SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-SB/A
(Amendment No. 4)
GENERAL FORM FOR REGISTRATION OF SECURITIES
OF SMALL BUSINESS ISSUERS
Under Section 12(b) or 12(g) of
The Securities Exchange Act of 1934
JRECK SUBS GROUP, INC.
Name of Small Business Issuer in its charter)
Colorado 84-1317674
(State or Other Jurisdiction (IRS Employer Identification No.)
of Incorporation or Organization)
2101 West State Road 434, Suite 100, Longwood, FL 32779
(Address of principal executive offices) (Zip Code)
(407) 682-6363
(Issuer's Telephone Number)
Securities to be registered under Section 12(b) of the Act:
Title of each class Name of Each Exchange on which
to be so registered each class is to be registered
None None
Securities to be registered pursuant to section 12(g) of the Act:
Common Stock, no Par Value
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PART I
Item 1. Description of Business
Background
In the summer of 1969 five school teachers from the Carthage, New York
Central School System - named Jerry, Richard, Ellis, Charles and Keith - JRECK
commenced a business of preparing and serving submarine style sandwiches from an
old school bus just outside of the main gate of Camp Drum. The business was
incorporated in 1974 in the State of New York under the name JRECK Subs, Inc.
In May, 1996 the Company concluded a reverse acquisition wherein all of
its capital stock was acquired by Circa Media, Inc., a Colorado corporation
formerly engaged in reproducing archival, public domain art and photographs in
digital form. Circa Media, Inc. was incorporated on July 19, 1995. Commencing
August 1995, Circa Media, Inc. issued 2,200,000 shares of common stock and 200
shares of preferred stock in reliance on Rule 504 of Regulation D. A Form D
reflecting this issuance was filed with the Securities and Exchange Commission
on August 21, 1995. 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. ("Company") on May 7, 1996 and the former common
shareholders of JRECK Subs, Inc. received 5,000,000 shares of Common Stock of
the Company in the transaction, or 56% of the outstanding shares, and the former
Series A Preferred Stockholders of JRECK Subs, Inc. received 700,000 shares of
Series A Preferred Stock. The former business of Circa Media, Inc. was
discontinued prior to May 1996. The historical information presented prior to
May 1996 is that of Jreck Subs, Inc.
The Company now consists of JRECK Subs Group, Inc., and its
wholly-owned subsidiaries, including JRECK Subs, Inc., a New York corporation,
Leovera, Inc. ("Leovera"), a Florida corporation, Admiral Subs of Washington,
Inc. ("ASWI"), a Washington corporation, owners of Seawest Subshops, Inc.
("Seawest"), Little King, Inc. ("Little King"), a Delaware corporation, Pastry
Products Producers, LLC, a New York limited liability company ("Pastry
Products"), SBK Franchise Systems, Inc. ("SBK"), a Florida corporation, Li'l
Dino Corporation ("Li'l Dino"), a North Carolina corporation, and Admiral's
Fleet, Inc. ("AFI"), a Washington corporation and AFI's wholly-owned
subsidiaries, Richey Enterprises, Inc. ("Georgio's"), a Washington corporation
and Quality Franchise Systems, Inc. ("Mountain Mike's"), a Delaware corporation.
Company Operations
The Company is a multiple-concept franchisor. The Company began with
the JRECK Subs franchise which currently has 47 restaurants. JRECK Subs offers a
menu of high quality, fresh submarine sandwiches, soups and hot and cold side
order items as well as a full line of bagel offerings in selected franchise
locations based on the Lox, Stock & Bagel menu which certain proprietary rights
were acquired by the Company in 1990.
During 1997, the Company commenced a growth strategy through
acquisitions which included the following:
* Hymie's Bagels, a 8 unit chain of licensed bagel shops in Tampa,
Florida along with a bakery;
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* Seawest Subs, a 40 unit submarine sandwich chain primarily located in
Seattle, Washington;
* Little King, a 36 unit submarine sandwich chain primarily located in
Nebraska;
* Georgio's, a 6 unit submarine sandwich chain primarily located in
Seattle, Washington;
* Mountain Mike's Pizza, a 78-unit pizza chain primarily located in
northern and central California;
* Sobik's Sandwich Shops, a 41-unit submarine sandwich chain primarily
located in the Orlando, Florida area;
* Li'l Dino, a 43-unit submarine sandwich chain primarily located in
North Carolina; and
* The completed acquisition of a 100% interest in Pastry Products
Producers, LLC which supplies the JRECK Subs restaurants with all of
their bakery products.
JRECK Subs Menu and Stores
The Company's JRECK Subs franchises offer a menu of different submarine
sandwiches, as well as a full line of bagel offerings and additional breakfast
items in selected franchise locations based on the Lox, Stock & Bagel menu.
JRECK Subs' emphasis in the submarine sandwich business is to offer a wider
selection of menu items and higher quality ingredients (such as rib-eye steak)
cooked on the premises. The food preparation area is open to customer view to
engage customer interest and to showcase freshness and cleanliness. The food
preparation process is designed to deliver a completed food order within 60
seconds. Sandwich menu prices range from $2.50 to $5.00. In addition, JRECK Subs
offers a selection of soft drinks, on-premises baked cookies and deep fried
items such as french fries, mushrooms, and cheese sticks.
As of September 30, 1998 there were 47 JRECK Subs franchisees, all of
which are located in New York State. Each location is designed as a "dine in"
location, although a number of franchises have drive up windows as well. Located
in strip shopping centers, shopping malls, and free standing buildings,
restaurants generally range from 1,000 to 2,000 square feet in size with 1,400
to 1,500 square feet being typical. The typical JRECK Subs store is decorated
with wood, brass tables and chairs, and brass lamps with green shades to impart
a friendly and cozy atmosphere. The green and white color scheme of the JRECK
"Admiral" signage is carried throughout the interior.
As is typical in sandwich shops, a majority of store sales occur during
lunch and the remainder during the dinner hours. Dine in and take out (including
delivery) typically comprise 60% and 40% of sales, respectively. Individual
franchisees can elect to offer catering services or home delivery.
Each franchisee leases or owns store facilities. Neither the Company
nor any of its affiliates leases store premises to franchisees.
Franchise Program
As of September 30, 1998 the Company had approximately 288 restaurants
of which 284 are franchised locations. The Company obtains prospective
franchisees from its current and former employees, from referrals from existing
franchisees and from franchise shows.
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The Company assists franchisees with selecting suitable locations by
the use of demographic and traffic pattern analysis, an analysis of the
proximity of business and community resources, and competition; advises on the
negotiation of lease terms and store design; assists with sourcing of food
product supply; and purchase of furniture and fixtures. The Company's experience
is that smaller towns with populations under 10,000 are prime locations for its
franchisees due to the lack of competition from larger fast food chains and the
high quality of its products. The Company has no formal policy with respect to
proximity of franchises, but deals with proximity issues on a case by case
basis. Certain franchisees are required to purchase all their baked goods from
the Company, such as submarine sandwich rolls. Bakery products for JRECK Subs
stores are supplied by the Company's bakery in Watertown, New York.
The Company intends to develop new franchise locations primarily
through existing franchisees. Management believes that the Company has a
national presence which it intends to strengthen by further developing each of
its regional concepts. The primary criteria considered by the Company in the
review and approval of franchisees are prior experience in operating restaurants
or other comparable businesses and capital available for investment.
Franchise fees in all franchising companies are to a large degree
competitively market driven. The Company intends to maintain franchise fees for
new franchised locations within industry norms of $10,000 to $12,500 for new
locations in the sandwich segment and $20,000 in the pizza segment. Franchise
fees are due upon execution of the Franchise agreement. The Company intends to
maintain royalty fees of 5% to 7% of sales for all new locations for each of its
brands on a going forward basis and advertising fees at 2% to 4% of sales. The
following table sets forth certain information regarding the Company's
franchises. <TABLE> <CAPTION>
- ------------------- -------------- --------------- ---------------- ----------------- -------------- ----------------
Concepts Franchised/LicensAve. Years Avg. Royalty Avg. Royalty on Price of New
Units Left on on Existing New Franchises Franchise Selling New
Contract Franchises Franchises
- ------------------- -------------- --------------- ---------------- ----------------- -------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
JRECK Subs 47 9.2 4.3% 5.0% $10,000 Yes
Mountain Mike's 78 10.0 4.6% 5.0% $20,000(d) Yes
Pizza
SBK Sandwich Shops 41 6.8 4.6% 5.0% $10,000(e) Yes
Li'l Dino 43 16.0 5.9% 7.0%(c) $12,500(f) Yes
Seawest Subs Shops 40 6.5 5.0% 5.0% $10,000(g) Yes
Little King 25 9.9 4.9% 6.0% $12,000 Yes
Hymie's Bagels 8(a) N/A N/A N/A N/A No
Georgio's 6(b) 8.5 4.0% 5.0% $10,000 Yes
- ------------------- -------------- --------------- ---------------- ----------------- -------------- ----------------
</TABLE>
(a) All Hymie's units are operated under a license agreement.
(b) Three franchised and three operating under a license agreement.
(c) Li'l Dino's receives 6% royalties from university locations.
(d) The initial franchise fee is reduced to $10,000 for existing franchise
owners acquiring another franchise.
(e) The initial franchise fee is reduced to $4,000 for existing franchise
owners acquiring another franchise and is $1,000 for a non-traditional
restaurant (i.e. convenience stores).
(f) The initial franchise fee is $5,000 for a non-traditional store.
(g) The initial franchise fee is $2,500 for a regional developer.
The Company maintains a staff of operations personnel to train and
assist franchisees in opening new restaurants and to monitor the operations of
existing restaurants. These services are provided as part of the Company's
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franchise program. New franchisees are required to complete a two-week training
program which consists of formal classroom training and in-restaurant training,
including human resources, accounting, purchasing and labor and food handling
laws. Upon the opening of a new franchised restaurant, Company representatives
are typically sent to the restaurant to assist the franchisee during the opening
period. These Company representatives work in the restaurant to monitor
compliance with the Company's standards and provide additional on-site training
of the franchisee's restaurant personnel.
The Company also provides development and construction support services
to its franchisees. Plans and specifications for the restaurants must be
approved by the Company before improvements begin. The Company's personnel
typically visit the facility during construction of leasehold improvements to
meet with the franchisee's site contractor and to verify that construction
standards are met.
To maintain uniformly high standards of appearance, service, food and
beverage quality, the Company has adopted policies and implemented a monitoring
program. Franchisees are required to adhere to the Company's specifications and
standards in connection with the selection and purchase of products used in the
operation of the restaurant. Detailed specifications are provided for the
products used, and franchisees must request the Company's approval for any
deviations. Except for submarine sandwich rolls, and other baked goods, the
Company does not generally sell equipment, supplies or products to its
franchisees. The various franchise agreements require franchisees to operate
their restaurants in accordance with the Company's requirements. Ongoing advice
and assistance is provided to franchisees in connection with the operation and
management of each restaurant.
Suppliers
In October 1997, the Company completed its acquisition of Pastry
Products in Watertown, New York. Pastry Products supplies the Company's JRECK
Subs franchises with all of its bakery products. Pastry Products sells
approximately 95% of its products to JRECK Subs franchises. The Company does not
believe that it would have difficulty in obtaining an alternate supplier to
Pastry Products due to the large number of alternate bakeries in New York State.
In connection with the Company's purchase of Hymie's Bagels, the
acquisition included a bakery which provides the bagels for all of the Hymie's
Bagel shops. The Company does not believe that it would have difficulty in
obtaining an alternate supplier to the Hymie's Bagels chain due to the large
number of alternate bakeries in Florida.
The Company's various franchisees obtain meat, cheese, vegetable and
paper products from several suppliers. Other than rolls used at the Company's
Little King and Seawest Subs restaurants, only fresh, never frozen, and Grade A
products are used.
Recent Acquisitions
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 aggregate purchase price of the Chai assets in the amount
of $1,331,156 consisted of 289,500 shares of the Company's Common Stock, valued
at $4.598 per share and $200,000 cash. In connection with the acquisition, the
Company entered into a five-year management agreement with a principal of
Leovera with an initial management fee of $85,000 for the first year. The
management agreement was terminated in February 1998 for $19,000.
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In June 1997, the Company, through its ASWI subsidiary, acquired all of
the outstanding shares of Seawest Sub Shops, Inc., headquartered in Bellevue,
Washington. Seawest Subs has 40 franchised submarine sandwich shops. The
consideration included $150,000 in cash, the issuance of options to purchase
100,000 shares of the Company's Common Stock at a price of $.001 per share for
15 years (valued at $406,000) and the assumption of certain liabilities
personally guaranteed by the former president of Seawest Sub Shops, Inc. The
optionees have the right to require the Company to repurchase these shares at
the greater of their "fair market value" (defined to be the average of the high
and low sales prices on a public market) or $3.25 per share, but in no event
more than 10,000 shares without the prior written agreement in any 3 month
period. The optionees were also granted piggyback registration rights. The
options become exercisable on a cumulative basis at 25% on each of December 19,
1997, May 19, 1998, November 19, 1998 and May 19, 1999. In connection with this
acquisition, the Company entered into a one year noncompete agreement with the
former president of Seawest Sub which calls for monthly payments of $8,000 which
commenced in June 1997.
In August 1997, the Company acquired all of the outstanding stock of
Little King, a 36-unit submarine shop including the assets of nine
corporately-owned restaurants. The consideration consisted of $50,000 cash, a
note for $100,000, 500,000 shares of the Company's Common Stock immediately
issued, 700,000 shares of the Company's Common Stock to be issued within 12
months plus 100,000 contingent shares based on Little King franchising revenues
or total revenues exceeding certain parameters for the year ending December 31,
1998. The acquisition also provided the principal of Little King an option to
repurchase Little King from the Company if the stock price of the Company's
Common Stock is not at least $1.50 per share on the second anniversary of the
closing with the repurchase based on the Company receiving back all of the
Company's shares issued, any funds invested by the Company into Little King and
a fair market value determination. The term of the acquisition also provided
that in the event the Company files bankruptcy within three years of the closing
and the bankruptcy is not dismissed within 90 days, the principal of Little King
is granted the first option to repurchase the Little King stock from the Company
for $25,000. In connection with the acquisition of Little King, the Company
entered into employment agreements with Sid Wertheim and Robert Wertheim to act
as president and vice-president of Little King respectively. Mr. Sid Wertheim's
employment agreement is for a seven-year period commencing August 2, 1997 with
an initial salary of $54,000 subject to annual increases up to 20% based on
operating performance. Mr. Robert Wertheim's employment agreement is for a
ten-year period commencing August 2, 1997 with an initial salary of $45,000
subject to annual increases up to 20% based on operating performance. The
agreements are subject to termination based upon certain events or conditions
set forth in the agreements.
In August 1997, the Company through its AFI subsidiary acquired all of
the outstanding stock of Richey Enterprises, Inc., a Washington corporation,
which franchises 6 Georgio's Sub shops. The consideration consisted of 93,794
shares of the Company's Common Stock and a stock price guarantee if any sale of
the Company's Common Stock sold by the seller to a third party, is valued within
30 days after the anniversary of the date of the close of escrow at less than
80% of the price of the Common Stock at the close of escrow. In connection with
the acquisition of Georgio's Sub, the Company entered into a
consulting/noncompete agreement with William and Colleen Richey which provided
for the provision of consulting services for sixty days for an initial fee of
$10,000, and a renewable consulting fee of $3,750 per month. After the initial
sixty-days, the consulting agreement was not renewed; however, the noncompete
agreement remained in effect during the period of the consulting agreement and
two years after termination of the consulting agreement.
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In September 1997 the Company, through its AFI subsidiary acquired all
of the outstanding shares of Quality Franchise Systems, Inc., the franchisor of
Mountain Mike's Pizza, a 78-unit pizza chain located primarily in northern and
central California. The consideration consisted of 899,967 shares of the
Company's Common Stock, 120 shares of the Company's Series C preferred stock,
and options to purchase 32,204 shares of Common Stock valued at $23,000. In
addition, the shareholders of QFS received 150,000 additional shares of the
Company's Common Stock since the stock price did not exceed $3.50 for 21
consecutive days between October 1, 1997 and January 31, 1998. 500,000
additional shares of Common Stock are to be issued if the Mountain Mike's income
from defined franchising operations exceed $500,000 for any consecutive
twelve-month period from October 1, 1997 to December 31, 1998.
On October 28, 1997, the Company acquired the remaining 50% interest of
Pastry Products, a bakery operation which primarily serves the JRECK restaurant
franchises. The $785,594 purchase price for the remaining 50% of Pastry Products
was paid by issuance of 262,500 shares of the Company's Common Stock valued at
$2.509 per share, options to purchase 37,500 shares of Common Stock valued at
$79,000 and other consideration valued at $48,000.
On December 4, 1997, the Company purchased the outstanding shares of
SBK, franchiser of 41 Sobik's Sandwich Shops located primarily in central
Florida, from Interfoods of America, Inc. The purchase price consisted of
$100,000 in cash, a $500,000 note and 187,266 shares of the Company's Common
Stock valued at $2.509 per share. The prior owners of SBK may require the
Company to repurchase a maximum of 187,266 shares of the Company's Common Stock
at a purchase price of $2.67 per share. The repurchase obligation is limited to
a maximum of 37,453 shares in any 6 month period commencing 6 months following
the closing. The repurchase obligation is noncumulative and expires in June
2000.
In March 1998 the Company acquired Li'l Dino Corporation, a 43-unit
sandwich shop franchisor located in North Carolina. The $2,400,000 purchase
price was paid by issuance of 735,294 shares of Common Stock valued at $2.72 per
share and the assumption of $400,000 in debt. The acquisition closed in March
1998 upon completion of a state fairness hearing held in accordance with state
securities laws to approve the transactions as fair to Li'l Dino Corporation
shareholders.
Competition
The fast food restaurant industry is highly competitive and can be
significantly affected by many factors, including changes in local, regional or
national economic conditions, changes in consumer tastes, consumer concerns
about the nutritional quality of quick-service food and increases in the number
of, and particular locations of, competing restaurants. Factors such as
inflation, increases in food, labor and energy costs, the availability and cost
of suitable sites, fluctuating interest and insurance rates, state and local
regulations and licensing requirements and the availability of an adequate
number of hourly paid employees can also adversely affect the fast food
restaurant industry. Multi-unit restaurant chains like the Company can also be
substantially adversely affected by publicity resulting from food quality,
illness, injury, or other health concerns. Major chains, which have
substantially greater financial resources and longer operating histories than
the Company, dominate the fast food restaurant industry. The Company competes
primarily on the basis of location, food quality and price. Changes in pricing
or other marketing strategies by these competitors can have an adverse impact on
the Company's sales, earnings and growth. There can be no assurance that the
Company will be able to compete effectively against its competitors. In
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addition, with respect to the sale of franchises, the Company competes with many
franchisors of restaurants and other business concepts for qualified and
financially capable franchisees.
Regulation
The Company is subject to a variety of federal, state, and local laws
affecting the conduct of its business. Operating restaurants are subject to
various sanitation, health, fire and safety standards and restaurants under, or
proposed for construction, are subject to state and local building codes, zoning
restrictions and alcoholic beverage regulations. Difficulties in obtaining or
failure to obtain required licenses or approvals could delay or prevent the
development or opening of a new restaurant in a particular area. The Company is
also subject to the Federal Fair Labor Standards Act, which governs minimum
wages, overtime, working conditions and other matters, and the Americans with
Disabilities Act, which became effective in January 1992. The Company believes
that it is in compliance with such laws, and that its restaurants have all
applicable licenses as required by governmental authorities.
The Company believes that it is in compliance with the applicable
federal and state laws concerning designated non-smoking and smoking areas in
its Company operated restaurants.
The Company is subject to regulations of the Federal Trade Commission
(the "FTC") and various states relating to disclosure and other requirements in
the sale of franchises and franchise operations. The FTC's regulations require
the Company to timely furnish prospective franchisees a franchise offering
circular containing prescribed information. Certain state laws also require
registration of the franchise offering with state authorities. Other states
regulate the franchise relationship, particularly concerning termination and
renewal of the franchise agreement. The Company believes that it is in
compliance with the applicable franchise disclosure and registration regulations
of the FTC and the various states that it operates in.
While the Company intends to comply with all federal, state and foreign
laws and regulations, there can be no assurance that it will continue to meet
the requirements of such laws and regulations, which, in turn, could result in a
withdrawal of approval to franchise in one or more jurisdictions. Any such loss
of approval may have a material adverse effect upon the Company's ability to
successfully market its franchises. Violations of franchising laws and/or state
laws and regulations regulating substantive aspects of doing business in a
particular state could subject the Company and its affiliates to rescission
offers, monetary damages, penalties, and/or injunctive proceedings. The state
laws and regulations concerning termination and non-renewal of franchisees are
not expected to have a material impact on the Company's operations. In addition,
under court decisions in certain states, absolute vicarious liability may be
imposed upon franchisors based upon claims, there can be no assurance that
existing or future franchise regulations will not have any adverse effect on the
Company's ability to expand its franchise program.
Business Strategy
The Company's business strategy is to increase its franchise revenue
base through continuing franchising of JRECK Subs shops and the affiliated
regional companies it has acquired. Each of these companies has a strong track
record of regional franchise brand recognition and long-term franchise operating
history in their respective markets.
The typical fast food customer frequents one franchise for the majority
of purchases but also relies on one or two additional concepts and a number of
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specialty restaurants. Increasing sales and franchise revenues through existing
franchisees is generally more profitable than through new franchises because
they do not require significant additional financing expenses, training calls or
other additional administrative expenses.
The Company intends to continue to supplement internal growth with
strategic acquisitions of existing fast food franchisees. The strategic
acquisition of complementary brands which are proven revenue generators in their
established markets allows the Company to grow more rapidly at less cost than
would be possible through internal growth alone. The Company has the facilities
and the management to support a larger distribution operation, therefore it
believes that it can reduce the operating expenses of the acquired businesses as
well as use economies of scale to increase gross sales, franchise revenue,
market share, and net profits. The Company is currently seeking attractive fast
food franchise businesses to acquire, but there are no assurances that the
Company will be able to acquire an ongoing business at a favorable price or that
any such acquisition would ultimately be successful.
Employees
As of November 20, 1998, the Company had approximately 66 employees
consisting of 30 administrative employees, 16 employees in the Company's 4
corporate restaurants and 20 employees in bakery operations.
Trademarks
The Company markets several products under the JRECK Subs, Seawest Sub
Shops, Little King, Li'l Dino's and Mountain Mike's Pizza labels in addition to
the Georgio's and Hymie's Bagel labels.
With respect to the "JRECK Subs" label, the Company has registered this
Mark on the Principal Register of the United States and Trademark Office ("PTO")
on October 14, 1975 (Registration No. 1,022,898) and the Company has filed all
required affidavits for, and has renewed, this Mark. On May 9, 1997, the Company
filed an application with the PTO for registration of one of its principal
trademarks, the "Admiral J" logo (Application 75/289578). As of September 30,
1997, the Company has yet to receive Principal Register federal registration for
the "Admiral J" logo.
The "Seawest Sub Shops" has registered trademarks, names, symbols and
designs on the Principal Register of the PTO on the following: "Original Deli
Taste Without The Cost Logo" (Registration No. 1,675,510, dated February 11,
1992), "Full Boat" (Registration No. 1,761,574, dated March 30, 1993),
"Destroyer" (Registration No. 1,761,573, dated March 30, 1993), "Enough for two
or just for you" (Registration No. 1,764,733, dated April 13, 1993), "Seawest
Sub Shops" (Registration No. 1,703,897, dated July 28, 1992), "Substantially
More:" (Registration No. 1,772,028, dated May 18, 1993 and "Sub Shop" (and
Design) (Registration No. 1,862,112, dated November 8, 1994). In addition the
trade name "Seawest Sub Shops" is registered as a service mark with the State of
Washington, under Registration Number 020443 as of March 29, 1991. The Company
has also registered in Canada its "Submarine Design Logo" (TMA 407,629), dated
February 5, 1993.
The "Little King" service mark and design was registered on the
Principal Register of the PTO on April 12, 1977 (Service Mark No. 1,063,555).
The service mark "Royal Treat" was registered on the Principal Register of the
PTO on October 29, 1991 (Service Mark No. 1,662,623). The service mark "Little
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King B America's Greatest Hero" was registered in Nebraska on February 2, 1983.
The service mark "The Little King - Where a Sandwich is a Complete Meal" and
design was registered in Iowa on December 22, 1975 and in California on December
30, 1975. All required affidavits of use and renewals have been filed.
The "Mountain Mike's" name, service mark and design was registered on
the Principal Register of the PTO on September 15, 1992 (Registration Nos.
1,716,962 and 1,716,963). The Company's new mark and design for "Mountain Mike's
Pizza" was registered on the Principal Register of the PTO on October 1, 1996
(Registration No. 2,004,536). The Company filed for registration the slogan
"Pizza the way it oughta be" on the PTO in September 1996 (Application No.
75/174377). The Company has been informed by the PTO of a potential conflict
between its slogan and the slogan "Pizza, the way Pizza was meant to be" used by
Godfather's Pizza. The Company and its trademark counsel are evaluating options
regarding the registration of this slogan. The slogan is still in use in the
Mountain Mike's Pizza system.
The "Li'l Dino" service mark was registered on the Principal Register
of the PTO on September 30, 1986 (Registration No. 1,411,762). The "Li'l Dino
Bagel Deli Grille" service mark and design was registered on the Principal
Register of the PTO on September 30, 1997 (Registration No. 2,101,316).
The "Sobik's Subs" service mark was registered on the Principal
Register of the PTO on August 12, 1997 (Registration No. 2,087,639).
Item 2. Management's Discussion and Analysis or Plan of Operation
Overview
The following discussion regarding the financial statements of the
Company should be read in conjunction with the financial statements and notes
thereto.
The following discussion and analysis contains forward-looking
statements involving risks and uncertainties that may cause the Company's actual
results to differ materially. Those risks and uncertainties include, but are not
limited to, economic, competitive, industry and market factors affecting the
operations, market products and prices of not only the company but also its
franchisees.
Year 2000
The Year 2000 issue is the result of computer programs using two digits
rather than four to define the applicable year. Such software may recognize a
date using "00" as the year 1900 rather than the year 2000. This could result in
system failures or miscalculations leading to disruptions in the Company's
activities and operations (the "Year 2000" or " Y2K" issue). If the Company or
its significant suppliers or customers fail to make necessary modifications,
conversions, and contingency plans on a timely basis, the Year 2000 issue could
have a material adverse effect on the Company's business, operations, cash flow,
and financial condition. However, the effect cannot be quantified at this time
because the Company cannot accurately estimate the magnitude, duration, or
ultimate impact of non compliance by suppliers, customers and third parties that
have no direct relationship to the Company. The Company believes that its
competitors face a similar risk. Although not quantifiable, the disclosure below
is intended to summarize the Company's actions to minimize the risk.
The Company's information systems currently are made up of networked
computers which are used internally and are not linked to any outside sources
other than the browser used by the Company. The Company's future information
system will cover a spectrum of software applications for its operations,
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certain of these may be custom designed. Currently, the Company is updating all
of its software to provide uniformity among all of its recent acquisitions and
provide management with timely interaction about operations. As the Company has
already embarked on a software modernization program, it is anticipated that the
remediation costs of Y2K problems in its existing software will impose no
significant additional costs to the Company. The Company will need to assure
itself that it has achieved Year 2000 compliance for both packaged and
custom-designed software. The costs of compliance has not yet been determined.
The Company has initiated formal communication with all of its
significant suppliers to determine the extent to which the Company is vulnerable
to the failure of such suppliers to resolve their own Year 2000 problems. The
Company will grade the responses from low risk to high risk. In addition,
although many of the Company's franchisees have been communicating with the
Company regarding the Year 2000 issues, the Company has not made any formal
assessment of the effect which the failure of its larger franchisees to resolve
their own Year 2000 problems could have on the Company's operations. Despite
these efforts, there can be no assurance that the systems of other companies on
which the Company relies will be converted on a timely basis or that a failure
to resolve by one or more of the Company's franchisees or suppliers would not
have a material adverse effect on the Company.
Nine months ended September 30, 1998 compared to nine months ended September 30,
1997.
Results of Operations:
The Company had a net loss of $1,914,771 for the nine months ended
September 30, 1998 compared to a net loss of $2,836,136 for the same period in
1997. The decrease in net loss is primarily the result significant business
acquisitions had in shifting the business structure, coupled with a decrease of
$2,096,810 in 1998 in non-cash consulting and business development expenses that
were reflected in the first nine months of 1997. The aggregate sales of
$1,353,366 generated by the company owned stores in 1998, offset by food costs
and operating costs of $568,474 and $891,612, respectively, resulted in
contributing $106,721 to the 1998 nine month loss. The bakery operations
generated revenues of $736,171 offset by Product costs of $214,549 and operating
expenses of $546,380 thereby contributing $24,759 toward the 1998 nine month
loss. Other changes for the period ended September 30, 1998 were an increase
over 1997 of $630,548 in amortization and depreciation expense, and interest
expense increasing from $79,875 to $248,830, primarily as the result of debt
assumed and, originating from the Company's acquisitions. Business expansion
expenses were $2,528,493 in 1997 compared to $1,204,000 in the same period of
1998. The revenue of the Company increased $4,255,057 to $4,849,510 for the nine
months ended September 30, 1998 from $594,453 for the same period in 1997. The
increase is primarily due to the impact of businesses acquired in the3rd and 4th
quarters of 1997 generating $2,400,774 of additional franchising revenue and the
sales contributions of $1,353,366 and $736,171 in 1998 from the Company stores
and bakery, respectively, compared to $61,551 and $174,703 for each of the
activities in 1997.
