U.S. Securities and Exchange Commission
Washington, D.C, 20549
Form 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 For the year ended December 31, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from _________ to _______________
0-23545
-----------------
Commission File Number
JRECK Subs Group, Inc.
--------------------------
(Exact name of small business issuer as Specified in Its charter)
Colorado 84-1317674
- ------------------------------- ------------------------------------
(State or other jurisdiction of (IRS Employer Identification Number)
Incorporation or organization
2101 West State Road 434, Suite 100, Longwood, Florida, 32779
----------------------------------------------------------------
(Address of principal executive offices)
(407) 682-6363
---------------------
(Issuers telephone number including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, No Par Value
Check whether the issuer (1) flied all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form and no disclosure will be contained, to
the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB [ ]
The Registrant' revenue for the fiscal year ended December 31, 1998: $5,990,544.
The aggregate market value of the voting and non-voting common equity held by
non-affiliates (computed by reference to the price at which the common equity
was sold, or the average bid and asked price of such common equity) at June 30,
1999 was $5,673,503 (for purposes of the foregoing calculation only, each of the
registrant's officers and directors is deemed to be an affiliate).
There were 27,653,268 shares of the registrant's common stock outstanding as of
June 30, 1999.
DOCUMENTS INCORPORATED BY REFERENCE:
Transitional Small Business Disclosure Format: Yes [ ] No [X]
<PAGE>
PART I
Item 1. Description of Business.
Form and Year of Organization
In May, 1996 the Company concluded a reverse acquisition wherein all of its
capital stock was acquired by Circa Media, Inc., a Colorado corporation,
incorporated on July 19, 1995 and formerly engaged in reproducing archival,
public domain art and photographs in digital form. Pursuant to an agreement and
Plan of Reorganization between JRECK Subs, Inc. and Circa Media, Inc., Circa
Media, Inc. changed its name to JRECK Subs Group, Inc. (the Company) on May 7,
1996 and the former shareholders of JRECK Subs, Inc. received 5,000,000 common
shares of the Company in the transaction or 56% of the outstanding shares. In
addition the former Series A Preferred shareholders of JRECK Subs, Inc. received
700,000 shares of the Company's Series A Preferred Stock. The former business of
Circa Media, Inc. was discontinued.
The Company grew through acquisitions in 1997 and 1998 and now consists of JRECK
Subs Group, Inc. (JRECK) and its wholly owned subsidiaries as follows:
- --------------------------------------------------------------------------------
State of Predominant
Corporation Name Incorporation Restaurant Concept
- ---------------- ------------- ------------------
JRECK Subs, Inc. New York "JRECK Subs", "Lox, Stox & Bagel"
Admiral's Fleet, Inc. Washington "Georgio's"/"Mountain Mike's"
Admiral Subs Group, Inc. Washington "Seawest Sub Shops"
Little King, Inc. Delaware "Little King"
SBK Franchise Systems, Inc. Florida "Sobik's"
Li'l Dino Corporation North Carolina "Li'l Dino"
Pastry Product Producers, LLC New York Bakery Operations
- --------------------------------------------------------------------------------
Recent Acquisition
In March of 1998 the Company acquired Li'l Dino Corporation, a 43-unit sandwich
shop franchisor located in North Carolina. The Company paid the purchase price
of $2,400,000 by assuming $400,000 in existing bank debt and issuing 735,294
common shares valued at $2.72 per share. The Company also issued 43,290
additional shares valued at $100,000 to two individuals as brokerage fees for
their assistance in arranging the transaction.
General Description of Business
The Company is a multiple concept franchisor of submarine sandwich restaurants
and sit-down pizza restaurants. Through its concepts, JRECK Subs Group, Inc.
offers a menu of high quality, fresh submarine sandwiches, soups and hot and
cold side order items, a full range of gourmet pizza selections and a full line
of bagel offerings at selected franchise locations.
Submarine Sandwich Menu and Stores
Through six of its subsidiaries, JRECK offers a lunch and dinner menu of
different submarine sandwiches, soups and hot and cold side orders as well as a
line of bagels and additional breakfast items. JRECK'S submarine shop philosophy
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 cleanliness and
freshness. The food preparation process is designed to deliver a completed food
order within 60 seconds. Sandwich menu prices range from $2.50-$5.95. In
addition, JRECK offers a selection of soft drinks, deep fried mushrooms, cheese
sticks and french fries as well as dessert items such as cookies. Certain
restaurant concepts also offer signature rolls baked fresh on the premises.
As of December 31, 1998 there was an aggregate of 200 franchised locations under
various submarine sandwich concepts as follows:
2
<PAGE>
Concept: Number of Units Geographic Area
"JRECK Subs", "Lox, Stox & Bagel" 47 Upstate New York
"Sub Shops"/"Georgio's" 47 Pacific Northwest
"Little King" 28 Nebraska
"Sobik's" 40 Central Florida
"Li'l Dino" 38 Central North Carolina
Each location is designed as a "dine in" location (with many offering a drive up
window). Restaurants range in size from 1,000 square feet to 2,000 square feet
(1,400 to 1,500 square feet being typical), and are located in strip shopping
centers, shopping malls and free standing buildings.
As is typical in sandwich shops, the majority of store sales occur during lunch
with the balance during the dinner hours. Dine in and take out (including
delivery) comprise 60% and 40% of sales respectively. Individual franchisees may
also offer catering services for special events and also may provide a full line
of products on a temporary site basis by utilizing authorized mobile facilities.
Each franchisee leases or owns its own store facilities. Neither the Company,
nor any of its affiliates, engage in leasing any store premises to any
franchisees.
Pizza Menu and Stores
Mountain Mike's provides high quality, fresh (never frozen) pizza made of the
finest ingredients available in the industry. Mountain Mike's uses only whole
milk mozzarella cheese, natural casing pepperoni and fresh "made in store daily"
pizza dough. The dough is never frozen and is always used the day it is made.
This gives Mountain Mike's pizza the "Signature Dough" quality for which it is
famous. Among Mountain Mike's pizzas are specialties such as the "Classic
Pepperoni", the "Robber's Roost" (tangy garlic chicken), or the mountain sized
"Mt. Everest", over five pounds of pizza with 8 toppings. Mountain Mike's has
been a regional innovator in the pizza industry for over 20 years.
The Mountain Mike's locations are designed for casual family dining in a fun
filled environment. The restaurants have large screen TV's, a children's game
room, and a menu offering pizza, salad bar, sandwiches, beer, wine and soft
drinks. Restaurants range in size from 2,500 square feet to 4,500 square feet
and typically seat 80-120 diners. Each franchisee leases or owns its own store
facilities. Neither the Company, nor any of its affiliates, engage in leasing
any of these store premises to any franchisees.
Mountain Mike's offers take out and delivery of its complete menu and currently
derives approximately 35%-40% of its revenue from such sales.
As of December 31, 1998 there was 73 franchised locations under the pizza
concept as follows:
Concept: Number of Units Geographic Area
-------- --------------- ---------------
"Mountain Mike's" 73 Northern California
Franchise Programs
Through the terms of its "Franchise Agreement" the Company authorizes
individuals and/or companies to form or establish and operate concept
restaurants at approved locations. Under the agreement, the Company is obligated
to provide certain services both for the opening of, and the ongoing support of,
each restaurant. Those services generally include:
- review and approval of restaurant location
- review and approval of plans and layout design
- identification of sources of supply of food purveyors and
other suppliers
- provide an operations manual with respect to service
guidelines and restaurant management techniques
- provide initial and ongoing training in acceptable methods
of operations, food preparation techniques, management
controls, accounting functions, legal framework of
restaurant operations, human resources, promotional programs
and public relations
- provide ongoing support with respect to maintaining quality
products and insuring such products are offered at
competitive prices
- perform ongoing consistency and quality inspections of
restaurants in order to maintain uniform acceptable
standards
3
<PAGE>
As of December 31, 1998 the Company had a combined 273 submarine sandwich and
pizza restaurants, all of which are franchised.
JRECK obtains prospective franchisees primarily from the ranks of its current
and former franchisees and employees, referrals from existing franchisees and
from selected marketing efforts such as restaurant trade shows. The Company
intends to develop new franchise locations primarily through existing
franchisees. The primary selective criteria considered by the Company in the
review and approval of new franchisees is prior experience in operating
restaurants or comparable business acumen and the existence of sufficient
capital resources to reasonably insure success.
Management believes the Company has a national presence which it intends to
strengthen by developing each of its regional concepts.
From time to time the Company will take over the operations of a store from a
franchisee before the contract term has expired. The Company may operate such
stores until a suitable franchisee can be found, at which time all or part of
the Company's investment in such operations may be recovered, or it may choose
to close the location.
Initial franchise fees are considered to be within industry norms and currently
range from $10,000 - $14,000 for new locations in the sandwich segment and are
$20,000 in the pizza segment. Initial franchise fees are due upon the execution
of the Franchise Agreement. Ongoing royalties are also considered to be within
industry norms ranging from 4%-7% of sales. In addition to ongoing royalties,
all franchisees are required to contribute 2%-4% of sales to a concept based
pooled marketing fund. The following table sets forth and summarizes certain
information about the Company's Concepts and current franchise agreements:
<TABLE>
<CAPTION>
Avg. Royalty Royalty
No. of Rate on Rate on Currently
Franchised Avg. Yrs. Existing Current Price of Selling
Units at Remaining Franchise Franchise New New
Concept Dec 31, 1998 On Contract Agreements Agreement Franchise Franchises
------- ------------ ----------- ---------- --------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
"JRECK Subs", "Lox, Stox & Bagel: 47 9.2 4.3% 5.0% $ 10,000 Yes
"Sub Shops"(1) 47 6.5 5.0% 5.0% 10,000 Yes
"Little King" 28 9.9 4.9% 6.0% 14,000 Yes
"Sobik's" 40 6.8 4.6% 5.0% 12,500 Yes
"Li'l Dino" 38 16.0 5.9% 7.0% 12,500 Yes
"Mountain Mike's" 73 10.0 4.6% 5.0% 20,000 Yes
</TABLE>
(1) The seven unit concept "Georgio's" was sold by the Company subsequent to
year end.
In connection with the Company's mandatory monitoring program, all franchisees
are required to adhere to the Company's specifications and standards on the
selection and purchase of products used in the operation of the restaurant. The
Company provides a detailed "product profile" of acceptable food, paper and
supply items for each concept. Franchisees requesting to use products not
falling under the concept "product profile" must first receive permission from
the Company.
Area Development Agreements
The Company offers to Area Developers a "Territory" within which to sell
franchised restaurants pursuant to the terms of an Area Development Agreement.
Territories are generally based on defined geographic areas and generally
require the Area Developer to increase the number of restaurants within that
territory and to provide continuing operational support.
As of December 31, 1998, the Company had an aggregate of seven agreements with
area developers under the Mountain Mike's and Li'l Dino's concepts covering
areas of California and North Carolina, respectively.
Each area developer pays the Company a negotiated fee for the non-exclusive
right to sell and open franchises in its defined geographic territory and also
requires the Area Developer to be responsible for marketing, soliciting and
screening prospective franchisees as well as identifying possible site
selections, providing on-site opening assistance and providing ongoing
operational support. The agreements also require the area developer to open a
minimum number of new franchised restaurants each year or forfeit future rights
to the territory. In some situations, the Company requires the Area Developer to
own and operate at least one franchised restaurant in their territory.
4
<PAGE>
The Area Development Agreement does not grant the Area Developer the exclusive
right to market or solicit franchisees in the territory. The Company reserves
the right, under the agreements, to market and sell franchises and/or establish
company owned restaurants in any territory.
The Company pays the area developer 50% of the initial franchise fee for any
franchises it sells in its respective territory. The Area Developers are also
entitled to an ongoing fee of 40% to 50% of continuing franchise royalties as
consideration for providing ongoing support. Ongoing support includes many of
the tasks required to be performed by the franchisor and are described above.
The Company believes the shared ongoing revenue approach rewards the area
developer for selecting higher quality franchisees and higher quality locations
while discouraging the area developer from selecting sites that may have an
adverse effect on current locations.
The Area Development Agreements set increasing "Minimum Performance Levels" that
require the area developer to sell and open a specified number of franchised
restaurants each year. The Company's experience with the area development
program indicates that while some area developers will exceed their development
schedules, others will fail. Delays in the sale and opening of restaurants can
occur for many reasons. The most common reasons are delays in locating desirable
sites, in negotiating acceptable site lease terms or in obtaining project
financing.
Suppliers
The Company has entered into distribution and pricing agreements with national
and regional food product manufacturers and distributors that allow owners to
obtain meat products, produce, cheeses, condiments, spices, paper products and
supplies at prices more favorable than those that could be obtained by
individual owners.
The Company believes that if such regional and national distributors could no
longer provide such goods and services, adequate alternate suppliers or
distributors are available to provide such goods and services without a
significant increase in costs.
In October, 1997 the Company completed its acquisition of Pastry Product
Producers, LLC (PPPI). PPPI is a bakery in Watertown, NY, and consists of a
plant, offices and equipment. PPPI produces the JRECK signature roll that is
supplied fresh (never frozen) to JRECK franchisees in upstate NY. PPPI produces
other baked goods such as bagels and cookies, however the rolls supplied to
JRECK franchisees account for 90% of sales. In 1997, JRECK franchisees committed
to purchase their sub rolls exclusively from PPPI over a 10 year period.
Government Regulation
The Company's principal activity of selling restaurant franchises is regulated
by the Federal Trade Commission (the "FTC") and various states. Such regulations
govern disclosure, performance and procedure in the sale and transfer of new and
existing franchises. In general the FTC's regulations require the Company to
timely furnish a franchise offering circular to prospective franchisees
containing prescribed information. Certain state laws also require registration
of the franchise offering circular with applicable state authorities. Other
states monitor or regulate the franchise relationship, particularly the sale,
renewal and termination of an agreement. The Company believes it is in
compliance with the applicable franchise disclosure and registration regulations
of the FTC and the various states that it operates in.
The Company is also subject to "Federal Fair Labor Standards Act", which governs
minimum wages, overtime, working conditions and other matters as well as the
"Americans With Disabilities Act".
From time to time the Company will operate company owned stores. While operating
stores, the Company is subject to a variety of federal, state and local laws
regarding minimum wage standards, sanitation, health, fire, alcoholic beverage
and safety codes. The Company does not currently operate any stores.
While the Company believes it is in compliance with all applicable federal,
state and local laws and regulations, there can be no assurance that it will
continue to meet the requirements of such laws and regulations. Such a default
could result in a withdrawal of approval to market franchises in one or more
jurisdictions. Any such loss of approval may have a material adverse effort upon
the Company's ability to successfully market its franchises. Violations of
federal and state franchising laws and/or regulations regulating substantive
aspects of the Company's business activity could subject the Company and it
affiliates to rescission offers, monetary damages, penalties or injunctive
proceedings. In addition, under court decisions in certain states, absolute and
vicarious liability may be imposed upon franchisors based upon the facts and
circumstances of the claim. Current expected changes in federal and individual
state laws and regulations concerning the sale, termination and non-renewal of
franchises are not expected to have a material impact on the Company's
operation. There can be
5
<PAGE>
no assurance that existing or future franchise regulations will not have an
adverse effect on the Company's ability maintain and expand its franchise
program.
Competition
The Company competes in the fast food sandwich and pizza segments of the
restaurant industry. As a franchisor of fast food sandwich and dine in-pizza
restaurants, the Company competes on two fronts. First it must attract
successful franchisees; and, second, it must assist its franchisees in
attracting customers in each of those two niches of the restaurant industry. The
Company and its franchisees compete with an increasing number of national chains
of quick service outlets, several of which have dominant market positions, and
possess substantially greater financial resources and longer operating histories
then the Company.
