE>
<TABLE>
<CAPTION>
Jreck Subs Group, Inc.
Consolidated Balance Sheets
March 31, 1998 and December 31, 1997
ASSETS
March 31, 1998 Dec, 31, 1997
Current Assets:
<S> <C> <C>
Cash & Cash Equivalents $ 439,554 $ 427,420
Accounts Receivable-Trade, net of
allowance of $199,228 300,039 391,567
Current Portion of Notes Receivable 100,000 168,560
Prepaid Expenses 664,989 730,811
Total Current Assets 1,504,582 1,718,358
Property & Equipment-Net
Other Assets:
Notes Receivable 549,555 173,704
Excess of Cost Over Fair Value of Assets
of Net Assets Acquired 14,266,312 11,521,526
Covenants Note To Compete & Other
Intangible Assets 527,707 512,777
Original Issue Discount 586,280 597,760
Other 29,401 34,097
Total Other Assets 15,959,255 12,839,864
Total Assets $ 19,417,161 $ 16,489,212
</TABLE>
The interim financial statements include all
adjustments which, in the opinion of management,
are necessary in order to make the financial
statements not misleading.
F-28
<PAGE>
<TABLE>
<CAPTION>
Jreck Subs Group, Inc.
Consolidated Balance Sheets
March 31, 1998 and December 31, 1997
LIABILITIES & STOCKHOLDERS' EQUITY
March 31, 1998 Dec, 31, 1997
Current Liabilities:
<S> <C> <C>
Current Portion of Long Term Debt $ 1,448,625 $ 2,163,554
Current Portion of Notes Payable to
Related Parties 157,381 434,785
Accounts Payable - Trade 955,194 1,020,101
Accrued Expenses 365,149 1,196,130
Liability to Issue Common Stock 1,793,750 2,234,375
Total Current Liabilities 4,720,099 7,048,945
Long Term Debt - Related Parties 179,016 323,032
- Other 2,031,502 1,619,115
Redeemable Common Stock 500,000 500,000
Stockholders' Equity:
Preferred Stock - 952,620 Shares Outstanding 4,520,000 2,020,000
Common Stock Authorized -50 Million Shares
- Issued 15.627 Million Shares 21,076,175 17,729,478
Less Stock Subscription Receivable (2,400,000) (2,400,000)
Accumulated Deficit (11,209,631) (10,351,358)
Total Stockholders' Equity 11,986,544 6,998,120
Total Liabilities & Stockholders' Equity $ 19,417,161 $ 16,489,212
</TABLE>
The interim financial statements include all
adjustments which, in the opinion of management,
are necessary in order to make the financial
statements not misleading.
F-29
<PAGE>
<TABLE>
<CAPTION>
Jreck Subs Group, Inc.
Income Statement
March 31, 1998 and 1997
Quarter Ended Quarter Ended
March 31, 1998 March 31, 1997
Revenues:
<S> <C> <C>
Continuing Royalties $ 547,141 $ 84,651
Initial Franchise & Franchise Transfer Fees 50,700 0
Retail Store Sales - net 531,597 0
Bakery Operations Sales - net 250,421 0
Other 175,441 0
Total Revenue 1,555,300 84,651
Costs Applicable to Sales & Revenue 308,542 0
Selling, General & Administrative Expenses 1,803,602 924,795
Interest 66,317 18,936
Depreciation & Amortization 194,880 5,000
Total Expenses 2,400,341 948,731
Net Loss $ (845,041) $ (864,080)
Weighted Average Common Shares Outstanding 14,465,764 9,150,873
Loss per Share $ (0.058) $ (0.094)
</TABLE>
The interim financial statements include all
adjustments which, in the opinion of management,
are necessary in order to make the financial
statements not misleading.
F-30
<PAGE>
<TABLE>
<CAPTION>
Jreck Subs Group, Inc.
Statement of Cash Flows
Quarters Ended
March 31, 1998 and 1997
Quarter Ended Quarter Ended
Operating Activities: March 31, 1998 March 31, 1997
<S> <C> <C>
Net Loss $ (845,041) $ (864,080)
Non-Cash Expenses Included in Net Income:
Depreciation & Amortization 194,880 5,965
Amortization of Prepaid Interest 11,480 0
Consulting Fees paid in Common Stock and Options 197,317 762,979
Adjustments to Reconcile Net Loss to Cash
Provided (Consumed) by Operating Activities:
(Increase) in Accounts Receivable 91,528 (947)
(Increase) in Prepaid Expenses 65,822 3,601
Increase in Accounts Payable & Accruals (895,188) (32,060)
Cash Consumed by Operating Activities (1,179,202) (124,542)
Financing Activities:
Proceeds From the Issuance of Preferred Stock (Common in '97) 2,067,490 220,000
Payment on Long Term Debt (597,196) (2,908)
Proceeds of Long Term Debt 200,000 0
Dividends Paid (13,232) (13,200)
Cash Generated by Financing Activities 1,657,062 203,982
Investing Activities:
Advances Made on Notes Receivable (321,860) (82,344)
Payments Collected on Notes Receivable 15,669 0
Acquisition of Equipment (42,700) 0
Cash Paid in Connection with Acquisitions (116,835) (10,392)
Cash Expended on Investing Activities (465,726) (92,736)
Net Increase (Decrease) in Cash 12,134 (13,296)
Cash & Cash Equivalents - Beginning 427,420 47,628
Cash & Cash Equivalents - Ending $ 439,554 $ 34,342
</TABLE>
The interim financial statements include all
adjustments which, in the opinion of management,
are necessary in order to make the financial
statements not misleading.
F-31
<PAGE>
Jreck Subs Group, Inc.
Notes to Interim Financial Statements
March 31, 1998
Note 1. The interim financial statements include all adjustments which, in the
opinion of management, are necessary in order to make the financial statements
not misleading.
Note 2. On March 22, 1998 the Company acquired the assets of Li'l Dino
Corporation, a 43 unit sandwich shop franchisor located in North Carolina. The
purchase price of $1,800,000 was paid by assuming $400,000 in debt and issuing
735,294 of the Company's common shares. The shares issued were valued at $2.72
per share and reflect the Company's policy of discounting by 30% in recognizing
the shares' limited marketability due to restrictions on trading and holding
periods in excess of one year. The acquisition has been recorded as follows:
<TABLE>
<CAPTION>
<S> <C>
Total Consideration Paid $ 1,400,000
Fair Value of Assets Acquired (15,000)
Liabilities Assumed 400,000
Excess of cost over net assets acquired $ 1,785,000
</TABLE>
Note 3. In January 1998, the Company completed an offering on Class D
Convertible Preferred Stock. The aggregate offering of 2,500 shares at
$1,000/share or $2,500,000 was used to pay down existing long term debt and to
fund current operations. $250,000 of the Company's debt converted to 250 shares
of preferred D as part of this offering.
Note 4. In February, 1998 the Company converted $277,404 of related party debt
to 112,783 shares of the Company's Common Stock.
F-32
<PAGE>
Report of Independent Auditor
Board of Directors
Jreck Subs Group, Inc.
Watertown, New York
I have audited the accompanying consolidated balance sheet of Jreck Subs Group,
Inc. as of December 31, 1996 and 1995 and the related consolidated statements of
income, cash flows and stockholders' equity for the years then ended. The
financial statements are the responsibility of the directors. My responsibility
is to express an opinion on these financial statements based on my audit.
I conducted my audit in accordance with generally accepted auditing standards.
Those standards require that I plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
I believe that my audit provides a reasonable basis for my opinion.
In my opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Jreck Subs Group, Inc. as of
December 31, 1996 and 1995 and the results of its operations, its cash flows and
changes in stockholders' equity for the years then ended in conformity with
generally accepted accounting principles.
January 22, 1997
Michael Cronin
Certified Public Accountants
Fairport, New York
F-45
<PAGE>
<TABLE>
<CAPTION>
Jreck Subs Group, Inc.
Consolidated Balance Sheet
ASSETS
September 30, December 31,
1997 1996
Current Assets: (unaudited)
<S> <C> <C>
Cash and Cash Equivalents $ 226,552 $ 47,368
Royalty and Advertising Receivable 290,970 146,685
Stock Subscriptions Receivable 10,000 10,000
Prepaid Expenses 20,948 25,666
Area Development Fees 49,357 0
Inventory 4,858 0
Loans Receivable 644,660 0
Other Current Assets 9,022 0
Total Current Assets 1,256,367 229,719
Investment in Unconsolidated Subsidiary
(Note A and I) 729,679 729,679
Property & Equipment, Net of Accumulated
Depreciation (Note A) 1,714,021 50,188
Goodwill, Net of Accumulated Amortization 4,914,477 0
Other Assets (Note D) 1,367,439 2,812,294
Total Assets $ 9,981,983 $3,821,880
LIABILITIES & STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts Payable and Accrued Expenses 582,018 15,580
Accrued Dividends 20,601 0
Loans Payable (Note B) 1,250,042 736,012
Current Portion of Long Term Debt (Note C) 20,000 20,000
Total Current Liabilities 1,872,661 771,592
Long Term Debt (Note C) 2,514,661 46,456
Deferred Income (Note D) 0 2,294,041
Stockholders' Equity:
Common Stock 12,248,834 and 8,781,000
shares outstanding) 3,279,178 999,664
NonRedeemable Preferred Stock (Note F) 2,020,000 2,100,000
Treasury Stock (8,000,000 shares of Subsidiary) (1,600,000) (1,600,000)
Accumulated Deficit (2,497,331) (789,873)
Total Stockholder's Equity 5,594,661 709,791
Total Liabilities & Stockholders' Equity $ 9,981,983 $ 3,821,880
See Notes to Financial Statements
</TABLE>
<TABLE>
<CAPTION>
F-46
<PAGE>
Jreck Subs Group, Inc.