Costs and operating expenses applicable to sales and revenue increased
$3,858,682 to $4,607,958 for the nine months ended September 30, 1998 from
$749,276 for the same period in 1997. This increase is primarily due to the
effects of business acquisitions made in 1997 including restaurant and bakery
food costs and operating expenses of $2,221,017 in 1998 compared to $324,266 in
1997. Additional franchise servicing costs of $1,358,298 in the first nine
months of 1998 over the same period in 1997 were the result of business
acquisitions made in 3rd and 4th quarter 1997.
11
<PAGE>
Liquidity and Capital Resources:
Working capital deficit at September 30, 1998 was $3,340,324 compared
with a deficit of $5,330,587 on December 31, 1997 a decrease of $1,990,263. 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 proceed of this offering were
substantially used to pay down existing debt or to satisfy other obligations.
The Company's primary capital requirements are for repayments of
current loans payable, including those payable to related parties, of $1,508,625
and accounts payable and accrued expenses of $1,245,430. 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.
Year ended December 31, 1997 compared to year ended December 31, 1996.
The results of operations for the year ended December 31, 1997 reflect
six months of operations from Hymie's Bagels and Seawest Subs, four months each
from Little King Subs and Georgio's Subs, three months from Mountain Mike's
Pizza and one month from SBK.
The Company had a net loss of $8,903,644 for the year ended December
31, 1997, compared to a net loss of $39,657 for the year ended December 31,
1996. The increase in the net loss is primarily the result of consulting costs
associated with acquisitions and equity financing of $4,492,664 and a loss of
$862,029 related to an early extinguishment of debt.
The revenue of the Company increased $2,017,721 or 362% to $2,575,459
for the year ended December 31, 1997 from $557,738 for the same period in 1996.
The increase is primarily due to the acquisitions of businesses made during 1997
which included increased franchising related revenues of approximately $688,000
and sales from the Company's corporate restaurants and bakeries of approximately
$1,310,000.
Cost of Sales and operating expenses applicable to revenue increased
$3,895,110 or 935% to $4,311,597 for the year ended December 31, 1997 from
$416,488 for the same period in 1996. This increase is primarily due to the
acquisitions of businesses made during the year including cost of sales from the
Company's corporate restaurants and bakeries of $552,940, additional
depreciation and amortization expense of approximately $507,000 and additional
operating costs from the acquired businesses of approximately $1,725,000.
Consulting costs and investor relations were $4,492,664 for the year
ended December 31, 1997 and resulted from the Company's acquisition and capital
raising activities. Included in the costs of $4,492,664 were $3,301,302 of
valuation related to options for 2,275,000 shares of the Company's Common Stock.
Hymie's Bagels:
On June 19, 1997, the Company through Leovera, acquired all of the
bakery equipment of Chai, the franchiser of the Hymie's Bagel restaurant chain.
12
<PAGE>
Sales for the five months ended December 31, 1997 totaled $373,295. Costs and
expenses applicable to revenue for the period amounted to $581,003 and the
Company recognized a goodwill impairment charge of $993,820.
Seawest Sub Shops:
In June 1997, the Company acquired the stock of Seawest Sub Shops, Inc.
Revenues for the six months ended December 31, 1997 totaled $288,471. Costs and
expenses applicable to revenue for the period were $291,482. Amortization of
goodwill was $22,371 and amortization of a non-compete agreement was $83,667.
Little King:
Operations as the Little King subsidiary of the Company commenced on
September 1, 1997. Income for the four months ended December 31, 1997 was
$648,499. Costs and expenses applicable to revenue for the period were $812,554.
Amortization of goodwill amounted to $76,337.
Georgio's:
Operations of the Georgio's subsidiary (through the Company's AFI
subsidiary) commenced in September 1997. Sales for the four months ended
December 31, 1997 were $144,685. Costs and expenses applicable to revenue for
the period amounted to $164,898. Amortization of goodwill amounted to $6,465.
Mountain Mike's Pizza:
In September 1997, the Company, through its AFI subsidiary, acquired
Mountain Mike's Pizza. Operations commenced on October 1, 1997 and revenues for
the three months ended December 31, 1997 were $462,524. Costs and expenses
applicable to revenue for the period were $242,342. Net interest expense was
$18,830 and amortization of goodwill was $49,365.
SBK:
On December 4, 1997, the Company purchased SBK Franchise Systems, Inc.,
the franchisor of Sobik's Subs. Revenues for the period from December 4, 1997 to
December 31, 1997 were $17,840. Costs and expenses applicable to revenue for the
period were $65,439. Amortization of goodwill was $4,693.
Pastry Products:
On October 28, 1997, the Company acquired the remaining 50% interest of
Pastry Products Producers, LLC. Pastry Products is a bakery operation which
primarily serves the Jreck restaurant franchisees. Sales for the two months
ended December 31, 1997 were $102,989. Costs and expenses applicable to sales
for the period were $145,168. Interest expense was $11,431 and amortization of
goodwill was $9,412.
Liquidity and Capital Resources
Working capital at December 31, 1997 was a deficit of $5,330,587
compared with a deficit of $541,873 at December 31, 1996, an increase of
$4,788,714. The increase is primarily attributable to debt assumed or originated
13
<PAGE>
with the Company's acquisitions during 1997. These debts consist of $3,736,831,
a liability to issue 700,000 shares of the Company's Common Stock related to the
Company's Little King acquisition valued at $2,143,750 and a liability to issue
150,000 shares of the Company's Common Stock related to the Company's Quality
Franchise Systems, Inc. acquisition valued at $440,625.
During 1997, the Company raised approximately $1,310,000 in cash from
the sale of capital stock and the exercise of stock options of which $408,417
was expended in conjunction with its acquisitions of businesses.
During 1997, the Company acquired certain assets of Hymie's Bagels,
Seawest Subs, Georgio's Subs, Little King, Mountain Mike's Pizza, SBK Subs and
the remaining 50% of Pastry Products for an aggregate purchase price of
$10,985,714, which resulted in excess of cost over fair value of net assets
acquired of $13,061,710. For the year ended December 31, 1997, amortization and
depreciation expense was $506,742 and the net excess of cost over fair value of
net assets acquired was $11,521,526 at December 31, 1997. Taking into account
the acquisitions made by the Company through May 31, 1998, amortization expenses
are expected to be approximately $700,000 in fiscal 1998.
In January 1998, the Company issued $2,500,000 in Series D Preferred
Stock. The proceeds from this offering were substantially used to pay down
existing debt or to satisfy other obligations. The Company's primary capital
requirements are for repayment of current loans payable of $2,163,554 and
accounts payable of $1,020,101. The Company's capital requirements are
anticipated to be funded through debt and/or equity financing. There is no
assurance that additional funding will be available, or that, if available, it
can be obtained on terms favorable to the Company. Failure to obtain such
funding could adversely affect the Company's financial condition.
In connection with the Company's acquisition of Quality Franchise
Systems, Inc. ("QFS") in September 1997 and for the continued employment and
services to be provided by Mr. Bradley Gordon, the president of QFS and
currently the chief operating officer and director of the Company and Mr.
Richard T. Silberman, a consultant to QFS and now a consultant to the Company,
Mr. Gordon and Mr. Silberman were sold 500,000 shares and 300,000 shares,
respectively, of the Company's common stock for $1,500,000 and $900,000,
respectively. The consideration for the shares were promissory notes, with
interest due at 9.5% per annum with principal and interest due in September
2000. Both Mr. Gordon and Mr. Silberman have the right to require the Company to
repurchase the shares of common stock for the cancellation of the promissory
notes.
The above transactions have no effect on the net stockholders equity of
the Company since the value of the value of the common shares issued of
$2,400,000 is offset by a contra to stockholders' equity of $2,400,000 of stock
subscriptions receivable. In the event that any time prior to September 2000,
either Mr. Gordon or Mr. Silberman pays the Company to retire the promissory
notes the Company's stockholders' equity will be increased by the principal and
interest income due from the promissory notes. In the event that either Mr.
Gordon or Mr. Silberman requires the Company to repurchase the shares of common
stock for the cancellation of the promissory notes, there is no effect on the
net stockholders' equity of the Company. Common stock would be reduced by the
same reduction in stock subscriptions receivable.
In connection with the Company's acquisition of Little King, Inc. in
August 1997, the Company provided Mr. Sid Wertheim, the principal of Little King
an option to repurchase Little King from the Company if the stock price of the
Company is not at least $1.50 per share on the second anniversary of the closing
with the repurchase based on the Company receiving back all of the Company's
14
<PAGE>
shares issued, any funds invested by the Company into Little King and a fair
market value determination. In the event Mr. Sid Wertheim repurchases Little
King from the Company, the transaction would be recorded as treasury stock of
the fair market value of the shares the Company reacquires plus the above
mentioned consideration with a reduction in the net assets relating to Little
King including the elimination of the net balance of excess of cost of net
assets acquired at the time of repurchase. Any difference is recorded as a
change to operations.
In connection with the Company's acquisition of SBK Franchise Systems,
Inc. on December 4, 1997, the Company issued 187,266 shares of its common stock
to Interfoods of America, Inc. ("IFA"). IFA shall have the non-cumulative right
to require the Company, beginning in June 1998 and continuing every six months
thereafter to require the Company to repurchase one-fifth of the common shares
issued to IFA in consideration of the repayment of $100,000. The 187,266 shares
valued at $500,000 was recorded as redeemable common stock and not as equity. In
May 1998, the Company was notified by IFA of its exercise of the right to have
the Company repurchase one-fifth of the shares on July 5, 1998. The repurchase
when consummated will be recorded as a reduction in cash and a reduction in
redeemable common stock.
In August 1998, the Company agreed to issued 500,000 shares of its
common stock to Mr. Bradley L. Gordon, chief operating officer and director of
the Company, 500,000 of its common stock to Mr. Michael Cronin, chief financial
officer of the Company, and 300,000 shares of its common stock to Mr. Richard T.
Silberman, consultant to the Company at a price of $1.375 per share to be paid
in the form of promissory notes with interest at 9.5% with interest and
principal due in August 2001. At any time prior to August 2001, these
individuals may require the Company to repurchase the 1,300,000 shares as
consideration for the cancellation of the notes. The Company anticipates the
agreements to be finalized during the fourth quarter of 1998.
The above transactions have no effect on the net stockholders' equity
of the Company since the value of the common shares issued of $1,787,500 is
offset by a contra to stockholders' equity of $1,787,500 of stock subscriptions
receivable. In the event that any time prior to August 2001, any of these
individuals pays the Company to retire the promissory notes, the Company's
stockholders' equity will be increased by the principal and interest income due
from the promissory notes. In the event that any of the individuals requires the
Company to repurchase the shares of common stock for the cancellation of the
promissory notes, there is no effect on the net stockholders' equity of the
Company. Common stock would be reduced by the same reduction in stock
subscriptions receivable.
Item 3: Description of Property
The Company's corporate offices are located in a 1,500 square foot
leased facility situated in Longwood, Florida. The lease expires on December 31,
2000. The Company also maintains offices and the Pastry Products bakery in a
8,188 square foot facility in Watertown, New York which the Company acquired in
October 1997. Under the terms of the acquisition of the Pastry Products
facility, the Company assumed an existing note on the facility of $150,222 at
10% payable in 84 equal installments of $2,494 beginning December 1, 1997.
The Company also leases corporate space for the operations of its
restaurant concepts through its subsidiaries. These leases generally are less
than two year leases, except for one lease in Omaha, Nebraska which expires in
2008 and calls for annual lease payments of $39,000. Total annual lease payments
for 1998 for these corporate leases are approximately $123,000.
The Company also leases the space for its 4 Little King corporate
restaurants.
15
<PAGE>
Item 4. 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, by the Company's directors and
executive officers, and by all of the Company's directors and executive officers
as a group as of November 20, 1998. The address of each person is care of the
Company unless noted.
Percentage
Name of Number of of Outstanding
Stockholder Shares Owned (1) Common Stock
Christopher M. Swartz(2)(3)(4) 5,925,000 35.2%
Bradley L. Gordon 1,095,113 6.0%
Michael F. Cronin 500,000 2.8%
Eric T. Swartz -0- --
Kelly A. Swartz -0- --
Jeremiah J. Haley(5) 190,000 1.0%
All executive officers and 7,710,113 0%
directors as a group (6 persons)(2)(3)(4)
(1) As used in this table, "beneficial ownership" means the sole or shared
power to vote, or to direct the voting of, a security, or the sole or
shared investment power with respect to a security (i.e., the power to
dispose of, or to direct the disposition of, a security). In addition,
for purposes of this table, a person is deemed, as of any date, to have
"beneficial ownership" of any security that such person has the right
to acquire within 60 days after such date.
(2) Includes 350,000 shares from the full conversion of Series B Preferred
Stock into the Company's Common Stock in June 1998.
(3) Includes 3,350,000 shares of Common Stock owned by Tri-Emp Enterprises,
Inc. Mr. Christopher M. Swartz is President and the sole shareholder of
Tri-Emp Enterprises, Inc and as such is deemed to have beneficial
ownership of the shares of the Company's stock owned by Tri-Emp
Enterprises, Inc.
(4) Includes 2,000,000 shares subject to options currently exercisable by
Mr. Christopher M. Swartz and 225,000 shares subject to options
currently exercisable by Tri-Emp Enterprises, Inc.
(5) Mr. Haley owns 25,000 shares of Common Stock and 165,000 shares of
Common Stock from his conversion of 150,000 shares of the Series A
Preferred Stock into the Company's Common Stock in June 1998.
Item 5.: Directors, Executive Officers, Promoters and Control Persons
The members of the Board of Directors of the Company serve until the
next annual meeting of stockholders, or until their successors have been
elected. The officers serve at the pleasure of the Board of Directors.
Information as to the directors, executive officers and key employees of the
Company is as follows.
Name Age Office
Christopher M. Swartz 28 Chairman, President and Chief Executive Officer
Bradley L. Gordon 45 Chief Operating Officer and Director
Eric T. Swartz 29 Secretary and Director
Michael F. Cronin 43 Chief Financial Officer
Kelly A. Swartz 27 Director
Jeremiah J. Haley 59 Director
Gary E. Rowe 44 Controller
16
<PAGE>
Christopher M. Swartz has been President, Chief Executive Officer, and Chairman
of the Company since April 1996 and of JRECK Subs, Inc. since September 1995.
From 1992 to September 1995, he was Director of Operations of Lox, Stox & Bagels
of Liverpool, Inc. Prior to 1992 Mr. Swartz was a student at Syracuse University
where his concentration was in the field of management. Mr. Swartz is a graduate
of Syracuse University who grew up in the subs business. He has worked in
construction, building sub shops and has managed sub shops. He is the second
generation of his family involved with JRECK. Mr. Swartz is also the President
of Tri- Emp Enterprises, Inc. and the brother of Eric T. Swartz and Kelly A.
Swartz.
Bradley L. Gordon has been Chief Operating Officer and Director of the Company
since September 1997. Prior to joining the Company, he was president from
September 1993 to September 1997 of Quality Franchise Systems, Inc. ("QFS"), the
franchisor of Mountain Mike's Pizza, QFS's chief executive officer since
September 1992 and one of its directors since January 1993. Before joining QFS,
he held various positions at Pace Membership Warehouse, Inc. in Denver, Colorado
beginning in November 1983, including executive vice president - sales, senior
vice-president-operations and vice president-human resources.
Eric T. Swartz has been a Director and Secretary of the Company since April
1996. He was awarded his J.D. degree from Syracuse University College of Law and
his Bachelor's Degree from Syracuse University. He has been a partner in the
Swartz Law Firm, P.C. from October 1993 to the present. From September 1992 to
May 1993 he was associated with the law firm of Pease & Willer, which he joined
after hi graduation from law school in 1992. Mr. Swartz is the brother of
Christopher M. Swartz and Kelly A. Swartz.
Michael F. Cronin has been Chief Financial Officer of the Company since March
1998. He is a Certified Public Accountant who has managed his own practice since
February 1985 specializing in SEC audits and business and tax planning. He has
been licensed in New York State for 16 years. Mr. Cronin, a graduate of St. John
Fisher College, began his career in public accounting in Rochester, NY in 1979.
From 1979 to 1985 Mr. Cronin was employed as Staff Accountant and Partner in a
regional public accounting firm in upstate New York. Prior to attending college,
Mr. Cronin served for three years in the United States Marine Corps.
Kelly A. Swartz has been a Director of the Company since April 1996. She is a
graduate of the State University of New York, at Plattsburgh. Ms. Swartz is an
elementary school teacher at Apollo Elementary in Titusville, Florida, where she
has been employed since September, 1991. From May 1990 to September 1991 she was
employed in various capacities with JRECK Subs, Inc., including the management
of several sub shops. Ms. Swartz is the sister of Eric T.
Swartz and Christopher M. Swartz.
Jeremiah J. Haley has been a Director of the Company since April 1996 He was one
of the original founders of JRECK Subs, Inc. (the "J" in the name JRECK stands
for the first letter of Mr. Haley's first name). Mr. Haley has a B.S. degree
from Mansfield State College in Mansfield, Pennsylvania. He also holds a
Master's degree from the State University of New York at Cortland. Mr. Haley has
been President of Haley Enterprises, Inc., a JRECK Subs, Inc. franchisee, from
1975 to the present. He had also been a teacher with the Carthage, New York
Central School District from 1965 until he retired in June 1993.
17
<PAGE>
Gary Rowe has been the Corporate Controller since September 1993. Prior to
joining the Company, Mr. Rowe was the controller of the quasi-independent New
York State government agency, the Development Authority of the North Country.
Mr. Rowe graduated from the State University of New York at Albany in 1974 where
he received a Bachelor of Science Degree in accounting. Mr. Rowe is a Certified
Public Accountant.
Item 6. Executive Compensation
The following table sets forth the cash compensation of the Company's
executive officers and directors during each of the last three fiscal years. The
remuneration described in the table does not include the cost to the Company of
benefits furnished to the named executive officers, including premiums for
health insurance and other benefits provided to such individual that are
extended in connection with the conduct of the Company's business. The value of
such benefits cannot be precisely determined, but the executive officers named
below did not receive other compensation in excess of the lesser of $25,000 or
10% of such officer's cash compensation.
18
<PAGE>
<TABLE>
<CAPTION>
Summary Compensation Table
- ----------------------------------------------------------------------------- -----------------------------------------
ANNUAL COMPENSATION LONG TERM COMPENSATION
- ----------------------------------------------------------------------------- -----------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Name and Other Annual Awards Payouts All
Principal Position Year Salary Bonus Compensation Other
Restricted Options/ HTIP
Stock(a) SARs(a) Payouts
- --------------------------- ---------- --------- --------- ----------------- ---------- ----------- ---------- --------
1997 115,393 0 0 0 1,000,000 0 0
---------- --------- --------- ------------------ --------- ----------- ---------- --------
Christopher M. Swartz 1996 26,000 0 0 0 0 0 0
President and CEO
---------- --------- --------- ------------------ --------- ----------- ---------- --------
1995 0 0 0 0 0 0 0
- --------------------------- ---------- --------- --------- ------------------ --------- ----------- ---------- --------
1997 52,600 0 0 0
---------- --------- --------- ------------------ --------- ----------- ---------- --------
Gary E. Rowe 1996 46,350 0 0 0 0 0
Controller
---------- --------- --------- ------------------ --------- ----------- ---------- --------
1995 39,000 0 0 0 0 0
- --------------------------- ---------- --------- --------- ------------------ --------- ----------- ---------- --------
Bradley L. Gordon 1997(a) 37,500 0 0 0 0 0 0
Chief Operating
Officer
- --------------------------- ---------- --------- --------- ------------------ --------- ----------- ---------- --------
</TABLE>
(a) For the period October 1, 1997 to December 31, 1997.
The Company carries no officers and directors liability insurance or
disability insurance benefits. The Company maintains a $3,000,000 key man life
insurance policy on Mr. Christopher Swartz of which the Company is the
beneficiary. No executive officer or director is currently covered by an
employment agreement except for Bradley L. Gordon and Michael Cronin. Other than
a 401(k) plan maintained at the Mountain Mike's division of Admiral's Fleet,
Inc., the Company does not maintain any pension plan, profit sharing plan or
similar retirement or employee benefit plans.
Mr. Bradley L. Gordon joined the Company as chief operating officer in
September 1997. Under the terms of his three-year employment agreement
commencing September 22, 1997, Mr. Gordon receives an initial annual
compensation of $150,000 subject to annual increases consistent with other
executives of the Company. If the employment agreement is terminated by the
Company, Mr. Gordon continues to receive his base salary until the earlier of
Mr. Gordon finding new employment or twelve months after such termination date.
Mr. Gordon was also granted a right to purchase 500,000 shares of the Company's
Common Stock at a price of $3.00 per share which shares were issued in November
1997. The purchase price of $1,500,000 was paid in the form of a promissory note
to the Company which calls for an annual interest of 9.5% with principal and
interest due in September 2000. At any time prior to September 2000, Mr. Gordon
has the right to require the Company to repurchase the 500,000 shares as
consideration for the cancellation of the promissory note. In July, 1998 Mr.
19
<PAGE>
Gordon purchased 500,000 shares of the Company's Common Stock for $685,000 which
was paid by a promissory note payable on or before July 30, 2001. The promissory
note bears interest at the rate of 9.5% per annum. Mr. Gordon has the right to
require the Company to repurchase the 500,000 shares as consideration for the
cancellation of the promissory note.
Mr. Michael F. Cronin joined the Company as chief financial officer in
March 1998. Under the terms of his three-year employment agreement commencing
July 31, 1998, Mr. Cronin receives an initial annual compensation of $125,000
subject to annual increases consistent with other executives of the Company. If
the employment agreement is terminated by the Company for other than "good
cause", Mr. Cronin continues to receive his base salary until the earlier of Mr.
Cronin finding new employment or twelve months after such termination date. Mr.
Cronin was also granted a right to purchase 500,000 shares of the Company's
Common Stock at a price of $1.375 per share which shares were issued in July
1998. The purchase price of $685,000 was paid in the form of a promissory note
to the Company which calls for an annual interest of 9.5% with principal and
interest due on July 31, 2001. At any time prior to July 31, 2001, Mr. Cronin
has the right to require the Company to repurchase the 500,000 shares as
consideration for the cancellation of the promissory note.
Directors currently receive no compensation for their duties as
directors. On December 29, 1997 the Company granted to Christopher Swartz an
option to purchase of 1,000,000 shares of the Company's Common Stock at $2.75
per share. The options are exercisable immediately and expire on December 29,
2000. On August 3, 1998 the Company granted to Christopher Swartz an option to
purchase of 1,000,000 shares of the Company's Common Stock at $1.55 per share.
The options are exercisable immediately and expire on Augsut 3, 2001. No stock
options have been issued to any other executive officers or directors.
Options Granted in Fiscal 1997 and Through 3rd Quarter 1998
Percentage of
Total Options
Granted to
Options Employees in Exercise Expiration
Granted Fiscal 1997 Price Date
------- ----------- ----- ----
Christopher Swartz 1,000,000 100% $ 2.75 December 29, 2000
Percentage of
Total Options
Granted to
Employees
through
Options September 30, Exercise Expiration
Granted 1998 Price Date
------- ---- ----- ----
Christopher Swartz 1,000,000 100% $ 1.55 August 3, 2001
The following table contains information concerning the exercise of stock
options and employment related options and information in unexercised stock
options held as of September 30, 1998 by the named executive officers:
20
<PAGE>
<TABLE>
<CAPTION>
Option Exercises and Year-end Value Table
Value of Unexercised
Options
Number of Unexercised at
Shares Options & Warrants September 30, 1998
Acquired on Value ------------------- ------------------
Exercise Realized(1) Exercisable NonExercisable Exercisable(2)
-------- ----------- ----------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Chistopher Swartz -0- -0- 2,000,000 0 -0-
</TABLE>
(1) Market Value at time of exercise less exercise price
(2) The closing sale price of the Common Stock at September 30, 1998 was
$.05625. Value realized equals the difference between market value and
exercise price, and is $0 at September 30, 1998 since the exercise
price for options granted in 1997 and in 1998 was higher than market
value.
Item 7. Certain Relationships and Related Transactions
Conflicts of Interest
Kalin Enterprises, Inc. ("Kalin") is the franchisee for five JRECK Subs
restaurants. Mr. Christopher Swartz is a 25% shareholder and an officer of
Kalin.
Tri-Emp Enterprises, Inc. borrowed $445,000 from 20 investors secured
by 445,000 shares of Jreck Sub Group Inc. Common Stock which were held by
Tri-Emp Enterprises, Inc. Tri-Emp Enterprises, Inc. loaned the $445,000 loan
proceeds to the Company. On October 8, 1997 the Company issued 495,000 shares of
Common Stock to the 20 noteholders in full satisfaction of the amounts owed by
Tri-Emp Enterprises, Inc.
The Company issued options to purchase 375,000 shares of Common Stock
to Gulf Atlantic Publishing Inc. on January 6, 1997, exercisable at $.75 per
share. On November 17, 1997 Gulf Atlantic assigned options to purchase 225,000
of these shares to Tri-Emp Enterprises, Inc. in conjunction with the purchase
from Tri-Emp Enterprises, Inc. of 225,000 shares by Gulf Atlantic.
In fiscal 1997, the Company wrote off a note receivable of $104,141
from Mr. Tom Swartz, a family member of Mr. Christopher Swartz.
In February, 1998 the Company converted $277,404 in notes payable owed
to Sid Wertheim into 112,783 shares of Common Stock.
Mr. Jeremiah Haley, a director, received 175,000 shares of Series A
Preferred Stock in exchange for his shares of Jreck Subs, Inc. Series A
Preferred Stock on May 6, 1996. Mr. Haley was elected to the Board of Directors
pursuant to the right of holders of Series A Preferred Stock to elect one member
of the Board of Directors. Pursuant to the dividend rights of holders of Series
A Preferred Stock, Mr. Haley received $15,750 in dividends on his shares in
fiscal 1997. In July 1997, Mr. Haley converted 25,000 shares of Series A
Preferred Stock into 25,000 shares of Company Common Stock. In June 1998, Mr.
Haley converted the balance of 150,000 shares of Series A Preferred Stock into
165,000 shares of the Company's Common Stock. The conversion included 15,000
shares in consideration of accrued but unpaid dividends.
21
<PAGE>
Mr. Christopher Swartz, chairman and the Company's president and chief
executive officer, received (through Tri-Emp Enterprises, a company of which he
is the sole shareholder) 5,000,000 shares of the Company's Common Stock in
exchange for all of the common stock of Jreck Subs, Inc. on May 6, 1996. Mr.
Swartz also received 350,000 shares of Series B Preferred Stock for 50% of
Pastry Products. Mr. Swartz was elected to the Board of Directors pursuant to
the right of holders of Series B Preferred Stock to elect one member of the
Board of Directors. In June 1998, Mr. Swartz converted all 350,000 shares of
Series B Preferred Stock into 350,000 shares of the Company's Common Stock.
Mr. Bradley Gordon, director and the Company's chief operating officer,
purchased 500,000 shares of the Company's Common Stock for $1,500,000. The
Company received a promissory note from Mr. Gordon with interest at 9.5% per
annum with principal and interest due in September 2000. At any time prior to
September 2000, Mr. Gordon has the right to require the Company to repurchase
the 500,000 shares as consideration for the cancellation of the promissory note.
In a separate transaction Mr. Gordon purchased 500,000 shares of the Company's
Common Stock for $685,000 which was paid by a promissory note payable on or
before July 30, 2001. The promissory note bears interest at the rate of 9.5% per
annum. Mr. Gordon has the right to require the Company to repurchase the 500,000
shares as consideration for the cancellation of the promissory note.
Mr. Richard Silberman, a shareholder of the Company, purchased 300,000
shares of the Company's Common Stock for $900,000. The Company received a
promissory note from Mr. Silberman with interest at 9.5% per annum with
principal and interest due in September 2000. At any time prior to September
2000, Mr. Silberman has the right to require the Company to repurchase the
300,000 shares as consideration for the cancellation of the promissory note. In
a separate transaction Mr. Silberman purchased 300,000 shares of the Company's
Common Stock for $411,000 which was paid by a promissory note payable on or
before July 31, 1998. The promissory note bears interest at the rate of 9.5% per
annum. Mr. Silberman has the right to require the Company to repurchase the
300,000 shares as consideration for the cancellation of the promissory note.
Michael Cronin, the chief financial officer of the Company purchased
500,000 shares of the Company's Common Stock for $685,000 which was paid by a
promissory note payable on or before July 31, 2001. The promissory note bears
interest at the rate of 9.5% per annum. Mr. Cronin has the right to require the
Company to repurchase the 500,000 shares as consideration for the cancellation
of the promissory note.
In connection with the acquisition of Little King, the Company provided
Mr. Sid Wertheim, the principal of Little King, an option to repurchase the
shares of Little King from the Company if the stock price of the Company's
Common Stock is not at least $1.50 per share on the second anniversary of the
closing with the repurchase based on the Company receiving back all of the
Company's shares issued, any funds invested by the Company into Little King. and
a fair market value determination. The term of the acquisition also provided
that in the event the Company files bankruptcy within three years of the closing
and the bankruptcy is not dismissed within 90 days, Mr. Wertheim is granted the
first option to repurchase the Little King stock from the Company for $25,000.
The agreement also provided the selling shareholders of Little King with
piggyback registration rights in the event the Company decides to register any
of its Stock. The agreement also provides that in the event the Company
completes a secondary offering of its Common Stock on or prior to March 31,
1998, the Company will invest an amount equal to 4% of the proceeds the Company
receives for the development of the Little King concept. Mr. Sid Wertheim also
has an agreement with Tri-Emp which is controlled by Mr. Christopher Swartz,
chairman, president and chief executive officer of the Company. Under this
22
<PAGE>
agreement, if Tri-Emp receives an offer to purchase its controlling interest
during the first three years after the Company's acquisition of Little King,
Tri-Emp will obtain an acceptable stock sale for Mr. Sid Wertheim. If Mr. Sid
Wertheim receives an offer for substantially all of his Common Stock of the
Company, he shall grant Tri-Emp or its designee a first option to make such
purchase. The option shall be on the same terms and conditions as that provided
to a third party bona fide purchaser.