The segments of the restaurant industry that the Company and Its franchisees
compete in are highly competitive with respect to price, service, outlet
location, and food quality and is often affected by changes in consumer taste,
local and national economic conditions, population trends and local traffic
patterns.
The three most prolific submarine sandwich chains the Company and its
franchisees compete with are Subway, Blimpe and Quiznos. Subway currently has
approximately 14,000 units while Blimpie and Quiznos each have about 2,000 and
500 units respectively. The Company's franchisees operate 200 units. Both Subway
and Blimpie offer a low cost product in a fast food style environment while
Quiznos is positioned between the traditional fast food style of Subway and
Blimpie and full service dining. Through its regional concepts, the Company
offers a comfortable, fast food style, family atmosphere in which to dine on
higher quality food products.
A number of companies have adopted "value pricing" strategies in response to
flattening growth rates and/or declines in average sale per restaurant. Such
strategies could draw customers away from companies that do not engage in "value
pricing", or discount pricing, and could also negatively impact the operating
margins by attempting to match competition pricing points.
In addition to competing with these chains as restaurants, the Company also
competes with these and other fast food chains for qualified franchisees. Many
franchisors, including but not limited to, those in the restaurant industry,
have greater market recognition and financial resources then the Company. The
Company believes its well established regional concepts offer prospective
franchisees the balance of a moderately priced alternative with which to enter
the fast food restaurant industry and the pride of ownership in a well
established and recognized name.
Trademarks
The Company, through its affiliates, currently owns the following trademarks or
service marks each of which is registered and listed on the Principal Register
of the United States Patent and Trademark Office:
<TABLE>
<CAPTION>
Registration
Number or Registration
Application or Renewal
Trademark Type Number Date
--------- ---- ------ ----
<S> <C> <C> <C>
"JRECK Subs" Service Mark 1,022,898 Oct 14, 1975
"Admiral J" Service Mark 75/28957B May 9, 1997
"Original Deli Taste Without Deli Cost" Service Mark 1,675,510 Feb 11, 1992
"Full Boat" Service Mark 1,761,574 March 30, 1993
"Destroyer" Service Mark 1,761,573 March 30, 1993
"Enough for two or just for you" Service Mark 1,764,733 April 13, 1993
"Seawest Sub Shops" Name, Service Mark & Design 1,703,897 July 28, 1992
"Substantially More" Service Mark 1,772,028 May 18, 1993
"Sub Shop" Name, Service Mark & Design 1,862,112 Nov 18, 1994
020443 (Wash) March 29, 1991
407629 (Canada) Feb 5, 1993
"Little King" Name, Service Mark a Design 1,063,555 April 12, 1977
"Royal Treat" Service Mark 1,662,623 Oct 29, 1991
"Little King B America's Greatest Hero" Service Mark Nebraska Feb 2, 1983
"The Little King-Where a Sandwich is a Complete Meal"Service Mark Iowa/California Dec 22, 1975
"Mountain Mike's" Name, Service Mark & Design 1,716,962 Sept 15, 1992
"Mountain Mike's Pizza" Service Mark 2,004,536 Oct 1, 1996
"Pizza The Way It Oughta Be" Service Mark 75/174377 Sept 1, 1996
"Li'l Dino" Name, Service Mark & Design 1,411,762 Sept 30, 1986
"Li'l Dino Bagel Deli and Grille" Name, Service Mark & Design 2,101,316 Sept 30, 1997
"Sobik's Subs" Name, Service Mark & Design 2,087,639 Aug 12, 1997
</TABLE>
6
<PAGE>
Employees
As of December 31, 1998 the Company had approximately 50 full time employees
consisting of 30 administrative employees and 20 employed in the Watertown
bakery.
Item 2. Description of Property
The Company owns its bakery plant in Watertown, NY. The land and building that
comprise that facility include 2,064 square feet of office space and 8,651
square feet of bakery facilities. The remainder of the Company's office space is
leased at terms varying from month to month or monthly expiring on various dates
up to August 14, 2003.
A summary of all real estate locations owned or leased by the Company at
December 31, 1998 is as follows:
<TABLE>
<CAPTION>
If Owned: If Owned: If Leased: If Leased:
Owned Current Current Base Lease
or Square Book Mortgage Monthly Expiration
Address of Property Type Leased Footage Value Balance Rent Date
- ------------------- ---- ------ ------- ----- ------- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
24685 NYS Rte 37 Office Owned 2,064 $371,803 $140,234
Watertown, NY 13601 Bakery 8,561
2101 W. State Road 434 Suite 100 Office Leased 3,064 $ 4,725 12/31/00
Longwood, FL 32779
4212 Freeway Blvd. Suite 6 Office Leased 1,830 1,175 10/31/00
Sacramento, CA 95834
4858 Mercury St. Suite 109 Office Leased 450 619 Mo.- Mo.
San Diego, CA 92111
11811 "I" St. Office Leased 750 1,500 08/14/03
Omaha, NE 68137
2619 151st Place, NE Office Leased 603 603 08/31/01
Redmond, WA 98052
802 Green Valley Road Suit 204 Office Leased 1,117 1,582 09/30/01
Greensboro, NC 27408 ----- ----- --------
TOTALS 18,439 $371,803 $140,234 $10,204
====== ======== ======== =======
</TABLE>
The Company believes it has obtained, and currently carries, adequate liability
insurance on all the properties it owns or leases.
Item 3. Legal Proceedings
None
Item 4. Submission of Matters to a Vote of Security Holders
The Company held its annual shareholder meeting on October 23, 1998 in Orlando,
Florida. Two matters were submitted to a vote of the common shareholders of
record on September 1, 1998. One was the election of Directors Christopher M.
Swartz, Bradley L. Gordon, Eric T. Swartz, Kelly A. Swartz and Jeremiah J.
Haley. The second matter was for approval of the Employee Stock Option Incentive
Plan. The Stock Option Plan (as included in the Company's Proxy statement and
filed with the Security and Exchange Commission and incorporated by reference
herein) was approved by the shareholders and all the directors were elected by
the following vote tabulation:
7
<PAGE>
Votes Votes
Cast Cast Votes Broker
Director For Against Withheld Non-Votes
- --------------------------------------------------------------------------------
Christopher M. Swartz 10,558,337 Not Tallied 194,538 5,900,000
Bradley L. Gordon 10,620,925 Not Tallied 131,950 5,900,000
Eric T. Swartz 10,552,737 Not Tallied 200,138 5,900,000
Kelly A. Swartz 10,551,613 Not Tallied 201,262 5,900,000
Jeremiah J. Haley 10,620,925 Not Tailed 131,950 5,900,000
Both Kelly Swartz and Jeremiah Haley have resigned as of December 31, 1998.
PART II
Item 5. Market for Common Equity
The Company's Common Stock is listed on the OTC Bulletin Board under the symbol
"JSUB". The prices reported below reflect interdealer prices and are without
adjustments for retail markups, markdowns or commissions, and may not
necessarily represent actual transactions.
High Bid Low Bid
Fiscal Year Ended December 31, 1997 First Quarter 4 1/8 1 3/4
Second Quarter 8 1/4 3 1/4
Third Quarter 4 1/8 3
Fourth Quarter 3 7/16 2 1/8
Fiscal Year Ended December 31, 1998 First Quarter 3 1/8 1 13/16
Second Quarter 2 11/16 1 3/4
Third Quarter 1 1/16 9/16
Fourth Quarter 7/8 1/4
Fiscal Year Ended December 31, 1998 First Quarter 17/32 1/16
Second Quarter 5/8 1/8
Stockholder:
As of June 30, 1999 there were approximately 8,200 record holders of the
Company's common stock.
Dividends:
The Company has never paid any dividends on its Common Stock and does not
expect to pay any dividends on its common stock in the foreseeable future.
Management currently intends to retain all available funds for working capital
and the development of its business. Dividends, if declared, must be from funds
legally available after dividends are first paid to any senior series of equity
securities such as the Company's Preferred Stock. Currently no surplus exists.
Recent Sale of Unregistered Securities
On January 5, 1998 the Company concluded its Preferred "D" stock offering. The
Company raised $2,500,000 through the offering. Eighteen investors purchased
2,500 shares for $1,000 each. The holders of the series "D" Preferred Stock have
no voting rights and are entitled to cumulative dividends of $80 per share, per
year, payable in cash or common stock. Holders of the Series "D" may convert a
portion or all of their holdings into common stock based upon a conversion rate
formula of 65% of the average five day closing bid price five trading days
before conversion. The conversion rate is further adjusted by two five percent
penalty increments for the Company's failure to file and make effective a Form
SB-2 within certain time parameters. As of December 31, 1998 the Company has
issued 615,384 common shares as conversion shares under this agreement.
Subsequent to December 31, 1998 the Company has issued approximately 2,750,936
additional common shares as conversion shares in the first quarter of 1999 and
1,319,248 shares in the second quarter of 1999. As of April 29, 1999 $600,000 of
the original $2,500,000 Preferred "D" had been converted to common stock.
8
<PAGE>
The following table sets forth information with respect to the sale or issuance
of unregistered securities by the Company over the last three fiscal years:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
Shares Type of Value or Exempt From
Issued Security Date Considera To Whom Issued Business Purpose 1933 Act
tion Registration In
Reliance of:
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
5,000,000 Common May 6, 1996 $ N/A Tri Emp Enterprises Reverse acquisition with Circa Media, Inc. Section 4(2)
700,000 Preferred "A"May 6, 1996 1,400,000 JRECK Pref "A" Holders Convert old Preferred "A" to new Preferred "A" Section 4(2)
360,000 Preferred "B"May 6, 1996 700,000 Christopher Swartz Acquire 50% Pastry Product Producers, LLC Section 4(2)
1,100,000 Common May 6, 1996 11,000 7 Circa Media Shhldrs Cash Investment Rule 504 Reg D
1,536,000 Common Dec 1, 1996 648,150 Public Offering Cash Investment Rule 504 Reg D
45,000 Common Dec15, 1996 90,533 Gerhartz Equipment Satisfaction of Debt Section 4(2)
415,095 Common Jan20, 1997 220,000 Public Offering Cash Investment Rule 504 Reg D
230,000 Common Feb 5, 1997 424,003 Certified Food Service Acquire Bakery Equipment Section 4(2)
94,650 Common Feb28, 1997 336,954 4 Individuals Consulting Services Section 4(2)
39,118 Common Apr 1, 1997 114,248 400 Wstrn FF Shhldrs Investors in Predecessor Company Section 4(2)
60,000 Common May23, 1997 30,000 Deegan Group Exercise of Options Section 4(2)
289,500 Common Jun19, 1997 1,331,156 Chai Entrp etal Acquisition of "Hymie's" Bagle Chain Section 4(2)
100,000 Common Jul 8, 1997 200,000 Pref "A" Holders Conversion to Common Stock Section 4(2)
300,000 Common Jul10, 1997 225,000 Corp. Relations Group Exercise of Options Section 4(2)
198,000 Common Jul25, 1997 198,000 Public Offering Cash Investment Rule 504 Reg D
59,710 Common Jul30, 1997 227,227 4 Individuals Consulting & Settlement of Debt Section 4(2)
93,794 Common Aug15, 1997 340,000 W. & C Richey Acquisition of "Georgio's" Restaurant Chain Section 4(2)
500,000 Common Sep 3, 1997 1,531,250 Sidney Wertheim etal Acquisition of "Little King" Restaurant Chain Section 4(2)
75,000 Common Sep17, 1997 229,286 Olympus Capital Consulting Services Section 4(2)
495,000 Common Oct15, 1997 547,800 20 Individuals Conversion of Debt to Equity-Cash Investment Section 4(2)
120 Preferred "C"Oct 8, 1997 120,000 12 Individuals Acquisition of "Mtn Mike's" Restaurant Chain Section 4(2)
899,967 Common Oct 8, 1997 2,643,653 QFS Shareholders Acquisition of "Mtn Mike's" Restaurant Chain Section 4(2)
262,500 Common Oct27, 1997 558,594 3 Individuals Acquire 50% Pastry Product Producers LLC Section 4(2)
60,000 Common Nov30, 1997 146,400 1 Investor Loan Inducement Section 4(2)
500,000 Common Sep24, 1997 1,500,000 Bradley Gordon Issued for Promissory Note-Corp Officer Section 4(2)
300,000 Common Sep24, 1997 900,000 Richard Silberman Issued for Promissory Note Section 4(2)
61,111 Common Nov 6, 1997 137,500 3 Individuals Cash Investment Section 4(2)
25,000 Common Nov 8, 1997 50,000 1 Individual Cash Investment Section 4(2)
187,266 Common Dec 4, 1997 526,686 Interfoods of America Acquisition of "Sobik's" Restaurant Chain Section 4(2)
138,889 Common Dec31, 1997 250,000 Nadaff & Youngman Cash Investment Section 4(2)
150,003 Common Mar26, 1998 309,375 QFS Shareholders Acquisition of "Mtn Mike's" Restaurant Chain Section 4(2)
2,500 Preferred "D"Jun 5, 1998 2,500,000 18 Investors Cash Investment Section 4(2)
25,000 Common Feb 5, 1998 25 Mitchall Day Exercise of Seawest Options Section 4(2)
11,550 Common Feb 9, 1998 30,319 Andrew Caffey Legal Services Section 4(2)
40,000 Common Mar15, 1998 97,500 Allen Richman Consulting Services Section 4(2)
9,400 Common Mar16, 1998 22,913 Francis Jenne Consulting Services Section 4(2)
52,631 Common Mar25, 1998 125,000 Frmr Seawest Shhdrs Acquisition of "Seawest" Restaurant Chain Section 4(2)
112,793 Common Apr20, 1998 277,404 Sidney Wertheim etal Settlement of Debt Section 4(2)
735,294 Common May18, 1998 2,000,000 Li'l Dino Shareholders Acquisition of "Li'l Dino" Restaurant Chain Section 3(a)(10)
115,000 Common May27, 1998 251,563 Pat Garrard Consulting Services Section 4(2)
350,000 Common Jun 3, 1998 700,000 Preferred "B" Hldrs Conversion to Common Section 4(2)
43,290 Common Jun16, 1998 100,000 R. Berg & S. Wemple Finder's Fee on Acquisition of "Li'l Dino" Section 4(2)
660,000 Common Jul 6, 1998 1,320,000 Preferred "A" Hldrs Conversion to Common Section 4(2)
6,857 Common Jul21, 1998 9,000 Interfoods of America Extend Due Date on Puts Section 4(2)
500,000 Common Jul31, 1998 687,500 Bradley Gordon Issued for Promissory Note-Corp Officer Section 4(2)
300,000 Common Jul31, 1998 412,500 Richard Silberman Issued for Promissory Note Section 4(2)
500,000 Common Jul31, 1998 687,500 Michael Cronin Issued for Promissory Note-Corp Officer Section 4(2)
10,000 Common Aug 5, 1998 13,125 W. & C. Richey Extend Due Date on Puts Section 4(2)
70,000 Common Sep16, 1998 70,000 5 Investors Loan Inducement Section 4(2)
33,333 Common Oct 1, 1998 29,166 Mitchell Day Acquisition of "Food Court" Concept Section 4(2)
20,000 Common Oct31, 1998 10,000 JG Partners L.P. Consulting Services Section 4(2)
500,000 Common Nov 6, 1998 250,000 QFS Shareholders Acquisition of "Mtn Mike's Restaurant Chain Section 4(2)
615,384 Common Nov25, 1998 150,000 Barry Seldman Conversion of 150 Sh of Preferred "D" Section 4(2)
39,727 Common Nov25, 1998 25,652 Barry Seldman Dividends on Preferred "D" Section 4(2)
50,000 Common Dec 4, 1998 21,875 Interfoods of America Inducement to Extend Loan Due Date Section 4(2)
300,000 Common Dec14, 1998 75,000 Sidney Wertheim etal Acquisition of "Little King" Restaurant Chain Section 4(2)
75,000 Common Dec22, 1998 75 Mitchell Day Exercise of Seawest Options Section 4(2)
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
9
<PAGE>
Options and Warrants
Since January, 1997 the Company has issued options and warrants to purchase its
common stock. The following table describes selected data with respect to
unexercised options and warrants at December 31, 1998:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
Date Expiration Name Number of Exercise Business Purpose
of Grant Date Shares Price
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Sept 15, 1997 Sept 15, 1999 Corporate Relations Group 100,000 $ 3.37 Advertising and Marketing Services
Sept 15, 1997 Sept 15, 2000 Corporate Relations Group 100,000 3.93 Advertising and Marketing Services
Sept 12, 1997 Sept 12, 1999 Olympus Capital 100,000 2.75 Investment Banking Services
Sept 12, 1997 Sept 12, 1999 Olympus Capital 100,000 3.50 Investment Banking Services
Dec 17, 1997 Dec 17, 2002 Business Advisors 375,000 1.92 Business Expansion Consulting Services
Dec 17, 1997 Dec 17, 2002 Business Advisors 375,000 2.56 Business Expansion Consulting Services
Dec 17, 1997 Dec 17, 2002 Business Advisors 375,000 3.20 Business Expansion Consulting Services
Dec 17, 1997 Dec 17, 2002 Business Advisors 125,000 0.84 Business Expansion Consulting Services
Dec 29, 1997 Dec 29, 2000 Christopher M. Swartz 1,000,000 2.75 Employee Compensation
Aug 3, 1998 Aug 3, 2001 Christopher M. Swartz 1,000,000 1.55 Employee Compensation
Jan 6, 1997 Jan 6, 2000 Tri-Emp Enterprises, Inc. 225,000 0.75 Assignment of Other Rights
May 23, 1997 April 1, 2002 Thomas Larcomb 60,000 0.50 Loan Inducement
May 23, 1997 April 1, 2002 Richard Deegan 60,000 0.50 Loan Inducement
Sept 30, 1997 Feb 1, 2001 AB Laffer & Canto Assoc. 13,500 3.08 Acquisition of Mtn. Mike's
Oct 27, 1997 Oct 1, 2008 Robin Longley & P. Truax 37,500 * Acquisition of Pastry Product Producers,
Inc.