Consolidated Statement of Operations
Nine Months Ended
September 30, Fiscal Year Ended
1997 1996 1996 1995
<S> <C> <C> <C> <C>
Net Sales (Note A) $ 594,453 $ 392,258 $ 557,738 $ 435,639
Costs and Expenses Applicable to
Sales & Revenue 122,658 15,396 23,946 16,548
Gross Profit 471,795 376,862 533,792 419,091
Provision for Doubtful Accounts Receivable 0 0 0 137
Selling, General & Administrative Expenses 548,144 263,143 392,542 310,315
Income (Loss) From Operations (76,349) 113,719 141,250 108,639
Parent Share of Income (Loss) of Unconsolidated
Subsidiary (Note A-4) 22,680 0 (4,819) 0
Other Income:
Gain Recognized on Extinguishment of Debt
(Note C-2,3) 0 57,969 126,001 384,815
Miscellaneous Income 3,531 0 0 0
Other Expense:
Interest and Amortization 79,928 92,925 186,800 85,544
Loss on Disposal of Fixed Assets 3,980 0 0 0
Write off Territorial Rights, Rent Guarantees
& Other Payments (Note H) 0 120,000 126,082 128,978
Costs Associated with Mergers and Acquisitions1,528,492 0 0 0
Income (Loss) Before Income Taxes (1,662,538) (41,237) (50,450) 278,932
Income Tax Expense (Benefit) (Notes E) 349 0 (10,973) 121,891
Net Income (Loss) $ (1,662,887) $ (41,237) $ (39,657) $ 157,041
Loss Per Share $ (0.17) $ (0.01) $ 0.00 $ 0.02
</TABLE>
See Notes to Financial Statements
F-47
<PAGE>
<TABLE>
<CAPTION>
Jreck Subs Group, Inc.
Consolidated Statements of Cash Flows
Nine Months Ended
September 30, Fiscal Year Ended
1997 1996 1996 1995
Operating Activities:
<S> <C> <C> <C> <C>
Net Income (Loss) $ (1,662,887) $ (41,237) $ (39,657) $ 157,041
Adjustments to Reconcile Net Income (Loss)
to Cash Provided (Consumed) by
Operating Activities:
Depreciation and Amortization of
Intangible Assets 72,945 89,164 14,518 21,763
Write off of Intangible Assets 0 0 0 128,978
Loss on Disposal of Property & Equipment 3,980 0 0 0
Interest in Income of Subsidiary 0 0 4,819 0
Adjustment for Tax Benefit of Net Operating
Loss Carryover 0 0 (11,135) 121,135
Forgiveness of Debt 0 0 (126,001) (384,815)
Issuance of common stock for services rendered 1,116,898 0 0 0
Changes in Operating Assets and Liabilities:
(Increase) Decrease in Current Assets (942,997) (83,195) (104,576) (13,300)
Increase (Decrease) in Accounts Payable &
Accrued Expenses 74,374 (364,443) 13,277 (19,301)
Net Cash Provided (Consumed) by Operating Activities(1,337,687) (399,711) (248,755) 11,501
Investing Activities:
Purchase of Property & Equipment (18,673) 0 (5,172) (40,721)
Other Investments Made 0 0 (34,498) 0
Payment of Promissory Note Offering Costs 0 0 (14,786) (70,710)
Payment for Acquisitions, net of Cash Acquired (331,984) 0 0 0
Net Cash Used in Investing Activities (350,657) 0 (54,456) (111,431)
Financing Activities:
Proceeds of Common Stock Offering net of Costs 715,000 548,305 681,650 0
Increase (Decrease) in Debt 1,197,099 (126,130) (281,914) 105,573
Dividends Paid on Preferred Shares (44,571) (26,400) (54,800) 0
Net Cash Provided (Used) by Financing Activities 1,867,528 395,775 344,936 105,573
Net Change in Cash 179,184 (3,936) 41,725 5,643
Cash & Cash Equivalents at the Beginning of Period 47,368 5,643 5,643 0
Cash & Cash Equivalents at the End of Period $ 226,552 $ 1,707 $ 47,368 $ 5,643
Supplemental Disclosure of Cash Flow Information:
F-48
<PAGE>
Decrease in Series A Preferred Stock $ (200,000)
Increase in Common Stock $ 200,000
Acquisition of Equipment from the Issuance
of Common Stock $ 500,000
Schedule of Non-cash Investing and Financing Activity:
Fair Value of Assets Acquired $ 6,855,215
Liabilities Assumed (2,297,801)
Fair Value of Common Stock Issued (4,225,430)
Cash Paid, net of Cash Acquired $ 331,984
</TABLE>
See Notes to Financial Statements
F-49
<PAGE>
<TABLE>
<CAPTION>
Jreck Subs Group, Inc.
Statements of Changes in Stockholders' Equity
Treasury
Stock of Retained
Common Stock Preferred Stock Jreck SubsEarnings
Shares Amount Shares Amount Inc. (Deficit)
Inception July 14, 1995
Issuance of Shares Aug. 1995 net of Offering
<S> <C> <C> <C> <C>
Costs of $3,700 1,100,000 $ 0 $ 0
Net income December 31, 1995
December 31, 1995 1,100,000 0 0
Issuance of Shares May 1996 1,100,000 11,000
Issuance of Shares May 1996 in Exchange for 100%
of the common stock of Jreck Subs, Inc. 5,000,000 318,014 $(1,600,000)
Consolidated Retained Earnings of Subsidiary (695,416)
Issuance of Series A NonRedeemable Convertible
Preferred Stock May 1996 in exchange for 100%
of Jreck Subs, Inc. Series A Preferred Stock 700,000 $ 1,400,000
Issuance of Series B NonRedeemable Convertible
Preferred Stock May 1996 in exchange for 100%
of Jreck Subs, Inc. Series B Preferred Stock 350,000 $ 700,000
Issuance of Shares pursuant to Section 504 Offering
under Regulation D, June 1996, net of offering costs 1,536,000 648,150
Issuance of Shares in Exchange for Cancellation of Debt 45,000 22,500
Payment of Preferred Dividends (54,800)
Consolidated net Loss Year Ended December 31, 1996 (39,657)
December 31, 1996 8,781,000 999,664 1,050,000 $ 2,100,000 $(1,600,000) $ (789,873)
Issuance of Shares for Purchase of Equipment 230,000 535,000
Conversion of Series A Preferred Stock to
Common Stock 100,000 200,000 (100,000) (200,000)
Issuance of Shares for Services 391,478 1,116,898
Issuance of Shares 915,095 715,000
Issuance of Shares for Acquisitions 1,831,261 4,105,430 120 120,000
Payment of Preferred Dividends (44,571)
Net Loss for the Nine Months Ended September 30, 1997 (1,662,887)
September 30, 1997 12,248,834 $ 7,671,992 950,120 $ 2,020,000 $(1,600,000) $(2,497,331)
</TABLE>
See Notes to Financial Statements
F-50
<PAGE>
JRECK SUBS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. Summary of Significant Accounting Policies:
1. The Company was organized April 25, 1994. Previous operations focus
primarily on servicing 51 submarine sandwich shops (known as Jreck Subs) as the
parent franchising organization. During 1997, the Company through a series of
acquisitions purchased Hymie's Bagels, Little King Subs, Georgio's Subs and
Mountain Mike's Pizza and as of September 30, 1997 had approximately 250
restaurants of which 230 are franchised locations. The Company sells territorial
rights and provides guidance and assistance to the franchisees in areas such as
the preparation, packaging and sale of products; purchasing equipment, marketing
and administrative support and conducting employee training.
2. Revenue and Expense Recognition: Royalty revenue is recognized weekly as
a percentage of franchise net sales. Expenses are charged to operations as
incurred.
3. Property & Equipment are recorded on the basis of cost. Depreciation is
computed using either the straight-line method or double declining balance
method over the estimated useful lives of the assets. Depreciation expense for
the year ended December 31, 1996 was $14,518. Expenditures for renewals and
betterments are capitalized. Expenditures for repairs and maintenance are
charged to operations as incurred. Gain or loss upon sale or retirement due to
obsolescence is reflected in the operating results in the period the event takes
place. Details of the Property & Equipment are as follows:
<TABLE>
<CAPTION>
Sep 30, 1997 Dec. 31, 1996
<S> <C> <C>
Machinery & Equipment $ 1,756,875 $ 21,703
Vehicles 63,175 58,591
1,820,050 80,294
Less Accumulated Depreciation 106,029 30,106
Net Property & Equipment $ 1,714,021 $ 50,188
</TABLE>
4. Principles of Consolidation: Investments in affiliates that are 50% or
less owned are accounted for by the equity method of accounting. This requires
that the Company's share of the affiliate's net income be included in its income
statement and that it carry its investment at cost plus its interest in
undistributed net earnings.