In connection with the Company's acquisition of Seawest Subs, the
Company issued options to purchase 100,000 shares of the Company's Common Stock
at a price of $.001 per share for 15 years (valued at $406,000) and the
assumption of certain liabilities personally guaranteed by the former president
of Seawest Subs. The optionees have the right to require the Company to
repurchase these shares at the greater of their "fair market value" (defined to
be the average of the high and low sales prices on a public market) or $3.25 per
share, but in no event more than 10,000 shares per month. The optionees were
also granted piggy back registration rights. The options become exercisable on a
cumulative basis at 25% on each of December 19, 1997, May 19, 1998, November 19,
1998 and May 19, 1999.
In connection with the Company's acquisition of SBK on December 4,
1997, the Company issued 187,266 shares of its Common Stock to Interfoods of
America, Inc. ("IFA"). Commencing six months after the closing and continuing
every six months thereafter until June 2000, IFA shall have the non-cumulative
right to require the Company, to the extent legally permissible, to repurchase
one-fifth (1/5) of the Company's Common Stock issued to IFA in consideration of
the repayment of $100,000. In May 1998, the Company was notified by IFA of its
exercise of the right to have the Company repurchase one-fifth of the shares on
July 5, 1998 and the Company purchased those shares for $100,000. In November
1998, the Company was notified by IFA of its exercise of the right to have the
Company repurchase one-fifth of the shares which have not yet been re-purchased.
Item 8. Description of Securities
Common Stock
The Company's Articles of Incorporation authorize the issuance of
50,000,000 shares of Common Stock, no par value per share, of which 16,678,836
shares were outstanding as of September 1, 1998. Holders of Common Stock are
entitled to one vote for each share on all matters to be voted on by the
stockholders. Holders of Common Stock have no cumulative voting rights. Holders
of Common Stock are entitled to share ratably in dividends, if any, as may be
declared, from time to time, by the Board of Directors in its discretion, from
funds legally available therefor, after dividends are first paid on Series C
Preferred Stock and Series D Preferred Stock. Pursuant to the Colorado Business
Corporations Act, dividends may be paid out of shareholder equity after
deductions for the liquidation preference for outstanding preferred stock. In
the event of a liquidation, dissolution or winding up of the Company, the
holders of Common Stock are entitled to share pro rata in all assets remaining
after payment in full of all liabilities. Holders of Common Stock have no
preemptive rights to purchase the Company's Common Stock. There are no
conversion rights or redemption or sinking fund provisions with respect to the
Common Stock. All of the outstanding shares of Common Stock are fully paid and
non-assessable except for 1,000,000 shares of the Company's Common Stock issued
to Mr. Bradley Gordon, 600,000 shares of the Company's Common Stock issued to
Mr. Richard Silberman, and 500,000 shares issued to Mr. Michael Cronin.
Information regarding the issuance of capital stock in connection with
the Company's acquisitions is set forth at Item 4, Recent Sales of Unregistered
Securities.
23
<PAGE>
Penny Stock Regulations - Restrictions on Marketability
The Securities and Exchange Commission (the "Commission") has adopted
regulations which generally define "penny stock" to be any equity security that
has a market price (as defined) less than $5.00 per share or an exercise price
of less than $5.00 per share, subject to certain exceptions. The Company's
securities may be covered by the penny stock rules, which impose additional
sales practice requirements on broker-dealers who sell such securities to
persons other than established customers and accredited investors (generally
institutions with assets in excess of $5,000,000 or individuals with net worth
in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 jointly
with their spouse). For transactions covered by the rule, the broker-dealers
must make a special suitability determination for the purchase and receive the
purchaser's written agreement of the transaction prior to the sale.
Consequently, the rule may affect the ability of broker-dealers to sell the
Company's securities and also may affect the ability of purchasers to sell their
shares in the secondary market.
Preferred Stock
The Company is authorized to issue 5,000,000 shares of Preferred Stock,
no par value per share (the "Preferred Stock"). The Preferred Stock may be
issued from time to time in one or more classes or series, each class or series
of which shall have the voting rights, designations, preferences and relative
rights as fixed by resolution of the Company's Board of Directors, without the
consent or approval of the Company's shareholders. The Preferred Stock may rank
senior to the Common Stock as to dividend rights, liquidation preferences, or
both, and may have extraordinary or limited voting rights. There are currently
no shares of Series A Voting Nonredeemable Cumulative Convertible Preferred
Stock (the "Series A Preferred Stock") no shares of Series B Voting
Nonredeemable Convertible Preferred Stock (the "Series B Preferred Stock"), 120
shares of Series C Non-voting Nonredeemable Convertible Preferred Stock (the
"Series C Preferred Stock") outstanding and 2,500 shares of Series D Non-voting
Nonredeemable Convertible Preferred Stock (the "Series D Preferred Stock")
outstanding.
The following table summarizes the principal terms of each outstanding
series of Preferred Stock.(1)
<TABLE>
<CAPTION>
Number of Annual Common Stock
Series Shares Authorized & Dividends Cumulative Liquidation Conversion Voting/Election
Capital Account Per Share Dividends Preference Formula Rights
- ------- --------------- --------- --------- ---------- ---------------- --------------
# Shares Amount
-------- ------
<S> <C> <C> <C> <C> <C> <C> <C>
C 120 120,000 $130.00 Yes Senior To All But 1:133.23 None
"A+B" Preferred
D 2,500 2,500,000 $80.00 Yes Senior Only to $1,000 divided None
Common Stock by 65% of market
value of Common
- ---------------------
</TABLE>
1. Series A Preferred Stock and Series B Preferred Stock
The Company was authorized to issue 700,000 shares of Series A Preferred
Stock, all of which were previously issued and none of which are currently
outstanding after the conversion of 100,000 shares of the Series A
Preferred Stock to Common Stock in July 1997 and 600,000 shares of the
Series A Preferred Stock to Common Stock in June 1998. Series A Preferred
Stock once converted have the status of authorized but unissued shares of
Preferred Stock without designation until such shares are once more
designated as part of a particular series by the Board of Directors
24
<PAGE>
The Company was authorized to issue 350,000 shares of Series B Preferred
Stock, all of which were previously issued and none of which are currently
outstanding. In June 1998, all 350,000 shares of Series B Preferred Stock
were converted to Common Stock. Series B Preferred Stock once converted
have the status of authorized but unissued shares of Preferred Stock
without designation until such shares are once more designated as part of a
particular series by the Board of Directors
Series C Preferred Stock
The Company is authorized to issue 120 shares of Series C Preferred
Stock, all of which were issued in connection with the Company's acquisition of
QFS. The relative rights, preferences and limitations of the Series C Preferred
Stock are as follows.
Voting. The holders of Series C Preferred Stock are not entitled to any
vote on all matters on which stockholders may vote at all meetings of
shareholders.
Dividends. The holders of the Series C Preferred Stock are entitled to
a cumulative annual dividend of $130 per share payable out of funds legally
available therefor, which dividend shall be subordinate to all other dividends
on the Series A and Series B Preferred Stock.
Liquidation. The Series C Preferred Stock has a liquidation preference
over the Common Stock, but not the Series A Preferred Stock and Series B
Preferred Stock, as to $120,000, together with the amount of any unpaid
dividends thereon, in the event of any dissolution, liquidation, or winding up
of the Company. If, upon any such dissolution, liquidation, or winding up of the
Company, the assets of the Company is distributable to the holders of the Series
C Preferred Stock shall be insufficient to permit payment in full of the
preferential amount aforesaid, then the entire assets of the Company, after
payment of the holders of the Series A Preferred Stock and Series B Preferred
Stock, shall be distributed ratably among the holders of the Series C Preferred
Stock according to the respective number of shares of Series C Preferred Stock
held by them.
Right to Convert. Each holder of Series C Preferred Stock may and upon
surrender to the Company of the certificate therefor at the principal office of
the Company or at such other place as the Company shall designate, convert all
of such holder's Series C Preferred Stock into shares of Common Stock at the
rate of 133.23 shares of the Company's Common Stock for each share of Series C
Preferred Stock (the "Series C Conversion Ratio"). In the event of either an
increase or decrease in the number of the shares of the Company's Common Stock
as a result of a stock dividend, stock split, recapitalization, combination, or
reclassification, the Series C Conversion Ratio shall be equitably adjusted.
Series D Preferred Stock
The Company is authorized to issue 2,500 shares of Series D Preferred
Stock, all of which were issued in January 1998 for $1,000 per share. The
relative rights, preferences and limitations of the Series D Preferred Stock are
as follows:
Voting. The holders of Series D Preferred Stock have no voting rights
on matters for which stockholder may generally vote.
Dividends. The holders of the Series D Preferred Stock are entitled to
a cumulative annual dividend of $80 per share payable out of funds legally
available therefor or in Common Stock.
25
<PAGE>
Right to Convert. Each holder of Series D Preferred Stock may and upon
surrender to the Company of the certificate therefor at the principal office of
the Company or at such other place as the Company shall designate, convert all
of such holder's Series D Preferred Stock into shares of Common Stock at the
lower of (a) 65% of the closing bid price averaged over the 5 trading days
before the date of conversion, or (b) $1.96875. In the event of either an
increase or decrease in the number of the shares of the Company's Common Stock
as a result of a stock dividend, stock split, recapitalization, combination, or
reclassification, the Series D Conversion Ratio shall be equitably adjusted.
Shares Eligible for Future Sale
Of the outstanding shares of the Company, 9,644,884 shares are subject
to resale restrictions and, unless registered under the Securities Act of 1933
(the "Act) or exempted under another provision of the Act, will be ineligible
for sale in the public market until one year from their issuance, following
which sales may be made under Rule 144.
In general, under Rule 144, as currently in effect, a person (or
persons whose shares are aggregated) who has beneficially owned shares privately
acquired or indirectly from the Company or from an affiliate, for at least one
year, or who is an affiliate, is entitled to sell within any three-month period,
a number of such shares that do not exceed the greater of 1% of the then
outstanding shares of the Company's Common Stock (approximately 170,000 shares)
or the average weekly trading volume in the Company's Common Stock during the
four calendar weeks immediately preceding such sale. Sales under Rule 144 are
also subject to certain manner of sale provisions, notice requirements and the
availability of current public information about the Company. A person (or
persons whose shares are aggregated) who is not deemed to have been an affiliate
at any time during the 90 days preceding a sale, and who has beneficially owned
shares for at least two years, is entitled to sell all such shares under Rule
144 without regard to the volume limitations, current public information
requirements, manner of sale provisions or notice requirements.
Sales of substantial amounts of the Common Stock of the Company in the
public market could adversely affect prevailing market prices.
PART II
Item 1. Market Price of and Dividends on the Registrant's Common Equity and
Other Shareholder Matters
(a) Market Information
The Company's Common Stock has been listed on the Electronic Bulletin
Board sponsored by the National Association of Securities Dealers, Inc. since
October, 1996. The prices reported reflect inter-dealer prices and are without
adjustments for retail markups, markdowns or commissions, and may not
necessarily represent actual transactions.
Quarter Ended Bid Price
------------- ---------
High Low
---- ---
December 31, 1996 3 7/8 1 1/4
March 31, 1997 4 1/8 1 3/4
June 30, 1997 8 1/4 3 1/4
26
<PAGE>
September 30, 1997 4 1/8 3
December 31, 1997 3 7/16 2 1/8
March 31, 1998 3 1/8 1 13/16
June 30, 1998 2 11/16 1 3/4
September 30, 1998 1 1/16 9/16
(b) Holders
As of September 1, 1998, there were approximately 8,000 record
holders of the Company's Common Stock.
(c) Dividends
The Company has not paid any dividends on its Common Stock.
The Company currently intends to retain any earnings for use in its business,
and therefore does not anticipate paying cash dividends to holders of Common
Stock in the foreseeable future. Holders of Series C Convertible Preferred Stock
are entitled to annual cash dividends of $130.00 per share. Holders of Series D
Convertible Preferred Stock are entitled to annual cash dividends of $80.00 per
share. Pursuant to the Company's Articles of Incorporation, holders of Common
Stock are not entitled to receive dividends unless dividends have been paid for
prior calendar years and paid and set aside for the then current calendar year
on the Series C and Series D Preferred Stock. The Company is under no other
contractual restrictions on the payment of dividends.
Item 2. Legal Proceedings
None.
Item 3. Changes in and Disagreements with Accountants.
On February 28, 1998, Michael F. Cronin resigned as accountant. The
Accountant's Report on the 1995 and 1996 financial statements of the Company
contained an unqualified opinion. There were no disagreements with the former
accountant on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure.
Item 4. Recent Sales of Unregistered Securities
Commencing August 1995, Circa Media, Inc. issued 2,200,000 shares of
common stock and 200 shares of preferred stock for cash consideration of $3,950
in reliance on Rule 504 of Regulation D.
On May 6, 1996, the Company issued the following securities in exchange
for all of the capital stock of JRECK Subs, Inc.:
Company JRECK Subs, Inc Securities
Securities Issued Exchanged
----------------- ---------
5,000,000 8,000,000 shares of
shares of Common Stock Common Stock
700,000 shares of 700,000 shares of Series
Series A Preferred A Preferred
27
<PAGE>
In addition, the Company issued 350,000 shares of Series B Preferred
for 50% of the Common Stock of Pastry Products. The sales were made in reliance
upon the exemption set forth in Section 4(2) of the Securities Act of 1933. As a
condition to each of the above sales, the purchaser consented to a placement of
a restrictive legend on the certificate representing the securities.
In May 1996 the Company issued 1,100,000 restricted shares for $11,000
cash to seven persons. No underwriter was involved and the holders agreed that a
restrictive legend would be placed upon the certificates representing the
Shares. The Company believes that this transaction was exempt under Section 4(2)
of the Act as a transaction not involving a public offering.
From May 1996 to December, 1996 the Company issued 1,536,000 shares of
Common Stock in an offering under Rule 504 of Regulation D to approximately 70
purchasers. Net proceeds of the offering were $648,150. No underwriter was
involved.
In December 1996, the Company in reliance upon Section 4(2) of the Act
issued 45,000 shares to Gerharz Equipment, Inc. for the cancellation of a debt
of approximately $90,533. The Company believes that this transaction was exempt
under Section 4(2) of the Act as a transaction not involving a public offering.
In January 1997, the Company issued 415,095 shares of Common Stock in
an offering under Rule 504 of Regulation D to Corporate Relations Group and
Olympus Capital, Inc. Net proceeds of the offering were $220,000. No underwriter
was involved.
On February 28, 1997 the Company issued 94,650 shares of Common Stock
valued at $3.56 per share to four individuals for marketing services. The
Company believes that this transaction was exempt under Section 4(2) of the Act
as a transaction not involving a public offering.
In February 1997, the Company issued 230,000 shares of Common Stock
valued at $424,003 to two individuals in connection with the purchase of bakery
equipment located in Missouri. The Company believes that this transaction was
exempt under Section 4(2) of the Act as a transaction not involving a public
offering.
In April 1997, the Company issued 39,118 shares of Common Stock valued
at $144,248 to approximately 400 shareholders of Western Fast Food. The shares
were issued without consideration. Western Fast Food had been organized by
Company affiliates to develop the Company's franchise concepts but had been
unsuccessful. The Company believes that this transaction was exempt under
Section 4(2) of the Act as a transaction not involving a public offering.
On May 23, 1997, the Company issued options to purchase 180,000 shares
of Common Stock at $.50 per share to the Deegan Group in connection with
obtaining a $180,000 loan. 60,000 shares of Common Stock were issued upon
partial exercise of this option on November 21, 1997. The Company believes that
this transaction was exempt under Section 4(2) of the Act as a transaction not
involving a public offering.
Between June 19, 1997 and August 5, 1997 the Company issued 289,500
shares of Common Stock, respectively, to approximately 20 individuals in
connection with the acquisition of Hymie's Bagel equipment. The Company believes
that this transaction was exempt under Section 4(2) of the Act as a transaction
not involving a public offering.
28
<PAGE>
On July 8, 1997, Messrs. Jeremiah Haley (a director) Charles Lehman,
Douglas Nichols and Keith Waltz, holders of Series A Preferred Stock, converted
an aggregate of 100,000 shares of Series A Preferred Stock into 100,000 shares
of the Company's Common Stock. The issuance of the Series A Preferred Stock and
the issuance of Common Stock upon conversion were transactions not involving a
public offering.
On July 10, 1997 Corporate Relations Group, exercised its options to
purchase 300,000 shares of Common Stock at $.75 per share. The Company believes
that this transaction was exempt under Section 4(2) of the Act as a transaction
not involving a public offering.
On July 25, 1997 and on August 25, 1997 the Company issued 150,000 and
48,000 shares of Common Stock, respectively, to Corporate Relations Group in an
offering under Rule 504 of Regulation D at a price of $1.00 per share.
On July 30, 1997 the Company issued 55,000 shares of Common Stock to
two individuals for operations consulting valued at $3.8125 per share. On August
7, 1997 the Company issued 1,951 shares of Common Stock to Mark McKinnon, an
employee, valued at $3.6875 per share, and on August 18, 1997 issued 2,759
shares of Common Stock to another employee, Brick Brunton, valued at $3.75 per
share. The Company believes that all of these issuances were exempt under
Section 4(2) of the Act as transactions not involving a public offering.
In August 1997, the Company acquired all of the outstanding shares of
Richey Enterprises, Inc. (Georgio's Subs) for 93,794 shares of its Common Stock.
The Company believes that this transaction was exempt under Section 4(2) of the
Act as a transaction not involving a public offering.
In September 1997, the Company acquired all of the outstanding shares
of Little King by the issuance of 500,000 shares of its Common Stock. The
Company believes that this transaction was exempt under Section 4(2) of the Act
as a transaction not involving a public offering.
On September 17, 1997 the Company issued 75,000 shares of Common Stock
to Olympus Capital, Inc. for financial consulting services valued at $229,286.
The Company believes that this transaction was exempt under Section 4(2) of the
Act as a transaction not involving a public offering.
On October, 1997, the Company issued 495,000 shares of its Common Stock
to twenty individuals for the full satisfaction of debt of $445,000 and interest
of $102,800. The Company believes that all of these issuances were exempt under
Section 4(2) of the Act as transactions not involving a public offering.
On October 8, 1997 the Company acquired all of the outstanding shares
of QFS (Mountain Mike's Pizza) by the issuance of 120 shares of the Company's
Series C Preferred Stock and 899,967 shares of the Company's Common Stock. The
Company believes that this transaction was exempt under Section 4(2) of the Act
as a transaction not involving a public offering.
On October 27, 1997, the Company issued 262,500 shares of its Common
Stock to three persons for the acquisition of the remaining 50% of the capital
stock of Pastry Products not already owned by it. The Company believes that this
transaction was exempt under Section 4(2) of the Act as a transaction not
involving a public offering.
29
<PAGE>
In November 1997, the Company issued 60,000 shares of its Common Stock
to three investors in consideration with obtaining a $250,000 loan. The Company
believes that this transaction was exempt under Section 4(2) of the Act as a
transaction not involving a public offering.
In November 1997, the Company issued 800,000 shares of its Common Stock
to two individuals for total consideration of $2,400,000 paid in the form of
promissory notes with interest at 9.5% with interest and principal due in
September 2000. At any time prior to September 2000, these individuals may
require the Company to repurchase the 800,000 shares as consideration for the
cancellation of the notes. The Company believes that this transaction was exempt
under Section 4(2) of the Act as a transaction not involving a public offering.
On November 6, 1997 the Company issued 61,111 shares of Common Stock to
three persons for cash of $2.25 per share, and issued 25,000 shares of Common
Stock to a fourth individual for $2.00 per share. The Company believes that all
of these issuances were exempt under Section 4(2) of the Act as transactions not
involving a public offering.
On December 4, 1997 the Company issued 187,266 shares of its Common
Stock to Interfoods of America, Inc. to acquire SBK. The Company believes that
this transaction was exempt under Section 4(2) of the Act as a transaction not
involving a public offering.
On January 5, 1998, the Company issued 2500 shares of its Series D
Preferred Stock to several investors for cash consideration of $2,500,000. The
Company believes that this transaction was exempt under Section 4(2) of the Act
as a transaction not involving a public offering.
On December 31, 1997 the Company issued 138,889 shares to Messrs.
Naddaff and Youngman for $250,000 cash and warrants to purchase up to 1,250,000
shares of the Company's Common Stock for consulting and fundraising services
valued at $1,517,500. The Company believes that this transaction was exempt
under Section 4(2) of the Act as a transaction not involving a public offering.
On February 9, 1998 25,000 shares of Common Stock were issued upon
exercise of options at $.01 per share; the options had been issued to in
connection with the acquisition of Seawest Subs. The Company believes that this
transaction was exempt under Section 4(2) of the Act as a transaction not
involving a public offering.
On February 9, 1998 the Company issued 11,550 shares of Common Stock to
its franchising attorney for services of $30,319. The Company believes that this
transaction was exempt under Section 4(2) of the Act as a transaction not
involving a public offering.
On March 16, 1998 the Company issued 9,400 shares of its Common Stock
to one individual for services valued at $22,913 and 50,000 shares to another
individual for services rendered valued at $121,875. The Company believes that
this transaction was exempt under Section 4(2) of the Act as a transaction not
involving a public offering.
On March 26, 1998 the Company issued 150,003 shares to shareholders of
QFS at a price of $2.9375 per share as part of the contingent share issuance
agreed to at the time of acquiring QFS in 1997. On the same day 52,631 shares
were issued to three shareholders of Seawest Corporation in connection with the
acquisition of Seawest Subs. The Company believes that this transaction was
exempt under Section 4(2) of the Act as a transaction not involving a public
offering.
30
<PAGE>
On April 29, 1998, 112,793 shares of Common Stock were issued to the
Wertheim family for satisfaction of $277,404 of Little King debt. The Company
believes that this transaction was exempt under Section 4(2) of the Act as a
transaction not involving a public offering.
On May 18, 1998, 735,294 shares of Common Stock were issued to
approximately 30 persons in connection with the acquisition of Li'l Dino
Corporation. The transaction was approved at a state fairness hearing in March
1998 and was exempt from registration under section 3(a)(10) of the Securities
Act of 1933.
On May 27, 1998 the Company issued 115,000 shares of Common Stock to
one individual for consulting services valued at $251,563. The Company believes
that this transaction was exempt under Section 4(2) of the Act as a transaction
not involving a public offering.
On August 3, 1998 the Company issued 500,000 shares to each of Bradley
L. Gordon and Michael Cronin, and 300,000 shares to Richard Silberman for
consideration of $1.3125 per share (the closing sales price of the Common Stock
on that date) paid in the form of promissory notes with interest at 9.5% with
interest and principal due on July 31, 2001. At any time prior to July 31, 2001,
these individuals may require the Company to repurchase the their respective
shares as consideration for the cancellation of the notes.
Since January, 1997, the Company has issued options and warrants as
follows:
<TABLE>
<CAPTION>
Date Name Number Exercise Price Purpose
---- ---- ------ -------------- -------
<S> <C> <C> <C> <C>
Jan. 6, 1997 Gulf Atlantic Publishing 375,000 $.75 Printing Services
Apr. 2, 1997 Corporate Relations Group 150,000 .75 Advertising and
Marketing Services
Sept. 15, 1997 Corporate Relations Group 100,000 2.81 Services
Sept. 15, 1997 Corporate Relations Group 100,000 3.37 Services
Sept. 15, 1997 Corporate Relations Group 100,000 3.93 Services
Sept. 12, 1997 Olympus Capital, Inc. 100,000 2.75 Investment Banking
Services
Sept. 12, 1997 Olympus Capital, Inc. 100,000 3.50 Services
Dec. 17, 1997 Naddoff & Youngman 375,000 1.92 Consulting Services
Dec. 17, 1997 Naddoff & Youngman 375,000 2.56 Services
Dec. 17, 1997 Naddoff & Youngman 375,000 3.20 Services
Dec. 17, 1997 Naddoff & Youngman 125,000 3.84 Services
Dec. 27, 1997 Christopher Swartz 1,000,000 2.75 Employee
Compensation
May 23, 1997 Richard Rudolf 60,000 .50 Compensation related
to loan
May 23, 1997 Thomas Larcomb 60,000 .50 Compensation related
to loan
May 23, 1997 William Deegan 60,000 .50 Compensation related
to loan
June 30, 1997 M. Day 100,000 .01 Acquisition of
Seawest Sub
Sept. 30, 1997 Spelman & Co. 18,704 3.08 Acquisition of QFS
Sept. 30, 1997 AB Laffer, VA Canto & Assoc. 13,500 3.08 Acquisition of QFS
31
<PAGE>
Oct. 27, 1997 R. Longley & P. Traux 37,500 * Acquisition of Pastry
Products
September 30, 1998 Wall Street Consultants 100,000 1.00 Consulting Services
August 3, 1998 Christopher Swartz 1,000,000 1.55 Employee
Compensation
</TABLE>
* 50% of mean of bid and ask on date of exercise.
Except for sales noted as made under Rule 504 of Regulation D and
Section 3(a)(10) of the Securities Act of 1933, the above sales were made in
reliance upon Section 4(2) of the Securities Act of 1933. As a condition to each
of the sales, in reliance on Section 4(2), the Company satisfied itself that
each issuance complied with Section 4(2). In this respect, there were no general
solicitations or advertisements. In some cases the Company relied on personal
knowledge of the purchaser and in other cases, the Company would receive
representations as to investment intent to not acquire the shares with a view to
further distribution. In all cases, the Company considered the sophistication of
the purchaser and the purchaser's understanding of the Company and the risk
inherent in the acquisition of the securities. The Company's officers and
directors provided information to the purchaser regarding the investment in the
Company and made the responded to inquiries. All securities issued pursuant to
available exemptions were legended.
Item 5. Indemnification of Directors and Officers
As permitted under the Colorado General Corporation Law, directors and
officers are not liable to the Company or its stockholders for monetary damages
arising from a breach of their fiduciary duty of care as directors. Such
provisions do not, however, relieve liability for breach of a director's duty of
loyalty to the Company or its stockholders, liability for acts or omissions not
in good faith or involving intentional misconduct or knowing violations of law,
liability for transactions in which the director derived an improper personal
benefit or liability for the payment of a dividend in violation of Colorado law.
Further, the provisions do not relieve a director's liability for violation of,
or otherwise relieve the Company or its directors from the necessity of
complying with, federal or state securities laws or affect the availability of
equitable remedies such as injunctive relief or recision. However, as a
practical matter, equitable remedies may not be available in all situations and,
there may be instances in which no effective remedy is available or can be
timely obtained.
At present, there is no pending litigation or proceeding involving a
director, officer, employee or agent of the Company where indemnification will
be required or permitted. The Company is not aware of any threatened litigation
or proceeding that may result in a claim for indemnification by any director or
officer.
PART F/S
Financial Statements
The following financial statements are included herein.
JRECK Subs Group, Inc.
Independent Auditors' Report; Consolidated Balance Sheet at December
31, 1997; Consolidated Statement of Operations for the Year Ended
December 31, 1997; Consolidated Statement of Cash Flows for the Year
Ended December 31, 1997; Consolidated Statement of Changes in
Stockholders' Equity for the Year Ended 1997; Notes to Consolidated
Financial Statements.
32
<PAGE>
JRECK Subs Group, Inc.
Independent Auditors' Report; Consolidated Balance Sheet at December
31, 1996; Consolidated Statement of Operations for the Year Ended
December 31, 1996; Consolidated Statement of Cash Flows for the Year
Ended December 31, 1996; Consolidated Statement of Changes in
Stockholders' Equity for the Year Ended December 31, 1996; Notes to
Consolidated Financial Statements.
L'il Dino Corporation
Independent Auditors' Report; Balance Sheet at October 31, 1997;
Statement of Loss and Retained Deficit for the year ended October 31,
1997; Statement of Cash Flows for the year ended October 31, 1997;
Notes to Financial Statements.
Pastry Products Producers, LLC
Balance Sheet at December 31, 1996; Statements of Operations and
Stockholders' Equity for the Year Ended December 31, 1996; Statement of
Cash Flows for the Year Ended December 31, 1996; Notes to Financial
Statements.
Seawest Sub Shops, Inc.
Independent Auditors' Report; Balance Sheet at December 31, 1996;
Statement of Income for the Year Ended December 31, 1996; Statement of
Cash Flows for the Year Ended December 31, 1996; Statement of Changes
in Stockholders' Equity for the Year Ended December 31, 1996; Notes to
Financial Statements.
Quality Franchise Systems, Inc. and Subsidiary
Independent Auditor's Report; Consolidated Balance Sheet at September
30, 1997; Consolidated Statement of Operations for the Nine Months
ended September 30, 1997; Consolidated Statement of Cash Flows for the
Nine Months ended September 30, 1997; Statement of Changes in
Stockholders' Equity for the Nine Months ended September 30, 1997;
Notes to Consolidated Financial Statements.
Little King, Inc.
Independent Auditor's Report: Balance Sheet at December 29, 1996;
Statement of Operations for the Year Ended December 29, 1996; Statement
of Cash Flows for the Year Ended December 29, 1996; Statement of
Changes of Stockholders' Equity for the Year Ended December 29, 1996;
Notes to Financial Statements.
Richey Enterprises, Inc.