Sept 30, 1998 Sept 30, 2003 Wall St. Group 114,285 0.875 Investment Banking Services
Sept 30, 1998 Sept 30, 2003 Dr. Sol Lizerbram 114,285 0.875 Investment Banking Services
---------
TOTAL 4,274,570
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
* 50% mean bid/ask on date of exercise.
The weighted average exercise price of these outstanding options is $ 2.22 and
the weighted average life until expiration is 34.3 months. Options representing
100,000 shares expired in 1998 and options representing 100,000 shares were
exercised in 1998 while the Company granted additional options on 1,228,570
shares during the year.
Item 6. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward Looking Statements
The following discussion contains certain forward-looking statements subject to
the safe harbor created by the "Private Securities Litigation Reform Act of
1995". These statements use such words as "may," "will," "expect," "believe,"
"plan," "anticipate" and other similar terminology. These statements reflect
management's current expectations and involve a number of risks and
uncertainties. Actual results could differ materially due to changes in global
and local business and economic conditions; the potential effect on business
from year 2000 issues; legislation and government regulation; competition;
success of operating, initiatives including advertising and promotional efforts;
changes in food, labor and other operating costs; availability and cost of land
and construction; adoption of new or changes in accounting policies and
practices; changes in consumer preferences, spending patterns and demographic
trends and changes in the political or economic climate.
Overview
The Company derives its revenue from several sources: royalties, franchise fees,
developer fees, company owned restaurants sales and other franchise related
activities as well as a bakery acquired to supply sandwich rolls to certain
franchisees. All company owned stores were disposed of in 1998.
Royalties
Royalties are based on a percentage of franchisees' net sales and are recognized
by the Company in the same period that the franchise store sales occur.
Generally royalties are earned at the rate of 4%-7% of sales. Royalties earned
under newer franchise agreements are paid by means of weekly automatic drafts by
the Company drawn on franchisee bank accounts. Royalties earned under older
agreements are generally paid by the remittance of a check payable to the
Company on a weekly, bi-weekly or monthly basis. A portion of the royalties
received by the Company are paid to its area developers as royalty service costs
for providing on-going services to franchisees in their respective territories
(see item 1. Business-Franchising-Area Developers). Royalties have increased
most dramatically as the result of the acquisition of the chains that now
constitute the Company. These acquisitions occurred in the last half on 1997 and
first quarter of 1998.
10
<PAGE>
Franchise Fees
Franchise Fees are payments received by the Company from franchisees and are
recognized as revenue in the period in which the store opens. The franchise fee
for a franchisee's initial store is currently $10,000 - $14,000 for submarine
sandwich restaurants and $20,000 for pizza restaurants. Expenses associated with
the sale of franchises also include area developer fees and are included in
franchise servicing costs. Generally, area developers are paid one half of the
franchise fees received or collected in their territory.
Area Developer Fees
The Company charges area developers a non-refundable fee for the exclusive right
to develop and market a defined territory for a specified period of time.
Typically, a portion of the developer fee is paid in cash and the balance is
paid with a promissory note (see Item 1. Business-Franchising-Area Developers).
When the Company has fulfilled substantially all of its contractual obligations
such as training, providing manuals, and reasonable efforts to obtain and retain
trademark registrations, the Company recognizes, as revenue, the cash portion of
the fee and the value of the promissory note. Certain performance obligations
are ongoing. On these the income has been deferred to future periods in which
the services will be substantially performed.
Restaurant Sales
Restaurant sales are reported from Company owned stores. These sales are
expected to decline as the Company completes its strategic shift to become
strictly a franchisor. The Company owned 11 stores at the and of 1997 and had
completely divested itself of all such stores by the end of 1998 by selling or
transferring them to new or existing franchisees. From time to time the Company
will take over the operations of a store from a franchisee before the contract
term has expired. Management's intent is to resell these stores to prospective
franchisees as soon as practicable. Management does not believe that the
operating costs of its Company owned stores are indicative of costs for
franchised stores on a systemwide basis. As such, store sales are not considered
to be a primary source of income. Store sales are expected to vary widely from
year to year and reflect the uncertainty of when, where and how long a store may
be operated by the Company before being returned to the franchising system.
Fiscal Year 1998 Compared to Fiscal Year 1997
Revenue: Total Revenue increased 132.7% in 1998 over 1997 from $2,574,209 to
$5,990,544.
Royalties increased $1,882,451, or about 191%, from $984,694 in 1997 to
$2,867,145 in 1998. This increase was due to three factors. The first was the
impact of $1,454,519 in additional royalties resulting from a full year of
ownership of the chains acquired throughout the last six months of 1997. The
second was a $305,071 increase as a result of the acquisition of the Li'l Dino
chain in March of 1998. Also contributing to the increase was a 9.3% increase in
systemwide sales in the Mtn. Mike's Pizza chain resulting in about $122,861 in
increased annualized royalties.
Franchise fees increased $119,166 from $41,500 to $160,666. $17,500 of the
increase was generated by the Li'l Dino chain with the balance of $101,666 being
generated through a full year of ownership of the chains acquired throughout the
last six months of 1997. The Company began 1998 with 243 franchised restaurants.
During the year the Company acquired 40 more units through the acquisition of
the Li'l Dino chain; sold or Transferred all 11 of its company owned stores to
franchisees and, while adding an additional 18 new stores, closed or terminated
franchise agreements on 28 stores. These closings were the result of voluntary
terminations due to competitive conditions in the Company's market segment and
to the cancellation or rescission of franchise agreements of certain franchisees
that were not fulfilling their contract obligations. The Company ended the year
with 273 franchised units or a pro-forma decrease of 7.14%. The eighteen new
stores were primarily opened by existing franchisees. This reflects the
Company's policy of growth through existing franchisees with the belief that
this will contribute to a high rate of new store successes.
Developer fees were $24,896 in 1998 compared to none in 1997. This was due to
the recognition of the deferred performance amounts on existing contracts. The
Company has not sold development rights in any territories in 1997 or 1998. The
Company anticipates that developer fees received in the future will primarily be
the result of re-marketing existing agreements.
Retail restaurant sales in company owned stores increased $357,448 from
$1,176,638 in 1997 to $1,534,086 in 1998. An increase of $681,267 in the Little
King chain was, again, primarily the result of operating 10-11 stores for most
of 1998 compared to operating those same stores for only about 5 months in 1997.
Comparative average store sales volume for these stores remained substantially
unchanged from the previous year. Retail sales from two Georgio's stores dropped
$192,244 over 1997's level of $303,488 due to the sale of both stores
11
<PAGE>
by May of 1998. The Company also discontinued its Hymie's retail bagel sales
efforts in Tampa in early 1998 resulting in a decrease of $131,575 over 1997's
retail bagel sales of $226,129.
Bakery sales for the two bakeries owned and operated in 1998 increased $582,750
from 1997's level of $247,053. An increase of $664,490 is due to a full twelve
months of operations by the Company's bakery in Watertown, N.Y. compared to
$102,888 in sales in 1997 for the three months of reportable operations there
after it was purchased in October 1997. The Company also closed the Tampa bakery
in 1998. This operation generated $62,425 in '98 sales before it was closed,
compared to $144,165 in '97 sales, or a decrease of $81,740.
Costs and Expenses
The Company segregates its operating expenses into six general categories as
follows:
Ongoing Franchise Servicing
Retail Company Owned Store Cost of Sales and Expenses
Bakery Cost of Sales and Expenses
Central Corporate Operating Expenses
Non-Cash
Other
Franchise servicing costs, including ongoing area developer fees, increased
$1,059,968 to $2,037,631 in 1998. $253,763 of this increase was due to the
addition of Li'l Dino operations in March of 1998. The remainder of the increase
of $806,205 results from a full twelve months of reportable operations in 1998
and corresponds to the reported increase in revenue from this activity discussed
above. The Company continues to focus its efforts on franchise royalty
management with the result that the operating profit from this activity
increased 800% form 1997 to 1998 or from $172,855 in '97 to $1,589,024 in 1998.
Retail cost of sales and operating expenses from company owned stores increased
$321,267 over 1997's level of $1,125,609 to $1,446,876 in 1998. These expenses
may increase or decrease from year to year as the number of Company operated
stores changes, As of December 31, 1998 the Company had completely divested
itself of all Company store operations.
Bakery cost of sales and expenses increased $706,770 in 1998 from 1997's level
of $326,036. The increase is substantially due to a full twelve months of
operations by the Company's bakery in Watertown, N.Y. The Company also closed
the Tampa bakery in 1998.
The following table illustrates the net cash flow derived from the Company's
three main operating activities:
[GRAPHICS OMITTED]
12
<PAGE>
Central corporate operating expenses generally include: officers and office
support staff payroll and payroll costs; legal, audit and other professional
fees; office occupancy costs and other general administrative costs. These
administrative costs increased 132% in 1998 to $1,391,521 from $598,591 in '97,
and as a percent of total revenue, remained at 23% for both years. This dollar
increase was the result of "staffing up" efforts made in the last quarter of
1997 to accommodate and manage the growth achieved in the third and fourth
quarters of that year. The Company also incurred $195,843 in 1998 for additional
legal and accounting fees in connection the audit of its 1997 financial
statements and the filing of its S.E.C. registration statements on forms 10-SB
and SB-2.
Routine or recurring non-cash charges such as depreciation, amortization (of
goodwill and non-compute covenants), write off of uncorrectable receivables, and
the amortization of certain prepaid expenses (interest and consulting) over
their contractual terms was $1,754,487 in 1998 compared to $740,840 in 1997. The
increase of $1,013,647 in '98 was principally the result of amortization of
$450,643 in prepaid consulting agreements entered into in December, 1997 and
increase of $581,473 in goodwill and non compete covenant amortization.
Non-routine or non-recurring non-cash charges such as stock and options issued
for services, asset valuation charges, losses on the sale of assets, deferred
taxes and a preferred stock conversion penalty totaled $3,334,176 in 1998 and
was $3,091,900 less than the $6,426,076 aggregate charge for those items in
1997. The net decrease was due to a combined mix of several factors. The
majority of the decrease was due to a $4,858,903 reduction in stock and stock
options issued for services. The charge of $387,486 in 1997 for deferred taxes
was not incurred in 1998. Items increasing this category of charges, in 1998
were the recognition of a loss of $525,382 on the sale of its restaurants and a
one time charge of $718,272 due to a penalty feature imposed on the Company by
the preferred "D" class of stock issued January 5, 1998. Asset valuation charges
were $908,470 higher than 1997's $993,820. In 1997 the Company recognized a
goodwill impairment charge of $993,820 on its Tampa bakery operations as that
operation was closed in May, 1998. In 1998 the Company renegotiated its
acquisition agreement with the previous owners of the "Little King" chain. The
amended agreement called for a reduction of the amount of shares to be issued in
1998 from 700,000 common shares to 300,000 shares of common stock. As a result,
the Company recognized a goodwill impairment charge of $1,000,000 on its Little
King division. The Company also wrote down the value of some of its bakery
equipment to reflect the current market value for such equipment at December 31,
1998. This resulted in a $725,078 charge to 1998's earnings.
Total non-cash expenses decreased $2,078,253 in 1998 to $5,088,663 from 1997's
level of $7,166,916.
Interest expense of $435,584 and $486,546 for 1998 and 1997 respectively,
decreased by $50,962 in 1998. The reduction in interest expense directly
reflects the $540,618 reduction in interest bearing debt realized by the end of
1998.
Liquidity and Capital Resources
Net cash used in operating activities was $1,273,638 in 1998. Accounts payable
and accrued liabilities decreased $446,381. Net cash of $195,558 was used in
investing activities. Net cash of $1,109,873 was generated by financing
activities. This was primarily the result of $1,817,500 raised through the
successful offering of the Company's Series D preferred stock. New borrowings of
$350,000 and matched against debt payments of $1,064,102 also contributed an
application of $714,102 to the net change in cash generated by financing
activities.
Net cash used in operating activities was $1,273,533 in 1997. Accounts payable
and accrued liabilities increased $569,373. Net cash of $513,517 was used in
investing activities. The substantial portion being $405,417 paid out in
connection with acquisitions. Net cash of $2,167,207 was generated by financing
activities. This was primarily the result of $1,310,000 raised through the
successful offering of the Company's common stock and proceeds received on the
exercise of stock options. New borrowings of $1,633,506 matched against debt
payments of $752,083 also contributed to an application of $881,423 to the net
change in cash generated by financing activities.
At December 31, 1997 the Company had $4,613,686 in debt outstanding. During
1998, the Company borrowed $350,000 to finance its operations and assumed
$400,000 in connection with its acquisition of L'il Dino. At December 31, 1997
the Company had $4,613,080 in debt outstanding. During 1997, the Company
borrowed $1,633,506 to finance is operations. The Company also assumed
$2,703,510 in debt in connection with its acquisitions of Seawest, Mountain
Mike's, Little King, Georgio's and Sobik's in 1997.
13
<PAGE>
The Company believes that cash flow from operations and collections from notes
receivable will continue to fund its operations as well as generate a portion of
the capital necessary to meet the Company's obligations of $2,003,198 in current
portion of its long term debt. The Company intends seek other sources of
financing, restructure and/or pay off all its current obligations in 1999. Of
the total amount of $2,003,198 due in 1999, the Company has already
restructured, paid or eliminated approximately $1,300,000. The Company's capital
requirements are anticipated to be funded through current operations
supplemented by additional debt or equity financing, as expansion plans require.
There is no assurance that additional funding will be available, or 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.