5. Goodwill: The Company classifies as goodwill the cost in excess of fair
value of assets of the companies acquired in purchase transactions. Goodwill is
amortized over periods ranging from 20 to 40 years.
F-51
<PAGE>
B. Notes Payable:
<TABLE>
<CAPTION>
A summary of the various obligations are as follows:
Sep 30, 1997 Dec 31, 1996
<S> <C> <C>
Promissory Notes $ 618,929 $ 399,679
FDIC 0 259,334
Ed Mahar 57,008 76,999
Commercial Paper 314,680 0
Noncompete Agreement 72,000 0
Other 187,425 0
Total $ 1,250,042 $736,012
</TABLE>
C. Long Tern Debt:
<TABLE>
<CAPTION>
A summary of obligations is as follows:
<S> <C> <C> <C> <C>
Description of Obligation: Sep 30, 1997 Dec 31, 1996
Convertible Notes Payable $ 530,000 0
Due to Christopher Swartz (President) 549,677 0
Iseman and Kane 360,000 0
Deegan Group 180,000 0
SRW, Inc. 100,000 0
Sid Wertheim - Little King, Inc. 427,076 0
First National Bank - Little King, Inc. 135,000 0
Other Little King, Inc. obligations 70,603 0
Georgio's obligations 121,760 0
Other 60,545 66,456
2,534,661 66,456
Less Current Portion 20,000 20,000
Total Long Term Debt $ 2,514,661 $ 46,456
</TABLE>
The convertible notes payable of $530,000 bears interest at 12.75% payable
quarterly and are due in April 2000. The notes are convertible into the
Company's common stock at $11.82 per share.
F-52
<PAGE>
D. Other Assets:
Deferred Offering Costs are the capitalized expenses incurred in connection
with the Company's efforts to raise financing through the issuance of its 10.5%
Promissory Notes. These expenses are amortized over the life of the notes, In
1996 the Company restate its Franchise Agreement to require an annual minimum
franchise royalty payment for 10 years for all of its franchisees. The present
value of these minimum payments has been imputed at 9% and reflected as
Franchise Agreements in Other Assets and, correspondingly, Deferred Income under
Other Liabilities. In 1997, the Company decided to not carry the present value
of the minimum payments in Other Assets and Deferred Income.
<TABLE>
<CAPTION>
Description: Sep 30, 1997 Dec. 31, 1996
<S> <C> <C>
Franchise Agreements $ 0 2,294,041
Deferred Offering Costs 0 14,786
Advances to Former Officer 257,114 115,641
Deferred Income Taxes (Note E) 387,846 387,846
Covenant Note to Compete 96,000 0
Other Intangibles 586,848 0
Miscellaneous 39,631 0
Total $ 1,367,439 $ 2,812,314
</TABLE>
E. Income Taxes:
The net non-current deferred tax asset as presented on the accompanying
balance sheets consist of the following deferred tax assets
<TABLE>
<CAPTION>
Sep 30, 1997 Dec 31, 1996
<S> <C> <C>
Federal and State Deferred Income Taxes $ 387,846 $ 387,846
Less Valuation Allowance 0 0
Total $ 387,846 $ 387,846
</TABLE>
The corporations have net operating loss carryforwards available of
$1,224,000 that may be used to offset future taxable income. These carryforwards
begin to expire in the fiscal year ending December 31, 2005.
F. Preferred Stock:
On November 22, 1995 the Company concluded an exchange offer in which
holders of the Notes Payable on the purchase of Treasury Stock would exchange
their notes for the Company's Series A nonredeemable Preferred Stock. 700,000
shares were issued and the notes, together with accrued interest of $363,165
were retired. Each shares of the Preferred Stock is convertible, at the
discretion of the Board of Directors, into one share of the Company's Common
Stock. Dividends on the Series A Preferred Stock accrue and become payable
weekly at the annual rate of 9 cents per share. The shares are nonredeemable.
The Company also issued its Series B Preferred Stock in exchange for 50% of the
voting common stock of its unconsolidated subsidiary (Note J). the rights and
preferences of the Series B preferred shares are similar to those of the series
A. In July 1997, 100,000 shares of the Series A Preferred Stock was converted
into 100,000 shares of the Company's Common Stock. In connection with the
Company's acquisition of Mountain Mike's Pizza, it issued 120 shares of the
Company's Series C nonredeemable Preferred Stock with a liquidation value of
$120,000. Dividends on the Series C Preferred Stock are $130 per share per
annum.
G. Common Stock Offering:
At December 31, 1996 the Company was actively engaged in a public offering
of its common stock. The offering is exempt from S.E.C. registration under Rule
504 of Regulation D. As of December 31, 1996 the Company had received $768,000
in cash and issued 1,536,000 shares of its common stock. The offering was
concluded in February, 1997 after receiving an additional $220,000 in cash.
All costs of the offering have been reflected as a reduction of the total amount
received.
H. Payment of Contingent Liability:
F-53
<PAGE>
In February, 1989, Jreck Subs, Inc. entered into an agreement to purchase
four stores from HLS Enterprises, Inc. In November, 1989 these stores were
subsequently resold to Bundeswehr, Inc. The sales agreement stipulated that all
debt owed by Jreck Subs, Inc. to HLS would be assumed and become an obligation
of Bundeswehr, Inc. In 1996 the Company paid $120,000 for full and complete
satisfaction of this liability. This payment has been charged against revenues
in the current period.
I. Investment in Unconsolidated Subsidiary:
In November, 1995 the Company acquired 50% of the voting common and 40% of
the preferred shares of Pastry Product Producers, LLC. This company currently
supplies the Jreck franchise stores with their baked goods and holds a 10 year
contract to supply submarine sandwich rolls for Jreck Subs, Inc. The investment
has been accounted for by the equity method (Note A). The Company also leases
its office space from its subsidiary for $500/month under a 10 year lease
agreement.
F-54
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Stockholders and Board of Directors
Li'l Dino Corporation
Greensboro, North Carolina
We have audited the accompanying balance sheet of Li'l Dino Corporation (a
wholly-owned subsidiary of Li'l Dino Management Corporation) as of October 31,
1997 and the related statements of loss and retained deficit and cash flow for
the year then ended. 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 audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentator.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Li'l Dino Corporation as of
October 31, 1997 and the results of its operations and its cash flows for the
year then ended in conformity with generally accepted accounting principles.
DIXON ODOM PLLC
CERTIFIED PUBLIC ACCOUNTANTS
January 15, 1998, except for Note E.
as to which the date is January 26, 1998
F-55
<PAGE>
<TABLE>
<CAPTION>
LI'L DINO CORPORATION
BALANCE SHEET
October 31, 1997
ASSETS
CURRENT ASSETS
<S> <C>
Cash $ 48,361
Royalties receivable 15,307
TOTAL CURRENT LIABILITIES $ 63,668
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 29,808
TOTAL CURRENT LIABILITIES 29,808
CONTINGENCY (NOTE E)
STOCKHOLDER'S EQUITY
Common stock, $1 par value, 1,000,000 shares
authorized 50,000 shares issued 50,000
Retained deficit (16,140)
33,860
$ 63,668
</TABLE>
See accompanying notes
F-56
<PAGE>
<TABLE>
<CAPTION>
LI'L DINO CORPORATION
STATEMENT OF LOSS AND RETAINED DEFICIT
Year Ended October 31, 1997
OPERATING REVENUE
<S> <C>
Franchise fees $ 38,750
Royalties 410,198
Franchise repurchase (19,692)
TOTAL OPERATING REVENUE 429,256
OPERATING EXPENSES
Management fee to parent 367,401
Commissions 73,844
Other 6,339
TOTAL OPERATING EXPENSES 447,584
LOSS FROM OPERATIONS (18,328)
OTHER INCOME
Interest income 1,180
NET LOSS (17,148)
RETAINED EARNINGS,
BEGINNING OF YEAR, as restated (Note D) 1,008
RETAINED DEFICIT, END OF YEAR $ (16,140)
</TABLE>
See accompanying notes
F-57
<PAGE>
<TABLE>
<CAPTION>
LI'L DINO CORPORATION
STATEMENT OF CASH FLOWS
Year Ended October 31, 1997
CASH FLOWS FROM OPERATING ACTIVITIES
<S> <C>
Net loss $ (17,148)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Franchise repurchase in exchange for cancellation
of note receivable 19,692
Change in assets and liabilities
Decrease in royalties receivable 4,359
Decrease in notes receivable 9,012
Increase in accounts payable 4,365
NET CASH PROVIDED BY OPERATING ACTIVITIES
AND NET INCREASE IN CASH 20,280
CASH, BEGINNING 28,081
CASH ENDING $ 48,361
SUPPLEMENT SCHEDULE OF NONCASH INVESTING AND
FINANCING ACTIVITIES
Note receivable written off against deferred franchise fees $ 4,000
</TABLE>
See accompanying notes
F-58
<PAGE>
LI'L DINO CORPORATION
NOTES TO FINANCIAL STATEMENTS
October 31, 1997
NOTE A - SIGNIFICANT ACCOUNTING POLICIES
Description of Business
The Company sells area and single location Li'l Dino sub shop franchises and
provides assistance ad guidance to franchisees. At October 31, 1997, there are
43 franchised units operating in North Carolina, Virginia, South Carolina and
Georgia.
Parent Company
The Company is a wholly owned subsidiary of Li'l Dino Management Corporation.