Independent Auditors' Report; Balance Sheets at August 15, 1997 and
December 31, 1996; Statements of Operations for the Seven and one-half
Months Ended August 15, 1997 and for the Year Ended December 31, 1996;
Statements of Cash Flows for the Seven and one-half Months Ended August
15, 1997 and for the Year Ended December 31, 1996; Statements of
Changes of Stockholders' Equity for the Seven and one-half Months Ended
August 15, 1997 and for the Year Ended December 31, 1996; Notes to
Financial Statements.
33
<PAGE>
PART III
The following exhibits required by Item 601 of Regulation S-B are filed
herewith:
Exhibit Document Description
No.
2. Plan of purchase, sale, reorganization, arrangement, liquidation or
succession.*
2.1 Repurchase Agreement between Paul M. Traux and Robin Longley and Jreck
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,
Inc., Admiral's Fleet, Inc. and Quality Franchise Systems, Inc.
("Quality Agreement")*
2.3 Amendment to Quality Agreement*
2.4 Agreement between the Company and CHAI Enterprises, Inc. ("Hymie's
Bagel Chain")*
* Previously filed
57
<PAGE>
Exhibit Document Description
No.
2.5 Agreement and Plan of Reorganization among JRECK Subs Group, Inc., Li'l
Dino Management Corporation and Li'l Dino Corporation dated December
18, 1977*
2.6 Purchase Agreement among JRECK Subs Group, Inc., Interfoods of America,
Inc. and SBK Franchise Systems, Inc. dated December 4, 1977 (Sobiks)*
2.7 Agreement between Jreck Subs Group, Inc. and Little King, Inc. dated
July 23, 1997*
2.8 Agreement among Jreck Subs, Inc. and Mitchell R. Day and Julie A. Day
to Purchase Seawest Sub Shops, Inc.*
2.9 Stock Option Grants to acquire Seawest Sub Shops, Inc.*
2.10 Representation and Warranty Agreement among Mitchell R. Day and Julie
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
Group, Inc. and RICHEY ENTERPRISES, INC.*
2.12 Repurchase agreement by Paul M. Truax and Robin Longley*
3. Articles of Incorporation and Bylaws*
3.1 Articles of Incorporation - Circa Media*
3.2 Articles of Amendment of Circa Media dated May 2, 1996 and filed May 7,
1996*
3.3 Articles of Amendment of Jreck Subs filed May 7, 1996*
3.4 Certificate of Correction to Articles of Amendment filed July 24,
1996.*
3.5 Articles of Amendment to Articles of Incorporation Re Certificate of
Description of Jreck Subs Group, Inc. dated September 23, 1997 (Series
C)*
3.6 Articles of Amendment File to Determine Rights of Shares (Certificate
of Determination) of JRECK Subs Group, Inc. dated January 5, 1998
(Series D)*
3.7 Bylaws of Jreck Subs Group dated August 21, 1995.*
10. Material Contracts*
10.1 Form of Franchise Agreement*
10.2 Facility Lease between Springs Equity, Ltd and JRECK SUBS GROUP, INC.
dated December 16, 1997*
10.3 Quality Franchise Systems, Inc.: Area Development Agreement
Quality Franchise Systems, Inc.*
a) MKJ Holdings, Inc.
b) Master Franchising and Development Systems, Inc.
c) John E. and Ann M. Maddox - To be filed separately
d) David and Terri Laursen - To be filed separately
e) Alex Golshanara
10.4 Promissory Note from Bradley L. Gordon to Jreck Subs Group, Inc. dated
September 24, 1997.*
10.5 Promissory Note from Richard T. Silberman to Jreck Subs Group, Inc.
dated September 24, 1997.*
10.6 Promissory Note from Michael Cronin to Jreck Subs Group, Inc. dated
July 31, 1998.*
10.7 Promissory Note from Richard T. Silberman to Jreck Subs Group, Inc.
dated July 31, 1998.*
* Previously filed
58
<PAGE>
Exhibit Document Description
No.
10.8 Promissory Note from Bradley L. Gordon to Jreck Subs Group, Inc. dated
July 31, 1998.*
10.9 Employment Agreement between Bradley L. Gordon and Jreck Subs Group,
Inc. effective September 24, 1997.*
10.10 Employment Agreement between Michael Cronin and Jreck Subs Group, Inc.
effective July 31, 1998.*
10.11 Stock Option Grant Agreement between Jreck Subs Group, Inc. and
Christopher Swartz dated August 3, 1998.*
10.12 Stock Option Grant Agreement between Jreck Subs Group, Inc. and
Christopher Swartz dated December 29, 1997.*
10.13 1998 Jreck Subs Group, Inc.*
16. Letter of change of certifying accountant*
16.1 Item 304(a)(3)*
21. Subsidiaries of the Registrant*
27. Financial Data Schedule*
* Previously filed
59
<PAGE>
SIGNATURES
In accordance with Section 12 of the Securities Exchange Act of 1934,
the Registrant has caused this registration statement to be signed on its behalf
by the undersigned, thereunto duly authorized.
Dated: February 16, 1999 JRECK SUBS GROUP, INC.
By: /s/ Christopher M. Swartz
-------------------------------------
President and Chief Executive Officer
60
<PAGE>
JRECK Subs Group, Inc.
Contents
- --------------------------------------------------------------------------------
Page
Report of Independent Certified Public Accountants F-2
Financial Statements
Consolidated balance sheet F-3 - F-4
Consolidated statement of operations F-5
Consolidated statement of stockholders' equity F-6
Consolidated statement of cash flows F-7
Summary of accounting policies F-8 - F-12
Notes to consolidated financial statements F-13 - F-39
F-1
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors:
JRECK Subs Group, Inc.
Longwood, Florida
We have audited the accompanying consolidated balance sheet of JRECK
Subs Group, Inc. as of December 31, 1997 and the related consolidated statements
of operations, stockholders' equity and cash flows for the year then ended.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also included
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of JRECK Subs
Group, Inc. at December 31, 1997, and the results of their operations and their
cash flows for the year then ended in conformity with generally accepted
accounting principles.
BDO Seidman, LLP
Orlando, Florida
May 8, 1998, except for Note 12 (d),
which is as of June 30, 1998
F-2
<PAGE>
JRECK Subs Group, Inc.
Consolidated Balance Sheet
- ------------------------------------- ------------------------------------------
December 31, 1997
Assets
Current:
Cash and cash equivalents $ 427,420
Accounts receivable - trade, net of allowance
for doubtful accounts of $199,228 (Note 7) 391,567
Current portion of notes receivable 168,560
Prepaid expenses (Note 2) 730,811
- --------------------------------------------------------------------------------
Total current assets 1,718,358
- --------------------------------------------------------------------------------
Notes receivable 173,704
Property, plant and equipment, net (notes 3 and 7) 1,930,990
Goodwill, net of accumulated amortization
of $1,190,184 (Note 4) 11,521,526
Other assets:
Covenants note to compete, net of accumulated
amortization of $89,223 (Note 4) 512,777
Prepaid interest, net (Note 9) 597,760
Other 34,097
- --------------------------------------------------------------------------------
Total assets $16,489,212
================================================================================
See accompanying summary of accounting policies
and notes to consolidated financial statements.
F-3
<PAGE>
<TABLE>
<CAPTION>
JRECK Subs Group, Inc.
Consolidated Balance Sheet
- ------------------------------------- ------------------------------------------------
December 31, 1997
Liabilities and Stockholders' Equity
Current liabilities:
<S> <C>
Current portion of long-term debt (Note 7) $2,163,554
Current portion of notes payable to related parties (Note 6) 434,785
Accounts payable 1,020,101
Accrued liabilities (Note 5) 1,196,130
Liability to issue common stock (Note 4) 2,234,375
- --------------------------------------------------------------------------------------
Total current liabilities 7,048,945
- --------------------------------------------------------------------------------------
Long-term debt, less current portion (Note 7) 1,619,115
Notes payable to related parties, less current portion(Note 6) 323,032
- --------------------------------------------------------------------------------------
Total liabilities 8,991,092
- --------------------------------------------------------------------------------------
Redeemable common stock (Note 4) 500,000
- --------------------------------------------------------------------------------------
Commitments and contingencies (Note 8)
Stockholders' equity (Notes 4, 9 and 13):
Series A Convertible Preferred Stock, $2 par value, 1,200,000
700,000 shares authorized,600,000 issued and outstanding,
Series B Convertible Preferred Stock, $2 par value, 700,000
350,000 shares authorized, issued and outstanding,
Series C Convertible Preferred Stock, no par value, 120,000
120 shares authorized, issued and outstanding
Series D Convertible Preferred Stock, 2,500 shares authorized,
none issued and outstanding -
Common Stock, no par value, shares authorized 17,729,478
50,000,000; 14,365,600 issued and outstanding,
Accumulated deficit (10,351,358)
Less: Stock subscription receivable (2,400,000)
- --------------------------------------------------------------------------------------
Total stockholders equity 6,998,120.
- --------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $16,489,212.
- --------------------------------------------------------------------------------------
</TABLE>
See accompanying summary of accounting policies and
notes to consolidated financial statements.
F-4
<PAGE>
JRECK Subs Group, Inc.
Consolidated Statement of Operations
- ------------------------------------- ------------------------------------------
Year Ended December 31, 1997
- -------------------------------------------------------------------------------
Revenues:
Retail sales: $1,310,205
Franchise revenues: 1,265,254
- -------------------------------------------------------------------------------
2,575,459
- -------------------------------------------------------------------------------
Operating costs and expenses:
Cost of sales: 552,940;
Operating expenses: 3,758,657
Consulting and investor relations: 4,492,664;
Goodwill writedown (Note 4): 993,820,
- -------------------------------------------------------------------------------
9,798,081
- -------------------------------------------------------------------------------
Operating loss (7,222,622)
- -------------------------------------------------------------------------------
Other income (expense):
Interest, net: (484,769);
Other: 55,733
- -------------------------------------------------------------------------------
Loss before income taxes and extraordinary item: (7,651,658)
Income tax expense (Note 10): (389,957)
- -------------------------------------------------------------------------------
Loss before extraordinary item: (8,041,615)
Extraordinary loss - early extinguishment of debt (Note 13): (862,029)
Net loss: (8,041,615)
Preferred Stock dividends: (57,506)
- -------------------------------------------------------------------------------
Net loss applicable to common stock: $(8,961,150)
- -------------------------------------------------------------------------------
Weighted average number of common shares outstanding: 11,040,600
- -------------------------------------------------------------------------------
Net loss per common share - basic and diluted:
Loss before extraordinary item: $ (.73)
Extraordinary item: (.08)
- -------------------------------------------------------------------------------
Net loss per common share: (.81)
- -------------------------------------------------------------------------------
See accompanying summary of accounting policies and
notes to consolidated financial statements.
F-5
<PAGE>
<TABLE>
<CAPTION>
JRECK Subs Group, Inc.
Consolidated Statement of Stockholders' Equity
- ---------------------------------------- -----------------------------------------------------------------------
Common Preferred Class A Preferred Class B Preferred Class C
Shares Amount Shares Amount Shares Amount Shares Amount
- ----------------------- ----------- ------------ ---------- ----------- -------- ----------- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance,
January 1, 1997 8,781,000 $ 700,000 $ 350,00 $ 700,000 - $
- 1,400,000 -
Conversion of
preferred Class
A to common
stock 100,000 200,000 (100,000) (200,000) - - - -
Common stock issued
for acquisitions 2,045,761 6,531,339 - - - - 120 120,000
Options issued in
connection with
acquisitions - 508,000 - - - - - -
Stock issued
for equipment 230,000 424,003 - - - - - -
Conversion of
debt to equity 445,000 1,307,029 - - - - - -
Stock issued for
payment of interest 50,000 146,857 - - - - - -
Other stock sales 1,077,213 1,055,500 - - - - - -
Stock sold for
subscription
notes receivable 800,000 2,400,000 - - - - - -
Stock issued for
services 229,360 805,048 - - - - - -
Exercise of options 360,000 255,000 - - - - - -
Issuance of options
and warrants for
services - 3,301,302 - - - - - -
Stock and options
issued in connection
with debt 60,000 795,400 - - - - - -
Preferred stock
dividend - - - - - - - -
Net loss - - - - - - - -
- ----------------------- ----------- ------------ ---------- ----------- -------- ----------- -------- ----------
Balance,
December 31, 1997 14,178,334 $17,729,478 600,000 $1,200,000 350,000 $ 700,000 120 $ 120,000
- --------------------------------------------- ----------- ------------ ---------- ----------- -------- ---------
Subscrip-
tion Accumulated Total
Notes Deficit Equity
------------ ------------- -----------
<S> <C> <C> <C>
Balance,
January 1, 1997 $ $ $ 709,792
- (1,390,208)
Conversion of
preferred Class
A to common
stock - - -
Common stock issued
for acquisitions - - 6,651,339
Options issued in
connection with
acquisitions - - 508,000
Stock issued
for equipment - - 424,003
Conversion of
debt to equity - - 1,307,029
Stock issued for
payment of interest - - 146,857
Other stock sales - - 1,055,500
Stock sold for
subscription
notes receivable (2,400,000) - -
Stock issued for
services - - 805,048
Exercise of options - - 255,000
Issuance of options
and warrants for
services - - 3,301,302
Stock and options
issued in connection
with debt - - 795,400
Preferred stock
dividend - (57,506) (57,506)
Net loss - (8,903,644) (8,903,644)
- ----------------------- ------------ ------------- -----------
Balance,
December 31, 1997 $(2,400,000)$(10,351,358) $ 6,998,120
----------- ------------ -----------
</TABLE>
See accompanying summary of accounting policies
and notes to consolidated financial statements.
F-6
<PAGE>
<TABLE>
<CAPTION>
JRECK Subs Group, Inc.
Consolidated Statement of Cash Flows
- ------------------------------------- -----------------------------------------------------------------------------------
Year ended December 31, 1997
- ----------------------------------------------------------------------------------------------- -------------------------
Cash flows from operating activities:
<S> <C>
Net loss: $ (8,903,644)
Adjustments to reconcile net loss to net cash used:
Amortization and depreciation: 506,742
Writedown and goodwill: 993,820
Bad debts: 166,831
Gain on disposal of equipment: (2,365)
Stock issued for interest expense: 146,857
Stock and stock options issued as consideration for consulting and investor relations 4,038,249
expense:
Extraordinary loss resulting from issuance of stock on retirement of debt: 862,029:
Charge off of offering costs and deferred loan costs 67,267
Other: (36,595)
Changes in assets and liabilities, net of assets and liabilities acquired:
Increase in accounts receivable: (48,274)
Increase in prepaid expenses: (21,774)
Decrease in deferred tax asset: 387,846
Increase in accounts payable: 366,879
Increase in accrued liabilities: 204,494
- ----------------------------------------------------------------------------------------------- -------------------------
Net cash used in operating activities: (1,273,638)
- ----------------------------------------------------------------------------------------------- -------------------------
Cash flows from investing activities:
Purchase of property and equipment: (49,726)
Net cash paid in connection with acquisitions: (408,417)
Note receivable considered worthless: 104,141
Advances made on notes receivable: (246,497)
Payments from notes receivable: 86,982
- ----------------------------------------------------------------------------------------------- -------------------------
Net cash used in investing activities: (513,517)
- ----------------------------------------------------------------------------------------------- -------------------------
Cash flows from financing activities:
Proceeds from the sale of common stock: 1,055,500
Proceeds from exercise of stock options: 255,000
Proceeds from long-term debt: 840,758
Payments on long-term debt: (652,096)
Proceeds from related party notes payable: 792,748
Payments on related party notes payable: (124,703)
- ----------------------------------------------------------------------------------------------- -------------------------
Net cash provided by financing activities: 2,167,207
- ----------------------------------------------------------------------------------------------- -------------------------
Net increase in cash and cash equivalents: 380,052
- ----------------------------------------------------------------------------------------------- -------------------------
Cash and cash equivalents, beginning of year: 47,368
- ----------------------------------------------------------------------------------------------- -------------------------
Cash and cash equivalents, end of year: $ 427,420
=============================================================================================== =========================
</TABLE>
See accompanying summary of accounting policies and
notes to consolidated financial statements.
F-7
<PAGE>
JRECK Subs Group, Inc.
Summary of Accounting Policies
- ------------------------------------- ------------------------------------------
Principles of The consolidated financial statements include the
Consolidation accounts of JRECK Subs Group, Inc. and its
wholly-owned subsidiaries ("the Company"). All
significant intercompany accounts and transactions
have been eliminated in consolidation.
Use of Estimates The preparation of financial statement in conformity
with generally accepted accounting principles
requires management to make estimates and assumptions
that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and
liabilities at the date of the financial statement
and the reported amounts of revenues and expenses
during the reporting period. Actual results could
differ from the estimates.
Cash and Cash For financial presentation purposes, the Company
Equivalents considers those short-term highly liquid investments
with original maturities of three months or less to
be cash and cash equivalents.
Property Property and equipment are stated at cost.
and Equipment Depreciation expense is provided using the straight-
line method for financial statement purposes and
accelerated methods for federal income tax purposes
over the estimated useful lives of the various
assets, generally 5 to 40 years.
Intangible Assets Goodwill
Goodwill represents the excess of cost over the fair
value of net assets acquired and is being amortized
on a straight-line method over 20 years. The
realizability of goodwill is evaluated periodically
for impairment events or if changes in circumstances
indicate a possible inability to recover the carrying
amount. When any such impairment exists, the related
assets are written down to fair value.
Covenants Not to Compete
Covenants not to compete are amortized straight-line
over the estimated useful lives, ranging from three
to six years.
F-8
<PAGE>
JRECK Subs Group, Inc.
Summary of Accounting Policies
- ------------------------------------- ------------------------------------------
Revenue Recognition Continuing franchise fee revenue is
recognized as earned. Franchise fee revenue from an
individual franchise sale is recognized when all
material services or conditions relating to the sale
have been substantially performed. Revenues from
company-owned stores are recognized when received.
Stock-Based Stock-based compensation is accounted for by using
Compensation the intrinsic value based method in accordance with
Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB
25"). The company has adopted Statements of Financial
Accounting Standards No. 123, "Accounting for
Stock-Based Compensation," ("SFAS No. 123") which
allows companies to either continue to account for
stock-based compensation to employees, or to adopt a
fair value based method of accounting. The Company
has continued with its current method of accounting
in accordance with APB 25 for employees, but has made
the required pro forma disclosures in accordance with
SFAS No. 123.
Fair Value of Financial Statement of Financial Accounting Standards No. 107,
Instruments "Disclosures about Fair Value of Financial
Instruments," requires disclosure of fair value
information about financial instruments. Fair value
estimates discussed herein are based upon certain
market assumptions and pertinent information
available to management as of December 31, 1997.
The respective carrying value of certain
on-balance-sheet financial instruments approximated
their fair values. These financial instruments
include cash and equivalents, trade receivables,
accounts payable and accrued expenses. Fair values
were assumed to approximated carrying values for
these financial instruments since they are short term
in nature and their carrying amounts approximate fair
values or they are receivable or payable on demand.
The fair value of the Company's notes payable is
estimated based upon the quoted market prices for the
same or similar issues or on the current rates
offered to the Company for debt of the same remaining
maturities. The carrying value approximates the fair
value of the notes payable.
F-9
<PAGE>
JRECK Subs Group, Inc.
Summary of Accounting Policies
- ------------------------------------- ------------------------------------------
Net Loss Per Effective December 31, 1997, the company has adopted
Common Share 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. Contingently issuable shares
under the applicable acquisition agreements (see Note
4) 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. Diluted earnings per share are computed
similarly to fully diluted earnings per share. The
Company's calculation for basic and diluted earnings
per share is the same as the Company has a loss, and
the impact of potential common shares is
antidilutive. Basic earnings per share includes
700,000 shares from the liability to issue common
stock. Potential common shares include 1,996,000
stock options, 1,250,000 warrants and 965,986 shares
underlying the convertible preferred stock. The
maximum number of contingent shares to be issued is
750,000, none of which would be issuable under the
terms of the acquisition agreements if the end of the
contingency period were the end of the reporting
period. All loss per share amounts for all periods
presented have been restated to conform to the
requirements of SFAS No. 128.
Income Taxes The Company accounts for income taxes in accordance
with Statement of Financial Accounting Standards No.
109, "Accounting for Income Taxes," which requires
recognition of estimated income taxes payable or
refundable on income tax returns for the current year
and for the estimated future tax effect attributable
to temporary difference and carryforwards.
Measurement of deferred income tax is based on
enacted income tax assets being reduced by available
tax benefits not expected to be realized.
Impairment of The Company adopted Statement of Financial Accounting
Long-Lived Assets Standards No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to be
Disposed Of," (SFAS No. 121") during 1997. SFAS No.
121 requires impairment losses to be recorded on
long-lived assets used in operations and goodwill
when indicators of impairment are present and the
undiscounted cash flows estimated to be generated by
those assets are less than the assets' carrying
amount.
F-10
<PAGE>
JRECK Subs Group, Inc.
Summary of Accounting Policies
- ------------------------------------- ------------------------------------------
Recent Accounting In June 1997, the Financial Accounting Standards
Pronouncements Board issued Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income"
("SFAS No. 130"), and No. 131, "Disclosure about
Segments of an Enterprise and Related Information"
("SFAS No. 131"). SFAS 130 establishes standards for
reporting and displaying comprehensive income, its
components and accumulated balances. SFAS 131
establishes standards for the way that public
companies report information about operating segments
in annual financial statements and requires reporting
of selected information about operating segments in
interim financial statements issued to the public.
Both SFAS 130 and SFAS 131 are effective for periods
beginning after December 15, 1997. The Company has
not determined the impact that the adoption of these
new accounting standards will have on its future
financial statements and disclosures.
In June 1998, the Financial Accounting Standards
Board issued SFAS 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133").
SFAS 133 requires companies to recognize all
derivatives contracts as either assets or liabilities
in the balance sheet and to measure them at fair
value. If certain conditions are met, a derivative
may be specifically designated as a hedge, the
objective of which is to match the timing of gain or
loss recognition on the hedging derivative with the
recognition of (i) the changes in the fair value of
the hedged asset or liability that are attributable
to the hedged risk or (ii) the earnings effect of the
hedged forecasted transaction. For a derivative not
designated as a hedging instrument, the fair or loss
is recognized in income in the period of change. SFAS
133 is effective for all fiscal quarters or fiscal
years beginning after June 15, 1999.
Historically, the Company has not entered into
derivatives contracts to hedge existing risks or for
speculative purposes. Accordingly, the Company does
not expect adoption of the new standard on January 1,
2000 to affect its financial statements.
F-11
<PAGE>
JRECK Subs Group, Inc.
Summary of Accounting Policies
- ------------------------------------- ------------------------------------------
Risk and The primary uncertainty which the Company faces
Uncertainties is its ability to locate knowledgeable franchises
who also have the financial resources to successfully
operate the stores. In addition, the Company needs to
be able to identify appropriate locations for its new
franchised stores. The company believes that it has
taken the steps necessary to minimize these risks.
F-12
<PAGE>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
1. Nature of Organization JRECK Subs Group, Inc., f/k/a/ Circa Media, Inc.,
(the "Company") was organized on July 19, 1995. On
May 7, 1996, the company acquired 100% of JRECK
Subs, Inc., a multi-concept franchisor of sandwich
shops in the state of New York. For financial
reporting purposes, the acquisition was accounted
for as a reverse merger, whereby JRECK Subs, Inc.
was deemed to be the acquiring entity. During 1997,
the Company acquired various other franchisor
companies located in various geographic locations
throughout the United States (see Note 4). The
company's headquarters are located in Longwood,
Florida. The various franchise agreements are for
terms ranging from 10 to 15 years and contain
various renewal options.
Currently, the company serves as the franchisor to
approximately 288 stores operating under various
trade names. Franchise arrangements include a
license to operate under the applicable trade name
and generally provide for the receipt of initial
fees, as well as continuing service fees and
royalties based upon a percentage of sales. In
addition, the Company offers guidance and assistance
to the franchisees in areas such as product
preparation, equipment purchasing, marketing,
administrative support and employee training. In
addition, the company owns and operates
approximately 11 of the franchised stores.
2. Prepaid Expenses Prepaid expenses are comprised of the following at
December 31, 1997:
-----------------------------------------------
Prepaid consulting fee: $ 618,056
Other: 112,755
-----------------------------------------------
$ 730,811
-----------------------------------------------
F-13
<PAGE>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
3. Property and Property and equipment are summarized as follows:
Equipment
1997
-----------------------------------------------
Land and building: $ 370,000
Machinery and equipment: 1,707,064
Office and computer equipment: 64,744
Vehicles: 82,135
Leasehold improvements: 41,457
-----------------------------------------------
2,265,400
Less accumulated depreciation: (334,410)
-----------------------------------------------
Net property and equipment: $1,930,990
-----------------------------------------------
4. Acquisitions During the year, the Company acquired seven entities
through the purchase of assets or stock. The
acquisition have been accounted for using the
purchase method of accounting, and the results of the
acquired businesses have been included in the
consolidated financial statements since the date of
acquisition. The excess of the purchase price over
the fair values of the net assets acquired was
$13,061,710 and has been recorded as goodwill, which
is being amortized on a straight-line basis over 20
years based on the expected future undiscounted
operating cash flows of the related businesses
acquired.
Chai Enterprises, Inc
On June 19, 1997, the company, through its
wholly-owned subsidiary, Leovera, Inc., acquired all
of the bakery equipment of Chai Enterprises, Inc.
("Chai"). Chai is the franchisor of the Hymie's bagel
restaurant chain located in Tampa, Florida. The
purchase price of the Chai assets consisted of
289,500 shares of the Company's Common Stock, valued
at $4.598 per share ($1,331,156) and $200,000 cash.
The transaction was recorded as follows:
F-14
<PAGE>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
-----------------------------------------------------
Total consideration paid $1,531,156
Less, fair value of assets acquired (537,336)
-----------------------------------------------------
Excess cost of net assets acquired $ 993,830
-----------------------------------------------------
Seawest Sub Shops, Inc.
On June 30, 1997, the Company acquired all of the
outstanding shares of Seawest Sub Shops, Inc.
("Seawest"). Seawest is the franchisor of sandwich
restaurants in Seattle, Washington. The purchase
price of Seawest was $150,000 cash. In addition, the
Company entered into a noncompete agreement with the
former shareholder valued at $502,000. Consideration
for the agreement consisted of a $96,000 note payable
and stock options valued at $4.06 per share
($406,000).
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. These options are
exercisable at $.001 per share during an 18-month
period between December 1997 and May 1999. Upon
requests of the prior owner of Seawest, the Company
is obligated to repurchase any exercised shares at
the greater of fair market value of $3.25 per share
over a mutually agreeable period of time which has
not been determined. Subsequent to year end, 25,000
options were exercised.
F-15
<PAGE>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
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.
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 is obligated to reimburse the prior
owners of Richey if the fair market value of the
Company's Common Stock falls below 80% of its value
on the original closing date. This contingency takes
effect only if the prior owners of Richey transfer
their shares to a third party during the first 30
days following the anniversary date of the closing.
F-16
<PAGE>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
Little King, Inc.
On August 31, 1997, the Company purchased the
outstanding share of Little King, Inc., a franchisor
of sandwich restaurants in Omaha, Nebraska. In
addition to the purchase of the Little King shares,
the Company purchased certain assets and assumed
certain liabilities from a separate entity related by
common ownership to the previous Little King Owners.
These assets and liabilities represent company-owned
stores. In addition, the Company entered into a
noncompete agreement with the former shareholder
valued at $100,000.
The purchase price of Little King and the
company-owned stores was $3,825,000 as follows:
-----------------------------------------------------
500,000 shares of Company Common Stock 1,531,250
700,000 shares of Company Common Stock
(to be issued within 12 months) 2,143,750
Cash paid 50,000
Note payable 100,000
-----------------------------------------------------
Total acquisition price $3,825,000
-----------------------------------------------------
The 1,200,000 shares of Company Common Stock were
valued at $3.0625 per share.
The transaction was recorded as follows:
-----------------------------------------------------
Total consideration paid $3,825,000
Less, fair value of assets acquired (475,470)
Liabilities assumed 1,230,675
-----------------------------------------------------
Excess cost of net assets acquired $4,580,205
-----------------------------------------------------
Total consideration paid is subject to periodic
adjustment based
F-17
<PAGE>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
on the difference between the market value of the
700,000 shares of the Company's stock at date of
acquisition until such time as the shares are issued.
At December 31, 1997, goodwill and the liability to
issue common stock decreased by $350,000 due to a
decline in market value of the Company's stock. The
obligation to issue the additional 700,000 shares is
included in the "Liability to issue common stock" on
the accompanying consolidated balance sheet.
In addition to the consideration shown above, the
Company is contingently liable to the previous owners
of Little King for up to 100,000 shares of Company
Common Stock. The issuance of these shares is
contingent upon Little King achieving $900,000 in
continuing franchise fees or selling $400,000 of
initial franchise fees during 1998. No provision has
been provided for this contingency in the
accompanying consolidated financial statements.
In addition, the Company must provided the prior
owners of Little King the opportunity to repurchase
Little King, based on a fair market value, as
defined, if the quoted closing market price of
Company Common Stock is less than $1.50 per share on
the second anniversary of the closing of the
acquisition.
F-18
<PAGE>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
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 $2,643,653
Liability to issue common stock 440,625
Company Series "C" Preferred Stock,
120 shares 120,000
Options for 32,204 shares of Company
Common Stock 23,000
----------------------------------------------------
Total acquisition price $3,227,278
----------------------------------------------------
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 is contingently liable to the previous
owners of QFS for up to 650,000 shares of Company
Common Stock as a result of the following
arrangements:
F-19
<PAGE>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
(1) A payment of up to an additional 500,000 shares
based on the 1998 earnings of the Mountain
Mike's division, as defined. Since this
contingency is based on an uncertain future
event, no purchase price adjustment was made in
the accompanying financial statements.