Working capital at December 31, 1998 was a deficit of $2,157,280 compared with a
deficit of $4,721,956 on December 31, 1997 a decrease of $2,564,676. The
decrease in deficit is primarily due to the Company's issuance of $2,500,000 in
Series D Preferred Stock in January of 1998. The proceeds of this offering were
substantially used to pay down existing debt or to satisfy other obligations.
Impact of Year 2000
The Company's business and relationships with it business partners and customers
depend significantly on a number of computer software programs, internal
operating systems and connections to other networks. The failure of any of these
programs, systems or networks to successfully address the Year 2000 rollover
problem could have a material adverse effect on the Company's business,
financial condition or results of operations. Many installed computer software
and network processing systems currently accept only two digit entries in the
date code field and may need to be upgraded or replaced in order to accurately
record and process information and transactions on or after January 1, 2000.
The Company utilizes personal computers (PC's) at all its employee workstations,
some of which are connected to a network while others are stand-alone units.
These personal computers all utilize Microsoft Windows or Microsoft Windows NT
as their operating system. The Company believes that the Windows version found
on all its computers is Year 2000 compliant. Additionally, the Company recently
acquired and updated software to operate all its accounting functions. The
Company believes this new software, the system in which it runs and its computer
hardware to be Year 2000 compliant. Management anticipates that all accounting
functions will be performed using Year 2000 compliant software by June of 1999.
The costs of acquiring and implementing the software are expected to be minimal.
Management believes that any additional expenditures required to implement this
software will be funded from the cash flow generated by operations.
The Company primarily does business with its subfranchisors and its franchisees
who in turn deal with retail customers and food distribution companies. The
Company has considered the transactions it conducts with its subfranchisors and
its franchisees in its analysis of the Year 2000 issue, and believes that it has
completed substantially all modifications to the computer systems used in these
transactions to ensure the systems are Year 2000 compliant. The Company is not
certain as whether the computer software and business systems of its
franchisees' suppliers are Year 2000 compliant. The failure or delay of these
distributors to successfully address the Year 2000 issue may result in delays in
placing or receiving orders for goods and services at the restaurant level. Such
delays may result in lost revenues for the franchisees and, in turn, lower
continuing royalties to the Company. The Company anticipates that such delays
and lost revenues, if any, would be minimal.
An inventory and assessment of all non-information technology systems (such as
telephone systems, fax machines and copiers) has not been completed. The Company
does not believe that the failure of such systems will have a significant impact
on its ability to conduct business. If a year 2000 failure should occur in any
of these systems, management intends to resort to traditional hand methods until
such failure can be cured.
The Company intends to continue to monitor its Year 2000 compliance and to
correct any noncompliance as it is discovered. Management will fund such efforts
out of operating cash flow. The Company believes that the effects on any
noncompliance on its part, or by its customers and suppliers, will not have a
material adverse effect on the Company's business, financial condition, results
of operations or cash flows.
Item 7. Financial Statements
Attached hereto and filed as part of this form 10-KSB are the consolidated
financial statements listed in the index to the Consolidated Financial
Statements at page F-1.
14
<PAGE>
Item 8. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure
None
Item 9. Directors, Executive Officers and Control Persons
The following table sets forth certain information with respect to the executive
officers, and directors of the Company. Each director holds such position until
the next annual meeting of the Company's shareholders and until his successor
has been duly qualified and elected. Any of the Company's officers may be
removed, with or without cause, by the Company's board of directors.
- --------------------------------------------------------------------------------
Name Age Director/Date Office or Position
Elected
- --------------------------------------------------------------------------------
Christopher M. Swartz 29 Yes/10/23/98 Chairman President and Chief
Executive Officer
Bradley L. Gordon 46 Yes/10/23/98 Chief Operating Officer
Eric T. Swartz 33 Yes/10/23/98 Secretary
Michael F. Cronin 43 No Chief Financial Officer/Treasurer
Gary E. Rowe 45 No Controller
- --------------------------------------------------------------------------------
Christopher M. Swartz has been Chairman, President and Chief Executive Officer
of the Company since April, 1996 and Chairman, President and Chief Executive
Officer of JRECK Subs, Inc. since September, 1995. From 1992 to 1995, he was
Director of Operations of Lox, Stox & Bagels of Liverpool, Inc. Mr. Swartz is a
graduate of Syracuse University. He is the second generation of his family to be
involved with JRECK. Mr. Swartz is also the President of Tri-Emp Enterprises,
Inc. and the brother of Eric Swartz.
Bradley L. Gordon has been Chief Operating Officer and Director of the Company
since September, 1997, From September 1993 up to joining the Company in 1997, he
was president of Quality Franchise Systems, Inc. (the franchisor of Mountain
Mike's Pizza), Quality Franchise Systems, Inc.'s Chief Executive Officer since
1992 and one of its directors since January, 1993. Before joining Quality
Franchise Systems, Inc., he hold various positions at Pace Membership Warehouse,
Inc. in Denver, Co. from 1983 forward as an 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 and undergraduate degree from Syracuse
University College of Law and Syracuse University respectively. From October,
1993 to the present he has been a partner in the Swartz Law Firm, P.C. and was
associated with the law firm of Pease and Willer after graduating from law
school in 1992. Mr. Swartz is the brother of Christopher M. Swartz.
Michael F. Cronin has been Chief Financial Officer of the Company since March 8,
1998 and Treasurer since January 1, 1999. He is a Certified Public Accountant
who has managed his own practice, specializing in S.E.C. audits and business and
tax planning, since February, 1985. He has been licensed in New York State for
17 years. Mr. Cronin is a graduate of St. John Fisher College. From 1979 to 1985
Mr. Cronin was employed as a staff accountant and partner in a regional public
accounting firm in Rochester, NY. Mr. Cronin served in the United States Marine
Corps for three years and was honorably discharged in 1976.
Gary Rowe has been the Corporate Controller since September, 1993. Prior to
joining the Company, Mr. Rowe was the Controller of the Development Authority of
the North Country, a quasi-independent New York State government agency. Mr.
Rowe graduated from the State University of New York at Albany in 1974 where he
received a bachelor's degree in Accounting. Mr. Rowe is a Certified Public
Accountant.
Item 10. 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 such as health insurance premiums, and other benefits, furnished to the
named executive officers, that are extended in connection with the ordinary
conduct of the Company's business. The value of such benefits cannot be
precisely determined, however no executive officer named below received any such
benefits in excess of the lesser of $25,000 or 10% of such officers cash
compensation.
15
<PAGE>
<TABLE>
<CAPTION>
Summary Compensation Table
Annual Compensation Long Term Compensation
- ------------------------------------------------------------------------------------------------------------------------------------
Name & Principal Other Annual Awards Awards Payouts All Other
Position Year Salary Bonus Compensation
----------------------------------------------------------
Restricted Options LTIP
Stock in $ SARS (#) Payouts ($)
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1998 $175,000 $0 $0 $0 1,000,000 $0 $0
Christopher M. Swartz 1997 $115,393 $0 $0 $0 1,000,000 $0 $0
President & CEO 1996 $26,000 $0 $0 $0 0 $0 $0
1998 $51,000 $0 $0 $0 0 $0 $0
Gary E. Rowe 1997 $52,600 $0 $0 $0 0 $0 $0
Controller 1996 $46,350 $0 $0 $0 0 $0 $0
1998 $150,000 $0 $60,000(b) $0 0 $0 $0
Bradley L. Gordon 1997(a) $37,500 $0 $0 $0 0 $0 $0
Chief Operating Officer 1996 $0 $0 $0 $0 0 $0 $0
1998 $93,750 $0 $0 $0 0 $0 $0
Michael F. Cronin 1997 $0 $0 $0 $0 0 $0 $0
Chief Financial Officer 1996 $0 $0 $0 $0 0 $0 $0
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Does not include compensation earned at Mountain Mike's prior to acquisition
by the Company in Oct., 1997.
(b) Relocation expense reimbursement.
Employment Contracts:
Mr. Gordon and Mr. Cronin have employment contracts with the Company. The
following table summarizes the significant terms of these agreements:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
Termination
Commencement Initial Clause Change in
Name Position Date Term Annual Salary Control
Compensation Continuation Arrangement
Period
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Bradley L. Gordon Chief Operating Officer/Director Sept 22, 1997 3 Years $150,000 12 Months No
Michael F. Cronin Chief Financial Officer July 31, 1998 3 Years $125,000 12 Months No
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Options and Rights Granted to Purchase Common Stock:
The following table summarizes options and rights to purchase common stock that
were granted or issued to executive officers and directors over each of the last
two fiscal years:
<TABLE>
<CAPTION>
Percent of
Number Number of Total Promissory
of Shares of Date of Exercise Options Note
Name Position Options Common Grant Expiration Price or Granted to Payout to
Granted Stock or Date Purchase Employees the
(in Shares) Purchased Purchase Price During year Company(1)
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Christopher M. Swartz President 1,000,000 Dec 29, 1997 Dec 29, 2000 $2.76 1997-100%
CEO/Director 1,000,000 Aug 3, 1998 Aug 3, 2001 $1.55 1998-100%
Bradley L. Gordon Chief Operating 500,000 Sept 22, 1997 Not $3.00 $1,500,000
Officer/Director 500,000 July 30, 1998 Applicable $1.38 $ 687,500
Michael F. Cronin Chief Financial 500,000 July 30, 1998 Not $1.38 $ 687,500
Officer Applicable
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
16
<PAGE>
(1) Mr. Gordon and Mr. Cronin each purchased common shares of the Company and
paid for such purchases by a promissory note(s). The notes call for annual
interest at 9.5% with principal and interest due three years from purchase
date. Both Mr. Gordon and Mr. Cronin have the right to require the Company
to repurchase their shares as consideration for the cancellation of the
note.
The following table sets forth information regarding the value of Options and
Stock Appreciation Rights granted to officers of the Company during 1998:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Number of Securities Underlying Value of In-The-Money
Unexercised Options and SAR's Options and SAR's
at December 31, 1998 at December 31, 1998
- --------------------------------------------------------------------------------------------------------------------
Shares Acquired
Name and Position on Exercise Value Realized Exercisable Unexercisable Exercisable Unexercisable
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Christopher M. None None 2,225,000 None None None
Swartz
President & CEO
Bradley L. Gordon 500,000 None None None None None
Chief Financial
Officer
Michael F. Cronin 500,000 None None None None None
Chief Financial
Officer
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
Other:
The Company does not carry officers & director's liability insurance or
disability benefits in excess of statutorily mandated amounts. Directors receive
no compensation for their duties.
The Company maintains, and is the beneficiary of, a $3,000,000 key man term life
insurance policy and a $1,000,000 whole life insurance policy on Mr. Christopher
Swartz.
Item 11. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth information relating to the beneficial ownership
of the Company's Common Stock by those persons beneficially holding more than 5%
of the Company's common stock or held by the Company's executive officers and
directors, and by all the Company's executive officers and directors as a group
as of December 31, 1998. The address of each person is in care of the Company
unless noted.
As used in the table, the term "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 to have "beneficial ownership" of any security if such person
has the right to acquire such security within sixty days.
Name and Officer Amount and
Number of Address of or Nature of
Shares Beneficial Director Beneficial Percent of
Owner Owner Class
Common Stock Christopher M. Swartz Yes (a) 5,569,300 18.51%
Common Stock Bradley L. Gordon Yes 1,114,956 4.00%
Common Stock Michael F. Cronin Yes 500,000 1.76%
Common Stock Eric Swartz Yes 0 0.00%
All Officers and Directors as a Group 7,184,256 23.88%
(a) Includes 3,344,300 shares of the common stock owned by Tri-Emp Enterprises,
Inc. Mr. Swartz is President and sole shareholder of Tri-Emp Enterprises,
Inc. and as such, is deemed to have beneficial ownership of the shares of
the Company owned by Tri-Emp Enterprises, Inc., it also includes 2,000,000
shares subject to options currently exercisable by Mr. Christopher Swartz
and 225,000 shares subject to options exercisable by Tri-Emp Enterprises,
Inc.
17
<PAGE>
Item 12. Certain Relationships and Related Transactions
Kalin Enterprises, Inc. is a franchisee of JRECK Subs in Watertown, NY. Mr.
Christopher M. Swartz is a 25% shareholder and officer of Kalin Enterprises,
Inc.
In April, 1997 Tri-Emp Enterprises, Inc. borrowed $445,000 from 20 investors
secured by 445,000 shares of the Company's common stock owned by Tri-Emp
Enterprises, Inc. Tri-Emp Enterprises, Inc. in turn, loaned the entire proceeds
to the Company. On October 8, 1997 the Company issued 495,000 shares of Common
Stock to the 20 note holders 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 Golf
Atlantic Publishing, Inc. on January 6, 1997, exercisable at $0.75 per share. On
November 17, 1997 Gulf Atlantic assigned 225,000 of those options to Tri-Emp
Enterprises, Inc. in exchange for purchasing 225,000 shares of the Company's
common stock directly from Tri-Emp Enterprises, Inc.
In 1997 the Company adjusted the $104,141 carring value of a note receivable
from Mr. H. Thomas Swartz to $0. Mr. Thomas Swartz is the father of Christopher
Swartz and Eric Swartz.
In February, 1998 the Company issued 112,793 shares of common stock to Sidney
Wertheim and or his designees in satisfaction of $277,404 in debt owed to him by
the Company's Little King, Inc. subsidiary.
Mr. Jeremiah Haley, a former director, received 175,000 shares of JRECK Subs
Group, Inc. Series A Preferred stock in exchange of his JRECK Subs, Inc. Series
A Preferred Stock on May 6, 1996. Mr. Haley was elected to the board of
directors pursuant to the rights of the holders of the series A. Mr. Haley
received $15,750 in cash dividends on his Preferred Stock in 1997. Mr. Haley has
converted all 175,000 shares of Preferred A into 190,000 shares of common stock
during 1998. The shares received upon conversion include 15,000 shares in
consideration of accrued dividends.
Mr. Christopher M. Swartz, Chairman of the Company and its President and Chief
Executive Officer, received (through his control of Tri-Emp Enterprises, Inc.)
5,000,000 shares of the Company in exchange for all the outstanding common
shares of JRECK Subs, Inc. on May 6, 1996. Mr. Swartz also received 350,000
shares of the Company's Series B Preferred Stock for his 50% interest in Pastry
Product Producers Inc. In June, 1998 Mr. Swartz converted all 350,000 shares of
Series B Preferred into 350,000 shares of the Company's Common Stock.
Mr. Bradley Gordon, the Company's Chief Operating Officer and a Director,
purchased 500,000 shares of the Company's Common Stock in each of two separate
transactions to obtain an aggregate of 1,000,000 shares. One transaction
occurred in September, 1997 and the other transaction occurred on July 30, 1998.
The Company received a promissory note from Mr. Gordon on each agreement for the
full amount of each purchase price of $1,500,000 and $687,500 respectively. The
notes each bear interest at 9.5% per annum and are due three years from the date
of issuance. Mr. Gordon has the right to require the Company to repurchase the
shares as consideration for the cancellation of the underlying promissory note.
Mr. Richard Silberman, a shareholder of the Company, purchased 300,000 shares of
the Company's Common Stock in each of two separate transactions to obtain an
aggregate of 600,000 shares. One transaction occurred in September, 1997 and the
other transaction occurred on July 30, 1998. The Company received a promissory
note from Mr. Silberman on each agreement for the full amount of each purchase
price of $900,000 and $412,500 respectively. The notes each bear interest at
9.5% per annum and are due three years from the date of issuance. Mr. Silberman
has the right to require the Company to repurchase the shares as consideration
for the cancellation of the underlying promissory note.
Mr. Michael F. Cronin, Chief Financial Officer and Treasurer of the Company,
purchased 500,000 shares of the Company's Common Stock. The transaction occurred
on July 30, 1998. The Company received a promissory note from Mr. Cronin on the
agreement for the full amount of the purchase price of $687,500. The note bears
interest at 9.5% per annum and is due three years from the date of issuance. Mr.