Franchise Fees
Revenue from sales of area and single location franchises is generally
recognized when substantially all significant services to be provided to the
area developer and franchisee have been performed. In situations where revenue
from such sales is collectible over an extended period of time and
collectibility is not reasonably certain, revenue is recognized on the
installment method as amounts are collected.
Royalties
The Company receives ongoing royalties from franchised stores based upon a
percentage of the stores sales. The royalties are recognized as revenue in the
period the sales occur.
Income Taxes
The Company and its parent file a consolidated federal income tax return. Income
taxes are allocated to the Company as if it were a separate taxpayer. Tax
benefits from operating losses have been eliminated by allowances to reduce them
to an amount likely to be realized.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the 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-59
<PAGE>
LI'L DINO CORPORATION
NOTES TO FINANCIAL STATEMENTS
October 31, 1997
NOTE B - RELATED PARTY TRANSACTIONS
The Company pays a management fee to its parent company. The amount of the
management fee is determined solely at the discretion of its parent's management
and may vary significantly from year to year.
The Company entered into an agreement with one of its area developers whereby
the Company agreed to waive future unit franchise fees for up to two new units
in exchange for the forgiveness of commissions due to the area developer for
sales generated by units located in the developer's franchise area from April
28, 1997 through October 26, 1997. Commission expense in the amount of
approximately $11,000 has not been recorded in the financial statements for the
year ended October 31, 1997 in accordance with the terms of the agreement.
NOTE C - SUMMARY OF FRANCHISE SALES AND OPERATING UNITS
<TABLE>
<CAPTION>
The following is a summary of franchise outlets for the year ended October 31,
1997:
<S> <C> <C>
Units in operation at November 1, 1996 44
Area franchises sold 1
Area franchises repurchased (1)
New units opened 6
Units closed (7)
Units in operation at October 31, 1997 43
</TABLE>
NOTE D - PRIOR PERIOD ADJUSTMENT
The retained earnings at October 31, 1996 have been decreased by a charge of
$6.695 to report accounts payable for commissions due to an area developer not
previously reported.
NOTE E - CONTINGENCY
The Company and its parent company (Li'l Dino Management Corporation) have
jointly and severally guaranteed certain debt incurred by Triad Subs, Inc., an
affiliated company, to an unrelated third party. Triad Subs, Inc. is an inactive
corporation and does not have any assets available to satisfy this debt which
amounts to approximately $135,000 at October 31, 1997, including unpaid interest
that has accrued on the outstanding balance. On January 26, 1998, under the
terms of the note agreement, the payee demanded immediate and full payment of
all amounts due.
F-60
<PAGE>
LI'L DINO CORPORATION
NOTES TO FINANCIAL STATEMENTS
October 31, 1997
NOTE E - CONTINGENCY (Continued)
Pursuant to the proposed sale of all the Li'l Dino Corporation common stock to
an unrelated third party, the parent company has entered into an agreement with
Li'l Dino Corporation indemnifying the Company against any losses incurred as a
result of the Company's guarantee. In consideration of this indemnification
agreement with its parent company, no liability has been recognized in the
Company's financial statements at October 31, 1997 in conjunction with this
guarantee.
<TABLE>
<CAPTION>
Pastry Product Producers, LLC
Balance Sheet
June 30, 1997 and December 31, 1996 (Unaudited)
F-61
<PAGE>
Assets
June 30, 1997 Dec. 31, 1996
Current Assets:
<S> <C> <C>
Cash $ 3,264 $ 3,326
Accounts Receivable-Net 81,317 75,455
Prepaid Expenses 0 5,000
Total Current Assets 84,581 83,781
Property and Equipment (Note A):
Machinery and Equipment 218,250 218,250
Delivery Vehicles 13,180 13,180
Real Estate & Improvements 184,502 184,502
Total Cost of Property and Equipment 415,932 415,932
Less Accumulated Depreciation (105,113) (105,113)
Property and Equipment (Net) 310,819 310,819
Other Assets:
Organization Costs 8,680 8,680
Capitalized Franchise Fees (Note D) 1,655,564 1,655,564
Total Other Assets 1,664,244 1,664,244
Total Assets $ 2,059,644 $ 2,058,844
</TABLE>
See Notes to Financial Statements
F-62
<PAGE>
<TABLE>
<CAPTION>
Pastry Product Producers, LLC
Balance Sheet
June 30, 1997 and December 31, 1996 (Unaudited)
Liabilities and Stockholder's Equity
June 30, 1997 Dec. 31, 1996
Current Liabilities:
<S> <C> <C>
Accounts Payable $ 8,306 $ 0
Current Portion of Long Term Debt 66,550 49,834
Total Current Liabilities 74,856 49,834
Deferred Franchise Contract Income (Note D) 1,655,564 1,655,564
Long Term Debt (Note C) 0 26,550
Stockholders' Equity:
Stockholders' Equity 329,224 326,896
Total Liabilities and Stockholder's Equity $ 2,059,644 $ 2,058,844
</TABLE>
See Notes to Financial Statements
F-63
<PAGE>
<TABLE>
<CAPTION>
Pastry Products Producers, LLC
Statement of Operations and Stockholders' Equity
For the Six Months Ended June 30, 1997 and 1996 and
the Years Ended December 31, 1996 and 1995 (Unaudited)
June 30, 1997 June 30, 1996 Dec. 31, 1996 Dec. 31, 1995
Sales
<S> <C> <C> <C> <C>
Cost of Sales: $ 454,989 $ 185,595 $ 708,296 $ 93,784
Materials and Supplies 183,996 64,729 178,795 36,282
Gross Profit 270,993 121,866 529,501 57,502
Selling, General and
Administrative Expenses 221,029 130,403 539,438 57,502
Income (Loss) Before Other
Income and Income Taxes 49,964 (8,537) (9,937) 0
Other Income:
Gain on Sale of Equipment 0 0 300 0
Income (Loss) Before Taxes 49,964 (8,537) (9,637) 0
Income Taxes (Note B) 0 0 0 0
Net Income (Loss) 49,964 (8,537) (9,637) 0
Stockholders' Equity -Beginning of Year 326,896 231,625 231,625 0
Capital Contributions
net of Repayments (47,636) 0 104,908 231,625
Stockholders' Equity - End of Year $ 329,224 $ 223,088 $ 326,896 $ 231,625
</TABLE>
See Notes to Financial Statements
F-64
<PAGE>
<TABLE>
<CAPTION>
Pastry Product Producers, LLC
Statements of Cash Flows
For the Six Months Ended June 30, 1997 and 1996 and
the Years Ended December 31, 1996 and 1995 (Unaudited)
June 30, 1997 June 30, 1996 Dec. 31, 1996 Dec. 31, 1995
Operating Activities:
<S> <C> <C> <C> <C>
Net Income (Loss) $ 49,964 $ (8,537) $ (9,637) $ 0
Adjustments to reconcile net
income to net cash provided
by operating activities:
Depreciation and amortization 0 0 38,294 0
Changes in operating assets
and liabilities:
(Increase) Decrease in
accounts receivable (5,862) (9,301) (75,455) (13,288)
(Increase) in prepaid expenses 5,000 0 (5,000) (4,000)
Increase in current liabilities 25,022 19,941 0 7,689
Total Cash Provided by Operating
Activities 74,124 2,103 (51,798) (9,599)
Investing Activities:
Purchase of equipment 0 0 0 (361,815)
Payment of Organization Costs Filing
Fees on Building 0 0 (10,811) 0
Cash Received on Sale of Equipment 0 0 157 0
Total Cash Used in Investing
Activities 0 0 (10,654) (361,815)
Financing Activities:
Increase in debt 0 0 0 375,176
Capital Contributions From Stockholders
(net of repayments) (47,636) 6,798 104,908 0
Principal payments on long term debt (26,550) 0 (42,892) 0
Total Cash Provided (Used) by
Financing Activities (74,186) 6,798 62,016 375,176
Increase (decrease) in cash (62) 8,901 (436) 3,762
Beginning cash 3,326 0 3,762 0
Ending Cash $ 3,264 $ 8,901 $ 3,326 $ 3,762
Other cash flow information -Interest paid $15,023
</TABLE>
See Notes to Financial Statements
F-65
<PAGE>
<TABLE>
<CAPTION>
Pastry Product Producers, LLC
Schedule of Selling, General and Administrative Expenses
Year Ended December 31, 1996 (Unaudited)
Year Ended
Dec. 31, 1996
<S> <C>
Commissions $ 37,547
Delivery 37,008
Depreciation and Amortization 38,294
Insurance 14,490
Interest 15,023
Legal and Accounting 2,176
Office and Miscellaneous 17,464
Payroll and Fringe Benefits 274,739
Real Estate Taxes 5,516
Repair and Maintenance (Facilities) 22,132
Sales Tax Portion of Lease Payments 4,886
Supplies 39,911
Telephone 4,222
Utilities & Water 26,030
</TABLE>
Total Selling, General and Administrative Expenses $ 539,438
See Notes to Financial Statements
F-66
<PAGE>
Pastry Product Producers, LLC
Notes to Financial Statements
Year Ended December 31, 1996
A. Summary of Significant Accounting Policies:
Property and Equipment. All property is stated at original cost less
accumulated depreciation. Depreciation is computed using the straight-line
method over the estimated useful life of the related assets as follows:
Bakery Equipment 7 years
Building & Improvements 39 years
Trucks 7 years
Depreciation expense is computed using IRS guidelines for the types of
assets owned by the Company. For the year ended December 31, 1996 depreciation
expense was $37,674.