(2) The contingency for the remaining 150,000
shares was based on the market price
performance of the Company's Common Stock for
the period of October 1, 1997 through January
31, 1998. Since the Company's stock did not
meet the required price levels, a purchase
price adjustment of $440,625 was made based on
the fair market value of the Company's stock at
the date of acquisition. In March 1998, the
Company issued these shares in satisfaction of
the obligation of this obligation.
Pastry Product Producers, LLC
On October 28, 1997, the Company acquired the
remaining 50% interest of Pastry Product Producers,
LLC ("Pastry"). Pastry is a bakery operation which
primarily serves the JRECK restaurant franchisees. In
1996, the Company purchased a 50% investment in
Pastry and accounted for it under the equity method.
The balance sheet of Pastry as of December 31, 1997
and its results of operation for the period between
the acquisition date of the remaining 50% ownership
and year end has been consolidated in the
accompanying financial statements. The Company's
share of operations prior to the acquisition have
been treated as a loss on equity investment and
classified as such in the statement of operations.
F-20
<PAGE>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
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, 262,5000 shares $658,594
Options for 37,500 shares of Company
Common Stock: 79,000
Other 48,000
-----------------------------------------------------
Total acquisition price of remaining
50% share $785,594
-----------------------------------------------------
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
-----------------------------------------------------
F-21
<PAGE>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
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 SBK 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 9,963
----------------------------------------------------
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.
F-22
<PAGE>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
Pro Forma Financial Information (Unaudited)
The following summarized unaudited pro forma
consolidated results of operation have been prepared
as if the preceding acquisitions occurred at the
beginning of 1997 and includes pro forma adjustments
for interest, depreciation amortization:
<TABLE>
<CAPTION>
-------------------------------------------------------- --------------------
<S> <C>
Revenue $ 5,929,447
Net loss before extraordinary item $ (9,066,438)
Loss from extraordinary item, net of taxes $ (862,029)
-------------------------------------------------------- --------------------
Net loss $ (9,928,467)
EPS - Basic and diluted:
Net loss before extraordinary item $ (.69)
Net loss from extraordinary item, net of taxes $ (.07)
-------------------------------------------------------- --------------------
Net loss $ (.76)
-------------------------------------------------------- --------------------
Weighted average number of common shares outstanding
$ 13,084,817
=============================================================================
</TABLE>
The pro forma consolidated results do not purport to
be indicative of results that would have occurred had
the acquisitions been in effect for the periods
presented, nor do they purport to be indicative of
the results that will be obtained in the future.
At December 31, 1997, the Company recognized a
goodwill impairment charge of $993,820 related to the
acquisition of Chai Enterprises. In determining the
amount of the impairment charge, the Company
developed its best estimate of the future operating
cash flows attributable to the assets purchased. In
the fourth quarter, the Company concluded that based
on current market
F-23
<PAGE>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
conditions, including the reduction in the number of
franchises, the anticipated future cash flows
indicated the recoverability of the goodwill was not
reasonably assured.
5. Accrued Accrued liabilities are comprised of the following
Liability at December 31, 1997:
-----------------------------------------------------
Accrued consulting fees $ 550,000
Deferred revenue 212,000
Accrued payroll and reltated 122,962
Other 311,168
-----------------------------------------------------
$ 1,196,130
-----------------------------------------------------
F-24
<PAGE>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
6. Notes Payable to Notes payable to related parties consist of the
Related Parties following:
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------
<S> <C>
Notes payable to stockholder bearing interest at 9%
monthly interest-only payments through January 1999,
then monthly payments of $3,121, including principal
and interest through its maturity in December 2008.
The notes are unsecured. $ 323,032 Note payable to
stockholder, unsecured, bearing interest at 8%
payable in monthly interest-only payments until
December 1998, at which time all remaining unpaid
interest plus principal is due. 334,785
Note payable to stockholder bearing interest at 10%
principal and accrued interest due upon demand. This
note is unsecured. 100,000
---------------------------------------------------------------------------------
Total related party notes payable 757,817
Less current portion (434,785)
---------------------------------------------------------------------------------
Long-term portion of related party notes payable $ 323,032
=================================================================================
</TABLE>
Interest expense on the above related party debt
totaled $38,854 during 1997
F-25
<PAGE>
<TABLE>
<CAPTION>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
7. Long Term Debt Long term debt consists of the following:
<S> <C>
Year ended December 31, 1997
- --------------------------------------- ---------------------------------------------------------------------------------
Various uncollateralized notes payable, bearing interest at rates between 8% and 12% per annum, $ 553,642
maturing between March 1998 and February 2002
Convertible notes payable bearing interest at 12.75% per annum, interest payable quarterly and 530,000
principal due March 2000, collateralized by revenues generated from franchise agreements,
convertible into Common Stock at $10.86 per share.
Note payable to former owner of acquired subsidiary bearing interest at 7% per annum, interest 500,000
payable monthly and principal due in full in December 1998, collateralized by all royalty
revenues generated by SBK, Inc.
Uncollateralized non-interest bearing debt assumed in acquisition of Seawest,
348,000 principal payable monthly in amounts of $4,000 until paid in full.
Commercial paper, bearing interest at 10.5% per annum, interest and principal due September 283,630
1998, notes are uncollateralized.
FDIC promissory notes bearing interest at 10% per annum, accrued interest and principal due on 257,584
demand, notes are uncollateralized.
Uncollateralized notes payable, bearing interest at 15% per annum, interest payable monthly and 180,000
notes mature November 2004.
Uncollateralized note payable, net of unamortized original issue discount of 176,800
$73,200, bearing interest at 15% per annum, interest payable monthly
with principal due in March 1998.
Uncollateralized note payable, bearing interest at 10% per annum, payable in weekly principal 155,523
and interest payments of $1,750 until April 17, 1998, in which a balloon payment of $139,408 is
due. The Company is in the process of negotiating a modification of the terms of the debt.
Uncollateralized note payable, bearing interest at 10% per annum, payable in monthly interest 150,000
and principal payments of $2,494 through November 2004.
Bank note payable, bearing interest at 10.75% per annum, principal monthly in the amount of 138,435
$500 plus accrued interest, collateralized by equipment.
F-26
<PAGE>
<CAPTION>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------------------------------------------------------
<S> <C>
Bank note payable, bearing interest at 6.5% per annum, interest payable monthly 135,000
with principal balance due April 1998, guaranteed by prior owner of Little
Kings.
Bank note payable, bearing interest at 10.5% per annum, interest and principal 124,111
payable monthly in the amount of $1,750 through February 2002 with a balloon
payment of $107,444 due March 2002, collateralized by certain accounts
receivable, inventory and fixed assets.
- ------------------------------------------------------------------------------------------------- -----------------------
3,782,669 Less current portion (2,163,554)
- ------------------------------------------------------------------------------------------------- -----------------------
Total long-term debt $ 1,619,115
================================================================================================= =======================
</TABLE>
Interest expense on long-term debt during 1997 amounted to $174,648
The annual maturities of long-term debt and related party debt for the five
years subsequent to year end are as follows:
Long- Related
Term Party
Debt Debt Total
- ----------------------- ----------------- ---------------- ----------------
1998 2,163,554 $ 434,785 $2,598,339
1999 192,683 39,636 232,319
2000 709,865 39,636 749,501
2001 216,533 39,636 256,169
2002 75,890 39,636 115,526
Thereafter 424,144 164,488 588,632
- ----------------------- ----------------- ---------------- ----------------
$3,782,669 $ 757,817 $4,540,486
- ----------------------- ----------------- ---------------- ----------------
F-27
<PAGE>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
8. Commitments and The Company leases office and store space under
Contingencies certain operating leases which expire through 2008.
Certain of these leases have been entered into with a
related party of the Company. Total rent expenses for
the year ended December 31, 1997 was $222,305, of
which $114,740 was allocable to the related party.
Future annual minimum lease payments due under these
operating leases at December 31, 1997 are as follows:
Related Third
Party Party
Leases Leases Total
------------ ------------ ----------- ------------
1998 $ 344,220 $ 98,616 $ 442,836
1999 185,820 83,616 269,436
2000 167,820 83,616 251,436
2001 167,820 26,916 194,736
2002 139,020 26,916 165,936
Thereafter 498,480 80,748 579,228
------------ ------------ ----------- ------------
$ 1,503,180 $ 400,428 $ 1,903,608
------------ ------------ ----------- ------------
As mentioned in Note 4, certain of the acquisitions
consummated during 1997 contained provisions for
contingent payment of options or shares of Company
Common Stock. In addition to these contingencies, the
company was also contingently liable for certain
consulting and investor relation services to third
party advisors. The following summarizes the
arrangements in which the Company is contingently
liable for consulting and investor relation services.
In December 1997, the Company entered into an
arrangement in which it was to receive certain
advisory services on capital and earnings growth. As
partial payment for these services, the Company is
contingently obligated to provide warrants for up to
500,000 shares of Company Common Stock in the event
the Company either raises $10,000,000 or achieves a
total store level of 630 units within three years.
The fair market value of these options at date of
issuance was
F-28
<PAGE>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
recorded as prepaid consulting expense of $512,500 as
management believes the Company will achieve the
630-store level through acquisitions.
During the year, the Company entered into an
agreement to have certain publishing services
performed. The consideration for these services
includes an obligation for the cash payment of
$550,000 and options to purchase up to 300,000 shares
of Company Common Stock at exercise prices ranging
from $2.81 to $3.93 per share. The fair value of the
options granted plus the $550,000 were recorded as a
consulting expense.
Franchise Agreements
Under the terms of the various franchise agreements,
the franchises are obligated for the payment of the
following fees to the Company:
Franchise Fees
In accordance with the terms of the franchise
agreements, the Company receives an initial
franchise fee of $5,000 to $25,000.
Royalties
The Company receives royalties ranging from 3% to
5% of gross sales from the franchisees' operations
of the restaurants.
Advertising Fund
The franchise agreements require the franchisees
to contribute to an advertising fund based upon 2%
to 4% of gross sales. The funds are maintained in
separate bank accounts, and their use is
restricted solely for advertising, marketing, and
public relations programs and materials to develop
the goodwill and public image of each of the
respective franchises.
F-29
<PAGE>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
9. Stockholders' The following is a synopsis of significant Equity transactions
involving Company Common and Preferred Stock.
(a) In 1996, the Company designated and issued
700,000 shares of Series A voting nonredeemable
cumulative convertible preferred stock. The
preferred stock is entitled to cumulative,
preferential dividends at a rate of $.09 per
share and is convertible into common stock at a
conversion rate of one share of common stock for
each preferred share. The stock is redeemable in
liquidation at $2.00 per share. During 1997, the
holders of Series A preferred stock converted
100,000 shares into 100,000 shares of common
stock.
(b) In 1996, the Company designated and issued
350,000 shares of Series B voting nonredeemable
convertible preferred stock. The Series B
preferred stock is entitles to receive
noncumulative preferential dividends only when
and as declared by the Board of Directors and is
convertible into common stock at a conversion
rate of one share of common stock for each
preferred share. The stock is redeemable in
liquidation at $2.00 per share.
(c) In September 1997, the Company designated and
issued 120 shares of no par value Series C
convertible preferred stock in connection with
the acquisition of Quality Franchise Systems,
Inc. The Series C preferred stock is entitled to
cumulative dividends at a rate of $32.50 per
share per quarter and is convertible into common
stock ar a rate of 133.22 shares of common stock
for each preferred share with a face amount of
$1,000. The stock is redeemable at the option of
the Company or in liquidation at a rate of
$1,000 per share.
(d) In December 1997, the company designated 2,500
shares of Series D convertible preferred stock.
The Series D preferred stock is entitled to
cumulative dividends at a rate of 8% of the face
value per year and is convertible into common
stock at a rate of 65% of the average market
price of the common stock for five days
immediately prior to the conversion date. The
stock is redeemable in liquidation at a rate of
$1,300 per share.
F-30
<PAGE>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
As mentioned in Note 12 these shares were part
of a private placement offering which occurred
in January 1998.
(e) During 1997, the Company acquired equipment
valued at $424,003 in exchange for 230,000
restricted shares of common stock.
(f) As described further in Note 13, the Company
issued 495,000 shares of its restricted shares
of common stock.
(g) During 1997, the Company sold to accredited
investors a total of 1,077,213 shares of the
Company's freely-traded common stock at purchase
prices ranging from $.53 to $2.25 per share in
private transactions exempt from registration
under applicable Federal securities laws. The
Company collected proceeds of $1,055,500 in
connection with these transactions. No offering
costs were incurred as part of the transactions.
(h) As mentioned in Note 13, the Company sold
to an officer and a consultant 800,000 shares of
restricted common stock for $3.00 per share
(fair value) in exchange for subscription notes
in the amount of $2,400,000. The subscription
notes bear interest at 9.5% per annum and are
due on or before September 2000. The officer and
the consultant also retain the right to require
the Company to repurchase the shares in exchange
for cancellation of the notes throughout the
three year note terms.
(i) During the year ended December 31, 1997, the
company issued 229,360 shares of restricted
common stock, options to purchase 1,025,000
shares of common stock at exercise prices
ranging from $.75 to #3.93, and warrants to
purchase 1,250,000 shares of common stock at
exercise prices ranging from $1.92 to $3.84 in
connection with the compensation of certain
consultants. The weighted average fair value of
the warrants is $1.51. The total expense
recorded in connection with the transactions
amounted to $805,048 for the common stock based
upon the market value at the date of issuance
and $3,301,302 for the options and warrants
based upon the market value at the date of
grant.
F-31
<PAGE>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
(j) During May 1997, the company borrowed $180,000
from three unrelated individuals and granted
these individuals options to purchase 180,000
shares of common stock at $.50 per share as
additional compensation for the loans. The stock
options were valued at $649,000 which
represented the market value at the date of
grant. This amount was recorded as prepaid
interest and is being amortized as interest
expense over seven years based on the life of
the loans.
During November 1997, the Company borrowed
$250,000 from an unrelated company and granted
60,000 shares of restricted common stock. The
common stock was valued at $146,400 based upon
the market value at the date of issuance and was
recorded as an original issue discount to be
accredited over the life of the loan.
(k) During 1997, two consultants and a lender
exercised their options in exchange for 360,000
shares of Company Common Stock. In connection
with these transactions the Company received
cash proceeds of $225,000.
(l) In December 1997, the Board of Directors voted
to retire all outstanding shares of treasury
stock. As a result of retiring the treasury
stock, the Company reclassified the outstanding
$1,600,000 balance to common stock.
The Company applies APB Opinion 25, "Accounting for
Stock Issued to Employees," and related
interpretations in accounting for options issued to
employees. Accordingly, no compensation cost has been
recognized for options granted to employees at
exercise prices which equal or exceed the market
price of the company's common stock at the date of
grant. Options granted at exercise prices below
market prices are recognized as compensation cost
measured as the difference between market price and
exercise price at the date of grant.
F-32
<PAGE>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
SFAS No. 123 "Accounting for Stock-Based
Compensation." requires the Company to provide pro
forma information regarding net income and earnings
per share as if compensation cost for the Company's
employee stock options had been determined in
accordance with the fair value based method
prescribed in SFAS 123. The company estimates the
fair value of each stock option at the grant date by
using the Black-Scholes option-pricing model with the
following weighted-average assumptions used for
grants in 1997; no dividend yield; an expected life
of five years; expected volatility of 64% and
risk-free interest rate of 6.0%.
Under the accounting provisions of SFAS 123, the
Company's net loss and loss per share would have been
reduced to the pro forma amounts indicated below:
1997
-----------------------------------------------------
Net loss
As reported $ (8,903,644)
Pro forma $(10,058,644)
Loss per share - basic and diluted
As Reported $ (.81)
Pro forma $ (.91)
-----------------------------------------------------
F-33
<PAGE>
<TABLE>
<CAPTION>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
A summary of the status of employee and nonemployee
options as of December 31, 1997 and changes during
the year ended on those dates are presented below:
1997
------------------------------
Weighted
Average
Exercise
Shares Price
-------------------------------------------------- ----------------- ------------
<S> <C> <C>
Balance at beginning of year - $ -
Granted 2,374,704 2.11
Less, options exercised during year 360,000 .71
Less, options expired during year 18,704 3.08
-------------------------------------------------- ----------------- ------------
Balance at end of year 1,996,000 2.36
-------------------------------------------------- ----------------- ------------
Options exercisable at year end 1,966,000 $2.36
Weighted average fair value of options granted
during the year $1.62
The following table summarizes information about
options under the plan outstanding at December 31,
1997:
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------- -----------------------------------
Number Weighted-Average Number
Range of Outstanding Remaining Weighted-Average Exercisable Weighted-Average
Exercise Prices at Dec. 31, 1997 Contractual Life Exercise Price at Dec. 31, 1997 Exercise Price
- ---------------------------- ---------------- ------------------ -------------------- ---------------- ------------------
<C> <C> <C> <C> <C> <C>
$.001 to 1.22 482,500 6.6 $ .57 482,500 $ .57
$2.75 to 3.93 1,513,500 3.5 2.93 1,513,500 2.93
- ---------------------------- ---------------- ------------------ -------------------- ---------------- ------------------
1,996,000 3.5 $2.36 1,996,000 $2.36
- ---------------------------- ---------------- ------------------ -------------------- ---------------- ------------------
</TABLE>
10. Income Taxes The components of net deferred income taxes consist
of the following:
F-34
<PAGE>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
1997
-----------------------------------------------------
Deferred income tax assets
Net operating loss carryforwards $ 1,470,000
Stock and stock options issued for
services of debt 1,573,000
Other 50,000
-----------------------------------------------------
Gross deferred income tax assets 3,093,000
Valuation allowance 3,093,000
-----------------------------------------------------
Total deferred income tax assets $ -
-----------------------------------------------------
The effect of deferred income tax liabilities are
nominal and have been netted with deferred tax assets
for financial statement disclosure purposes.
Unused net operating losses for income tax purposes,
expiring in various amounts from 2007 through 2011,
of approximately $3,870,000 are available at December
31, 1997 for carry forward against future year'
taxable income. Under Section 382 of the Internal
Revenue Code, the annual utilization of this loss may
be limited due to changes in ownership. A valuation
allowance has been offset against the tax benefit of
these losses in 1997 due to it being more likely than
not that the deferred income tax assets will not be
realized.
Income tax expense represents the change in the
estimated recoverability of the deferred tax asset
11.Supplemental Cash Flow Certain supplemental disclosure of cash flow
Information information and noncash investing and financing
activities for the year ended December 31, 1997 is as
follows:
The components of net deferred income taxes consist
of the following:
F-35
<PAGE>
<TABLE>
<CAPTION>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ----------------------------------------------------------------------
1997
-------------------------------------------------------------- ------------------
<S> <C>
Cash paid for interest during 1997 $ 144,283
-------------------------------------------------------------- ------------------
Issuance of common stock in exchange for subscription 2,400,000
receivable:
Capitalized franchise agreements were written off
against 2,294,041 deferred revenue of the same
value:
Equipment classified as prepaid expense in 1996 was placed 9,500
in service in 1997 and reclassified to property and
equipment:
Equipment was purchased in exchange for common stock: 424,003
Stock and stock options issued in exchange for consulting 4,106,350
services:
Stock issued to pay down related party notes payable 1,307,029
($445,000) and record extraordinary loss ($862,029)
Stock and stock options issued in exchange for prepaid 795,400
interest ($649,000) and original issue discount ($146,400)
Conversion of Class A preferred to Common Stock: 200,000
Stock issued for payment of interest 146,857
Equipment valued at $47,635 was sold in exchange for note 50,000
receivable
-------------------------------------------------------------- ------------------
</TABLE>
In addition to the above non-cash items, the
following is a summary of non-cash transactions
entered into for the acquisitions listed in Note 4:
F-36
<PAGE>
<TABLE>
<CAPTION>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ----------------------------------------------------------------------
-------------------------------------------------------------- ------------------
<S> <C>
Common stock and stock options issued: $(7,539,339)
Preferred Stock issued: (120,000)
Issuance of related party notes payable (100,000)
Issuance of long-term debt: (596,000)
Original 50% equity investments in wholly-owned subsidiary: (729,679)
Current year gain on equity investment: (14,304)
Liability to issue common stock: (2,234,375)
Miscellaneous accrued (48,000)
-------------------------------------------------------------- ------------------
Total non-cash consideration paid: (11,381,697)
-------------------------------------------------------------- ------------------
Accounts receivable acquired: 353,459
Prepaid expenses acquired: 60,029
Notes receivable acquired: 121,248
Property, plant and equipment acquired: 1,644,402
Goodwill acquired: 12,711,710
Other intangible assets acquired: 636,097
-------------------------------------------------------------- ------------------
Total non-cash acquisition of assets: 15,526,945
-------------------------------------------------------------- ------------------
Accounts payable assumed: (643,821)
Accrued liabilities assumed: (389,500);
Long-term debt assumed: (2,268,739)
Related party notes payable assumed: (434,771)
-------------------------------------------------------------- ------------------
Total non-cash assumption of liabilities: (3,736,831)
-------------------------------------------------------------- ------------------
Net cash paid: $408,417
-------------------------------------------------------------- ------------------
</TABLE>
12. Subsequent Events (a) Private Placement
In January 1998, the Company completed a private
placement offering of Class D Convertible
Preferred Stock. An aggregate of 2,500 shares of
this issuance was sold for $2,500,000. The
proceeds from this offering were substantially
used to pay down existing long-term debt or to
satisfy other obligations.
F-37
<PAGE>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
(b) Debt Conversions
In February 1998, the Company converted $277,404
of related party notes payable to 155,475 shares
of Company Common Stock. These shares had a fair
market value of $382,470 on the date of
transfer.
(c) Acquisition
In March 1998, the Company acquired the assets
of a franchisor of sandwich restaurants located
in North Carolina. The acquisition price of this
new entity was approximately $2,400,000. To
satisfy the purchase price, the Company agreed
to issue $2,000,000 of Common Stock and assume
approximately $400,000 of debt. Upon completion
of the acquisition, the Company issued 735,294
shares of its Common Stock having a market value
of $2.72 per share.
(d) Series A and B Convertible Preferred Stock
On June 30, 1998, the holders of the shares of
Series A and B convertible preferred stock
converted the remaining outstanding shares into
950,000 shares of common stock.
13. Related Party Significant related party transactions and balances
Transactions not previously disclosed are as follows:
During the year, the Company's major shareholder
incurred debt of $445,000 which was advanced
directly to the Company. This debt was
collateralized by the Shareholder's freely
traded shares of Company Common Stock. The debt
of the stockholder was subsequently satisfied by
the Company through the issuance of 445,000
shares valued at $2.94 per share ($1,307,029) of
its own restricted Common Stock. These shares
were issued directly to the note holders in
return for the satisfaction of the original debt
of the Company's major shareholder. An
extraordinary loss on the early extinguishment
of debt in the amount of $862,029 was
F-38
<PAGE>
JRECK Subs Group, Inc.
Notes to Consolidated Financial Statements
- ------------------------------------- ------------------------------------------
recorded as a result of this transaction. In
addition, 50,000 shares valued at $2.94 per
share ($146,857) were issued, representing
additional interest expense in connection with
the retirement of debt.
The Company granted stock options for 1,800,000
shares of Common Stock to related parties during
1997. Options for 800,000 shares of Company
Common Stock were granted to the Chief Operating
Officer and a consultant. These options were
exercised with a note receivable for $2,400,000,
which was classified as a stock subscription
receivable at year end. The remaining options,
granted to the President and Chief Executive
Officer, are exercisable at $2.75 per share
until December 2000. The President has yet to
exercise any portion of these options.
F-39
<PAGE>
Cronin & Co.
Certified Public Accountants
12 Blandford Lane
Fairport, NY 14450
Board of Directors and Shareholders
Jreck Subs Group, Inc.
Watertown, New York
I have audited the accompanying consolidated balance sheet of Jreck Subs Group,
Inc. as of December 31, 1996 and 1995 and the related consolidated statements of
income, cash flows and stockholders' equity for the years then ended. The
financial statements are the responsibility of the directors. My responsibility
is to express an opinion on these financial statements based on my audit.
I conducted my audit in accordance with generally accepted auditing standards.
Those standards require that I plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles, used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
I believe that my audit provides a reasonable basis for my opinion.
In my opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Jreck Subs Group, Inc, as of
December 31, 1996 and 1995 and the results of its operations, its cash flows and
changes in stockholders' equity for the year then ended in conformity with
generally accepted accounting principles.
The December 31, 1994, and 1993 financial statements were audited by other
auditors, whose report dated November 2, 1995, stated that the balance sheet and
related statements of operations and cash flows as of and for the years then
ended, were presented fairly and in conformity with generally accepted
accounting principles applied on a consistent basis.
January 22, 1997
/s/ Michael F. Cronin
Cronin & Co.
Certified Public Accountants
F-40
<PAGE>
<TABLE>
<CAPTION>
JRECK SUBS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
December 31, 1996 December 31, 1995 December 31, 1994 December 31, 1993
----------------- ----------------- ----------------- -----------------
Current Assets:
<S> <C> <C> <C> <C>
Cash and Cash Equivalents $ 47,368 $ 5,643 $ 0 $ 0
Receivables:
Trade 146,665 55,620 48,644 121,601
Employees 0 0 6,447 2,322
Related Parties 0 0 7,164 5,279
Prepaid Expenses 25,666 22,135 0 0
----------------- ----------------- ----------------- -----------------
Total Current Assets 219,699 83,398 64,455 129,202
Investment in Unconsolidated Subsidiary
(Note A and I) 729,679 700,000 0 0
Property & Equipment, Net of Accumulated
Depreciation (Note A) 50,188 59,534 26,620 55,904
Other Assets (Note D) 2,812,314 435,636 496,670 583,105
Total Assets $ 3,811,880 $ 1,278,568 $ 589,745 $ 768,211
================= ================= ================= =================
LIABILITIES & STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts Payable $ 9,445 $ 2,303 $ 21,604 $ 33,790
Notes Payable (Note B) 736,012 711,205 587,476 605,124
Current Portion of Long Term Debt (Note C) 20,000 85,000 240,956 174,975
Other Current Liabilities (Note C-1) 6,135 100,000 463,630 336,106
----------------- ----------------- ----------------- -----------------
Total Current Liabilities 771,592 898,508 1,313,866 1,149,995
Long Term Debt (Note C) 46,456 257,459 1,424,733 1,503,495
Deferred Income (Note _) 2,294,041 0 0 0
Stockholders' Equity:
Common Stock (8,781 million shares outstanding 0 1,200 3,600 3,600
Capital Stock Premium 0 316,814 300,000 300,000
Stock Subscriptions Receivable (10,000) 0 0 0
Accumulated Deficit (1,390,209) (695,413) (852,854) (588,879)
NonRedeemable Preferred Stock (Note F) 2,100,000 2,100,000 0 0
Treasury Stock (8 million shares of Subsidiary) 0 (1,660,000) (1,600,000) (1,600,000)
----------------- ----------------- ----------------- -----------------
Total Stockholders' Equity 699,791 122,601 (2,148,854) (1,885,279)
Total Liabilities & Stockholders' Equity $ 3,811,880 $ 1,278,568 $ 589,745 $ 768,211
================= ================= ================= =================
</TABLE>
See Notes to Financial Statements.
F-41
<PAGE>
<TABLE>
<CAPTION>
JRECK SUBS GROUP, INC.
CONSOLIDATED INCOME STATEMENTS
Fiscal Years Ended
-----------------------------------------------------------------------------
December 31, 1996 December 31, 1995 December 31, 1994 December 31, 1993
----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Net Sales (Note A) $ 557,738 $ 435,639 $ 468,762 $ 490,681
Costs and Expenses Applicable to Sales & Revenue 23,946 16,548 24,209 36,267
----------------- ----------------- ----------------- ----------------
Gross Profit 533,792 419,091 445,553 454,414
Provision for Doubtful Accounts Receivable 0 137 120,153 105,339
Selling, General & Administrative Expenses 392,542 310,315 272,048 262,873
----------------- ----------------- ----------------- ----------------
Income From Operations 141,250 106,639 52,352 86,202
Parent Sheare of Income (Loss) of Unconsolidated
Subsidiary (Note A-4) (4,819) 0 0 0
Other Income:
Gain Recognized on Extinguishment of Debt (Note C-2,3) 126,001 364,815 0 0
Other Expense:
Interest and Amortization of Debt Offering Costs 186,800 85,544 178,562 197,329
Loss on Disposal of Fixed Assets 0 0 52,564 0
Write off Territorial Rights, Rent Guarantees
& Other Payments (Note H) 126,082 128,978 159,598 0
----------------- ----------------- ----------------- ----------------
Income (Loss) Before Income Taxes (50,450) 278,932 (338,372) (111,127)
Income Tax Expense (Benefit)(Notes E) (10,793) 121,891 (74,979) (32,101)
----------------- ----------------- -----------------
Net Income (Loss) $ (39,657) $ 157,041 $ (263,575) $ (79,026)
================= ================= ================= ================
Per Share Amounts (Adjusted to Retroactively
Reflect Recapitalization and Common Stock
Offering-8.781 million shares) $ (0.004) $ 0.018 $ (0.030) $ (0.009)
================= ================= ================= ================
</TABLE>
See Notes to Financial Statements.