Cronin has the right to require the Company to repurchase the shares as
consideration for the cancellation of the underlying promissory note.
Mr. Christopher M. Swartz, Chairman of the Company and its President and Chief
Executive Officer, was granted options to purchase 2,000,000 shares of the
Company's Common Stock. The options were granted in the amount of 1,000,000
shares each on December 29, 1997 and August 3, 1998. The exercise prices were
$2.75 and $1.55, respectively, and expire three years from the date of grant.
Mr., Swartz has not exercised his rights to acquire any shares under these
agreements.
18
<PAGE>
On January 5, 1998 the Company concluded its Preferred "D" stock offering. The
Company raised $2,500,000 through the offering. Eighteen accredited investors
purchased a total of 2,500 shares for $1,000 each. The holders of the series "D"
Preferred Stock have no voting rights and are entitled to cumulative dividends
of $80 per share, per year, payable in cash or Common Stock. Holders of the
Series "D" may convert a portion or all of their holdings into common stock
based upon a conversion rate formula of 65% of the average five day closing bid
price five trading days before conversion. The conversion rate is further
adjusted by two five percent penalty increments for the Company's failure to
file and make effective a Form SB-2 within certain time parameters. As of
December 31, 1998 the Company has issued 615,384 common shares as conversion
shares under this agreement. Subsequent to December 31, 1998 the Company has
issued approximately 3,000,000 additional common shares as conversion shares. As
of April 22, 1999 $490,000 of the original $2,500,000 Preferred "D" had been
converted to Common Stock.
19
<PAGE>
PART III
Item 13. Exhibits and Reports on Form 8-K
Schedule of Exhibits:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
Exhibit Description of Exhibit Reserved Incorporated Date of
Item No. for Future by Filing
Use Reference in:
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
2.0 Plan of purchase, sale, reorganization, arrangement, liquidation or
succession.
2.1 Repurchase Agreement between Paul Traux and Robin Longley and JRECK Form 10-SB 02/17/99
Subs, Inc., a New York corporation and JRECK Subs Group, Inc., a
Colorado corporation dated October 28, 1997 (Pastry Products)
2.2 Agreement and Plan of Reorganization and Merger among JRECK Subs Group, Form 10-SB 02/17/99
Inc., Admiral's Fleet, Inc. and Quality Franchise Systems, Inc.
("Quality Agreement")
2.3 Amendment to Quality Agreement Form 10-SB 02/17/99
2.4 Agreement between JRECK Subs Group, Inc. and CHAI Enterprises, Inc. Form 10-SB 02/17/99
("Hymie's Bagel Chain")
2.5 Agreement and Plan of Reorganization among JRECK Subs Group, Inc., Li'l Form 10-SB 02/17/99
Dino Management Corporation and Li'l Dino Corporation dated December
18, 1997
2.6 Purchase Agreement among JRECK Subs Group, Inc., Interfoods of America, Form 10-SB 02/17/99
Inc. and SBK Franchise Systems, Inc. dated December 4, 1997 (Sobik's)
2.7 Agreement between JRECK Subs Group, Inc. and Little King, Inc. dated Form 10-SB 02/17/99
July 23, 1997
2.8 Agreement among JRECK Subs, Inc. and Mitchell R. Day and Julie A. Day Form 10-SB 02/17/99
to Purchase Seawest Sub Shops, Inc.
2.9 Stock Option Grants to acquire Seawest Sub Shops, Inc. Form 10-SB 02/17/99
2.10 Representation and Warranty Agreement among Mitchell R. Day and Julie Form 10-SB 02/17/99
A. Day and Admiral Subs of Washington Inc. dated May 19, 1997.
2.11 Purchase and Sale Agreement between Admiral's Fleet Inc., JRECK Subs Form 10-SB 02/17/99
Group, Inc. and Richey Enterprises, Inc.
2.12 Repurchase agreement by Paul Truax and Robin Longley Form 10-SB 02/17/99
3.0 Articles of Incorporation and Bylaws
3.1 Articles of Incorporation - Circa Media, Inc. Form 10-SB 02/17/99
3.2 Articles of Amendment of Circa Media dated May 2, 1996 and filed May 7, Form 10-SB 02/17/99
1996
3.3 Articles of Amendment of JRECK Subs filed May 7, 1997 Form 10-SB 02/17/99
3.4 Certificate of Correction to Articles of Amendment filed July 24, Form 10-SB 02/17/99
1996.
3.5 Articles of Amendment to Articles of Incorporation regarding Form 10-SB 02/17/99
Certificate of Description of JRECK Subs Group, Inc. Series C Preferred
Stock dated September 27, 1997
3.6 Articles of Amendment to articles of Incorporation regarding Form 10-SB 02/17/99
Certificate of Description of JRECK Subs Group, Inc. Series D Preferred
Stock dated January 5, 1998
3.7 Bylaws of JRECK Subs Group dated August 23, 1998 Form 10-SB 02/17/99
10.0 Material Contracts:
10.1 Form of Franchise Agreement Form 10-SB 02/17/99
10.2 Facility Lease between Springs Equity, Ltd and JRECK Subs Group, Inc. Form 10-SB 02/17/99
dated December 16, 1997
10.3 Quality Franchise Systems, Inc. Area Development Agreements: Form 10-SB 02/17/99
a) MKJ Holdings, Inc.
b) Master Franchising and Development Systems, Inc.
c) John E. and Ann M. Maddox
d) Alex Golshanara
10.4 Promissory Note from Bradley L. Gordon to JRECK Subs Group, Inc. dated Form 10-SB 02/17/99
September 24, 1997
10.5 Promissory Note from Richard T. Silberman to JRECK Subs Group, Inc. Form 10-SB 02/17/99
dated September 24, 1997
10.6 Promissory Note from Michael F. Cronin to JRECK Subs Group, Inc. dated Form 10-SB 02/17/99
July 31, 1998
10.7 Promissory Note from Richard T. Silberman to JRECK Subs Group, Inc. Form 10-SB 02/17/99
dated July 31, 1998
10.8 Promissory Note from Bradley L. Gordon to JRECK Subs Group, Inc. dated Form 10-SB 02/17/99
July 31, 1998
10.9 Employment Agreement between Bradley L. Gordon and JRECK Subs Group, Form 10-SB 02/17/99
Inc. effective September 24, 1997
10.10 Employment Agreement between Michael F. Cronin and JRECK Subs Group, Form 10-SB 02/17/99
Inc. effective July 31, 1998
10.11 Stock Option Grant Agreement between JRECK Subs Group, Inc. and Form 10-SB 02/17/99
Christopher M. Swartz dated August 3, 1998
10.12 Stock Option Grant Agreement between JRECK Subs Group, Inc. and Form 10-SB 02/17/99
Christopher M. Swartz dated December 29, 1997
16.0 Letter of change of certifying accountant
16.1 Former accountants letter to Commission Form 10-SB 02/17/99
21. Subsidiaries of the Registrant Form 10-SB 02/17/99
27. Financial Data Schedule
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
No reports have been filed on form 8-K.
20
<PAGE>
SIGNATURES
In accordance with all the requirements of the Exchange Act,
the Registrant has caused this registration statement to be signed on its behalf
by the undersigned, thereunto duly authorized.
JRECK SUBS GROUP, INC.
- ----------------------
(Registrant)
President & Duly
7/29/99 Christopher M. Swartz Authorized Officer /s/Christopher M. Swartz
- ------- --------------------- ------------------ ------------------------
Date Print Name Title Signature
Chief Financial
Officer & Principal
7/29/99 Michael F. Cronin Accounting Officer /s/ Michael F. Cronin
- ------- --------------------- ------------------ ------------------------
Date Print Name Title Signature
21
<PAGE>
JRECK Subs Group, Inc.
Contents
Page
Report of Independent Certified Public Accountants F-1
Financial statements
Consolidated balance sheets F-2 - F-3
Consolidated statements of operations F-4 - F-5
Consolidated statements of stockholders' equity F-6
Consolidated statements of cash flows F-7
Notes to consolidated financial statements F-8 - F-33
i
<PAGE>
Report of Independent Certified Public Accountants
To the Board of Directors and Stockholders
JRECK Subs Group, Inc.
Longwood, Florida
We have audited the accompanying consolidated balance sheets of JRECK Subs
Group, Inc. as of December 31, 1998 and 1997 and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
years 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 audits.
We conducted our audits 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 our audits provide 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, 1998 and 1997, and the results of their operations and
their cash flows for the years then ended in conformity with generally accepted
accounting principles.
BDO Seidman, LLP
Orlando, Florida
April 1, 1999, except for Notes 13 b) and c), which
are as of June 10 and June 11, 1999, respectively
F-1
<PAGE>
<TABLE>
<CAPTION>
JRECK Subs Group, Inc.
Consolidated Balance Sheets
December 31, 1998 1997
- --------------------------------------------------------------------------------------------------------------------
Assets
Current:
<S> <C> <C>
Cash and cash equivalents $ 310,578 $ 427,420
Accounts receivable - trade, net of allowance for doubtful accounts of
$157,000 and $198,000 398,755 274,329
Prepaid expenses (Note 3) 650,215 720,020
Current portion of notes receivable (Note 4) 398,778 168,560
- --------------------------------------------------------------------------------------------------------------------
Total current assets 1,758,326 1,590,329
- --------------------------------------------------------------------------------------------------------------------
Notes receivable (Note 4) 159,182 262,283
Property, plant and equipment, net (Note 5) 820,722 1,930,990
Goodwill, net of accumulated amortization of $767,385 and $196,365 (Note
2) 11,102,937 11,521,526
Other assets:
Covenants not to compete, net of accumulated amortization of $283,039
and $89,223 (Note 2) 318,961 512,777
Other 547,726 530,057
- --------------------------------------------------------------------------------------------------------------------
Total assets $ 14,707,854 $ 16,347,962
- --------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
F-2
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
JRECK Subs Group, Inc.
Consolidated Balance Sheets
December 31, 1998 1997
- ---------------------------------------------------------------------------------------------------------------------
Liabilities and Stockholders' Equity
Current liabilities:
<S> <C> <C>
Current portion of long-term debt (Note 8) $ 2,003,198 $ 2,336,754
Accounts payable 1,002,109 1,111,444
Accrued liabilities (Note 6) 708,759 1,045,805
Accrued preferred stock dividends 201,540 24,532
Liability to issue common stock (Note 9) - 1,793,750
- --------------------------------------------------------------------------------------------------------------------
Total current liabilities 3,915,606 6,312,285
- --------------------------------------------------------------------------------------------------------------------
Long-term debt, less current portion (Note 8) 1,511,642 1,773,900
Note payable to related party (Note 7) 363,339 323,032
- --------------------------------------------------------------------------------------------------------------------
Total liabilities 5,790,587 8,409,217
- --------------------------------------------------------------------------------------------------------------------
Redeemable common stock (Note 2) 593,000 500,000
- --------------------------------------------------------------------------------------------------------------------
Commitments and contingencies (Note 10)
Stockholders' equity (Notes 2, 9 and 14):
Series A Convertible Preferred Stock, no par value, 700,000 shares
authorized, 0 and 600,000 issued and outstanding, respectively - 1,200,000
Series B Convertible Preferred Stock, $2 par value, 350,000 shares
authorized, 0 and 350,000 issued and outstanding, respectively - 700,000
Series C Convertible Preferred Stock, no par value, 120 shares authorized,
issued and outstanding 120,000 120,000
Series D Convertible Preferred Stock, no par value, 2,500 shares authorized,
2,350 and no issued and outstanding, respectively 3,918,271 -
Common stock, no par value, 50,000,000 shares authorized; 19,503,596 and
14,328,337 issued and outstanding, respectively 26,225,338 18,170,103
Accumulated deficit (17,751,842) (10,351,358)
Less: Stock subscriptions receivable (4,187,500) (2,400,000)
- --------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 8,324,267 7,438,745
- --------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 14,707,854 $ 16,347,962
- --------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
F-3
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
JRECK Subs Group, Inc.
Consolidated Statements of Operations
Year ended December 31, 1998 1997
- --------------------------------------------------------------------------------------------------------------------
Revenues:
<S> <C> <C>
Continuing royalty revenues $ 2,867,145 $ 984,694
Initial royalty revenues 160,666 41,500
Retail sales - company-owned stores 1,534,086 1,176,638
Retail sales - bakery and other products 829,803 247,053
Other revenues 598,844 124,324
- --------------------------------------------------------------------------------------------------------------------
5,990,544 2,574,209
- --------------------------------------------------------------------------------------------------------------------
Operating costs and expenses:
Cost of retail sales 858,608 494,351
General and administrative 7,274,762 3,518,677
Consulting and investor relations 741,777 4,703,244
Long-lived asset writedown (Notes 2 and 15) 1,902,290 993,820
- --------------------------------------------------------------------------------------------------------------------
10,777,437 9,710,092
- --------------------------------------------------------------------------------------------------------------------
Operating loss (4,786,893) (7,135,883)
Other income (expense):
Interest, net (Notes 7 and 8) (435,584) (486,546)
Loss on disposal of property, plant and equipment (525,382) -
Other, net 84,077 (28,728)
- -------------------------------------------------------------------------------------------------------------------
Loss before income taxes and extraordinary item (5,663,782) (7,651,157)
Income tax expense (Note 11) (12,610) (390,458)
- -------------------------------------------------------------------------------------------------------------------
Loss before extraordinary item (5,676,392) (8,041,615)
Extraordinary loss - early extinguishment of debt (Note 14) - (862,029)
- -------------------------------------------------------------------------------------------------------------------
Net loss (5,676,392) (8,903,644)
Preferred stock dividends (1,724,092) (57,506)
- -------------------------------------------------------------------------------------------------------------------
Net loss applicable to common stock $ (7,400,484) $ (8,961,150)
- -------------------------------------------------------------------------------------------------------------------
Weighted average number of common shares outstanding 16,333,684 11,048,244
- -------------------------------------------------------------------------------------------------------------------
Net loss per common share - basic and diluted:
Loss before extraordinary item $ (.45) $ (.73)
Extraordinary item - (.08)
- -------------------------------------------------------------------------------------------------------------------
Net loss per common share $ (.45 ) $ (.81)
- --------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
F-4
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
JRECK Subs Group, Inc.
Consolidated Statements of Stockholders' Equity
Common Preferred Class A Preferred Class
B
--------------------- -------------------- -------------------
Shares Amount Shares Amount Shares Amount
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1997 8,781,000 $ - 700,000 $1,400,000 350,000 $ 700,000
Stock issued for services 229,360 805,048 - - - -
Common stock issued for acquisitions 2,195,764 6,971,964 - - - -
Stock sold for subscription notes receivable 800,000 2,400,000 - - - -
Conversion of debt to equity 445,000 1,307,029 - - - -
Stock issued for payment of interest 50,000 146,857 - - - -
Conversion of preferred Class A to common stock 100,000 200,000 (100,000) (200,000) - -
Stock issued for equipment 230,000 424,003 - - - -
Other stock sales 1,077,213 1,055,500 - - - -
Exercise of options 360,000 255,000 - - - -
Stock and options issued in connection with debt 60,000 795,400 - - - -
Options issued in connection with acquisitions - 508,000 - - - -
Issuance of options and warrants for services - 3,301,302 - - - -
Preferred stock dividend - - - - - -
Net loss - - - - - -
- ----------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 14,328,337 18,170,103 600,000 1,200,000 350,000 700,000
Exercise of options for redeemable common stock 100,000 (325,000) - - - -
Stock issued to settle liability to issue common stock 300,000 918,750 - - - -
Common stock issued for acquisition 778,584 2,100,000 - - - -
Conversion of debt to equity 112,793 277,404 - - - -
Stock issued for services 248,581 537,295 - - - -
Conversion of preferred Class A to common stock 600,000 1,200,000 (600,000) (1,200,00) - -
Conversion of preferred Class B to common stock 350,000 700,000 - - (350,000) (700,000)
Stock sold for subscription notes receivable 1,300,000 1,787,500 - - - -
Preferred stock dividends 99,727 130,651 - - - -
Stock issued in connection with debt 70,000 70,000 - - - -
Stock issued to satisfy acquisition contingencies 500,000 250,000 - - - -
Issuance of options for services - 85,366 - - - -
Issuance of preferred Class D shares - - - - - -
Conversion of preferred Class D to common stock 615,384 250,102 - - - -
Preferred Class D stock dividend - - - - - -
Other 100,190 73,167 - - - -
Net loss - - - - - -
- ----------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 19,503,596 $26,225,338 - $ - - $ -
- ----------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
F-5
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
JRECK Subs Group, Inc.