B. Income Taxes:
In April of 1996 the Company converted its tax form of ownership from a
"C" corporation to a Limited Liability Corporation (LLC). New York State as well
as the U.S. Government taxes LLC's as partnerships. Partnerships, acting as a
flow through entity, normally do not incur any income tax. Therefore no
provision for income tax expense has been made.
C. Long Term Debt:
Long term debt consists of six separate financing arrangements made for
the acquisition of (and secured by) a substantial portion of the Company's
bakery equipment. Monthly payments total approximately $5,092. A summary of
maturities is as follows:
Year Ended Amount
December 31, 1997 $ 49,834
December 31, 1998 26,546
December 31, 1999 0
TOTAL $ 76,830
D. Contract Values/Deferred Income:
The Company has secured about 50 long term contracts for commitments of
a minimum amount of rolls & bagels to be delivered over a 10 year period. The
Company has computed the present value of these minimum deliveries over the 10
year period and reflected the corresponding value as an asset and deferred
income on the balance sheet.
F-67
<PAGE>
Cronin & Co.
Certified Public Accountants
12 Blandford Lane
Fairport, NY 14450
Board of Directors and Shareholders
Seawest Sub Shops, Inc.
Bellevue, WA
I have audited the accompanying balance sheet of Seawest Sub Shops, Inc. as of
December 31, 1996 and the related statements of income, cash flows and
stockholders' equity for the year then ended. The financial statements are the
responsibility of the directors. My responsibility is to express an opinion on
these financial statements based on my audit.
I conducted my audit in accordance with generally accepted auditing standards.
Those standards require that I plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
I believe that my audit provides a reasonable basis for my opinion.
In my opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Seawest Sub shops, Inc. as of
December 31, 1996 and the results of its operations, in cash flows and changes
in the stockholder's equity for the year then ended in conformity with the
generally accepted accounting principles.
The December 31, 1995 financial statements were audited by other auditors, whose
report dated March 22, 1996, state that the balance sheet and related statements
of operations and cash flows as of and for the years then ended, were presented
fairly and in conformity with generally accepted accounting principles applied
on a consistent basis.
July 13, 1997
Cronin & Co.
Certified Public Accountants
F-68
<PAGE>
<TABLE>
<CAPTION>
SEAWEST SUB SHOPS, INC.
BALANCE SHEETS
ASSETS
June 30 December 31,
1997 1996
Current Assets:
<S> <C> <C>
Cash and Cash Equivalents $ 24,424 $ 11,421
Receivables:
Trade 93,332 69,290
Employees 0 0
Related Parties 0 0
Inventories 76,262 3,561
Prepaid Expenses 5,000 5,179
Current Portion of Notes Receivable 4,397 59,265
Total Current Assets 203,415 148,716
Property & Equipment, Net of Accumulated
Depreciation (Note A) 64,241 64,241
Other Assets (Note B) 625,364 598,059
Total Assets $ 893,020 $ 811,016
LIABILITIES & STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts Payable $ 95,365 $ 146,118
Deposits from Franchisees 11,750 6,750
Accrued Expenses 170,327 31,470
Jreck Subs 54,000 0
Current Portion of Long Term Debt (Note C) 138,700 138,700
Total Current Liabilities 470,142 323,038
Long Term Debt (Note C) 402,004 402,004
Deferred Income (Note D) 100,000 100,000
Contingent Liabilities (Note F)
Stockholders' Equity:
Common Stock (No par value, 5,000,000 shares authorized
2,271,000 shares outstanding) 220,497 220,497
Retained Earnings (Deficit) (299,623) (234,523)
Total Stockholders' Equity (79,126) (14,026)
Total Liabilities & Stockholders' Equity $ 893,020 $ 811,016
</TABLE>
F-69
<PAGE>
<TABLE>
<CAPTION>
SEAWEST SUB SHOPS, INC.
STATEMENTS of OPERATIONS
Six Months Ended Fiscal Year Ended
June 30, December 31,
1997 1996 1996 1995
Revenue (Note A):
<S> <C> <C> <C> <C>
Initial Franchise Fees $ 0 $ 20,500 $ 41,000 $ 88,501
Continuing Franchise Fees 188,310 164,755 329,510 522,818
Territorial Franchising Rights 0 32,225 64,450 0
Marketing Fees 0 47,350 94,700 0
Marketing Co-op Rebates 0 37,792 75,583 0
Sales Generated by Corporate Operated
Sub Shops (Note G) 151,044 28,082 56,165 138,114
Total Revenues 339,354 330,704 661,408 749,433
Costs and Expenses Applicable to Sales Revenue:
Commissions on Sale & Resale of Franchises 0 6,811 13,622 29,281
Marketing and Advertising Expenditures 0 65,069 130,136 142,612
Food Costs Applicable to Sub Shop
Operations (Note G) 60,417 14,411 28,822 62,271
Total Costs & Expenses
Applicable to Sales 60,417 86,291 172,580 234,164
Gross Profit 278,937 244,413 488,828 515,269
Provision for Doubtful Accounts Receivable 33 0 20,177 64,515
Selling, General & Administrative Expenses 311,669 201,241 402,483 505,415
Income (Loss) From Operations (32,765) 43,172 66,168 (54,661)
Other Income:
Interest 3,924 10,668 21,335 35,416
Miscellaneous 1,750 24,027 48,056 36,099
Gains on Resale of Reacquired Stores 0 0 0 77,706
Other Expense:
Interest 5,009 11,281 22,562 50,305
Amortization of Intangibles 33,000 38,837 77,674 72,250
Losses on Store Repossessions and
Closures (Note G) 0 87,811 245,013 0
Total Other Income (Expense) (32,335) (103,234) (275,858) 26,666
Income (Loss) Before Income Taxes (65,100) (60,062) (209,690) (27,995)
Income Tax Expense (Benefit) (Notes E) 0 0 0 0
Net Income (Loss) $ (65,100) $ (60,062) $ (209,690) $ (27,995)
</TABLE>
F-70
<PAGE>
<TABLE>
<CAPTION>
SEAWEST SUB SHOPS, INC.
STATEMENTS OF CASH FLOWS
Six Months Ended Fiscal Year Ended
June 30, December 31,
1997 1996 1996 1995
Operating Activities:
<S> <C> <C> <C> <C>
Net Income (Loss) $ (65,100) $ (60,062) $ (209,690) $ (27,995)
Adjustments to Reconcile Net Income (Loss) to
Cash Provided (Consumed) by Operating Activities:
Depreciation and Amortization of
Intangible Assets 33,000 33,000 82,201 72,250
Write off Uncollectible Trade Accounts
Receivable 33 0 20,177 0
Loss on Sub Shops Sold/Closed 0 0 245,013 67,175
Expenses Recognized Through Issuance of
Common Stock 0 0 0 7,500
Changes in Operating Assets and Liabilities:
(Increase) Decrease in Accounts & Notes
Receivable (24,042) (27,366) 62,933 45,619
(Increase) Decrease in Other
Current Assets (17,654) 27,877 9,954 12,830
Increase (Decrease) in Accounts Payable &
Accrued Expenses 147,085 (20,212) 42,909 (37,326)
Net Cash Provided (Consumed)
by Operating Activities 73,322 (46,763) 253,497 140,053
Investing Activities:
Purchase of Property & Equipment 0 0 (28,070) (30,431)
Collections on Notes Receivable 0 16,806 82,962 0
Increases on Notes Receivable (60,319) 0 (201,500) 0
Net Cash Used in Investing Activities (60,319) 16,806 (146,608) (30,431)
Financing Activities:
Payments on Long Term Debt 0 0 (105,213) (108,847)
Financing Proceeds 0 0 0 0
Net Cash Provided (Used) by
Financing Activities 0 0 (105,213) (108,847)
Net Change in Cash 13,003 (29,957) 1,676 775
Cash & Cash Equivalents at the
Beginning of Period 11,421 9,745 9,745 8,970
Cash & Cash Equivalents at the
End of Period $ 24,424 $ (20,212) $ 11,421 $ 9,745
</TABLE>
See Notes to Financial Statements
F-71
<PAGE>
<TABLE>
<CAPTION>
SEAWEST SUB SHOPS, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Common Stock
Shares Amount
Additional Retained
Paid-In Paid-In Earnings
Capital Capital (Deficit)
<S> <C> <C> <C> <C> <C> <C>
December 31, 1993 2,162,000 $ 0 $ 157,917 $ 223,586
Issuance of Shares in Exchange for Cancellation of Debt 79,000 45,080
Issuance of Shares in Exchange for Professional Services 15,000 7,500
Net Loss December 31, 1994 (220,424)
December 31, 1994 2,256,000 0 212,997 (3,162)
Issuance of Shares in Exchange for Professional Services 15,000 7,500
Net Income December 31, 1995 (27,995)
December 31, 1995 2,271,000 0 220,497 (24,833)
Net Loss December 31, 1996 (209,690)
December 31, 1996 2,271,000 0 220,497 (234,523)
Net Loss for the Six Months Ended June 30, 1997 (65,100)
June 30, 1997 2,271,000 $ 0 $ 220,497 $ (299,623)
</TABLE>
See Notes to Financial Statements
F-72
<PAGE>
SEAWEST SUB SHOPS, INC.