F-42
<PAGE>
<TABLE>
<CAPTION>
JRECK SUBS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Fiscal Years Ended
-------------------------------------------------------------
Dec. 31, 1996 Dec. 31, 1995 Dec. 31, 1994 Dec. 31, 1993
------------- ------------- ------------- -------------
Operating Activities:
<S> <C> <C> <C> <C>
Net Income (Loss) $ (39,657) $ 157,041 $ (263,575) $ (79,026)
Adjustments to Reconcile Net Income (Loss) to Cash Provided
(Consumed) by Operating Activities:
Depreciation and Amortization of Intangible Assets 14,516 21,763 4,054 45,764
Write off Intangible Assets 0 128,976 159,596 0
Write off Uncollectible Trade Accounts Receivable 0 0 120,153 72,308
Loss on Disposal of Property & Equipment 0 0 52,564 0
Interest in Income of Subsidiary 4,619 0 0 0
Adjustment for Tax Benefit of Net Operating Loss Carryover (11,135) 121,135 (75,163) (32,475)
Forgiveness of Debt (126,001) (384,815) 0 0
Changes in Operating Assets and Liabilities:
(Increase) Decrease in Accounts & Notes Receivable (101,045) 8,835 (48,910) (176,329)
(Increase) Decrease in Other Current Assets (3,531) (22,135) 0 0
Increase (Decrease) in Accounts Payable & Accrued Expenses 13,277 (19,301) 115,538 164,749
----------- ----------- ----------- -----------
Net Cash Provided (Consumed) by Operating Activities (248,755) 11,501 64,259 (7,009)
Investing Activities:
Purchase of Property & Equipment (5,172) (40,721) (2,031) 0
Other Investments Made (34,496) 0 (6,496) (4,623)
Payment of Promissory Note Offering Costs (14,786) (70,710) 0 0
----------- ----------- ----------- -----------
Net Cash Used in Investing Activities (54,456) (111,431) (8,527) (4,823)
Financing Activities:
Proceeds of Common Stock Offering net of Costs 681,650 0 0 0
Payments on Long Term Debt and Accrued Interest (287,577) (93,920) (52,886) (39,104)
Financing Proceeds 62,379 371,386 5,002 42,937
(Payments to) Advances From Former Officers (56,716) (171,893) (7,848) 6,535
Dividends Paid on Perferred Shares (54,800) 0 0 0
----------- ----------- ----------- -----------
Net Cash Provided (Used) by Financing Activities 344,936 105,573 (56,732) 10,368
Net Change in Cash 41,725 5,643 0 (1,464)
Cash & Cash Equivalents at the Beginning of Period 5,643 0 0 1,464
----------- ----------- ----------- -----------
Cash & Cash Equivalents at the End of Period $ 47,368 $ 5,643 $ 0 $ 0
=========== =========== =========== ===========
</TABLE>
See Notes to Financial Statements.
F-43
<PAGE>
<TABLE>
<CAPTION>
JRECK SUBS GROUP, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Common Stock Preferred Stock Treasury Retained
Shares Amount Shares Amount Stock of Earnings
Jreck Subs, Inc. (Deficit)
<S> <C> <C> <C> <C> <C> <C>
Inception July 14, 1995
Issuance of Shares Aug. 1995 net of
Offering Costs of $3,700 1,100,000 $ 0
Net Income December 31, 1995 $ 0
--------- ------- ---------
December 31, 1995 1,100,000 0 0
Issuance of Shares May, 1996 1,100,000 11,000
Issuance of Shares May, 1996 in Exchange
for 100% of the common Jreck Subs, Inc. 5,000,000 318,014 $ (1,600,000)
Consolidated Retained Earnings of
Subsidiary (695,416)
Issuance of Series a NonRedeemable
Convertible Preferred Stock May, 1996
in Exchange for 100% of Jreck Subs, Inc.
Series A Preferred Stock 700,000 $ 1,400,000
Issuance of Series B NonRedeemable
Convertible Preferred Stock May, 1996
in Exchange for 100% of Jreck Subs, Inc.
Series B Preferred Stock 350,000 700,000
Issuance of Shares Pursuant to Section
504 Offering under Regulation D, June
1996, Net of Offering Costs 1,536,000 648,150
Issuance of Shares in Exchange for
Cancellation of Debt 45,000 22,500
Payment of Preferred Dividends (54,800)
Constructive Retirement of Treasury Stock (999,664) 1,600,000 (600,336)
Consolidated Net Loss Year Ended
December 31, 1996 (39,657)
--------- ------- --------- ----------- ----------- -----------
December 31, 1996 6,781,000 $ 0 1,050,000 $ 2,100,000 $ 0 $(1,390,209)
========= ======= ========= =========== =========== ===========
</TABLE>
See Notes To Financials Statements.
F-44
<PAGE>
JRECK SUBS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. Summary of Significant Accounting Policies:
1. The Company was organized April 25, 1974. Current operations focus primarily
servicing 47 submarine sandwich shops (known as Jreck Subs) as the parent
franchising organization. The Company sells territorial rights and provides
guidance and assistance to the franchisees in areas such as the preparation,
packaging and sale of products; purchasing equipment; marketing and
administrative support and conducting employee training programs. Jreck Subs
Group, Inc. (Group)(Formeerly Circa Media, Inc.) was incorporated in the state
of Colorado on July 19, 1995. On May 7, 1996, pursuant to a stock exchange
agreement, Jreck Subs Group, Inc. acquired all of the stock of Jreck Subs, Inc.
in exchange for 5,000,000 shares of common stock or 56% of its outstanding
common shares. The former series A preferred shareholders received 700,000 of
series A preferred of Jreck Subs Group, Inc. Group acquisition of Jreck Subs,
Inc. by Jreck Subs Group, Inc. was accounted for as a purchase of the net
liabilities of Group consisting principally of an insignificant amount of
accounts payable.
2. Revenue and Expense Recognition: Continuing franchise fee revenue is
recognized quarterly, monthly or weekly and is charged to the franchisees at 5%
of franchise net sales. Initial Franchise fee revenue is recognized upon the
execution of the Franchise Agreement and is generally nonrefundable. In addition
to the continuing franchise fees, franchisees are required to remit 2% of their
sales in the form of a pooled marketing contribution. The Company has no "Trust
Fund" obligation with respect to these funds and, accordingly, recognizes this
form of revenue in the period in which the franchisee obligation becomes due and
payable. The Company also receives marketing incentives, in the form of rebates,
from it major suppliers. The Company has no Area Developers. Expenses, including
advertising/marketing, are charged to operations as incurred.
3. Property & Equipment are recorded on the basis of cost. Depreciation is
computed using either the straight-line method or double declining balance
method over the 5-10year useful lives of the assets. Depreciation expense for
the year ended December 31, 1996 was $14,518. Expenditures for renewals and
betterment's are capitalized. Expenditures for repairs and maintenance are
charged to operations as incurred. Gain or loss upon sale or retirement due to
obsolescence is reflected in the operating results in the period the event takes
place. Details of the Property & Equipment accounts are as follows:
B. Other Assets:
Other Assets consist of a 10 year covenant not to compete from former
shareholders pursuant to a 1991 stock sale agreement (see note C-1 ). The
covenant is amortized annually at a rate exactly equal to annual principal
reductions in the corresponding obligations to the former shareholders as
reflected in long term debt; notes receivable on the sale/resale of its stores
and a 5 year non-compete covenant arising from the acquisition of 7 stores in
1993. This covenant is being amortized over the 5 year period.
<TABLE>
<CAPTION>
Estimated Dec. 31, 1996 Dec. 31, 1995 Dec. 31, 1994 Dec. 31, 1993
Life ------------- ------------- ------------- -------------
----
<S> <C> <C> <C> <C>
Leasehold Improvement $ 0 $ 0 $ 0 $ 94,848
Machinery & Equipment 7 Yr. 21,703 16,531 10,116 82,970
Vehicles 5 Yr. 58,591 58,591 24,285 4,175
------------- ------------- ------------- -------------
80,294 75,122 34,401 181,993
Less Accumulated Depreciation 30,106 15,588 7,781 126,089
------------- ------------- ------------- -------------
Net Property & Equipment $ 50,188 $ 59,534 $ 26,620 $ 55,904
============= ============= ============= =============
</TABLE>
4. Principles of Consolidation: Investments in affiliates that are 50% or less
owned are accounted for by the equity method of accounting. This requires that
the Company's share of the affiliate's net income be included in its income
statement and that it carry its investment at cost plus its interest in
undistributed net earnings. Any excess of cost over the fair value of the
underlying assets will be treated as goodwill and amortized over 20 years.
5. Impairment of Long Lived Assets: The Company adopted Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment of Long Lived
Assets and for Long Lived Assets to be Disposed of," ("SFAS 121"). SFAS 121
requires impairment losses to be recorded on long lived assets used in
operations and goodwill when indications of impairment are present and the
undiscounted cash flows estimated to be generated by those assets are less than
the carrying amount of the asset.
F-45
<PAGE>
Notes to Financial Statements (Continued)
6. Impact of Recent Pronouncements: Effective for periods beginning after
December 15, 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income," ("SFAS
131") and Statement of Financial Accounting Standards No. 131, "Disclosure about
segment of an Enterprise and Related Information," ("SFAS 131"). SFAS 130
established standards for reporting and displaying comprehensive income, its
components and accumulated balances. SFAS 131 establishes standards for the way
that public companies report information about operating segments in annual
financial statements and requires reporting of selected information about
operating statements in interim financial statements issued to the public. The
Company has not determined the impact adoption of these new accounting standards
will have on its future financial statements and disclosures.
B. Notes Payable:
The Promissory Notes bear interest at 10.5% and are due in May, 1997. A summary
of the various obligations are as follows:
<TABLE>
<CAPTION>
Payee Dec. 31, 1996 Dec. 31, 1995 Dec. 31, 1994 Dec. 31, 1993
- ----- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Promissory Notes* $ 399,679 $ 337,300 $ 0 $ 0
FDIC 0 0 69,344 76,036
FDIC 259,334 259,334 259,334 268,813
Ed Mahar 75,999 96,999 96,999 96,999
Daniel Patterson 0 0 23,465 23,465
Mett Management 0 0 14,414 14,414
Charles Lehman 0 15,000 15,000 15,000
Employees 0 2,572 6,371 0
Stockholder 0 0 102,549 110,397
------------- ------------- ------------- -------------
Total $ 736,012 $ 711,205 $ 587,476 $ 605,124
============= ============= ============= =============
</TABLE>
*Secured/Unsecured
C. Long Term Debt:
1. Due on Purchase of Treasury Stock bears interest at 10% and was personally
guaranteed by a former officer. This obligation was retired upon the issuance of
Series A Preferred Stock. All but $100,000 of unpaid and accrued interest at the
time of conversion ($463,165) was forgiven. In addition, $21,650 of the
principal was forgiven. As a result of the conversion, the Company has realized
income on the forgiveness of these obligations in the amount of $384,815 in
1995.
2. Chase Manhattan Bank, NA. Secured by equipment, furniture and fixtures and a
personal guarantee of a former officer. Interest is computed at prime plus 2%.
The loan was settled at $60,000 paid in full in 1996. The excess of the balance
of the loan obligation over the settlement amount has been recognized in the
current period as a gain on the extinguishment of debt.
3. Gerhartz Equipment, Inc. Secured by equipment and bears interest at prime
plus 2%. This obligation was converted to 45,000 shares of common stock in 1996.
The conversion was valued at the Company's public stock offering price of $0.50
per share (or $22,500). The balance of $68,033 has been reflected on the income
statement in the current period as gain on extinguishment of debt.
4. Gencarelli and Algiere is an interest free, unsecured obligation resulting
from an arbitrated settlement of a third party guarantee whereby the Company
agreed to pay $500 per month. The original amount of the obligation was $24,000.
5. Sullivan Secured by a corporate vehicle, payable in monthly installment of
$583 bearing interest at 10%.
F-46
<PAGE>
Notes to Consolidated Financial Statements (Continued)
6. Due to Margot is a vehicle loan payable in monthly installments of $376
bearing interest at 8%.
7. S. Foy and Associates payable in monthly installments of $481 and bears
interest at 14%.
A summary of obligations is as follows:
<TABLE>
<CAPTION>
Description of Obligation: Dec. 31, 1996 Dec. 31, 1995 Dec. 31, 1994 Dec. 31, 1993
- ------------------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Elliott $ 0 $ 64,300 $ 0 $ 0
Due on Purchase of Treasury Stock 0 0 1,421,649 1,421,649
Chase Manhattan Bank, NA* 0 115,335 119,602 137,606
Gerhatrz Equipment, Inc. 0 90,533 81,695 81,000
Gencarelli & Algiere 23,695 23,695 23,695 23,500
Mark Russell 0 0 0 4,729
Key Bank 0 0 16,985 0
Margot 7,994 11,704 0 0
S. Foy Associates 15,405 13,284 0 0
Morris Realty 0 0 851 4,351
Peter Whitmore 0 0 1,212 3,584
Masterlease Corporation 0 0 0 2,051
Sullivan 19,362 22,608 0 0
------------- ------------- ------------- -------------
66,456 342,459 1,665,689 1,678,470
Less Current Portion 20,000 85,000 240,956 174,975
------------- ------------- ------------- -------------
Total Long Term Debt $ 46,456 $ 257,459 $ 1,424,733 $ 1,503,495
============= ============= ============= =============
</TABLE>
*Secured/Unsecured
D. Other Assets:
Deferred Offering Costs are the capitalized expenses incurred in connection with
the Company's efforts to raise financing through the issuance of its 10.5%
Promissory Notes. These expenses are amortized over the 9 month life of the
notes. In 1996 the Company restated its Franchise Agreement to require an annual
minimum franchise royalty payment for 10 years for all of its franchisees. The
present value of these minimum payments has been imputed at 9% and reflected as
Franchise Agreements in Other Assets and, correspondingly, Deferred Income under
Other Liabilities.
<TABLE>
<CAPTION>
Description: Dec. 31, 1996 Dec. 31, 1995 Dec. 31, 1994 Dec. 31, 1993
- ------------------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Investments $ 0 $ 0 $ 824 $ 824
Franchise Agreements 2,294,041 0 0 0
Reacquired Franchise Rights 0 0 0 18,400
Reacquired Operating Rights 0 0 0 141,198
Deferred Offering Costs 14,786 0 0 0
Advances to Former Officer 115,641 58,925 0 0
Deferred Income Taxes (Note E) 387,846 376,711 497,946 422,683
------------- ------------- ------------- -------------
Total $ 2,812,314 $ 435,636 $ 498,670 $ 583,105
============= ============= ============= =============
<CAPTION>
E. Income Taxes: The net non-current deferred tax asset as presented on the
accompanying balance sheets consist of the following deferred tax assets
Dec. 31, 1996 Dec. 31, 1995 Dec. 31, 1994 Dec. 31, 1993
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Federal & State Deferred Income
Tax Assets $ 387,846 $ 376,711 $ 497,946 $ 422,883
Less Valuation Allowance 0 0 0 0
------------- ------------- ------------- -------------
Total $ 387,846 $ 376,711 $ 497,946 $ 422,883
============= ============= ============= =============
</TABLE>
The deferred tax asset balances are the result of net operating loss
carryforwards. As it is more likely than not that all future tax benefits will
be realized, no valuation allowance has been recorded for the deferred
F-47
<PAGE>
Notes to Consolidated Financial Statements (Continued)
tax assets. There was no prior balance in the valuation allowance, and
therefore, there was no change in the valuation allowance for this period.
The components of the income tax provision (benefit) for income taxes are as
follows:
<TABLE>
<CAPTION>
Dec. 31, 1996 Dec. 31, 1995 Dec. 31, 1994 Dec. 31, 1993
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Federal $ 7,049 $ 98,120 $ 60,846 $ 26,289
New York State 4,086 23,771 14,317 6,186
------------- ------------- ------------- -------------
Total $ 11,135 $ 121,891 $ 75,163 $ 32,475
============= ============= ============= =============
</TABLE>
The Corporations have net operating loss carryforwards available of $1,224,000
that may be used to offset future taxable income. These carryforwards begin to
expire in the fiscal year ending December 31, 2005.
F. Preferred Stock:
On November 22, 1995 the Company concluded an excluded an exchange offer in
which holders of the Notes Payable on the purchase of Treasury Stock could
exchange their notes for the Company's Series A nonredeemable Preferred Stock.
700,000 shares were issued and the notes, together with accrued interest of
$363,165 were retired. Each share of the Preferred Stock is convertible, at the
discretion of the Board of Directors, into one share of the Company's Common
Stock. Dividends on the Preferred Stock accrue and become payable weekly at the
annual rate of 9 cents per share. The shares are nonredeemable. The Company also
issued its Series B Preferred Stock in exchange for 50% of the voting common
stock of its unconsolidated subsidiary (Note J). The rights and preferences of
the Series B preferred shares are similar to those of the series A.
G. Common Stock Offering:
At December 31, 1996 the Company was actively engaged in a public offering of
its common stock. The offering is exempt from S.E.C. registration under Rule 504
of Regulation D. As of December 31, 1996 the Company had received $768,000 in
cash and issued 1,536,000 shares of its common stock. The offering was concluded
in February, 1997 after receiving an additional $220,000 in cash. All costs of
the offering have been reflected as a reduction of the total amount received.
H. Payment of Contingent Liability:
In February, 1989, Jreck Subs, Inc. entered into an agreement to purchase four
stores from HLS Enterprises, Inc. In November, 1989 these stores were
subsequently resold to Bundeswehr, Inc. The sales agreement stipulated that all
debt owed by Jreck Subs, Inc. to HLS would be assumed and become and obligation
of Bundeswehr, Inc. In 1996 the Company paid $120,000 in full and complete
satisfaction of this liability. This payment has been charged against revenues
in the current period.
I. Investment in Unconsolidated Subsidiary:
In November, 1995 the Company acquired 50% of the voting common and of Pastry
Product Producers, LLC. This company currently supplies the Jreck franchise
stores with their baked goods and holds a 10 year contract to supply submarine
sandwich rolls for Jreck Subs, Inc. The investment has been accounted for by the
equity method (Note A). The Company also leases its office space from its
subsidiary for $500/month under a 10 year lease agreement.
F-48
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Stockholders and Board of Directors
Li'l Dino Corporation
Greensboro, North Carolina
We have audited the accompanying balance sheet of Li'l Dino Corporation (a
wholly-owned subsidiary of Li'l Dino Management Corporation) as of October 31,
1997 and the related statements of loss and retained deficit and cash flow for
the year then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentator.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Li'l Dino Corporation as of
October 31, 1997 and the results of its operations and its cash flows for the
year then ended in conformity with generally accepted accounting principles.
DIXON ODOM PLLC
CERTIFIED PUBLIC ACCOUNTANTS
January 15, 1998, except for Note E.
as to which the date is January 26, 1998
F-49
<PAGE>
<TABLE>
<CAPTION>
LI'L DINO CORPORATION
BALANCE SHEET
October 31, 1997
ASSETS
CURRENT ASSETS
<S> <C>
Cash $ 48,361
Royalties receivable 15,307
TOTAL CURRENT LIABILITIES $ 63,668
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 29,808
TOTAL CURRENT LIABILITIES 29,808
CONTINGENCY (NOTE E)
STOCKHOLDER'S EQUITY
Common stock, $1 par value, 1,000,000 shares
authorized 50,000 shares issued 50,000
Retained deficit (16,140)
33,860
$ 63,668
</TABLE>
See accompanying notes
F-50
<PAGE>
<TABLE>
<CAPTION>
LI'L DINO CORPORATION
STATEMENT OF LOSS AND RETAINED DEFICIT
Year Ended October 31, 1997
OPERATING REVENUE
<S> <C>
Franchise fees $ 38,750
Royalties 410,198
Franchise repurchase (19,692)
TOTAL OPERATING REVENUE 429,256
OPERATING EXPENSES
Management fee to parent 367,401
Commissions 73,844
Other 6,339
TOTAL OPERATING EXPENSES 447,584
LOSS FROM OPERATIONS (18,328)
OTHER INCOME
Interest income 1,180
NET LOSS (17,148)
RETAINED EARNINGS,
BEGINNING OF YEAR, as restated (Note D) 1,008
RETAINED DEFICIT, END OF YEAR $ (16,140)
</TABLE>
See accompanying notes
F-51
<PAGE>
<TABLE>
<CAPTION>
LI'L DINO CORPORATION
STATEMENT OF CASH FLOWS
Year Ended October 31, 1997
CASH FLOWS FROM OPERATING ACTIVITIES
<S> <C>
Net loss $ (17,148)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Franchise repurchase in exchange for cancellation
of note receivable 19,692
Change in assets and liabilities
Decrease in royalties receivable 4,359
Decrease in notes receivable 9,012
Increase in accounts payable 4,365
NET CASH PROVIDED BY OPERATING ACTIVITIES
AND NET INCREASE IN CASH 20,280
CASH, BEGINNING 28,081
CASH ENDING $ 48,361
SUPPLEMENT SCHEDULE OF NONCASH INVESTING AND
FINANCING ACTIVITIES
Note receivable written off against deferred franchise fees $ 4,000
</TABLE>
See accompanying notes
F-52
<PAGE>
LI'L DINO CORPORATION
NOTES TO FINANCIAL STATEMENTS
October 31, 1997
NOTE A - SIGNIFICANT ACCOUNTING POLICIES
Description of Business
The Company sells area and single location Li'l Dino sub shop franchises and
provides assistance ad guidance to franchisees. At October 31, 1997, there are
43 franchised units operating in North Carolina, Virginia, South Carolina and
Georgia.
Parent Company
The Company is a wholly owned subsidiary of Li'l Dino Management Corporation.
Franchise Fees
Revenue from sales of area and single location franchises is generally
recognized when substantially all significant services to be provided to the
area developer and franchisee have been performed. In situations where revenue
from such sales is collectible over an extended period of time and
collectibility is not reasonably certain, revenue is recognized on the
installment method as amounts are collected.
Royalties
The Company receives ongoing royalties from franchised stores based upon a
percentage of the stores sales. The royalties are recognized as revenue in the
period the sales occur.
Income Taxes
The Company and its parent file a consolidated federal income tax return. Income
taxes are allocated to the Company as if it were a separate taxpayer. Tax
benefits from operating losses have been eliminated by allowances to reduce them
to an amount likely to be realized.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
F-53
<PAGE>
LI'L DINO CORPORATION
NOTES TO FINANCIAL STATEMENTS
October 31, 1997
NOTE B - RELATED PARTY TRANSACTIONS
The Company pays a management fee to its parent company. The amount of the
management fee is determined solely at the discretion of its parent's management
and may vary significantly from year to year.
The Company entered into an agreement with one of its area developers whereby
the Company agreed to waive future unit franchise fees for up to two new units
in exchange for the forgiveness of commissions due to the area developer for
sales generated by units located in the developer's franchise area from April
28, 1997 through October 26, 1997. Commission expense in the amount of
approximately $11,000 has not been recorded in the financial statements for the
year ended October 31, 1997 in accordance with the terms of the agreement.
NOTE C - SUMMARY OF FRANCHISE SALES AND OPERATING UNITS
The following is a summary of franchise outlets for the year ended October 31,
1997:
Units in operation at November 1, 1996 44
Area franchises sold 1
Area franchises repurchased (1)
New units opened 6
Units closed (7)
Units in operation at October 31, 1997 43
NOTE D - PRIOR PERIOD ADJUSTMENT
The retained earnings at October 31, 1996 have been decreased by a charge of
$6.695 to report accounts payable for commissions due to an area developer not
previously reported.
NOTE E - CONTINGENCY
The Company and its parent company (Li'l Dino Management Corporation) have
jointly and severally guaranteed certain debt incurred by Triad Subs, Inc., an
affiliated company, to an unrelated third party. Triad Subs, Inc. is an inactive
corporation and does not have any assets available to satisfy this debt which
amounts to approximately $135,000 at October 31, 1997, including unpaid interest
that has accrued on the outstanding balance. On January 26, 1998, under the
terms of the note agreement, the payee demanded immediate and full payment of
all amounts due.
F-54
<PAGE>
LI'L DINO CORPORATION
NOTES TO FINANCIAL STATEMENTS
October 31, 1997
NOTE E - CONTINGENCY (Continued)
Pursuant to the proposed sale of all the Li'l Dino Corporation common stock to
an unrelated third party, the parent company has entered into an agreement with
Li'l Dino Corporation indemnifying the Company against any losses incurred as a
result of the Company's guarantee. In consideration of this indemnification
agreement with its parent company, no liability has been recognized in the
Company's financial statements at October 31, 1997 in conjunction with this
guarantee.
F-55
<PAGE>
Michael F. Cronin
Certified Public Accountant
12 Blandford Lane
Fairport, New York 14450
716-248-5790
Pastry Product Producers, LLC
Watertown, New York
I have audited the accompanying balance sheets of Pastry Product Producers, LLC.
as of December 31, 1996, and the related statements of income, partners' equity,
and cash flows for the year the ended. The financial statements are the
responsibility of the directors. My responsibility is to express an opinion on
these financial statements based on my audit.
I conducted my audit in accordance with generally accepted auditing standards.
Those standards require that I plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
I believe that my audit provides a reasonable basis for my opinion.
In my opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Pastry Product Producers, LLC as of
December 31, 1996 and the results of its operations, its cash flows and changes
in owners' equity for the year then ended in conformity with generally accepted
accounting principles.
September 29, 1997
/s/ Michael F. Cronin
Michael F. Cronin
Certified Public Accountant
F-56
<PAGE>
<TABLE>
<CAPTION>
Pastry Product Producers, LLC
Balance Sbeet
December 31, 1996
Assets
Dec. 31, 1996
Current Assets: -------------
<S> <C>
Cash $ 3,326
Accounts Receivable-Net 75,455
Prepaid Expenses 5,000
-------------
Total Current Assets 83,781
Property and Equipment (Note A):
Machinery and Equipment 218,250
Delivery Vehicles 13,180
Real Estate & Improvements 184,502
-------------
Total Cost of Property and Equipment 415,932
Less Accumulated Depreciation (105,113)
-------------
Property and Equipment (Net) 310,819
Other Assets:
Organization Costs 8,680
Capitalized Franchise Fees (Note D) 1,655,564
-------------
Total Other Assets 1,664,244
Total Assets $ 2,058,844
=============
</TABLE>
See Notes to Financial Statements
F-57
<PAGE>
<TABLE>
<CAPTION>
Liabilities and Stockholder's Equity
Dec. 31, 1996
Current Liabilities: -------------
<S> <C>
Accounts Payable $ 0
Current Portion of Long Term Debt 49,834
-------------
Total Current Liabilities 49,834
Deferred Franchise Contract Income (Note D) 1,655,564
Long Term Debt (Note C) 26,550
Partners' Equity:
Partners' Equity 326,896
Total Liabilities and Stockholder's Equity $ 2,058,844
=============
</TABLE>
F-58
<PAGE>
<TABLE>
<CAPTION>
Pastry Product Producers, LLC
Statement of Income and Retained Earnings
Year Ended December 31, 1996
Year Ended
Dec. 31, 1996
-------------
<S> <C>
Sales $ 708,296
Cost of Sales:
Materials and Supplies 178,795
-------------
Gross Profit 529,501
Selling, General and Administrative Expenses 539,438
-------------
Income (Loss) Before Other Income and Income Taxes (9,937)
Other Income;
Gain on Sale of Equipment 300
-------------
Income (Loss) Before Taxes (9,637)
Income Taxes (Note B) 0
Net Income (Loss) (9,637)
Partners' Equity-Beginning of Year 231,625
Partners' Capital Contributions net of Repayments 104,908
-------------
Partners' Equity-End of Year $ 326,896
=============
</TABLE>
See Notes to Financial Statements.
F-59
<PAGE>
<TABLE>
<CAPTION>
Pastry Product Producers, LLC
Statements of Cash Flows
Year Ended December 31, 1996
Year Ended
Dec. 31, 1996
Operating Activities: -------------
<S> <C>
Net Income (Loss) $ (9,637)
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 38,294
Changes in operating assets and liabilities
(Increase) Decrease in accounts receivable (75,455)
(Increase) in prepaid expenses (5,000)
-------------
Total Cash (Consumed) Provided by Operating Activities (51,798)
Investing Activities:
Payment of Organization Costs & Filing Fees on Building (10,511)
Cash Received on Sale of Equipment 300
-------------
Total Cash used in investing Activities (10,511)
Financing Activities:
Advances From Partners (net of repayments) 104,908
Principal payments on long term debt (42,892)
-------------
Total Cash Provided ( Used) by Financing Activities 62,016
Decrease in cash and cash equivalents (293)
Cash and cash equivalents-beginning 3,619
-------------
Cash and cash equivalents ending1 $ 3,326
=============
</TABLE>
Other cash flow information-Interest paid $15,023
See Notes to Financial Statements.
F-60
<PAGE>
<TABLE>
<CAPTION>
Pastry Product Producers, LLC
Schedule or Selling, General and Administrative Expenses
Year Ended December 31, 1996
Year Ended
Dec. 31, 1996
-------------
<S> <C>
Commissions $ 37,547
Delivery 370,008
Depreciation and Amortization 38,294
Insurance: 14,490
Interest 15,023
Legal and Accounting 2,176
Office and Miscellaneous 17,464
Payroll and Fringe Benefits 274,739
Real Estate Taxes 5,516
Repair and Maintenance (Facilities) 22,132
Sales Tax Portion of Lease Payments 4,886
Supplies 39,911
Telephone 4,222
Utilities & Water 26,030
--------------
Total Selling, General and Administrative Expenses $ 539,438
==============
</TABLE>
See Notes to Financial Statements.
F-61
<PAGE>
Pastry Product Producers, LLC
Notes to Financial Statements
Year Ended December 31, 1996
A. Summary of Significant Accounting Policies:
Property and Equipment. All property is stated at original cost less accumulated
depreciation. Depreciation is computed using the straight-line method over the
estimated useful life of the related assets as follows:
Bakery Equipment 7 years
Building & Improvements 39 years
Trucks 7 years
Depreciation expense is computed using IRS guidelines for the types of assets
owned by the Company. For the year ended December 31, 1996 depreciation expense
was $37,674.