Consolidated Statements of Stockholders' Equity
Subscrip-
Preferred Preferred tion
Class C Class D Subscrip-
---------------- ------------------ tion Accumulated Total
Shares Amount Shares Amount Notes Deficit Equity
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1997 - $ - - $ - $ - $(1,390,208) $ 709,792
Stock issued for services - - - - - - 805,048
Common stock issued for acquisitions 120 120,000 - - - - 7,091,964
Stock sold for subscription notes receivable - - - - (2,400,000) - -
Conversion of debt to equity - - - - - - 1,307,029
Stock issued for payment of interest - - - - - - 146,857
Conversion of preferred Class A to common stock - - - - - - -
Stock issued for equipment - - - - - - 424,003
Other stock sales - - - - - - 1,055,500
Exercise of options - - - - - - 255,000
Stock and options issued in connection with debt - - - - - - 795,400
Options issued in connection with acquisitions - - - - - - 508,000
Issuance of options and warrants for services - - - - - - 3,301,302
Preferred stock dividend - - - - - (57,506) (57,506)
Net loss - - - - - (8,903,644) (8,903,644)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 120 120,000 - - (2,400,000) (10,351,358) 7,438,745
Exercise of options for redeemable common stock - - - - - - (325,000)
Stock issued to settle liability to issue
common stock - - - - - - 918,750
Common stock issued for acquisition - - - - - - 2,100,000
Conversion of debt to equity - - - - - - 277,404
Stock issued for services - - - - - - 537,295
Conversion of preferred Class A to common stock - - - - - - -
Conversion of preferred Class B to common stock - - - - - -
Stock sold for subscription notes receivable - - - - (1,787,500) - -
Preferred stock dividends - - - - - (341,491) (210,840)
Stock issued in connection with debt - - - - - - 70,000
Stock issued to satisfy acquisition contingencies - - - - - - 250,000
Issuance of options for services - - - - - - 85,366
Issuance of preferred Class D shares - - 2,500 2,785,772 - - 2,785,772
Conversion of preferred Class D to common stock - - (150) (250,102) - - -
Preferred Class D stock dividend - - - 1,382,601 - (1,382,601) -
Other - - - - - - 73,167
Net loss - - - - - (5,676,392) (5,676,392)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 120 $ 120,000 2,350 $3,918,271 $(4,187,500) $(17,751,842) $ 8,324,267
- ------------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
F-6
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
JRECK Subs Group, Inc.
Consolidated Statements of Cash Flows
Year ended December 31, 1998 1997
- --------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
<S> <C> <C>
Net loss $ (5,676,392) $ (8,903,644)
Adjustments to reconcile net loss to net cash used:
Amortization 783,911 202,438
Depreciation 256,349 304,304
Write down of long-lived assets 1,902,290 993,820
Bad debts 125,418 166,831
(Gain) loss on disposal of equipment 525,382 (2,365)
Stock issued for interest expense - 146,857
Stock and stock options issued for services 188,232 4,038,249
Extraordinary loss resulting from issuance of stock on retirement of debt - 862,029
Conversion penalty on Series D preferred stock 718,272 -
Prepaid interest and loan fees amortized to interest expense 83,055 67,267
Amortization of deferred loan costs 55,111 -
Prepaid consulting fees amortized to consulting and investor relations expense 450,643 -
Other 14,630 (36,595)
Cash provided by (used for):
Accounts receivable (84,018) (48,274)
Prepaid expenses 72,341 (21,774)
Deferred tax asset - 387,846
Accounts payable (109,335) 366,879
Accrued liabilities (337,046) 202,494
- --------------------------------------------------------------------------------------------------------------------
Net cash used in operating activities (1,031,157) (1,273,638)
- --------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchase of property and equipment (214,934) (49,726)
Proceeds from disposal of property, plant and equipment 149,982 -
Net cash paid in connection with acquisitions - (408,417)
Note receivable considered worthless - 104,141
Advances made on notes receivable (200,373) (246,497)
Payments from notes receivable 145,241 86,982
Increase in other assets (75,474) -
- --------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (195,558) (513,517)
- --------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from the sale of common stock - 1,055,500
Proceeds from the sale of Series D preferred stock 1,817,500 -
Proceeds from exercise of stock options - 255,000
Payments on redeemable common stock (232,000) -
Proceeds from long-term debt 350,000 1,188,506
Payments on long-term debt (832,102) (752,083)
Proceeds from related party notes payable 40,307 445,000
Payments on related party notes payable - (24,716)
Payment of preferred stock dividends (33,832) -
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 1,109,873 2,167,207
- --------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (116,842) 380,052
Cash and cash equivalents, beginning of year 427,420 47,368
- --------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 310,578 $ 427,420
- --------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
F-7
</TABLE>
<PAGE>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
1. Summary of Nature of Organization
Significant
Accounting JRECK Subs Group, Inc., f/k/a Circa Media, Inc., (the
Policies "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 upstate 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 1998 and 1997, the Company acquired various other
franchisor companies located throughout the United States (see
Note 2). The Company's headquarters are now located in
Longwood, Florida.
Currently, the Company serves as the franchisor to
approximately 273 stores operating under various trade names.
Franchise arrangements include a license to operate under the
applicable trade name and generally provide for the receipt of
initial royalty revenues, as well as continuing royalty
revenues 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.
The Company also operates a bakery and company-owned stores.
As mentioned in Note 2, the bakery is the supplier of bread
products to certain JRECK Subs franchisees. During the years
ended December 31, 1998 and 1997, sales of bakery products to
the JRECK franchisees amounted to $767,378 (12.8% of total
revenues) and $102,887 (4.0% of total revenues), respectively.
As of December 31, 1998, all company-owned stores had been
disposed of.
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.
Operating Segments
In June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related
Information" ("FAS 131"). FAS 131 establishes standards for
the way that public companies report information about
operating segments in annual financial statements. It also
requires the disclosure of certain information regarding
services provided, geographic areas of operation and major
customers. See Note 16 for a further description of these
segments and certain business information.
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 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 the
estimates.
F-8
<PAGE>
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, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation
expense is provided using the straight-line method over the
estimated useful lives of the various assets, generally five
to 40 years.
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 (see Note 2).
Covenants Not to Compete
Covenants not to compete are amortized using the straight-line
method over the estimated useful lives of the underlying
agreements, ranging from three to six years.
Revenue Recognition
Continuing franchise royalty revenue is recognized monthly as
earned. Initial franchise royalty revenue is recognized when
all services or conditions relating to the sale of the
individual franchise has been substantially performed.
Revenues from company-owned stores and bakery products are
recognized upon the sale of products.
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, 1998.
The respective carrying value of certain on-balance-sheet
financial instruments approximates their fair values. These
financial instruments include cash and equivalents, trade
receivables, prepaid expenses, accounts payable, accrued
liabilities and accrued preferred stock dividends. Fair values
were assumed to approximate 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 values of the
Company's notes receivable and long-term debt are estimated
based upon the quoted market prices for the same or similar
issues or on the current rates offered for instruments of the
same remaining maturities. The carrying value of the Company's
notes receivable and long-term debt approximates their fair
market value.
F-9
<PAGE>
Net Loss Per Common Share
Effective December 31, 1997, the Company 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.
Contingently issuable shares are included in basic earnings
(loss) per share as of the date all necessary conditions have
been satisfied. Contingently issued shares are included in
diluted earnings (loss) per share based on the number of
shares, if any, that would be issuable under the terms of the
acquisition agreements if the end of the reporting period were
the end of the contingency period.
The Company's basic and diluted earnings per share are the
same since the Company has a loss for both years presented,
and the impact of potential common shares is antidilutive.
Basic earnings per share at December 31, 1997 include 700,000
shares from the liability to issue common stock. Potential
common shares at December 31, 1998 and 1997 include 4,274,570
and 3,246,000 stock options and warrants, 1,398,071 and
965,986 shares underlying the convertible preferred stock and
48,803 shares from the convertible notes payable,
respectively. The maximum number of contingent shares to be
issued is 333,846 and 600,000 as of December 31, 1998 and
1997, respectively.
Income Taxes
The Company accounts for income taxes on the liability method.
Under this method, deferred tax assets and liabilities are
determined based on differences between financial reporting
and tax bases of assets and liabilities. Measurement of
deferred income tax is based on enacted tax rates and laws
that will be in effect when the differences are expected to
reverse, with the measurement of deferred income tax assets
being reduced by available tax benefits not expected to be
realized.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities"
("FAS 133"). FAS 133 requires companies to recognize all
derivative 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 gain 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, 2000.
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, 2001 to affect its financial
statements.
F-10
<PAGE>
Risk and Uncertainties
The primary uncertainty which the Company faces is its ability
to locate knowledgeable franchisees 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 newly franchised stores. The Company
believes that it has taken the steps necessary to minimize
these risks.
Reclassifications
Certain amounts in the 1997 financial statements have been
reclassified to conform to the 1998 presentation.
2. Acquisition During 1998 and 1997, the Company acquired eight entities
of through the purchase of assets or stock. The acquisitions
Subsidiaries have been accounted for using the purchase method of
accounting, and the results of the acquired businesses have
been included in the consolidated financial statements since
the date of acquisition.
Li'l Dino Corporation
On March 22, 1998, the Company acquired all of the
outstanding common stock of Li'l Dino Corporation ("Li'l
Dino"). Li'l Dino is a franchisor of sandwich shops in North
Carolina.
The purchase price of Li'l Dino consisted of 778,584 shares
of the Company's common stock, valued at $2.72 per share,
plus debt assumed. The transaction was recorded as follows:
------------------------------------------------------------
Total consideration paid $ 2,100,000
Less fair value of assets acquired (15,000)
Debt assumed 400,000
------------------------------------------------------------
Excess of cost over net assets acquired $ 2,485,000
------------------------------------------------------------
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:
--------------------------------------------------------------
Total consideration paid $ 1,531,156
Less, fair value of assets acquired (537,336)
--------------------------------------------------------------
Excess cost of net assets acquired $ 993,820
--------------------------------------------------------------
F-11
<PAGE>
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.
During 1998, the Company ceased all operations of the Leovera
subsidiary, and as further discussed in Note 5, recorded an
impairment in the value of certain of the subsidiary's
property, plant and equipment.
Seawest Sub Shops, Inc.
On June 30, 1997, the Company acquired all of the outstanding
shares of Seawest Sub Shops, Inc. ("Seawest"). Seawest is a
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).
The transaction was recorded as follows:
--------------------------------------------------------------
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
--------------------------------------------------------------
As noted above, options were granted to purchase up to 100,000
shares of Company common stock to the prior owners of Seawest
at an exercise price of $.001 per share. During 1998, all of
these options were exercised.
Upon request of the prior owner of Seawest, the Company is
obligated to repurchase these exercised shares at the greater
of fair market value or $3.25 over a mutually agreeable period
of time which has not been determined. During 1998, $32,000
was paid pursuant to the guarantee and the remaining
obligation to repurchase these shares has been recorded as
redeemable common stock.
Richey Enterprises, Inc.
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.
F-12
<PAGE>
The transaction was recorded as follows:
--------------------------------------------------------------
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
--------------------------------------------------------------
The Company was 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 was to take effect August 15, 1999 and only
if the prior owners of Richey transfer their shares to a third
party during the first 30 days following the second
anniversary date of the closing.
In February 1999, the Company executed an agreement to sell
the Richey Enterprises, Inc. back to the prior owners. Per the
agreement, the prior owners surrendered all of their Company
shares, paid $35,000 cash and assumed certain liabilities. As
a result of this transaction, an impairment to the Richey
Enterprises, Inc. acquisition goodwill was recorded at
December 31, 1998 in the amount of $177,000.
Little King, Inc.
On August 31, 1997, the Company purchased the outstanding
shares 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.
Included in the original purchase price was an obligation to
issue 700,000 additional shares of common stock within one
year of the acquisition. This obligation was accrued for in
the balance of "Liability to issue common stock" at December
31, 1997. In 1998, the Company and the former owners of Little
King renegotiated the purchase price and agreed to reduce the
number of shares to be issued to 300,000. As a result of this
renegotiation, the goodwill and the liability to issue common
stock was reduced by $875,000.
The Company must provide 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>
The final purchase price of Little King and the company-owned
stores was $2,600,000 as follows:
--------------------------------------------------------------
500,000 shares of Company common stock $ 1,531,250
300,000 shares of Company common stock 918,750
Cash paid 50,000
Note payable 100,000
--------------------------------------------------------------
Total acquisition price $ 2,600,000
--------------------------------------------------------------
The 800,000 shares of Company common
stock were valued at $3.0625 per share.
The transaction was recorded as follows:
--------------------------------------------------------------
Total consideration paid $ 2,600,000
Less, fair value of assets acquired (475,470)
Liabilities assumed 1,230,675
--------------------------------------------------------------
Excess cost of net assets acquired $ 3,355,205
--------------------------------------------------------------
During 1998, the Company sold all of its Little King
company-owned stores for notes receivable totaling
approximately $185,000, resulting in a loss on disposal of
approximately $490,000, including $438,729 of net acquisition
goodwill allocated to the stores.
During the fourth quarter of 1998, the Company completed an
evaluation of the economic value of this acquisition's
goodwill through an updated analysis of the expected cash
flows. It was determined during the evaluation that the cash
flow to be generated from the Little King acquisition would be
less than the recorded cost of the investment and the
unamortized goodwill balances at December 31, 1998.
Accordingly, the Company recorded a provision for impairment
of goodwill for $1,000,000 to reduce the carrying value of the
goodwill to its current fair value based on the discounted
cash flows expected.
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:
--------------------------------------------------------------
Company common stock $3,084,278
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
--------------------------------------------------------------
F-14
<PAGE>
Included in the acquisition price were 899,967 shares of
common stock issued at date of acquisition and an additional
150,000 shares that were issued during 1998. The additional
150,000 shares were issued upon the resolution of a
contingency relating to market price performance of the
Company's common stock.
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.
The transaction was recorded as follows:
--------------------------------------------------------------
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
--------------------------------------------------------------
The Company was contingently liable to the previous owners of
QFS for the payment of up to an additional 500,000 shares of
common stock based on the 1998 earnings of the Mountain Mike's
division, as defined. These shares, with a fair market value
of $250,000 on the date of issuance, were issued during 1998,
resulting in a corresponding increase to goodwill.
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 operations for the period between the
acquisition date of the remaining 50% ownership and year end
have 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:
-------------------------------------------------------------
Company common stock, 262,500 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
-------------------------------------------------------------
F-15
<PAGE>
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:
--------------------------------------------------------------
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
--------------------------------------------------------------
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:
--------------------------------------------------------------
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
--------------------------------------------------------------
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.
During 1998, the Company repurchased 74,906 shares of the
redeemable common stock.