NOTES TO FINANCIAL STATEMENTS
A. Summary of Significant Accounting Policies:
1. The Company was organized December 30, 1985. Current operations focus
primarily servicing is chain of franchised submarine sandwich shops (known as
"Sub Shops") as the parent franchising organization. The Company sells franchise
rights, primarily in and around the Seattle area, and provides guidance and
assistance to the franchisees in areas such as the preparation, packaging and
sale of products; purchasing equipment; marketing and administrative support and
conducting employee training programs.
2. Revenue and Expense Recognition: Continuing franchise fee revenue is
recognized quarterly, monthly or weekly and is charged to the franchisees at 5%
of franchise net sales (a monthly or quarterly flat fee is required in
agreements made prior to 1992). Initial Franchise Fee revenue is recognized upon
the execution of the Franchise Agreement and is generally nonrefundable. In
addition to the continuing franchise fees, franchisees are required to remit 2%
of their sales in the form of a pooled marketing contribution. The Company has
no "Trust Fund" obligation with respect to these funds and, accordingly,
recognizes this form of revenue in the period in which the franchise obligation
becomes due and payable. The Company also receives marketing incentives, in the
form of rebates, from its major suppliers. Expenses, including
advertising/marketing, are charged to operations as incurred.
3. Property & Equipment are recorded on the basis of cost. Depreciation is
computed using either the straight-line method or double declining balance
method over the estimated useful lives of the assets. Depreciation expense for
the year ended December 31, 1996 was $4,527. Expenditures for renewals and
betterments are capitalized. Expenditures for repairs and maintenance are
charged to operations as incurred. Gain or loss upon sale or retirement due to
obsolescence is reflected in the operating results in the period the event takes
place.
B. Other Assets:
Other Assets consist of a 10 year covenant not to compete from former
shareholders pursuant to a 1991 stock sale agreement (see note C-1). The
covenant is amortized annually at a rate exactly equal to annual principal
reductions in the corresponding obligations to the former shareholders as
reflected in long-term debt; notes receivable on the sale/resale of its stores
and a 5 year non-compete covenant arising from the acquisition of 7 stores in
1993. This covenant is being amortized over the 5 year period.
F-73
<PAGE>
SEAWEST SUB SHOPS, INC.
NOTES TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
June 30, 1997 Dec. 31, 1996
Description of Asset:
<S> <C> <C>
Notes Receivable $ 373,047 $ 342,734
Less Valuation Allowance 124,379 124,739
Net Realizable Value of Notes Receivable 248,668 217,995
Equipment Lease Security Deposits 9,981 9,981
Corporate Covenant Not to Compete 700,000 700,000
Store Covenants Not to Compete 58,369 58,369
Less Accumulated Amortization 362,021 329,021
Net Carrying Value of Non-Compete Covenants 396,348 429,348
Total Other Assets 654,997 657,324
Less Current Portion of Notes Receivable 29,633 59,265
Total $ 625,364 $ 598,059
</TABLE>
C. Long Term Debt:
1. Due to Former Shareholders: On February 25, 1991 a stock purchase and sale
agreement was executed between Messrs. Kane & Isemen (the former shareholders
and sellers) and Mitchell Day (the current majority shareholder and purchaser).
This agreement bound the Company to pay $700,000 over 10 years for a 10 year
covenant not to compete from the former shareholders. The Notes are non-interest
bearing and are secured by the pledged stock of the purchaser. Minimum payments
over the 10 year period of the covenant are as follows:
PERIOD AMOUNT
April 1, 1991 - March 31, 1996 $ 4,000/Month
April 1, 1996 - March 31, 2001 $ 6,000/Month
May 1, 2001 $ 100,000
2. Note Payable - Graham & Dunn: On March 26, 1996 the Company converted unpaid
legal fees in the amount of $35,524 to an unsecured promissory note in the
amount of $20,524. The note bears interest at 12% and is payable over 16 months
commencing April 1, 1996.
F-74
<PAGE>
SEAWEST SUB SHOPS, INC.
NOTES TO FINANCIAL STATEMENTS
3. Note Payable - Sternfeld: Arising from the settlement of a lawsuit in 1993,
the note is unsecured, payable in monthly installments of $1,000 and bear
interest at 12%.
4. Notes Payable on Store Reacquisitions: The Company engages in the
repossession, acquisition, reacquisition and resale of franchised Sub Shops
Stores from time to time. As a result of this activity, the Company may be
obligated to assume certain debts of the repossessed store or will incur an
obligation upon the outright purchase of a Sub Shop Store. These notes are
services by the Corporation during its term of ownership and may be secured by
certain equipment or be unsecured. The capitalized costs associated with the
acquisition of a store are reflected as an asset. Upon the subsequent sale or
closure of a store, these costs are treated as a reduction in the total amount
realized or as charge against earnings in the period the store is closed.
<TABLE>
<CAPTION>
A summary of obligations is as follows:
June 30, 1997 Dec. 31, 1996
Description of Obligation:
<S> <C> <C>
Due to Former Shareholders $ 406,000 $ 406,000
Graham & Dunn 11,707 11,707
Sternfeld 24,428 24,428
Payable on Store Reacquisitions 98,569 98,569
540,704 540,704
Less Current Portion 138,700 138,700
Total Long Term Debt $ 402,004 $ 402,004
</TABLE>
Five Year Maturities For Fiscal Years Ending December 31 Are As Follows:
1997 $ 138,700
1998 98,088
1999 78,837
2000 78,379
2001 79,056
2002 and After 67,644
Total $ 540,704
D. Deferred Income:
F-75
<PAGE>
SEAWEST SUB SHOPS, INC.
NOTES TO FINANCIAL STATEMENTS
In 1996 the Company sold territory franchise rights covering Japan. The
contract calls for 3 annual installments of $50,000 each payable in November
1996, 1997 and 1998. Seawest has received the 1996 payment and recognized
$50,000 as income on the 1996 financial statements. Management has elected to
defer recognition of income on the balance until collection can be reasonably
assured.
E. Income Taxes:
The Corporation has net operating loss carryforwards available of
$317,690 that may be used to offset future taxable income. These carryforwards
begin to expire in the fiscal year ending December 31, 2011. The deferred tax
benefit arising from these loss carryforwards has been fully reserved.
F. Leases, Commitment and Contingent Liabilities:
The Company rents its current office space under a month to month
agreement. Rent expense for the year ended December 31, 1996 was $17,628. In
addition to its corporate offices, the Company pays rent on corporately owned
and operated Sub Shops and make payments on store equipment leases while these
stores are under corporate management. Store rent and equipment lease expense
for 1996 was $33,156. The Company is also contingently liable for equipment &
facility leases and rents as part of its franchise agreements.
Contingent future minimum lease payments are as follows:
1997 $ 213,376
1998 120,801
1999 121,672
2000 100,609
2001 50,146
$ 606,604
The Company is currently a defendant in several lawsuits and has 3
items in arbitration. Approximately 16 stores have asserted claims of franchisee
discrimination under the Franchise Investment Protection Act and are seeking a
recision of the franchise agreement along with damages in an unspecified sum.
Settlement discussions are likely whereby all parties will agree to dismiss
their respective claims without cost. Seawest is reviewing a $20,000 offer in
settlement of a store lease guarantee claim of $34,222. The Company is also a
defendant in several other legal actions regarding store lease breaches and
guarantees aggregating in the amount of $364,795. Management is unable to
estimate the amount of loss, if any, on these lease guarantees.
F-76
<PAGE>
SEAWEST SUB SHOPS, INC.
NOTES TO FINANCIAL STATEMENTS
G. Franchises Sold, Purchased or Operated:
During 1996 the Company wrote off the carrying value of 5 stores
previously sold for a total amount of $242,045. These write offs were the result
of store closures and the subsequent default on notes receivable. The Company
resold 1 store in its inventory for $18,000 realizing a loss of $2,968. Seawest
currently operates 1 store due to a foreclosure in July 1996. Summary operating
results of franchisor operated stores for 1996 are:
Sales $ 56,165
Food Costs 28,822
Gross Profit 27,343
Operating Expenses 56,014
Net Loss $ (28,671)
F-77
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors
Quality Franchise Systems, Inc. and Subsidiary
We have audited the accompanying consolidated balance sheets of Quality
Franchise Systems, Inc. and Subsidiary as of December 31, 1996, and the related
consolidated statements of operations, shareholders' equity (deficit), and cash
flows for the year then ended. 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 audit. The financial statements of
Quality Franchise Systems, Inc. as of December 31, 1995 and for each of the two
years ended December 31, 1995, were audited by other auditors whose report dated
March 26, 1996, expressed an unqualified opinion on those statements.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that out audit provides 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 Quality Franchise
Systems, Inc. and Subsidiary as of December 31, 1996, and the results of their
operations and their cash flows for the year then ended, in conformity with
generally accepted accounting principles.