B. Income Taxes
In April of 1996 the Company converted its tax form of ownership from a "C"
corporation to a Limited Liability Corporation (LLC). New York State as well as
the U.S. Government taxes LLC's as partnerships. Partnerships, acting as a flow
through entity, normally do not incur any income tax. Therefore no provision for
income tax expense has been made.
C. Long Term Debt:
Long term debt consists of six separate financing arrangements, bearing interest
at 11%-14%, made for the acquisition of (and secured by) a substantial portion
of the Company's bakery equipment. Monthly payments total approximately $5,092.
A summary of maturities is as follows:
Year Ended Amount
December 31, 1997 $ 49,834
December 31, 1998 26,546
December 31, 1999 0
--------
TOTAL $ 76,380
========
D. Contract Values/Deferred Income:
The Company has secured about 50 long term contracts for commitments of a
minimum amount of rolls & bagels to be delivered over a 10 year period. The
Company has computed the present value of these minimum deliveries over the 10
year period and reflected the corresponding value as an asset and deferred
income on the balance sheet.
F-62
<PAGE>
Cronin & Co.
Certified Public Accountants
12 Blandford Lane
Fairport, NY 14450
Board of Directors and Shareholders
Seawest Sub Shops, Inc.
Bellevue, Wa
I have audited the accompanying balance sheet of Seawest Sub Shops, Inc. as of
December 31, 1996 and the related statements of income, cash flows and
stockholders' equity for the year then ended. The financial statements are the
responsibility of the directors. My responsibility is to express an opinion on
these financial statements based on my audit.
I conducted my audit in accordance with generally accepted auditing standards.
Those standards require that I plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles, used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
I believe that my audit provides a reasonable basis for my opinion.
In my opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Seawest Sub Shops, Inc, as of
December 31, 1996 and the results of its operations, its cash flows and changes
in stockholders' equity for the year then ended in conformity with generally
accepted accounting principles.
The December 31, 1995, and 1994 financial statements were audited by other
auditors, whose report dated March 22, 1996, stated that the balance sheet and
related statements of operations and cash flows as of and for the years then
ended, were presented fairly and in conformity with generally accepted
accounting principles applied on a consistent basis.
July 13, 1997
/s/ Michael F. Cronin
Cronin & Co.
Certified Public Accountants
F-63
<PAGE>
<TABLE>
<CAPTION>
SEAWEST SUB SHOPS, INC.
BALANCE SHEETS
ASSETS
December 31, 1996 December 31, 1995 December 31, 1994
----------------- ----------------- -----------------
Current Assests:
<S> <C> <C> <C>
Cash and Cash Equivalents $ 11,421 $ 9,745 $ 8,970
Receivables:
Trade 69,290 132,223 117,787
Employees 0 0 0
Related Parties 0 12,884 7,996
Inventories 3,561 0 6,463
Prepaid Expenses 5,179 0 0
Current Portion of Notes Receivable 59,265 72,195 56,547
----------------- ----------------- -----------------
Total Current Assests 148,716 227,047 197,763
Property & Equipment, Net of Accumulated
Depreciation (Note A) 64,241 36,364 85,683
Other Assets (Note B) 598,059 719,601 866,233
Total Assets $ 811,016 $ 983,012 $ 1,149,679
================= ================= =================
LIABILITIES & STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts Payable $ 146,119 $ 134,680 $ 173,280
Deposits From Franchisees 6,750 6,750 26,000
Accrued Expenses 31,470 0 0
Current Portion of Long Term Debt (Note C) 138,700 105,213 142,614
----------------- ----------------- -----------------
Total Current Liabilities 323,039 246,643 341,894
Long Term Debt (Note C) 402,004 540,705 591,626
Deferred Income (Note D) 100,000 0 0
Contingent Liabilities (Note F)
Stockholders' Equity:
Common Stock (No par value, 5,000,000 shares authorized) 220,497 220,497 212,997
Retained Earnings (Deficit) (234,524) (24,833) 3,162
----------------- ----------------- -----------------
Total Stockholders' Equity (14,027) 195,664 216,156
Total Liabilities & Stockholders' Equity $ 811,016 $ 983,012 $ 1,149,679
================= ================= =================
</TABLE>
See Notes to Financial Statements.
F-64
<PAGE>
<TABLE>
<CAPTION>
SEAWEST SUB SHOPS, INC.
INCOME STATEMENTS
Fiscal Years Ended
-------------------------------------------------------------
December 31, 1996 December 31, 1995 December 31, 1994
----------------- ----------------- -----------------
Revenue (Note A):
<S> <C> <C> <C>
Initial Franchise Fees $ 41,000 $ 88,501 $ 85,400
Continuing Franchise Fees 329,510 522,818 503,528
Territorial Franchising Rights 64,450 0 0
Marketing Fees' 94,700 0 0
Marketing Co-Op Rebates' 75,583 0 0
Sales Generated by Corporately Operated Sub Shops (Note G) 56,165 138,114 918,882
----------------- ----------------- -----------------
Total Revenues 661,408 749,433 1,507,810
Costs and Expenses Applicable to Sales & Revenue:
Commissions on Sale & Resale of Franchises 13,622 29,281 57,584
Marketing and Advertising Expenditures 130,136 142,612 142,405
Food Costs Applicable to Sub Shop Operations (Note G) 28,822 62,271 386,720
----------------- ----------------- -----------------
Total Costs & Expenses Applicable to Sales & Revenue 172,580 234,164 586,709
Gross Profit 486,828 515,269 919,101
Provision for Doubtful Accounts Receivable 20,177 64,515 99,559
Selling, General & Admimistrative Expenses 402,483 396,093 1,041,808
----------------- ----------------- -----------------
Income From Operations 66,168 (54,661) (222,266)
Other Income:
Interest 21,335 35,416 12,659
Miscellaneous 46,056 36,099 7,409
Gains an Resale of Reacquired Stores 0 77,706 186,466
Other Expense:
Interest 22,562 50,305 99,559
Amortization of Intangibles 77,674 72,250 105,333
Losses on Store Repossession and Closures (Note G) 245,013 0 0
----------------- ----------------- -----------------
Total Other Income/Expenses 275,856 26,666 1,842
Income (Loss) Before Income Taxes (209,690) (27,995) (220,424)
Income Tax Expense (Benefit)(Notes E) 0 0 0
----------------- ----------------- -----------------
Net Income (Loss) $ (209,690) $ (27,995) $ (220,424)
================= ================= =================
</TABLE>
*No Data Available for Comparison in 1995 & 1994
See Notes to Financial Statements.
F-65
<PAGE>
<TABLE>
<CAPTION>
SEAWEST SUB SHOPS, INC.
STATEMENTS OF CASH FLOWS
Fiscal Years Ended
-------------------------------------------------------------
December 31, 1996 December 31, 1995 December 31, 1994
----------------- ----------------- -----------------
Operating Activities:
<S> <C> <C> <C>
Net Income (Loss) $ (209,690) $ (27,995) $ (220,424)
Adjustments to Reconcile Net Income (Loss) to Cash Provided
(Consumed) by Operating Activities:
Depreciation and Amortization of Intangible Assets 82,201 72,250 106,333
Write off Uncollectible Trade Accounts Receivable 20,177 0 0
Loss on Sub Shops Sold/Closed 245,013 67,175 221,265
Expenses Recognized Through Issuance of Common Stock 0 7,500 7,500
Changes in Operating Assets and Liabilities:
(Increase) Decrease in Accounts & Notes Receivable 62,933 45,619 (139,977)
(Increase) Decrease in Other Current Assets 9,954 12,830 9,813
Increase (Decrease) in Accounts Payable & Accrued Expenses 42,909 (37,326) 69,987
----------------- ----------------- -----------------
Net Cash Provided (Consumed) by Operating Activities 253,497 140,053 53,497
Investing Activities:
Purchase of Property & Equipment (26,070) (30,431) (1,443)
Collections on Notes Receivable 82,962 0 0
Increases on Notes Receivable (201,500) 0 0
----------------- ----------------- -----------------
Net Cash Used in Investing Activities (146,608) (30,431) (1,443)
Financing Activities:
Payments on Long Term Debt (105,213) (108,847) (81,000)
Financing Proceeds 0 0 7,904
----------------- ----------------- -----------------
Net Cash Provided (Used) by Financing Activities (105,213) (106,847) (73,096)
Net Change in Cash 1,676 775 (21,042)
Cash & Cash Equivalents at the Beginning of Period 9,745 6,970 30,012
----------------- ----------------- -----------------
Cash & Cash Equivalents at the End of Period $ 11,421 $ 9,745 $ 8,970
================= ================= =================
</TABLE>
See Notes to Financial Statements.
F-66
<PAGE>
<TABLE>
<CAPTION>
SEAWEST SUB SHOPS, INC.
STATEMENTS OF CHANGES STOCKHOLDERS' EQUITY
Common Stock Retained
Shares Amount Earnings
Additional (Deficit)
Paid-in Paid-in
Capital Capital
--------- ------- --------- -----------
<S> <C> <C> <C> <C>
December 31, 1993 2,162,000 0 $ 157,917 $ 223,586
Issuance of Shares in Exchange for Cancellation of Debt 79,000 45,080
Issuance of Shares in Exchange for Professional Services 15,000 7,500
Net Loss December 31, 1994 (220,424)
--------- ------- --------- -----------
December 31, 1994 2,256,000 0 212,997 (3,162)
Issuance of Shares in Exchange for Professional Services 15,000 7,500
Net Income December 31, 1995 (27,995)
--------- ------- --------- -----------
December 31, 1995 2,271,000 0 220,497 (24,833)
Net Loss December 31, 1996 (209,690)
--------- ------- --------- -----------
December 31, 1996 2,271,000 $ 0 $ 220,497 $ (234,523)
========= ======= ========= ===========
</TABLE>
See Notes To Financials Statements.
F-67
<PAGE>
SEAWEST SUB SHOPS, INC.
NOTES TO FINANCIAL STATEMENTS
A. Summary of Significant Accounting Policies:
1. The Company was organized December 30, 1985. Current operations focus
primarily servicing is chain of franchised submarine sandwich shops (known as
"Sub Shops") as the parent franchising organization. The Company sells franchise
rights, primarily in and around the Seattle area, and provides guidance and
assistance to the franchisees in areas such as the preparation, packaging and
sale of products; purchasing equipment; marketing and administrative support and
conducting employee training programs.
2. Revenue and Expense Recognition; Continuing franchise fee revenue is
recognized quarterly, monthly or weekly and is charged to the franchisees at 5%
of franchise net sales (a monthly or quarterly flat fee is required in
agreements made prior to 1992). Initial Franchise fee revenue is recognized upon
the execution of the Franchise Agreement and is generally nonrefundable. In
addition to the continuing franchise fees, franchisees are required to remit 2%
of their sales in the form of a pooled marketing contribution. The Company has
no "Trust Fund" obligation with respect to these funds and, accordingly,
recognizes this form of revenue in the period in which the franchisee obligation
becomes due and payable. The Company also receives marketing incentives, in the
form of rebates, from it major suppliers. Expenses, including
advertising/marketing, are charged to operations as incurred.
3. Property & Equipment are recorded on the basis of cost. Depreciation is
computed using either the straight-line method or double declining balance
method over the estimated useful lives of the assets. Depreciation expense for
the year ended December 31, 1996 was $4,527. Expenditures for renewals and
betterment's are capitalized. Expenditures for repairs and maintenance are
charged to operations as incurred. Gain or loss upon sale or retirement due to
obsolescence is reflected in the operating results in the period the event takes
place.
B. Other Assets:
Other Assets consist of a 10 year covenant not to compete from former
shareholders pursuant to a 1991 stock sale agreement (see note C-1 ). The
covenant is amortized annually at a rate exactly equal to annual principal
reductions in the corresponding obligations to the former shareholders as
reflected in long term debt; notes receivable on the sale/resale of its stores
and a 5 year non-compete covenant arising from the acquisition of 7 stores in
1993. This covenant is being amortized over the 5 year period.
<TABLE>
<CAPTION>
Dec. 31, 1996 Dec. 31, 1995 Dec. 31, 1994
------------- ------------- -------------
Description of Asset:
<S> <C> <C> <C>
Notes Receivable $ 342,734 $ 313,138 $ 351,187
Less Valuation Allowance 124,739 30,500 8,494
------------- ------------- -------------
Net Realizable Value of Notes Receivable 217,995 282,638 342,693
Equipment Lease Security Deposits 9,981 15,021 21,387
Corporate Covenant Not to Compete 700,000 700,000 700,000
Store Covenants Not to Compete 58,369 58,369 58,369
Less Accumulated Amortization 329,021 251,348 191,673
------------- ------------- -------------
Net Carrying Value of Non-Compete Covenants 432,348 507,021 566,693
Total Other Assets 657,324 904,680 930,773
Less Current Portion of Notes Receivable 59,265 85,079 64,543
------------- ------------- -------------
Total $ 508,059 $ 719,601 $ 566,230
============= ============= =============
</TABLE>
F-68
<PAGE>
Notes to Financial Statements (Continued)
C. Long Term Debt:
1. Due to Former Shareholders: On February 25, 1991 a stock purchase and sale
agreement was executed between Mssrs Kane & Isemen (the former shareholders and
sellers) and Mitchell Day (the current majority shareholder and purchaser). This
agreement bound the Company to pay $700,000 over 10 years for a 10 year
covenant not to compete from the former shareholders. The Notes are non-interest
bearing and are secured by the pledged stock of the purchaser. Minimum payments
over the 10 year period of the covenant are as follows:
PERIOD AMOUNT
------ ------
April 1, 1991-March 31, 1996 $ 4,000/Month
April 1, 1996-March 31, 2001 $ 6,000/Month
May 1, 2001 $ 100,000
2. Note Payable-Graham & Dunn; On March 26, 1906 the Company converted unpaid
paid legal fees in the amount of $35,524 to an unsecured promissory note in the
amount of $20,524. The note bears interest at 12% and is payable over 16 months
commencing April 1, 1996.
3. Note Payable-Sternfeld: Arising from the settlement of a lawsuit in 1993, the
note is unsecured, payable in monthly installments of $1,000 and bears interest
at 12%.
4. Notes Payable on Store Reacquisitions: The Company engages in the
repossession, acquisition, reacquisition and resale of franchised Sub Shop
Stores from time to time. As a result of this activity, the Company may be
obligated to assume certain debts of the repossessed store or will incur an
obligation upon the outright purchase of a Sub Shop Store. These notes are
serviced by the Corporation during its term of ownership and may be secured by
certain equipment or be unsecured and bear interest at 8%-11%. The capitalized
costs associated with the acquisition of a store are reflected as an asset. Upon
the subsequent sale or closure of a store, these costs are treated as a
reduction in the total amount realized or as charge against earnings in the
period the store is closed.
A summary of obligations is as follows:
<TABLE>
<CAPTION>
Description of Obligation: Dec. 31, 1996 Dec. 31, 1995 Dec. 31, 1994
- -------------------------- ------------- ------------- -------------
<S> <C> <C> <C>
Due to Former Shareholders $ 406,000 $ 472,000 $ 520,000
Graham & Dunn 11,707 0 0
Sternfeld 24,428 32,934 50,000
Payable on Store Reacquisitions 98,569 140,984 164,240
------------- ------------- -------------
540,704 645,918 734,240
Less Current Portion 136,700 105,213 142,614
------------- ------------- -------------
Total Long Term Debt $ 402,004 $ 540,705 $ 591,626
============= ============= =============
</TABLE>
Five Year Maturities For Fiscal Years Ending December 31 Are As Follows:
1997 $ 138,700
1998 98,088
1999 78,837
2000 78,379
2001 79,058
2002 and After 67,644
------------
Total $ 540,704
============
F-69
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors
Quality Franchise Systems, Inc. and Subsidiary
We have audited the accompanying consolidated balance sheets of Quality
Franchise Systems, Inc. and Subsidiary as of December 31, 1996, and the related
consolidated statements of operations, shareholders' equity (deficit), and cash
flows for the year then ended. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audit. The financial statements of
Quality Franchise Systems, Inc. as of December 31, 1995 and for each of the two
years ended December 31, 1995, were audited by other auditors whose report dated
March 26, 1996, expressed an unqualified opinion on those statements.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that out audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above, present fairly, in
all material respects, the consolidated financial position of Quality Franchise
Systems, Inc. and Subsidiary as of December 31, 1996, and the results of their
operations and their cash flows for the year then ended, in conformity with
generally accepted accounting principles.
Grant Thornton LLP
Sacramento, California
March 7, 1997
F-70
<PAGE>
<TABLE>
<CAPTION>
Quality Franchise Systems, Inc. and Subsidiary
Consolidated Balance Sheet
September 30, 1997 (Unaudited) and December 31, 1996
ASSETS
1997 1996
----------- -----------
<S> <C> <C>
Cash $ 125,233 $ 126,089
Royalties receivable, net 114,028 160,792
Current portion of area development fees receivable 10,795 25,991
Other current assets 8,040 25,110
----------- -----------
Total current assets 258,096 337,982
----------- -----------
Interest-bearing deposit in bank 0 750,000
Notes and long-term royalties receivable, net 0 24,481
Area development fees receivable, less current portion 38,562 348,424
Deferred financing costs, net 38,635 63,805
Franchising rights, contracts and trademarks, net 203,278 249,910
Merger costs (Jreck Subs Group, Inc.) 64,777 0
Investment in restaurant 0 45,001
Furniture and equipment, net 9,622 41,840
----------- -----------
$ 612,970 $ 1,861,443
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued expenses $ 527,934 $ 633,595
Current portion of notes payable 6,667 26,545
Notes payable to shareholders 172,850 312,850
Deferred franchise fees 20,000 70,000
----------- -----------
Total current liabilities 727,451 1,042,990
----------- -----------
Deferred area development fees 74,500 424,500
Convertible notes payable 530,000 530,000
----------- -----------
Total liabilities 1,331,951 1,997,490
=========== ===========
Shareholders' Equity (Deficit):
Preferred stock ($.001 par value, 2,000,000 shares
authorized, 545 shares issued and outstanding) 1 1
Common stock ($.001 par value, 10,000,000 shares
authorized, 353,650 shares issued and outstanding) 354 354
Class B common stock ($.001 par value, 10,000,000 shares
authorized, 2,229,496 and 2,464,100 shares issued and
outstanding) 2,229 2,464
Additional paid-in capital 1,859,472 2,588,845
Accumulated deficit (2,581,037) (2,563,003)
Treasury stock, at cost, 73,204 shares 0 (164,708)
----------- -----------
Total shareholders' equity (deficit) (718,981) (136,047)
=========== ===========
$ 612,970 $ 1,861,443
=========== ===========
</TABLE>
See notes to consolidated financial statements.
F-71
<PAGE>
<TABLE>
<CAPTION>
Quality Franchise Systems, Inc. and Subsidiary
Consolidated Statement of Operations
For the Nine and Three Months Ended September 30, 1997 and 1996 (Unaudited)
Nine Month Ended Three Months Ended
September 30, September 30,
1997 1996 1997 1996
----------- ------------ ----------- -----------
Revenue:
<S> <C> <C> <C> <C>
Franchise royalties $ 905,337 $ 848,897 $ 315,787 $ 311,776
Initial franchise and transfer fees 160,260 111,000 80,260 10,000
Area development fees 45,000 171,987 (15,000) (70,153)
Vendor funds 229,850 101,496 138,005 44,311
Other 137,591 93,346 57,491 32,335
----------- ------------ ----------- -----------
1,478,038 1,326,726 576,543 327,909
----------- ------------ ----------- -----------
Expenses:
General and administrative 496,581 636,093 157,846 233,430
Restaurant servicing and area developer
share of fees 581,553 600,020 208,269 246,042
Area development expense 43,125 364,664 (23,079) 126,294
Other 46,751 46,381 26,828 14,498
1,168,010 1,647,158 369,864 620,264
Operating income (loss) 310,028 (320,432) 206,679 (292,355)
Other income (expense):
Loss from operation and (84,010) (23,807) (8,361) (23,807)
disposition of restaurant
Business expansion expense (98,630) - (98,630) -
Interest expense (92,430) (121,247) (32,642) (33,332)
Net income (loss) $ 34,958 $ (465,486) $ 67,046 $ (349,494)
----------- ------------ ----------- -----------
Preferred stock dividends (52,992) (21,957) (17,858) (17,550)
----------- ------------ ----------- -----------
Net income (loss) to common shareholders $ (18,034) $ (487,443) $ 49,188 $ (367,044)
----------- ------------ ----------- -----------
</TABLE>
See notes to consolidated financial statements.
F-72
<PAGE>
<TABLE>
<CAPTION>
Quality Franchise Systems, Inc. and Subsidiary
Statement of Cash Flows
For the Nine Months Ended September 30, 1997 and 1996 (Unaudited)
1997 1996
Cash Flows from Operating Activities:
<S> <C> <C>
Net loss $ (18,034) $ (487,443)
Adjustments to Reconcile Net Loss to Net
Cash Provided by Operating Activities:
Provision for uncollectible amounts and write-offs 84,481 50,000
Amortization of discount on non-interest bearing notes 27,514 31,823
Amortization and depreciation expense 61,176 49,198
Increase in current and long-term royalties receivable (13,236) (80,076)
(Increase) decrease in area development fees receivable (24,942) 28,159
(Increase) decrease in other current assets 17,070 (26,999)
Increase (decrease) in accounts payable and accrued expenses (105,661) 11,970
Increase (decrease) in deferred area development fees - 304,500
Increase (decrease) in deferred franchise fees (50,000) (25,000)
Net Cash Used in Operating Activities (21,632) (143,868)
Cash Flows from Investing Activities:
Net increase (decrease) in interest-bearing deposit 750,000 (800,000)
Merger costs (64,777)
Investment in restaurant 45,001 (45,508)
Sale (purchase) of equipment 17,674 (20,021)
Net Cash Provided (Used) in Investing Activities 747,898 (865,529)
Cash Flows from Financing Activities:
Issuance (repurchase) of common stock 564,900 805,000
Issuance of preferred stock for cash and conversion of
notes payable, net of costs - 8,716
Payments on notes payable (22,222) (22,222)
Borrowings (repayment) of notes payable to shareholders (140,000) 90,000
Net Cash Provided by (Used in) Financing Activities (727,122) 881,494
Net Increase (Decrease) in Cash (856) (127,903)
Cash at Beginning of Period 126,089 193,848
Cash at End of Period $125,233 $ 65,945
</TABLE>
The accompanying notes are an integral part of these statements.
F-73
<PAGE>
Quality Franchise Systems, Inc. and Subsidiary
Notes to Consolidated Financial Statements
September 30, 1997 (Unaudited) and December 31, 1996
NOTE A - ORGANIZATION AND NATURE OF BUSINESS
Quality Franchise Systems, Inc. (the "Company"), a Delaware corporation was
formed on February 10, 1995. On February 15, 1995, the Company was merged
with Q & S Management with the Company being the surviving entity.
Shareholders of Q & S Management are now the shareholders of the Company.
Quality Marketing Systems, Inc., a Delaware corporation, is a wholly-owned
subsidiary of the Company. It commenced operations on June 5, 1996 and was
formed to operate the Mountain Mike's Pizza restaurant in Boulder, Colorado
which was subsequently sold in April 1997.
On April 1, 1996, the Company filed a Restated Certificate of Incorporation
which increased its authorized shares of capital stock from 10,000,000
shares to 22,000,000 shares consisting of 2,000,000 shares of Preferred
Stock, 10,000,000 shares of Common Stock and 10,000,000 shares of Class B
Common Stock. All existing shareholders of the Company's capital stock at
April 1, 1996 became shareholders of the Company's Class B Common Stock. In
addition, at any time prior to July 2, 1996, each Class B Common Stock
shareholder could convert each share of Class B Common Stock into 1.1
shares of Common Stock. The shareholders of Class B Common Stock are
entitled to one vote per share and the shareholders of Common Stock are
entitled to one-tenth of one vote per share. Shareholders for 321,500
shares of Class B Common Stock converted to 353,650 shares of Common Stock.
The Company is a franchisor which enters into franchise agreements with
various franchisees to own and operate pizza restaurants, within defined
territories, under the name of Mountain Mike's Pizza. There are 75 and 71
franchised restaurants at September 30, 1997 and December 31, 1996,
respectively. The Company also enters into agreements with area developers
whereby the developer performs substantially all of the Company's
obligations under the franchise agreement in exchange for a portion of the
initial franchise fee and ongoing franchise royalties. These agreements
generally provide for the area developer to open a specified number of
franchises in each 12 month period in order for the agreement to remain in
force.
The Company is expanding into other national regions; however, the Company
currently derives substantially all of its revenues from restaurants
operating in the state of California.
NOTE B - SUMMARY OF ACCOUNTING POLICIES
1. Principles of consolidation
The consolidated financial statements include the accounts of Quality
Franchise Systems, Inc. and its wholly-owned subsidiary Quality Marketing
Systems, Inc. All material intercompany accounts and transactions have been
eliminated.
F-74
<PAGE>
Quality Franchise Systems, Inc. and Subsidiary
Notes to Consolidated Financial Statements
September 30, 1997 (Unaudited) and December 31, 1996
2. Use of estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the consolidated financial statements and the reported amounts of
revenues and expenses during the period. Actual results could differ from
those estimates.
3. Revenue recognition
Franchise royalties are generally between 4% and 5% of the individual
franchisee's monthly gross sales (i.e., sales less promotions and
discounts) and are recognized as income when earned.
Initial franchise fees are recognized as income when the Company has
completed substantially all of its obligations in opening the restaurant.
Initial franchise fees are $20,000 to first time franchisees and $10,000 to
existing franchisees opening another restaurant. Deferred franchise fees at
September 30, 1997 and December 31, 1996 are $20,000 and $70,000,
respectively, for unopened restaurants.
Fees received in exchange for area development agreements are recognized as
income when the Company has performed substantially all of the initial
services required under the area development agreement and has no further
obligations to perform services or refund any fees received from the
developer. Fees for area development agreements which are dependent on the
establishment of future franchises or for which collectibility is not
reasonably estimable are deferred and recognized as income when received.
4. Amortization
Amortization of franchising rights, contracts and trademarks (original
amount of $559,824) is provided on a straight-line basis over ten years.
Accumulated amortization at September 30, 1997 and December 31, 1996 is
$356,546 and $309,914, respectively.
5. Income Taxes
On June 5, 1996, the Company became a C corporation for purposes of
computing corporate Federal and state taxes. Prior to June 5, 1996, the
shareholders have elected to have the
F-75
<PAGE>
Quality Franchise Systems, Inc. and Subsidiary
Notes to Consolidated Financial Statements
September 30, 1997 (Unaudited) and December 31, 1996
Company taxed pursuant to subchapter S of the Internal Revenue Code which
provides that, in lieu of Federal corporate income taxes, the shareholders
recognize their proportionate share of the Company's taxable revenue and
deductible expenses on their individual tax returns. For California state
purposes a corporate tax is imposed on S corporations at the rate of 1.5%
of taxable income.
The Company utilizes an asset and liability approach in accounting for
income taxes. This approach requires the recognition of the deferred tax
liabilities and assets for the expected future tax consequences of
temporary differences between the financial statements carrying amounts and
tax basis of assets and liabilities. Deferred tax assets and liabilities
are reflected as currently enacted income tax rates applicable to the
period in which the deferred tax assets or liabilities are expected to be
realized or settled. As changes in tax laws or rates are enacted, deferred
tax assets and liabilities are adjusted through the provision for income
taxes.
6. Reclassifications
Certain amounts in the prior year's financial statements have been
reclassified to conform to the presentation used in the current year.
NOTE C - CASH/INTEREST BEARING DEPOSIT IN BANK
In connection with the issuance of the convertible notes payable in 1995,
there were provisions which designated certain uses of the proceeds. One
provision was to set aside one quarter's interest payment on the
convertible notes payable (see note E). Another provision was to reserve
funds sufficient for the amortizing payments on the Second Priority Note
(see note D). Restricted cash at September 30, 1997 for the interest
reserve and for the retirement of the Second Priority Note was $17,291 and
$6,667, respectively. The savings account of $750,000 at December 31, 1996
was pledged as collateral for a personal loan of the Company's chairman
(see note H).
NOTE D - NOTES PAYABLE
Notes payable consist of a Second Priority Note in the original amount of
$80,000. The Second Priority Note does not bear interest and is secured by
the assets of the Company. The Second Priority Note is payable in 36 equal
monthly installments with the last installment due in January 1998. The
unpaid balance on the second priority note is $6,667 and $28,889 at
September 30, 1997 and December 31, 1996, respectively. Unamortized
discount at September 30, 1997 and December 31, 1996 is $0 and $2,344,
respectively.
F-76
<PAGE>
Quality Franchise Systems, Inc. and Subsidiary
Notes to Consolidated Financial Statements
September 30, 1997 (Unaudited) and December 31, 1996
NOTE E - CONVERTIBLE NOTES PAYABLE/CONVERTIBLE PREFERRED STOCK
In 1995, the Company issued $1,025,000 of promissory notes in conjunction
with the Company's private placement including the conversion of a $100,000
note payable to a shareholder (see note H). The promissory notes are due on
March 24, 2000 and are secured by 22 specific franchise agreements of the
Company. The promissory notes call for interest at 12.75% payable quarterly
and are convertible into Class B Common Stock of the Company at $5.48 per
share.
The proceeds from the promissory notes less offering commissions and
expenses were used to retire indebtedness associated with the Company's
1991 acquisition of the "Mountain Mike's Pizza" restaurant chain and for
working capital purposes.
In connection with the issuance of the convertible promissory notes, the
Company granted the placement manager the right to purchase 18,704 shares
of the Company's Class B Common Stock at a price equal to $5.48 per share
at any time prior to December 5, 1997.