Pro Forma Financial Information (Unaudited)
The following summarized unaudited pro forma consolidated
results of operations have been prepared as if the preceding
acquisitions occurred at the beginning of the applicable year
presented and includes pro forma adjustments for interest,
depreciation and amortization:
F-16
<PAGE>
<TABLE>
<CAPTION>
1998 1997
--------------------------------------------------------------------------------
<S> <C> <C>
Revenue $ 6,114,936 $ 5,929,447
Net loss before extraordinary item $ (5,684,118) $ (9,066,438)
Loss from extraordinary item, net of taxes $ - $ (862,029)
--------------------------------------------------------------------------------
Net loss $ (5,684,118) $ (9,928,467)
EPS - basic and diluted:
Net loss before extraordinary item $ (.34) $ (.69)
Net loss from extraordinary item, net of taxes $ - $ (.07)
--------------------------------------------------------------------------------
Net loss $ (.34) $ (.76)
--------------------------------------------------------------------------------
Weighted average number of common shares
outstanding 16,631,492 13,047,554
--------------------------------------------------------------------------------
</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.
3. Prepaid Prepaid expenses are comprised of the following at December
Expenses 31:
1998 1997
----------------------------------------------------------
Prepaid consulting fees $ 601,842 $ 618,056
Other 48,373 101,964
----------------------------------------------------------
$ 650,215 $ 720,020
----------------------------------------------------------
F-17
<PAGE>
4. Notes Notes receivable are comprised of the following at December
Receivable 31:
<TABLE>
<CAPTION>
1998 1997
----------------------------------------------------------------------------------------------
<S> <C> <C>
$321,342 note receivable from a franchisee; payable in equal
monthly installments of principal and interest at 15% through
September 2013; this note is secured by the underlying
franchise rights $ 180,000 $ 145,280
$130,000 note receivable from an area developer; payable in
annual installments of $50,000 plus interest at 8 1/4%; final
payment was due November 1998; this note is unsecured and is
now due upon demand 80,000 100,000
$50,000 note receivable from a franchisee; payable in monthly
installments of $1,185 including principal and interest at 12%
through November 2001; this note is secured by the underlying
franchise rights 38,229 50,000
Eight notes receivable from franchisees; payable in monthly
installments of $879 including principal and interest at an
average rate of 9%; the notes mature at various dates
beginning April 1999 through September 2004; collateralized by
the underlying franchise rights 235,582 88,580
Three notes receivable from franchisees; entire amount of
principal and interest at an average rate of 9% currently due;
collateralized by the underlying franchise rights 24,149 46,983
----------------------------------------------------------------------------------------------
557,960 430,843
Less current portion (398,778) (168,560)
----------------------------------------------------------------------------------------------
$ 159,182 $ 262,283
----------------------------------------------------------------------------------------------
</TABLE>
5. Property, Property, plant and equipment are comprised of the following
Plant and at December 31:
Equipment
<TABLE>
<CAPTION>
1998 1997
--------------------------------------------------------------------------------
<S> <C> <C>
Land and building $ 371,771 $ 370,000
Machinery and equipment 378,730 1,707,064
Office and computer equipment 110,948 64,744
Vehicles 92,636 82,135
Leasehold improvements 110,787 41,457
--------------------------------------------------------------------------------
1,064,872 2,265,400
Less accumulated depreciation (244,150) (334,410)
--------------------------------------------------------------------------------
Net property, plant and equipment $ 820,722 $ 1,930,990
--------------------------------------------------------------------------------
</TABLE>
F-18
<PAGE>
During 1998, the Company ceased operations of the Leovera
subsidiary and evaluated the future undiscounted cash flows of
its bakery operations. In the fourth quarter of 1998, pursuant
to FAS 121, "Accounting for Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed of," the Company has
adjusted those assets to their estimated net realizable value
of approximately $80,000. This resulted in a writedown of
property, plant and equipment of $725,078.
6. Accrued Accrued liabilities are comprised of the following at December
Liabilities 31:
<TABLE>
<CAPTION>
December 31, 1998 1997
---------------------------------------------------------------------------------
<S> <C> <C>
Accrued payroll and payroll-related items $ 256,590 $ 122,962
Deferred revenue 162,500 212,000
Accrued interest 118,888 72,040
Accrued insurance and taxes 51,452 15,153
Accrued consulting fees - 550,000
Other 119,329 73,650
---------------------------------------------------------------------------------
$ 708,759 $ 1,045,805
---------------------------------------------------------------------------------
</TABLE>
7. Note Payable Note payable to related party consists of a working capital
to Related borrowing facility with the Company's largest stockholder. The
Party note agreement calls for interest-only payments at 9% payable
monthly through January 1999, monthly principal and interest
payments of $3,121 through December 2008, at which time any
remaining unpaid balances are due. The note had an outstanding
balance of $363,339 and $323,032 at December 31, 1998 and
1997, respectively, and is unsecured.
Interest expense on the related party debt totaled $22,172 and
$20,870 during 1998 and 1997, respectively.
F-19
<PAGE>
<TABLE>
<CAPTION>
Long-term debt consists of the following:
Year ended December 31, 1998 1997
------------------------------------------------------------------------------------------------------
<S> <C> <C>
Seventeen convertible notes payable with an aggregate face
amount of $530,000; quarterly interest-only payments at 12
3/4% due through December 1999; all unpaid principal and
interest due March 2000; collateralized by royalty revenues
generated by the Mountain Mike's franchises; convertible into
Company common stock at $10.86 per share. $ 530,000 $ 530,000
Note payable to former owner of acquired subsidiary; monthly
interest-only payments due at 7%; entire principal amount due
July 1999; collateralized by royalty revenues generated by the
Sobik's franchises [see Note 13 c)] 500,000 500,000
Note payable to bank assumed upon the Li'l Dino's acquisition;
payable in monthly installments of $4,762 principal and
interest at the bank's prime lending rate plus 1% (8 3/4% at
December 31, 1998) through February 2000; final payment of
$290,474 due March 2000; collateralized by personal assets and
a personal guarantee of the prior owners of Li'l Dino's. 357,142 -
Note payable to bank; principal and interest at 10% payable
upon demand; note is uncollateralized. 257,583 257,583
Four notes payable to individuals with an aggregate face
amount of $350,000 net of unamoritzed loan costs of $38,889;
all unpaid principal and interest at 8% is due May 1999;
collateralized by a personal guarantee of the Company's Chief
Executive Officer. 311,111 -
Two notes payable to former owners of Seawest with an
aggregate face amount of $700,000; monthly principal payments
of $4,000 are due through April 2004, at which time any
remaining unpaid principal is due; these notes are
uncollateralized. 301,400 348,000
Note payable to franchisee; monthly interest-only payments at
9% due through December 1999; thereafter monthly principal and
interest payments of $2,236 are due through December 2009;
this note is uncollateralized. 176,476 249,944
Three notes payable to individuals; monthly interest-only
payments at 15% due through November 2004, at which time any
remaining unpaid principal and interest is due; these notes
are uncollateralized and are net of unamortized loan costs of
$156,000 and $180,000, respectively. 24,000 -
Mortgage note payable to former owner of Pastry; monthly
payments of $2,494 including principal and interest at 10% due
through November 2004, at which time any remaining unpaid
principal and interest is due; collateralized by real
property. 140,234 150,222
Note payable to bank; monthly interest-only payments at 6 1/2%
due through March 1999; any remaining unpaid principal and
interest is due April 1999; collateralized by a personal
guarantee by the former owner of Little King. Subsequent to
year end, the due date was extended to April 1, 2000. 135,000 135,000
F-20
<PAGE>
Note payable to bank; monthly principle payments of $500 plus
interest at 10 1/2% due through January 1999, at which time
any remaining unpaid principal and interest is due;
collateralized by equipment and personal guarantee by the
prior owner of Little King. Subsequent to year end, the due
date was extended to October 5, 1999. 134,317 138,435
Note payable to bank; monthly payments of $1,750 including
interest at 10 1/2% are due through March 2002, at which time
any remaining unpaid principal and interest is due;
collateralized by certain fixed assets. 124,111 124,111
Note payable to supplier; monthly principal payments of $7,000
plus interest at 10% are due until paid in full; all unpaid
principal and interest is due upon demand; this note is
uncollateralized. 120,000 128,676
Note payable to former owner of Little King; payable in
monthly interest-only payments at 8% with the principal due
upon demand; this note is uncollateralized. 60,000 334,785
Commercial paper bearing interest at 10 1/2% per annum, repaid
in September 1998; notes were uncollateralized. - 283,630
Note payable to individual; interest-only payments were due at
15%; converted into 250 shares of preferred Series D stock
during 1998. - 250,000
Note payable to former owner of Little King; paid off in 1998;
this note was uncollateralized. - 100,000
Various uncollateralized notes payable; due in average monthly
principal payments of $825 including interest at an average
rate of 9 1/4%; maturing at various dates beginning March 1999
through November 2000. 343,466 580,268
-----------------------------------------------------------------------------------------------------
3,514,840 4,110,654
Less current portion (2,003,198) (2,336,754)
-----------------------------------------------------------------------------------------------------
Total long-term debt $ 1,511,642 $ 1,773,900
-----------------------------------------------------------------------------------------------------
</TABLE>
Interest expense on long-term debt during 1998 and 1997
amounted to $291,580 and $463,006, respectively.
The annual maturities of long-term debt and related party debt
for the five years subsequent to December 31, 1998 are as
follows:
Long-Term Related
Debt Party
Debt Total
--------------------------------------------------------------
1999 $ 1,368,198 $ - $ 2,003,198
2000 1,193,984 25,047 1,012,603
2001 358,852 27,397 314,821
2002 127,478 29,967 86,017
2003 115,646 32,778 76,996
Thereafter 545,571 248,150 579,433
--------------------------------------------------------------
$ 3,709,729 $ 363,339 $ 4,073,068
--------------------------------------------------------------
F-21
<PAGE>
9. Stockholders' The following is a synopsis of significant transactions
Equity involving the Company's stockholders' equity accounts:
Preferred Series A
In 1996, the Company designated and issued 700,000 shares of
no par value 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 and
600,000 and 100,000 shares were converted into common stock
during 1998 and 1997, respectively.
Preferred Series B
In 1996, the Company designated and issued 350,000 shares of
$2 par value Series B voting nonredeemable convertible
preferred stock. The Series B preferred stock is entitled to
receive noncumulative preferential dividends only when
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. During 1998, the 350,000
shares were converted to common stock.
Preferred Series 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 QFS (see Note 2). 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 at 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.
Preferred Series D
In January 1998, the Company sold 2,500 shares of no par value
Series D convertible preferred stock under a private placement
offering at a stated face value of $1,000 per share. The net
proceeds to the Company were $1,817,500 after deducting the
placement agent commission and expenses. In addition, $250,000
of long-term debt was extinguished through the issuance of 250
shares of the Series D convertible preferred stock. Each share
of the Series D preferred stock is convertible, at the option
of the shareholder at any time, into a number of shares of
common stock of the Company at a conversion rate which shall
be a number of shares of common stock equal to $1,000 divided
by the lower of 55% of the average market price of the common
stock for the five trading days immediately prior to the
conversion date or $1.96875. The conversion price is based on
55% of the fair market value of the Company's common stock at
the date of conversion. The holders of the Series D preferred
stock are entitled to receive cumulative yearly dividends at a
rate of 8% of the face value in cash or, at the option of the
Company, in shares of common stock. The Series D shares are
entitled to a liquidation preference of $1,300 per share.
Since the Series D preferred stock is convertible at a
discount, a Series D preferred stock dividend of $1,382,601
has been recorded for the year ended December 31, 1998 for the
difference between the discounted conversion price of the
Series D preferred stock and the fair market value of the
Company's common stock at the time of issuance.
F-22
<PAGE>
Pursuant to the terms of the private placement agreement, the
Company was required to register with the Securities and
Exchange Commission the shares of common stock underlying the
Series D preferred stock within 30 days of the final closing
of the private placement. In addition, the registration was
required to be declared effective within 120 days of the
closing date. Since those events did not occur, the Company
was required to increase the discount rate by 10% from 35% to
45% to the purchasers of the private placement during 1998.
This additional discount was valued at $718,272 (the
difference between the original discounted conversion price
and the fair market value of the common stock) and was
recorded in selling, general and administrative expenses in
1998. As of December 31, 1998, the holders of the Series D
preferred stock had converted 150 shares of Series D preferred
stock into 615,384 shares of common stock.
Stock Subscriptions Receivable
During 1998, the Company sold the following common shares in
exchange for subscription notes receivable: (1) 500,000 shares
valued at $687,500 to the Company's Chief Operating Officer,
(2) 500,000 shares valued at $687,500 to the Company's Chief
Financial Officer, and (3) 300,000 shares valued at $412,500
to a consultant. Each of the underlying stock subscription
agreements bear interest at 9 1/2% per annum and are due on or
before July 2001. The shareholders also retain the right to
require the Company to repurchase the shares within three
years of their issuance in exchange for the cancellation of
the notes.
During 1997, the Company sold the following common shares in
exchange for subscription notes receivable: (1) 500,000 shares
valued at $1,500,000 to the Company's Chief Operating Officer
and (2) 300,000 shares valued at $900,000 to a consultant of
the Company. Each of the underlying stock subscription
agreements bear interest at 9 1/2% 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 within three years of their issuance in exchange for
cancellation of the notes.
The fair value of each subscription was based on the quoted
market price of the Company's common stock on the date of
issuance.
Common Stock Issued in Connection with Debt
During 1998, the Company borrowed $350,000 from four
individuals. The Company issued 70,000 shares of common stock
to these investors. The market price of the shares on the date
of the issuance was $1.00 per share, and accordingly, $70,000
was recorded as original issue discount and is being amortized
as interest expense over the life of the loan. The Company is
obligated to issue additional shares to these investors if the
underlying per share value of the stock is less than $1.50
upon the occurrence of certain defined future events. The
number of shares to be issued will be based upon the fair
market value of the Company's common stock at the date the
contingency is met.
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. Of this amount, $180,000 was recorded as
deferred loan costs and the remainder is classified as prepaid
interest and is included in other assets. These amounts are
being amortized as interest expense over the life of the loan.
F-23
<PAGE>
Stock Issued for Equipment and Services
During 1998, the Company issued 248,581 shares of its common
stock in exchange for consulting and legal services. The
aggregate fair value of these shares was calculated to be
$537,295 based on the market value of the stock on the date of
issuance. Of this amount, $434,429 was classified as prepaid
consulting fees and is being amortized over one year based on
the lives of the agreements.
During 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.
During 1997, the Company acquired equipment valued at $424,003
in exchange for 230,000 restricted shares of common stock.
Conversion of Debt to Equity
During 1998, the Company issued 112,793 shares of its common
stock with a fair market value of $277,404 in exchange for
extinguishment of long-term debt.
As described further in Note 14, during 1997 the Company
issued 495,000 shares of its restricted common stock in
exchange for the extinguishment of certain long-term debt and
related interest.
Private Placement of Common Stock
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.
Common Stock Issued in Conjunction with Prior Year Subsidiary
Acquisitions
In November 1998, the Company issued 50,000 shares of its
common stock to the former owners of Sobik's. These shares
were issued as consideration for the granting of an extension
on the due date of long-term debt of $500,000 (see Note 8)
incurred on the acquisition. The fair value of these shares,
$21,875, has been classified as prepaid loan fees and is
included in other assets as December 31, 1998. The loan fees
are being amortized over the remaining contractual life of the
loan.
Common Stock Options and Warrants
During 1998, the Company granted two consultants options to
purchase a total of 228,570 shares of common stock at an
exercise price of $0.875 per share, the quoted market price of
the underlying shares on the date of the grant. The fair value
of these options, $85,366, was recorded as prepaid consulting
fees and is being amortized over one year, the life of the
underlying consulting agreements.
F-24
<PAGE>
In addition, options to purchase 100,000 shares of the
Company's common stock that were granted in 1997 were
exercised by the prior owners of Seawest during 1998. The
Company waived the exercise price of $0.001 per share.
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 $255,000.