Grant Thornton LLP
Sacramento, California
March 7, 1997
F-78
<PAGE>
<TABLE>
<CAPTION>
Quality Franchise Systems, Inc. and Subsidiary
Consolidated Balance Sheet
September 30, 1997 (Unaudited) and December 31, 1996
ASSETS
1997 1996
<S> <C> <C>
Cash $ 125,233 $ 126,089
Royalties receivable, net 114,028 160,792
Current portion of area development fees receivable 10,795 25,991
Other current assets 8,040 25,110
Total current assets 258,096 337,982
Interest-bearing deposit in bank 0 750,000
Notes and long-term royalties receivable, net 0 24,481
Area development fees receivable, less current portion 38,562 348,424
Deferred financing costs, net 38,635 63,805
Franchising rights, contracts and trademarks, net 203,278 249,910
Merger costs (Jreck Subs Group, Inc.) 64,777 0
Investment in restaurant 0 45,001
Furniture and equipment, net 9,622 41,840
$ 612,970 $1,861,443
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued expenses $ 527,934 $ 633,595
Current portion of notes payable 6,667 26,545
Notes payable to shareholders 172,850 312,850
Deferred franchise fees 20,000 70,000
Total current liabilities 727,451 1,042,990
Deferred area development fees 74,500 424,500
Convertible notes payable 530,000 530,000
Total liabilities 1,331,951 1,997,490
Shareholders' Equity (Deficit):
Preferred stock ($.001 par value, 2,000,000 shares
authorized, 545 shares issued and outstanding) 1 1
Common stock ($.001 par value, 10,000,000 shares
authorized, 353,650 shares issued and outstanding) 354 354
Class B common stock ($.001 par value, 10,000,000 shares
authorized, 2,229,496 and 2,464,100 shares issued and
outstanding) 2,229 2,464
Additional paid-in capital 1,859,472 2,588,845
Accumulated deficit (2,581,037) (2,563,003)
Treasury stock, at cost, 73,204 shares 0 (164,708)
Total shareholders' equity (deficit) (718,981) (136,047)
$ 612,970 $1,861,443
</TABLE>
See notes to consolidated financial
statements.
F-79
<PAGE>
<TABLE>
<CAPTION>
Quality Franchise Systems, Inc. and Subsidiary
Consolidated Statement of Operations
For the Nine and Three Months Ended September 30, 1997 and 1996 (Unaudited)
Nine Month Ended Three Months Ended
September 30, September 30,
1997 1996 1997 1996
Revenue:
<S> <C> <C> <C> <C>
Franchise royalties $ 905,337 $ 848,897 $ 315,787 $ 311,776
Initial franchise and transfer fees 160,260 111,000 80,260 10,000
Area development fees 45,000 171,987 (15,000) (70,153)
Vendor funds 229,850 101,496 138,005 44,311
Other 137,591 93,346 57,491 32,335
1,478,038 1,326,726 576,543 327,909
Expenses:
General and administrative 496,581 636,093 157,846 233,430
Restaurant servicing and area developer
share of fees 581,553 600,020 208,269 246,042
Area development expense 43,125 364,664 (23,079) 126,294
Other 46,751 46,381 26,828 14,498
1,168,010 1,647,158 369,864 620,264
Operating income (loss) 310,028 (320,432) 206,679 (292,355)
Other income (expense):
Loss from operation and (84,010) (23,807) (8,361) (23,807)
disposition of restaurant
Business expansion expense (98,630) - (98,630) -
Interest expense (92,430) (121,247) (32,642) (33,332)
Net income (loss) $ 34,958 $ (465,486) $ 67,046 $ (349,494)
Preferred stock dividends (52,992) (21,957) (17,858) (17,550)
Net income (loss) to common shareholders $ (18,034) $ (487,443) $ 49,188 $ (367,044)
</TABLE>
See notes to consolidated financial
statements.
F-80
<PAGE>
<TABLE>
<CAPTION>
Quality Franchise Systems, Inc. and Subsidiary
Statement of Cash Flows
For the Nine Months Ended September 30, 1997 and 1996 (Unaudited)
1997 1996
Cash Flows from Operating Activities:
<S> <C> <C>
Net loss $ (18,034) $(487,443)
Adjustments to Reconcile Net Loss to Net
Cash Provided by Operating Activities:
Provision for uncollectible amounts and write-offs 84,481 50,000
Amortization of discount on non-interest bearing notes 27,514 31,823
Amortization and depreciation expense 61,176 49,198
Increase in current and long-term royalties receivable (13,236) (80,076)
(Increase) decrease in area development fees receivable (24,942) 28,159
(Increase) decrease in other current assets 17,070 (26,999)
Increase (decrease) in accounts payable and accrued (105,661) 11,970
expenses
Increase (decrease) in deferred area development fees - 304,500
Increase (decrease) in deferred franchise fees (50,000) (25,000)
Net Cash Used in Operating Activities (21,632) (143,868)
Cash Flows from Investing Activities:
Net increase (decrease) in interest-bearing deposit 750,000 (800,000)
Merger costs (64,777)
Investment in restaurant 45,001 (45,508)
Sale (purchase) of equipment 17,674 (20,021)
Net Cash Provided (Used) in Investing Activities 747,898 (865,529)
Cash Flows from Financing Activities:
Issuance (repurchase) of common stock 564,900 805,000
Issuance of preferred stock for cash and conversion of
notes payable, net of costs - 8,716
Payments on notes payable (22,222) (22,222)
Borrowings (repayment) of notes payable to shareholders (140,000) 90,000
Net Cash Provided by (Used in) Financing Activities (727,122) 881,494
Net Increase (Decrease) in Cash (856) (127,903)
Cash at Beginning of Period 126,089 193,848
Cash at End of Period $125,233 $ 65,945
</TABLE>
The accompanying notes are an integral part of
these statements.
F-81
<PAGE>
NOTE A - ORGANIZATION AND NATURE OF BUSINESS
Quality Franchise Systems, Inc. (the "Company"), a Delaware corporation was
formed on February 10, 1995. On February 15, 1995, the Company was merged
with Q & S Management with the Company being the surviving entity.
Shareholders of Q & S Management are now the shareholders of the Company.
Quality Marketing Systems, Inc., a Delaware corporation, is a wholly-owned
subsidiary of the Company. It commenced operations on June 5, 1996 and was
formed to operate the Mountain Mike's Pizza restaurant in Boulder, Colorado
which was subsequently sold in April 1997.
Quality Franchise Systems, Inc. and Subsidiary
Notes to Consolidated Financial Statements
September 30, 1997 (Unaudited) and December 31, 1996
On April 1, 1996, the Company filed a Restated Certificate of Incorporation
which increased its authorized shares of capital stock from 10,000,000
shares to 22,000,000 shares consisting of 2,000,000 shares of Preferred
Stock, 10,000,000 shares of Common Stock and 10,000,000 shares of Class B
Common Stock. All existing shareholders of the Company's capital stock at
April 1, 1996 became shareholders of the Company's Class B Common Stock. In
addition, at any time prior to July 2, 1996, each Class B Common Stock
shareholder could convert each share of Class B Common Stock into 1.1
shares of Common Stock. The shareholders of Class B Common Stock are
entitled to one vote per share and the shareholders of Common Stock are
entitled to one-tenth of one vote per share. Shareholders for 321,500
shares of Class B Common Stock converted to 353,650 shares of Common Stock.
The Company is a franchisor which enters into franchise agreements with
various franchisees to own and operate pizza restaurants, within defined
territories, under the name of Mountain Mike's Pizza. There are 75 and 71
franchised restaurants at September 30, 1997 and December 31, 1996,
respectively. The Company also enters into agreements with area developers
whereby the developer performs substantially all of the Company's
obligations under the franchise agreement in exchange for a portion of the
initial franchise fee and ongoing franchise royalties. These agreements
generally provide for the area developer to open a specified number of
franchises in each 12 month period in order for the agreement to remain in
force.
The Company is expanding into other national regions; however, the Company
currently derives substantially all of its revenues from restaurants
operating in the state of California.
NOTE B - SUMMARY OF ACCOUNTING POLICIES
1. Principles of consolidation
The consolidated financial statements include the accounts of Quality
Franchise Systems, Inc. and its wholly-owned subsidiary Quality Marketing
Systems, Inc. All material intercompany accounts and transactions have been
eliminated.
2. Use of estimates
F-82
<PAGE>
Quality Franchise Systems, Inc. and Subsidiary
Notes to Consolidated Financial Statements
September 30, 1997 (Unaudited) and December 31, 1996
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the consolidated financial statements and the reported amounts of
revenues and expenses during the period. Actual results could differ from
those estimates.
3. Revenue recognition
Franchise royalties are generally between 4% and 5% of the individual
franchisee's monthly gross sales (i.e., sales less promotions and
discounts) and are recognized as income when earned.
Initial franchise fees are recognized as income when the Company has
completed substantially all of its obligations in opening the restaurant.
Initial franchise fees are $20,000 to first time franchisees and $10,000 to
existing franchisees opening another restaurant. Deferred franchise fees at
September 30, 1997 and December 31, 1996 are $20,000 and $70,000,
respectively, for unopened restaurants.
Fees received in exchange for area development agreements are recognized as
income when the Company has performed substantially all of the initial
services required under the area development agreement and has no further
obligations to perform services or refund any fees received from the
developer. Fees for area development agreements which are dependent on the
establishment of future franchises or for which collectibility is not
reasonably estimable are deferred and recognized as income when received.
4. Amortization
Amortization of franchising rights, contracts and trademarks (original
amount of $559,824) is provided on a straight-line basis over ten years.
Accumulated amortization at September 30, 1997 and December 31, 1996 is
$356,546 and $309,914, respectively.
5. Income Taxes
On June 5, 1996, the Company became a C corporation for purposes of
computing corporate Federal and state taxes. Prior to June 5, 1996, the
shareholders have elected to have the
F-83
<PAGE>
Quality Franchise Systems, Inc. and Subsidiary
Notes to Consolidated Financial Statements
September 30, 1997 (Unaudited) and December 31, 1996
Company taxed pursuant to subchapter S of the Internal Revenue Code which
provides that, in lieu of Federal corporate income taxes, the shareholders
recognize their proportionate share of the Company's taxable revenue and
deductible expenses on their individual tax returns. For California state
purposes a corporate tax is imposed on S corporations at the rate of 1.5%
of taxable income.
The Company utilizes an asset and liability approach in accounting for
income taxes. This approach requires the recognition of the deferred tax
liabilities and assets for the expected future tax consequences of
temporary differences between the financial statements carrying amounts and
tax basis of assets and liabilities. Deferred tax assets and liabilities
are reflected as currently enacted income tax rates applicable to the
period in which the deferred tax assets or liabilities are expected to be
realized or settled. As changes in tax laws or rates are enacted, deferred
tax assets and liabilities are adjusted through the provision for income
taxes.
6. Reclassifications
Certain amounts in the prior year's financial statements have been
reclassified to conform to the presentation used in the current year.
NOTE C - CASH/INTEREST BEARING DEPOSIT IN BANK
In connection with the issuance of the convertible notes payable in 1995,
there were provisions which designated certain uses of the proceeds. One
provision was to set aside one quarter's interest payment on the
convertible notes payable (see note E). Another provision was to reserve
funds sufficient for the amortizing payments on the Second Priority Note
(see note D). Restricted cash at September 30, 1997 for the interest
reserve and for the retirement of the Second Priority Note was $17,291 and
$6,667, respectively. The savings account of $750,000 at December 31, 1996
was pledged as collateral for a personal loan of the Company's chairman
(see note H).
NOTE D - NOTES PAYABLE
Notes payable consist of a Second Priority Note in the original amount of
$80,000. The Second Priority Note does not bear interest and is secured by
the assets of the Company. The Second Priority Note is payable in 36 equal
monthly installments with the last installment due in January 1998. The
unpaid balance on the second priority note is $6,667 and $28,889 at
September 30, 1997 and December 31, 1996, respectively. Unamortized
discount at September 30, 1997 and December 31, 1996 is $0 and $2,344,
respectively.
F-84
<PAGE>
Quality Franchise Systems, Inc. and Subsidiary
Notes to Consolidated Financial Statements
September 30, 1997 (Unaudited) and December 31, 1996
NOTE E - CONVERTIBLE NOTES PAYABLE/CONVERTIBLE PREFERRED STOCK
In 1995, the Company issued $1,025,000 of promissory notes in conjunction
with the Company's private placement including the conversion of a $100,000
note payable to a shareholder (see note H). The promissory notes are due on
March 24, 2000 and are secured by 22 specific franchise agreements of the
Company. The promissory notes call for interest at 12.75% payable quarterly
and are convertible into Class B Common Stock of the Company at $5.48 per
share.
The proceeds from the promissory notes less offering commissions and
expenses were used to retire indebtedness associated with the Company's
1991 acquisition of the "Mountain Mike's Pizza" restaurant chain and for
working capital purposes.
In connection with the issuance of the convertible promissory notes, the
Company granted the placement manager the right to purchase 18,704 shares
of the Company's Class B Common Stock at a price equal to $5.48 per share
at any time prior to December 5, 1997.
In 1996, the Company offered its convertible note holders to exchange their
notes for convertible preferred stock. The Company offered one share of its
Series A preferred stock for each $1,000 principal of notes. The Series A
preferred stock has a cumulative dividend rate of 13% and each $1,000
principal is convertible into 287.36 shares of the Company's Class B Common
Stock or 316.09 shares of Common Stock. On June 5, 1996, 495 shares of the
Company's Series A preferred stock were issued in exchange for $495,000 of
promissory notes. In July 1996, the Company issued 50 shares of its Series
A preferred stock for $50,000.
NOTE F - INCOME TAXES
At December 31, 1996, the Company has accumulated net operating losses of
approximately $370,000. These losses can be carried forward and applied
against future income of the Company for federal and state income tax
purposes. The net operating losses will begin to expire in 2011. Management
has provided a valuation allowance for the net deferred tax asset due to
their assessment that this asset will "more likely than not" not be
realized.
Deferred taxes at December 31, 1996 are as follows:
F-85
<PAGE>
Quality Franchise Systems, Inc. and Subsidiary
Notes to Consolidated Financial Statements
September 30, 1997 (Unaudited) and December 31, 1996
<TABLE>
<CAPTION>
Deferred tax assets:
<S> <C>
Net operating loss carryforwards $ 148,800
Accounts payable and accrued liabilities 253,400
Franchise fees collected 28,000
430,200
Deferred tax liabilities:
Royalties receivable and other (84,200)
Depreciation (3,000)
(87,200)
Net deferred tax asset 343,000
Valuation allowance (343,000)
$ -
</TABLE>
NOTE G - EMPLOYEE SAVINGS PLAN
The Company has an employee savings plan in which any eligible employee may
participate. The plan is a defined contribution plan 401(k) qualified under
the Internal Revenue Code. The Company made no discretionary contributions
to the plan in 1997, 1996 and 1995.
NOTE H - RELATED PARTY TRANSACTIONS
In May 1995, the Company amended its personal services contract with a
shareholder and the former president which contract was originally entered
in September 1993. Under the terms of the amended contract, the Company
engages the former president to provide consulting services to develop the
"Mountain Mike's" Pizza restaurant chain and compensates the former
president through a base monthly fee and a portion of certain other fees
collected by the Company. For the years ended December 31, 1996 and 1995,
the Company paid $84,000 and $109,733, respectively, to the former
president under the personal services contract. In 1997, the Company and
the former president mutually agreed to cancel the personal services
contract.
The Company had expended amounts and provided services to the former
president and companies controlled by the former president. In April 1995,
the Company and the former
F-86
<PAGE>
Quality Franchise Systems, Inc. and Subsidiary
Notes to Consolidated Financial Statements
September 30, 1997 (Unaudited) and December 31, 1996
president agreed that the total amounts due to the Company including those
due from companies controlled by the former president was $164,708. In
April 1995, the Company acquired 73,204 shares of Class B Common Stock
owned by the former president at $2.25 per share for satisfaction of the
amounts due to the Company by the former president.
The Company has a month-to-month agreement with a shareholder to provide
general consulting services to the Company. The Company paid the
shareholder $84,000 in each of the two years ended December 31, 1996 for
consulting services.
Notes payable to shareholder of $172,850 at September 30, 1997 are payable
to the president of the Company and bears interest at 10%. In connection
with the merger of the Company with and into Admiral's Fleet, Inc., a
Washington corporation (and wholly-owned subsidiary of Jreck Subs Group,
Inc. ("JSGI"), the president accepted JSGI stock for satisfaction of this
note.
The Chairman of the Company personally obtained an $800,000 loan from a
bank with which he acquired 230,000 shares of the Company's Class B Common
Stock at $3.50 per share on June 4, 1996. The Company had pledged as
collateral a $750,000 savings account for the Chairman's loan. In September
1997, the Chairman returned 161,400 shares of the Company's Class B Common
Stock.
NOTE I - COMPANY-OPERATED RESTAURANT
In June 1996, the Company's wholly-owned subsidiary, Quality Marketing
Systems, Inc.
began operating a restaurant in Boulder, Colorado which was sold in April
1997.
From June 5, 1996 through December 31, 1996, the restaurant had a net loss
of approximately $70,100. For the period January 1, 1997 until the
restaurant was sold in April 1997, the restaurant had a net loss of
approximately $77,400 which included the loss on disposition.
F-87
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM THE STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 1997 AND AS OF
DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0001018725
<NAME> JRECK SUBS GROUP, INC.
<MULTIPLIER> 1
<CURRENCY> US dollars
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> Dec-31-1997
<PERIOD-START> Jan-01-1997
<PERIOD-END> Dec-31-1997
<EXCHANGE-RATE> 1
<CASH> 427,420
<SECURITIES> 0
<RECEIVABLES> 559,728
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 1,718,358
<PP&E> 1,930,990
<DEPRECIATION> 334,410
<TOTAL-ASSETS> 16,489,212
<CURRENT-LIABILITIES> 7,048,945
<BONDS> 0
0
2,120,000
<COMMON> 17,729,478
<OTHER-SE> (12,751,358)
<TOTAL-LIABILITY-AND-EQUITY> 16,489,212
<SALES> 2,575,459
<TOTAL-REVENUES> 0
<CGS> 552,940
<TOTAL-COSTS> 9,798,081
<OTHER-EXPENSES> 429,036
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (484,769)
<INCOME-PRETAX> (7,651,658)
<INCOME-TAX> (389,957)
<INCOME-CONTINUING> (8,041,615)
<DISCONTINUED> 0
<EXTRAORDINARY> (862,029)
<CHANGES> 0
<NET-INCOME> (8,041,615)
<EPS-PRIMARY> (.82)
<EPS-DILUTED> (.82)
</TABLE>