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 1998: 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 increased to the pro forma
amounts indicated below:
<TABLE>
<CAPTION>
1998 1997
--------------------------------------------------------------------------------
<S> <C> <C>
Net loss applicable to common stock
As reported $ (7,400,484) $ (8,961,150)
Pro forma $ (7,650,484) $(10,116,150)
Loss per share - basic and diluted
As reported $ (.45) $ (.81)
Pro forma $ (.47) $ (.92)
--------------------------------------------------------------------------------
</TABLE>
Changes in options outstanding are summarized as follows:
<TABLE>
<CAPTION>
Weighted-
Weighted- Average
Average Fair Value
Exercise of Options
Shares Price Granted
---------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, December 31, 1996 - $ - $ -
Granted 3,624,704 2.30 1.58
Less options exercised (360,000) .71 -
Less options expired (18,704) 3.08 -
---------------------------------------------------------------------------------
Balance, December 31, 1997 3,246,000 2.48 -
Granted 1,228,570 1.42 .27
Less options exercised (100,000) - -
Less options expired (100,000) 2.81 -
---------------------------------------------------------------------------------
Balance, December 31, 1998 4,274,570 $2.22 -
---------------------------------------------------------------------------------
</TABLE>
F-25
<PAGE>
The following table summarizes information about options
outstanding at December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding and Exercisable
-----------------------------------------------------
Weighted - Weighted-
Average Average
Range of Remaining Exercise
Exercise Prices Number Contractual Life Price
--------------------------------------------------------------------------------
<S> <C> <C> <C>
$ .50 to 1.75 1,611,070 36.3 months $1.24
$2.56 to 3.93 2,663,500 33.2 months 2.82
--------------------------------------------------------------------------------
4,274,570 34.3 months $2.22
--------------------------------------------------------------------------------
</TABLE>
10. Commitments Operating Leases
and
Contingencies The Company leases office space under certain operating leases
which expire through 2003. Total rent expense for the years
ended December 31, 1998 and 1997 was $323,473 and $222,305,
respectively.
Future annual minimum lease payments due under these operating
leases at December 31, 1998 are as follows:
--------------------------------------------------------------
1999 $ 115,526
2000 115,006
2001 38,729
2002 18,000
2003 11,250
--------------------------------------------------------------
$ 298,511
--------------------------------------------------------------
Legal Issues
The Company is involved in various lawsuits and litigation
matters on an ongoing basis as a result of its day-to-day
operations. However, the Company does not believe that any of
these other or any threatened lawsuits and litigation matters
will have a material adverse effect on the Company's financial
position or results of operations.
F-26
<PAGE>
Franchise Agreements
Under the terms of the various franchise agreements, which are
for terms ranging from 10 to 15 years and contain various
renewal options, the franchisees are obligated for the payment
of the following fees to the Company:
o Franchise Fees
In accordance with the terms of the
franchise agreements, the Company
receives an initial franchise fee of
$10,000 to $20,000.
o Royalties
The Company receives royalties
ranging from 4% to 7% of gross sales
from the franchisees' operations of
the restaurants.
o 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.
Employment Agreements
The Company is a party to employment agreements with its Chief
Operating Officer and Chief Financial Officer. Pursuant to the
agreements, these officers are to receive an annual salary of
approximately $150,000 and $125,000 through September 2000 and
July 2001, respectively.
Consulting Fees
In October 1998, the Company entered into an agreement with a
consultant to receive advisory services. Pursuant to this
agreement, the Company is obligated to pay consulting fees
ranging from 3% to 10% based upon performance results, as
defined.
During 1997, the Company entered into an agreement with a
consultant to receive advisory services. The Company is
contingently obligated to the consultant to provide for
options of 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 by December 2000. Since
management believes the 630-store level will be achieved,
options with a fair market value of $681,000 were recorded as
prepaid consulting, which is being amortized over the life of
the agreement.
F-27
<PAGE>
11. Income Taxes The components of income tax expense are as follows:
Year ended December 31, 1998 1997
--------------------------------------------------------
Current:
Federal $ - $ -
State 12,610 10,612
--------------------------------------------------------
12,610 10,612
--------------------------------------------------------
Deferred:
Federal - 379,846
State - -
--------------------------------------------------------
- 379,846
--------------------------------------------------------
Total income taxes $ 12,610 $ 390,458
--------------------------------------------------------
The componassets and liabilities are comprised of the
following at December 31:
<TABLE>
<CAPTION>
1998 1997
--------------------------------------------------------------------------------
Deferred tax assets:
<S> <C> <C>
Net operating loss carryforwards $ 1,796,000 $ 1,101,000
Stock and stock options issued for services 1,066,000 1,034,000
Allowance for doubtful accounts 128,000 85,000
Goodwill and covenants not to compete 69,000 25,000
Property, plant and equipment 51,000 -
Accrued expenses 36,000 -
--------------------------------------------------------------------------------
Gross deferred income tax assets 3,146,000 2,245,000
Valuation allowance (3,146,000) (2,103,000)
--------------------------------------------------------------------------------
Total deferred tax assets - 142,000
--------------------------------------------------------------------------------
Deferred tax liabilities:
Property and equipment - (142,000)
--------------------------------------------------------------------------------
Total deferred tax liabilities - (142,000)
--------------------------------------------------------------------------------
Net deferred tax asset (liability) $ - $ -
--------------------------------------------------------------------------------
The following summary reconciles differences from taxes at the
federal statutory rate with the effective rate:
<CAPTION>
1998 1997
--------------------------------------------------------------------------------
<S> <C> <C>
Income taxes at federal statutory rates (34.0 %) (34.0 %)
State income taxes, net of federal benefit .3 % .3 %
Operating loss with no tax benefit 34.0 % 38.3 %
--------------------------------------------------------------------------------
Income taxes at effective rates .3 % 4.6 %
--------------------------------------------------------------------------------
</TABLE>
F-28
<PAGE>
At December 31, 1998, the Company has net operating loss
carryforwards of approximately $4,700,000 for federal income
tax purposes that expire as follows:
------------------------------------------------------------
2012 $ 2,900,000
2018 1,800,000
------------------------------------------------------------
$ 4,700,000
------------------------------------------------------------
12. Supplemental Certain supplemental disclosure of cash flow information and
Cash Flow non cash investing and financing activities is as follows:
Information
<TABLE>
<CAPTION>
Year ended December 31, 1998 1997
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash paid for interest during the year $ 266,904 $ 144,283
- ------------------------------------------------------------------------------------------------------------------
Issuance of common stock in exchange for subscriptions receivable $ 1,787,500 $ 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 prepaid expenses 456,304 68,101
Stock issued to pay down related party notes payable - 445,000
Stock and stock options issued in exchange for prepaid interest and deferred loan
costs 92,125 795,400
Conversion of Class A preferred to common stock 1,200,000 200,000
Conversion of Class B preferred to common stock 700,000 -
Conversion of Class D preferred to common stock 250,102 -
Stock issued for payment of interest - 146,857
Equipment valued at $47,635 was sold in exchange for note receivable - 50,000
Common shares issued to satisfy liability to issue common stock to prior owner of
Little King 918,750 -
Renegotiation of liability to issue common stock to prior owner of Little King 875,000 -
Common shares issued to satisfy Mountain Mike's acquisition contingency 250,000 -
Conversion of long-term debt into preferred Series D stock 250,000 -
Dividend on assumed conversion of Series D preferred stock into common stock 1,382,601 -
Redeemable common stock obligation incurred upon exercise of stock options 325,000 -
Conversion of long-term debt into common stock 277,404 -
Decrease in goodwill resulting from the disposals of property, plant and
equipment with a book value of $274,080 in which notes receivable of $185,000
were received as partial consideration 499,080 -
Preferred stock dividends paid in common stock 130,651 -
Preferred stock dividends accrued 201,540 -
Other increases in notes receivable 43,369 -
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
F-29
<PAGE>
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 2:
<TABLE>
<CAPTION>
1998 1997
--------------------------------------------------------------------------------
<S> <C> <C>
Common stock and stock options issued $ (2,100,000) $ (7,979,964)
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 - (1,793,750)
Miscellaneous accrued liability - (48,000)
-------------------------------------------------------------------------------
Total non-cash consideration paid (2,100,000) (11,381,697)
--------------------------------------------------------------------------------
Accounts receivable acquired - 353,459
Prepaid expenses acquired - 60,029
Notes receivable acquired - 121,248
Property, plant and equipment acquired 15,000 1,644,402
Goodwill acquired 2,485,000 12,711,710
Other intangible assets acquired - 636,097
--------------------------------------------------------------------------------
Total non-cash acquisition of assets 2,500,000 15,526,945
--------------------------------------------------------------------------------
Accounts payable assumed - (643,821)
Accrued liabilities assumed - (389,500)
Long-term debt assumed (400,000) (2,268,739)
Related party notes payable assumed - (434,771)
--------------------------------------------------------------------------------
Total non-cash assumption of liabilities (400,000) (3,736,831)
--------------------------------------------------------------------------------
Net cash paid $ - $ 408,417
--------------------------------------------------------------------------------
</TABLE>
13. Subsequent a) Conversion of Series D Preferred Stock
Events
Subsequent to December 31, 1998,
shareholders holding 340 shares of the
Company's Series D preferred stock
converted their shares in to 2,750,936
shares of common stock.
b) Private Placement
On June 10, 1999, the Company completed
a private placement offering of 250
shares of its $12,500 face value Series
F preferred stock. Each share of the
Series F is entitled to a cumulative
yearly cash dividend of $1,000 and the
shareholders have the right to require
the Company to repurchase all
F-30
<PAGE>
outstanding shares for $12,500 per
share between June 1, 2001 and August
1, 2001. The Series F shares are
redeemable for $12,500 per share any
time prior to February 1, 2001 at the
option of the Company. Each share is
entitled to receive $13,000 per share
upon the liquidation of the Company.
The holders of the Series F preferred
stock have no voting rights. As of July
1999, approximately 198 shares of the
Series F shares have been issued.
c) SBK Franchise Systems, Inc.
On June 11, 1999, the Company
renegotiated certain provisions of the
SBK Franchise Systems, Inc.
acquisition. Among the changes to this
agreement is a provision to reduce the
outstanding balance of the $500,000
note payable to $200,000 in exchange
for 250,000 shares of the Company's
common stock and other consideration.
The renegotiated note will have an
interest rate of 7% and equal annual
payments beginning August 1, 2000. In
addition, the $300,000 redeemable
common stock will be exchanged for
450,187 shares of Company common stock.
14. Related Significant related party transactions and balances not
Party previously disclosed are as follows:
Transactions
In August 1998, the Company granted options to purchase
1,000,000 shares of common stock to the President and Chief
Executive Officer. The options are exercisable at $1.55 per
share until August 2001. The President has yet to exercise any
portion of these options.
During 1997, 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.
During 1997, the Company granted stock options for 1,000,000
shares of common stock to the President and Chief Executive
Officer. These options are exercisable at $2.75 per share
until December 2000. The President has yet to exercise any
portion of these options.
15. Fourth The Company recorded numerous year-end adjustments during the
Quarter fourth quarter of 1998 which resulted in earnings being
Adjustments reduced by $1,902,290 during this period.
The adjustments were primarily attributed to the writedown of
goodwill of $1,177,212 and the writedown of property, plant
and equipment of $725,078.
F-31
<PAGE>
16. Quarterly During the fourth quarter of 1998, the Company also recorded
Financial various year-end adjustments related primarily to amortization
Data of prepaid expenses, loss on disposal of property, plant and
(Unaudited) equipment, accrued expenses and the conversion penalty
related to the Series D convertible preferred stock, which
resulted in adjustments to its previously reported earnings
for the first three quarters of 1998. The impact of these
adjustments is as follows:
<TABLE>
<CAPTION>
March 31, June 30, September 30,
1998 1998 1998
--------------------------------------------------------------------------------
<S> <C> <C> <C>
Net loss as previously reported $ (845,041) $ (469,854) $ (599,875)
Impact of fourth quarter
adjustments (637,903) 250,213 (63,000)
Adjusted net loss (1,482,944) (219,641) (662,875)
Loss per share, as previously
reported (0.058) (0.029) (0.036)
Adjusted loss per share (0.1025) (0.0138) (0.0397)
--------------------------------------------------------------------------------
</TABLE>
17. Operating The Company is engaged in nine operating segments. Pursuant to
Segments FAS 131, the Company defines an operating segment as:
o A business activity from which it may earn revenue
and incur expenses;
o Whose operating results are regularly reviewed by
the chief operating decision maker to make
decisions about resources to be allocated to the
segment and assess its performance; and
o For which discrete financial information is
available.
The Company defines segments as each separate franchising
concept it operates. It clearly views each business as a
separate segment and makes decisions based on the activity and
profitability of that particular segment.
Pursuant to FAS 131, the Company has aggregated two or more
operating segments into two reportable segments to ease in the
presentation and understanding of its business. The Company
used the following criteria to aggregate its segments:
o The nature of its products and services;
o The nature of the production processes;
o The type or class of customer for its products and
services;
o The methods used to distribute its products or
provide its services; and
o The nature of the regulatory environment.
F-32
<PAGE>
The reportable segments are defined as follows:
o The franchise operations segment is engaged in
the franchising of various quick-service
restaurants located throughout the United States.
These restaurants feature submarine sandwiches,
pizza, soups and hot and cold side order items.
The Company assists the franchisees with selecting
suitable locations, advises on the negotiation of
lease terms and store design, assists with
securing of food product supply and purchase of
furniture and fixtures. The Company also operates
company-owned stores on a limited basis.
o The bakery operations segment is comprised of a
bakery that primarily serves the JRECK restaurant
franchises.
The table below shows certain financial information by
business segment for 1998 and 1997:
<TABLE>
<CAPTION>
Segment Reporting Franchise Bakery Consolidated
December 31, 1998 Operations Operations Total
--------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenue from external
customers $ 5,160,741 $ 829,803 $ 5,990,544
Interest expense - net 408,836 26,748 435,584
Depreciation and
amortization 873,981 166,279 1,040,260
Segment loss (5,457,918) (218,474) (5,676,392)
Segment assets 13,068,764 1,639,090 14,707,854
Expenditures for
segment assets 208,685 21,249 229,934
--------------------------------------------------------------------------------
<CAPTION>
Segment Reporting Franchise Bakery Consolidated
December 31, 1997 Operations Operations Total
--------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenue from external
customers $ 2,327,156 $ 247,053 $ 2,574,209
Interest expense - net 475,115 11,431 486,546
Depreciation and
amortization 484,053 22,689 506,742
Segment loss (8,842,267) (61,377) (8,903,644)
Segment assets 14,528,432 1,819,530 16,347,962
Expenditures for
segment assets 1,073,772 620,356 1,694,128
--------------------------------------------------------------------------------
</TABLE>
F-33
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 310,578
<SECURITIES> 0
<RECEIVABLES> 555,755
<ALLOWANCES> 157,000
<INVENTORY> 0
<CURRENT-ASSETS> 1,758,326
<PP&E> 1,064,872
<DEPRECIATION> 244,150
<TOTAL-ASSETS> 14,707,854
<CURRENT-LIABILITIES> 3,915,606
<BONDS> 3,514,840
0
4,038,271
<COMMON> 22,037,838
<OTHER-SE> (17,751,842)
<TOTAL-LIABILITY-AND-EQUITY> 14,707,854
<SALES> 2,363,889
<TOTAL-REVENUES> 5,990,544
<CGS> 858,608
<TOTAL-COSTS> 858,608
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 125,418
<INTEREST-EXPENSE> 435,584
<INCOME-PRETAX> (4,786,893)
<INCOME-TAX> 12,610
<INCOME-CONTINUING> (5,676,392)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,400,484)
<EPS-BASIC> (0.45)
<EPS-DILUTED> (0.45)
</TABLE>