In 1996, the Company offered its convertible note holders to exchange their
notes for convertible preferred stock. The Company offered one share of its
Series A preferred stock for each $1,000 principal of notes. The Series A
preferred stock has a cumulative dividend rate of 13% and each $1,000
principal is convertible into 287.36 shares of the Company's Class B Common
Stock or 316.09 shares of Common Stock. On June 5, 1996, 495 shares of the
Company's Series A preferred stock were issued in exchange for $495,000 of
promissory notes. In July 1996, the Company issued 50 shares of its Series
A preferred stock for $50,000.
NOTE F - INCOME TAXES
At December 31, 1996, the Company has accumulated net operating losses of
approximately $370,000. These losses can be carried forward and applied
against future income of the Company for federal and state income tax
purposes. The net operating losses will begin to expire in 2011. Management
has provided a valuation allowance for the net deferred tax asset due to
their assessment that this asset will "more likely than not" not be
realized.
Deferred taxes at December 31, 1996 are as follows:
F-77
<PAGE>
<TABLE>
<CAPTION>
Quality Franchise Systems, Inc. and Subsidiary
Notes to Consolidated Financial Statements
September 30, 1997 (Unaudited) and December 31, 1996
Deferred tax assets:
<S> <C>
Net operating loss carryforwards $ 148,800
Accounts payable and accrued liabilities 253,400
Franchise fees collected 28,000
430,200
Deferred tax liabilities:
Royalties receivable and other (84,200)
Depreciation (3,000)
(87,200)
Net deferred tax asset 343,000
Valuation allowance (343,000)
$ -
</TABLE>
NOTE G - EMPLOYEE SAVINGS PLAN
The Company has an employee savings plan in which any eligible employee may
participate. The plan is a defined contribution plan 401(k) qualified under
the Internal Revenue Code. The Company made no discretionary contributions
to the plan in 1997, 1996 and 1995.
NOTE H - RELATED PARTY TRANSACTIONS
In May 1995, the Company amended its personal services contract with a
shareholder and the former president which contract was originally entered
in September 1993. Under the terms of the amended contract, the Company
engages the former president to provide consulting services to develop the
"Mountain Mike's" Pizza restaurant chain and compensates the former
president through a base monthly fee and a portion of certain other fees
collected by the Company. For the years ended December 31, 1996 and 1995,
the Company paid $84,000 and $109,733, respectively, to the former
president under the personal services contract. In 1997, the Company and
the former president mutually agreed to cancel the personal services
contract.
The Company had expended amounts and provided services to the former
president and companies controlled by the former president. In April 1995,
the Company and the former
F-78
<PAGE>
Quality Franchise Systems, Inc. and Subsidiary
Notes to Consolidated Financial Statements
September 30, 1997 (Unaudited) and December 31, 1996
president agreed that the total amounts due to the Company including those
due from companies controlled by the former president was $164,708. In
April 1995, the Company acquired 73,204 shares of Class B Common Stock
owned by the former president at $2.25 per share for satisfaction of the
amounts due to the Company by the former president.
The Company has a month-to-month agreement with a shareholder to provide
general consulting services to the Company. The Company paid the
shareholder $84,000 in each of the two years ended December 31, 1996 for
consulting services.
Notes payable to shareholder of $172,850 at September 30, 1997 are payable
to the president of the Company and bears interest at 10%. In connection
with the merger of the Company with and into Admiral's Fleet, Inc., a
Washington corporation (and wholly-owned subsidiary of Jreck Subs Group,
Inc. ("JSGI"), the president accepted JSGI stock for satisfaction of this
note.
The Chairman of the Company personally obtained an $800,000 loan from a
bank with which he acquired 230,000 shares of the Company's Class B Common
Stock at $3.50 per share on June 4, 1996. The Company had pledged as
collateral a $750,000 savings account for the Chairman's loan. In September
1997, the Chairman returned 161,400 shares of the Company's Class B Common
Stock.
NOTE I - COMPANY-OPERATED RESTAURANT
In June 1996, the Company's wholly-owned subsidiary, Quality Marketing
Systems, Inc. began operating a restaurant in Boulder, Colorado which was
sold in April 1997.
From June 5, 1996 through December 31, 1996, the restaurant had a net loss
of approximately $70,100. For the period January 1, 1997 until the
restaurant was sold in April 1997, the restaurant had a net loss of
approximately $77,400 which included the loss on disposition.
F-79
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Stockholders
Little King, Inc.
We have audited the accompanying balance sheet of Little King, Inc., as of
December 29, 1996, and the related statements of operations, stockholders'
equity and cash flows for the year then ended. These financial statements are
the responsibility of the Company's management. our responsibility is to express
an opinion on these financial statements based on our audit. The financial
statements of Little King, Inc. as of December 31, 1995, were audited by other
accountants whose report dated April 18, 1996, except for Note E as to which the
date was December 20, 1996, expressed an unqualified opinion on those
statements.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
we believe that our audit provides a reasonable basis for our opinion.
In our opinion, the 1996 financial statements referred to above present fairly,
in all material respects the financial position of Little King, Inc. as of
December 29, 1996, and the results of its operations and its cash flows for the
year then ended in conformity with generally accepted accounting principles.
/s/ Awerkamp, Goodnight, Schwaller & Nelson, P.C.
Omaha, Nebraska
July 24, 1997
F-80
<PAGE>
<TABLE>
<CAPTION>
LITTLE KING, INC.
BALANCE SHEETS
December 29, 1996 and December 31, 1995
ASSETS (note E)
1996 1995
----------- -----------
CURRENT ASSETS
<S> <C> <C>
Cash $ 2,343 $ 22,595
Current installments of notes receivable
(note B) 18,753 34,702
Franchise fees receivable 9,866 16,563
Other receivables 10,923 4,573
Inventory 5,653 18,545
Prepaid expenses 6,200 10,817
Deferred income taxes 3,411 -
----------- -----------
57,149 107,795
----------- -----------
PROPERTY AND EQUIPMENT, at cost (note C) 104,758 173,368
----------- -----------
OTHER ASSETS
Notes receivable less current
installments above (note B) 89,413 58,188
Franchise rights, net of amortization
of $144,100 and $99,721, respectively 521,606 565,985
Organization costs, net of accumulated
amortization of $1,625 and $1,125, respectively 875 1,375
Deferred stock issue costs (note M) - 41,747
----------- -----------
611,894 667,295
----------- -----------
$ 773,801 $ 948,458
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Checks issued in excess of deposits $ - $ 6,118
Notes payable (note D) 135,000 195,000
Current installments of long-term
notes payable (note E) 2,565 8,654
Accounts payable 104,040 145,680
Accrued expenses 29,271 21,919
Refundable deposit (note F) 54,500 54,500
Due to affiliate (note G) 18,960 18,207
----------- -----------
344,336 450,078
LONG-TERM NOTES PAYABLE, less current
installments (note E) 401,913 452,445
----------- -----------
DEFERRED INCOME TAXES 703 950
----------- -----------
COMMITMENTS (note H)
STOCKHOLDER'S EQUITY (notes E, L, M, N)
Common stock, $0.001 par value; 5,000,000
shares authorized, 3,013,250 and
3,000,000 shares issued and outstanding in 1996 and 1995 3,013 3,000
Additional paid-in capital 311,734 311,734
Accumulated deficit (287,898) (269,749)
----------- -----------
26,849 44,985
----------- -----------
$ 773,801 $ 948,458
=========== ===========
</TABLE>
See accompanying notes
F-81
<PAGE>
<TABLE>
<CAPTION>
LITTLE KING, INC.
STATEMENTS OF OPERATIONS
For the years ended December 29, 1996 and December 31, 1995
1996 1995
----------- -----------
REVENUES
<S> <C> <C>
Net sales $ 630,444 $ 1,124,339
Continuing franchise fees 209,646 175,517
Initial franchise fees 53,500 -
----------- -----------
893,590 1,299,856
----------- -----------
COSTS AND EXPENSES
Product costs 139,139 303,200
Labor costs 334,649 471,037
Operating expenses 449,238 571,580
Depreciation and amortization 68,765 72,670
----------- -----------
991,791 1,418,487
----------- -----------
NET LOSS FROM OPERATIONS (98,201) (118,631)
----------- -----------
OTHER INCOME (EXPENSE)
Interest income 9,462 11,904
Interest expense (60,479) (85,870)
Stock issue costs (38,156) -
Other income 26,731 9,600
Gain on sale of operating stores 138,836 -
----------- -----------
76,394 (64,366)
----------- -----------
NET LOSS BEFORE INCOME TAXES (21,807) (182,997)
INCOME TAX BENEFIT (EXPENSE)
(note I) 3,658 (950)
----------- -----------
NET LOSS $ (18,149) $ (183,947)
=========== ===========
</TABLE>
See accompanying notes
F-82
<PAGE>
<TABLE>
<CAPTION>
LITTLE KING, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
For the years ended December 29, 1996 and December 31, 1995
Common Additional Total
Stock Paid-In Accumulated Stockholders
Issued Capital Deficit Equity
------ ------- ------- ------
BALANCE AT
<S> <C> <C> <C> <C>
JANUARY 1, 1995 $ 10 $ 314,474 $ (85,802) $ 228,682
Net loss - - (183,947) (183,947)
Reclassification due
to reorganization 2,990 (2,990) - -
Sale of 100 shares of
common stock - 250 - 250
------- --------- ---------- ---------
BALANCE AT
DECEMBER 31, 1995 $ 3,000 $ 311,734 $ (269,749) $ 44,985
Net loss - - (18,149) (18,149)
Sale of 13,150 shares
of common stock 13 17,868 17,881
Stock issue costs
(note M) (17,868) (17,868)
------- --------- ---------- ---------
BALANCE AT
DECEMBER 29, 1996 $ 3,013 $ 311,734 $ (287,898) $ 26,849
======= ========= ========== =========
</TABLE>
See accompanying notes.
-4-
F-83
<PAGE>
<TABLE>
<CAPTION>
LITTLE KING, INC.
STATEMENTS OF CASE FLOWS
For the years ended December 29, 1996 and December 31, 1995
1996 1995
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
<S> <C> <C>
Cash received from customers $ 896,692 $ 1,292,254
Cash paid to suppliers and employees (936,828) (1,338,077)
Interest received 6,707 12,174
Interest paid (65,230) (78,384)
Other income 26,731 9,600
----------- -----------
NET CASH USED IN
OPERATING ACTIVITIES (71,928) (103,433)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of equipment 69,632 -
Payment received on notes for sale of
operating stores 62,009 80,795
Purchase of property and equipment (72) (7,710)
----------- -----------
NET CASH PROVIDED BY INVESTING ACTIVITIES 131,569 73,085
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of long-term
notes payable - 6,650
Principal payments on long term
notes payable (367,927) (110,594)
Proceeds from issuance of long-term
notes payable to stockholders 325,667 -
Principal payments on long-term notes
payable to stockholders (23,612) -
Net payments to affiliate - (9,415)
Net borrowing under short-term notes payable (14,034) 195,000
Proceeds from issuance of common stock 17,875 250
Stock issue costs (17,862) (41,747)
----------- -----------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES (79,893) 40,144
----------- -----------
NET INCREASE (DECREASE) IN CASH (20,252) 9,796
CASH AT BEGINNING OF YEAR 22,595 12,799
----------- -----------
CASH AT END OF YEAR $ 2,343 $ 22,595
=========== ===========
RECONCILIATION OF NET EARNINGS To NET
CASH FROM OPERATING ACTIVITIES
Net loss $ (18,149) $ (183,947)
Adjustments to reconcile net loss to
net cash from operating activities
Depreciation 23,886 27,809
Amortization 44,879 44,861
Gain on sale of equipment (138,836) -
Stock issue costs 41,747 -
(Increase) Decrease in receivables 347 (8,332)
Decrease in inventory 12,892 3,015
(Increase) Decrease in prepaid expenses 4,617 (5,080)
Increase (Decrease) in accounts payable
and other current liabilities (39,653) 17,291
Increase (Decrease) in deferred
income taxes (3,658) 950
$ (71,928) $ (103,433)
=========== ===========
</TABLE>
See accompanying notes
-5-
F-84
<PAGE>
LITTLE KING, INC.
NOTES TO FINANCIAL STATEMENTS
December 29, 1996 and December 31, 1995
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business, Risks and Uncertainties
The Company is the owner and franchisor of Little King restaurants. Each Little
King restaurant is essentially a deli selling "submarine" sandwiches, but also
offers a wide variety of other menu items. There are 37 Little King franchises,
operating in eight states, primarily located in the Midwest. In addition to
franchising, the Company owns and operates two Little King restaurants in
Nebraska.
Use of Estimates
The process of preparing financial statements in conformity with generally
accepted accounting principles requires the use of estimates and assumptions
regarding certain types of assets, liabilities, revenues, and expenses. Such
estimates primarily relate to unsettled transactions and events as of the date
of the financial statements. Accordingly, upon settlement, actual results may
differ from estimated amounts.
Risks and Uncertainties
Substantially all of the restaurant food items and paper are acquired from a
single supplier. A change in suppliers could have an adverse affect on operating
results due to higher costs and fewer rebates.
Fiscal Year
The Company's fiscal year ends on the Sunday which falls closest to December 31.
The years ended December 29, 1996 and December 31, 1995 consisted of 52 weeks.
Franchise Fees
Franchise fees consist of an initial fee due upon awarding the franchise to the
franchisee and a continuing weekly service fee based upon a percentage of gross
sales of the franchisee.
The initial fee is recognized as revenue when all material conditions relating
to the franchise sale have been satisfied and the franchise commences
operations. Continuing franchise fee revenue, based on a percentage of
restaurant sales of the franchisee is recorded as earned.
Inventory
Inventory is stated at the lower of cost (first-in, first-out) or market, and
consists of restaurant food items and paper.
Depreciation
Property and equipment is depreciated using straight-line methods for financial
reporting purposes and accelerated methods for income tax purposes over the
estimated useful lives of the assets.
Franchise Rights
Franchise rights represent the acquisition cost attributable to the franchise
agreements and are being amortized using the straight-line method over 15 years.
Amortization expense charged to operations for the periods ended 1996 and 1995
was $44,379 and $44,361, respectively.
-6-
F-85
<PAGE>
LITTLE KING, INC.
NOTES TO FINANCIAL STATEMENTS
December 29, 1996 and December 31, 1995
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Organization Costs
Organization costs are amortized on the straight-line method over 5 years.
Amortization expense charged to operations for the periods ended December 1996
and 1995 was $500.
NOTE B - NOTES RECEIVABLE
The notes receivable are from franchisees who purchased operating stores. The
Company receives weekly payments of principal and interest from the franchisees
in lieu of continuing franchise fees. The notes receivable bear interest at 10%.
NOTE C - PROPERTY AND EQUIPMENT
The following is a summary of property and equipment - at cost, less
accumulated depreciation:
1996 1995
---------- ------------
Vehicles $ 4,584 $ 4,584
Leasehold improvements 45,334 45,334
Furniture and Fixtures 109,303 183,752
---------- ------------
159,221 233,670
Less: Accumulated Depreciation (54,463) (60,302)
---------- ------------
$ 104,758 $ 173,368
========== ============
Depreciation expense change to operations was $23,886 and $27,809 in 1996 and
1995, respectively.
NOTE D - NOTES PAYABLE
Short-term notes payable consist of the following:
1996 1995
---------- ------------
First National Bank of Omaha $ 135,000 $ 135,000
Other - 60,000
---------- ------------
$ 135,000 $ 195,000
========== ============
Note payable to First National Bank of Omaha is due on June 27, 1997 and bears
interest at the bank's investment savings account base rate plus 2.25% (7.87% at
December 29, 1996). The note is secured by a savings account held at the bank
and owned by the President of the Company. This note was subsequently refinanced
with the Pinnacle Bank with similar terms.
Notes payable other were due on March 31, 1996 and bear interest at 18%. The
notes are secured by funds collected in connection with a January 15, 1996 small
stock offering (note M). These notes were refinanced as long-term obligations
(note E).
F-86
<PAGE>
LITTLE KING, INC
NOTES TO FINANCIAL STATEMENTS
December 29, 1996 and December 31, 1995
NOTE E - LONG-TERM NOTES PAYABLE
1996 1995
---------- ----------
UNRELATED PARTIES
Notes payable to Douglas County Bank & Trust
Co., Omaha, Nebraska in aggregate monthly
installments of $6,000, including interest at
311% in excess of Citibank, N.A. prime rate of
interest through June 25, 1996, at which time
the remaining balance is due. Secured by
substantially all assets and personally
guaranteed by Sidney B. Wertheim $ - $ 363,054
Note payable to W.R. Lesoing and Delia Lesoing
in monthly installments of $361 including
interest at 12.5% through April 1997. Secured
by certain equipment. 1,406 5,291
Note payable to H.P. Smith Motors, Inc. in
monthly installments of $130 including interest
at 15.65% through April 1, 1998. Secured by
related vehicle 3,019 4,007
Notes payable other to Albert Walla and Irene
Nosal due January 1, 1998 with interest at 10%.
These notes can be converted to common stock at
anytime before payment at a rate of $0.50 per
share. Subsequent to year and these notes have
been repaid. 45,966 -
---------- ----------
TOTAL UNRELATED PARTIES 50,391 372,352
RELATED PARTY
Note payable to Sidney a. Wertheim majority
shareholder, in weekly installments of $400
through January, 1999, where the remaining
balance and interest at 8% compounded annually
will be due 354,087 88,747
---------- ----------
Total long-term notes payable 404,478 461,099
Less current installments 2,565 8,654
---------- ----------
$ 401,913 $ 452,445
========== ==========
Maturities of long-term notes payable for the years subsequent to December 29,
1996 are as follows:
1997 $ 2,565
1998 47,324
1999 354,589
----------
$ 404,478
==========
F-87
<PAGE>
LITTLE KING, INC.
NOTES TO FINANCIAL STATEMENTS
December 29, 1996 and December 31, 1995
NOTE F - REFUNDABLE DEPOSIT
The refundable deposit is payable to Jeffrey M. Trenk, a potential shareholder
of the Company. Mr. Trenk was unable to complete his financial commitment to the
Company and never became a shareholder. Subsequent to year and this deposit was
settled by the majority shareholder and the balance is due to him.
NOTE G - RELATED PARTY TRANSACTIONS
The Company had the following transactions with SRW, Inc. (majority owned by the
Company's president);
1996 1995
---------- ----------
Continuing franchise fees due Little King, Inc. $ 37,491 $ 39,829
========== ==========
Area development fees due SRW, Inc. $ 38,051 $ 21,375
========== ==========
Franchise fees receivable $ - $ 2,419
========== ==========
Due to affiliate $ 18,960 $ 18,207
========== ==========
NOTE H - LEASE COMMITMENT
The Company leases office space and one operating store from Sidney B. Wertheim,
President. The agreements provide that the Company pay monthly rental, real
estate taxes, insurance and maintenance costs. Total rent expense relating to
these leases amounted to $59,291 and $63,188 for the periods ending 1996 and
1995, respectively.
In addition, the Company leased four- operating stores under agreements
accounted for as operating leases. Certain of these leases contain renewal
options which management expects to renew. Total rent expense under these leases
was $57,166 and $106,882 for the periods ending December 31, 1995 and January
1, 1995, respectively.
The future minimum rental commitments of noncancellable operating leases are as
follows:
1997 $ 76,264
1998 77,843
1999 70,343
2000 60,190
2001 61,927
Thereafter 380,943
-------------
$ 727,510
=============
NOTE I - INCOME TAXES
Change in tax status
The Company has terminated the Subchapter S election as of October 31, 1995.
Earnings and losses after that date will be recorded on the Company's income tax
return and taxed at the corporate level instead of the individual shareholders,
income tax return. Effective as of the termination date of the Subchapter S
status, the Company will record income taxes currently payable and deferred
income taxes. As a result, the Company recorded an expense for the change in tax
status of $7,015 as of that date.
F-88
<PAGE>
LITTLE KING, INC.
NOTES TO FINANCIAL STATEMENTS
December 29, 1996 and December 31, 1995
NOTE I - INCOME TAXES (continued)
The provision (benefit) for income taxes includes these components:
1996 1995
---------- ----------
Taxes currently payable $ - $ -
Deferred income taxes (3,658) 155
Benefits of net operating loss carryforward - (6,310)
Change in tax status to taxable entity - 7,105
---------- ----------
$ (3,658) $ 905
========== ==========
Deferred income taxes arise from temporary differences resulting from income and
expense items reported for financial accounting and tax purposes in different
periods. Deferred taxes are classified as current or noncurrent, depending on
the classification of the assets and liabilities to which they relate. Deferred
taxes arising from temporary differences that are not related to an asset or
liability are classified as current or noncurrent depending on the periods in
which the temporary differences are expected to reverse.
Temporary differences giving rise to the deferred tax liability primarily
consist of the excess of depreciation for tax purposes over the amount for
financial reporting purposes.
As of December 29, 1996, the Company has available an unused operating loss
carryforward of $18,586, which expires December 31, 2010.
NOTE J - ADDITIONAL CASH FLOW INFORMATION
1996 1995
---------- ----------
Noncash Investing and Financing Activities
Long-term note receivable received for the
sale of operating store $ 114,000 $ -
========== ==========
Long-term note receivable paid to majority
stockholders as payment $ 36,715 $ -
========== ==========
Short-term debt refinanced as long term debt $ 45,966 $ -
========== ==========
Long-term debt issued for property,
plant and equipment $ - $ 23,014
========== ==========
Par value of common stock given as an
inducement for notes payable (note 2) $ 6 $ -
========== ==========
NOTE K - RETIREMENT PLAN
The Company has a contributory retirement plan (401 (k) plan) covering
substantially all of its employees. To be eligible for the plan, the employee
must have one year of service and have attained the age of 21. The Company
matches 50% of the employees, contributions, not to exceed 6% of the
participating employee's annual compensation. The matching contributions
amounted to $917 and $1,348 for the periods ended 1996 and 1995, respectively.
F-89
<PAGE>
LITTLE KING, INC.
NOTES TO FINANCIAL STATEMENTS
December 29, 1996 and December 31, 1995
NOTE L - SHAREHOLDERS' EQUITY
On September 29, 1995, the Company's sole shareholder amended the Certificate of
Incorporation increasing the authorized shares of common stock from 1,000
shares of $0.01 par value common stock to 5,000,000 shares of $0.001 par value
common stock effective as of October 31, 1995. Additionally, the shareholder
approved a reorganization in which all of the previously authorized and
outstanding shares of $0.01 par value common stock were converted into 2,999,900
shares of $0.001 par value common stock.
NOTE M - SMALL STOCK OFFERING
On January 15, 1996, the company made a $1,000,000 maximum offering in
accordance with an exemption from registration under Rule 304 of Regulation D
promulgated under the Securities Act of 1933, as amended or other exemptions
under the Act. A maximum of 200,000 units with each unit comprised of two (2)
shares of $0.001 par value Common Stock is being offered at $5.00 per unit.
The Company received $17,875 (3,575 units) from this offering. The proceeds from
this offering were used to pay certain offering cost and to reduce the notes
payable to Albert Walla and Irene Nosal (note E).
The Company incurred $56,026 of costs relating to the offering of which $27,868
was charged to additional paid in capital and $38,158 was charged to current
operations.
In addition, the Company issued 6,000 shares to Albert Walla and Irene Nosal as
an inducement for them for their loans to the Company to pay the offering costs.
NOTE N - SUBSEQUENT EVENT
On July 23, 1997, the Company and it's majority shareholder, Sidney B. Wertheim,
entered into an agreement with Jreck Subs Group, Inc., (JRECK) a publically
traded company, that provided for JRECK to acquire all of the outstanding common
stock owned by Mr. Wertheim (3,000,000 shares) for 1,200,000 shares of JRECK'S
common Stock.
In addition, JRECK will purchase from Mr. Wertheim the assets of seven Little
Kings stores currently owned by him for $250,000. The agreement also provides
for an employment agreement for Mr. Wertheim to continue as the Chief Operating
officer of the Company.
-11-
F-90
<PAGE>
Ronald R. Antonucci
Certified Public Accountant
687 Lee Road
Rochester, New York 14606
716-254-7790
Richey Enterprises, Inc.
I have audited the accompanying balance sheets of Richey Enterprises, Inc. as of
August 15, 1997 and December 31, 1996 and the related statements of income, and
cash flows for the seven & 1/2 months and year then ended. The financial
statements responsibility of the directors. My responsibility is to express an
opinion on these financial statements based on my audit.
I conducted my audit in accordance with generally accepted auditing standards.
Those standards require that I plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
I believe that my audit provides a reasonable basis for my opinion.
In my opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Richey Enterprises, Inc. as of
December 31, 1996 and the results of its operations, its cash flows for the year
then ended in conformity with generally accepted accounting principles.
January 14, 1999
Ronald Antonucci
Certified Public Accountant
F-91
<PAGE>
<TABLE>
<CAPTION>
Richey Enterprises, Inc.
Balance Sheet
August 15, 1997 and December 31, 1996
Assets
Aug. 15, 1997 Dec. 31, 1996
------------- -------------
Current Assets:
<S> <C> <C>
Cash $ 9,145 $ 11,247
Prepaid Expenses 0 8,795
------------- -------------
Total Current Assets 9,145 20,042
Property and Equipment:
Restaurant Equipment & Store Improvements 135,745 135,591
Vehicle 18,343 18,343
Office Equipment 3,740 2,281
------------- -------------
Total Cost of Property and Equipment 157,828 156,215
Less Accumulated Depreciation (58,926) (46,710)
------------- -------------
Property and Equipment (Net) 98,902 109,505
Other Assets:
Goodwill-net 15,000 15,000
Covenant not to Compete-net 6,734 17,267
Organization Costs-net 187 563
------------- -------------
Total Other Assets 21,921 32,830
Total Assets $ 129,968 $ 162,377
============= =============
Liabilities and Stockholder's Equity
Aug. 15, 1997 Dec. 31, 1996
------------- -------------
Current Liabilities:
Accounts Payable $ 11,360 $ 9,364
Current Portion of Long Term Debt 31,548 13,779
------------- -------------
Total Current Liabilities 42,908 23,143
Long Term Debt 118,333 149,881
Stockholder's Equity:
Common Stock 65,113 65,113
Retained Earnings (Deficit) (96,386) (75,760)
------------- -------------
Total Stockholder's Equity (Deficit) (31,273) (10,647)
Total Liabilities and Stockholder's Equity $ 129,968 $ 162,377
============= =============
</TABLE>
See Notes to Financial Statements.
F-92
<PAGE>
<TABLE>
<CAPTION>
Richey Enterprises, Inc.
Statement of Income and Retained Earnings
Seven and One Half Months Ended August 15, 1997
and Year Ended December 31, 1996
7 & 1/2
Months
Ended Year Ended
Aug. 15, 1997 Dec. 31, 1996
------------- -------------
<S> <C> <C>
Sales $ 264,839 $ 476,936
Cost of Sales:
Food & Paper Supplies 100,298 180,914
------------- -------------
Gross Profit 164,541 296,022
Selling, General and Administrative Expenses 177,207 309,265
Income (Loss) Before Other Income and Income Taxes (12,666) (13,243)
Other Income 0 0
------------- -------------
Income (Loss) Before Taxes (12,666) (13,243)
Income Taxes 0 0
------------- -------------
Net Income (Loss) (12,666) (13,243)
Accumulated Adjustments-Beginning of Year (75,760) (44,951)
Shareholder's Capital Contributions 0 0
Distributions (7,960) (17,566)
------------- -------------
Accumulated Adjustments (Retained Earnings)-End of
Year $ (96,386) $ (75,760)
============= =============
</TABLE>
See Notes to Financial Statements.
F-93
<PAGE>
<TABLE>
<CAPTION>
Richey Enterprises, Inc.
Statements of Cash Flows
Seven and One Half Months Ended August 15, 1997
and Year Ended December 31, 1996
7 & 1/2
Months
Ended Year Ended
Aug. 15, 1997 Dec. 31, 1996
------------- -------------
Operating Activities:
<S> <C> <C>
Net Income (Loss) $ (12,666) $ (13,243)
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 23,126 51,374
Changes in operating assets and liabilities
(Increase) Decrease in prepaid expenses 8,795 4,654
(Decrease) Increase in accounts Payable (1,996) 4,193
------------- -------------
Total Cash (Consumed) Provided by Operating Activities 17,259 46,978
Investing Activities:
Acquisition of Equipment (1,614) (56,575)
Cash Received on Sale of Equipment 3,992 0
------------- -------------
Total Cash Used in Investing Activities 2,378 (56,575)
Financing Activities:
Distributions to Shareholders (7,960) (17,566)
Proceeds of Long Term Debt Borrowings 0 75,546
Payments on Long Term Debt (13,779) (26,140)
------------- -------------
Total Cash Provided (consumed) by Financing Activities (21,739) 31,840
Decrease in cash and cash equivalents (2,102) 22,243
Cash and cash equivalents-beginning 11,247 (10,996)
------------- -------------
Cash and cash equivalents ending $ 9,145 $ 11,247
============= =============
Other cash flow information-Interest paid $ 10,614 $ 14,760
</TABLE>
See Notes to Financial Statements
Page 4
F-94
<PAGE>
Richey Enterprises, Inc.
Notes to Financial Statements
Seven and One Half Months Ended August 15, 1997
and Year Ended December 31, 1996
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statement and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from the estimates.
Cash & Cash Equivalents
For financial statement presentation purposes, the Company considers those
short-term, highly liquid investments with original maturities of three
months or less to be cash or cash equivalents.
Property & Equipment
All property is stated at original cost less accumulated depreciation.
Depreciation expense is computed using IRS guidelines for the types of
assets owned by the Company. For the seven and one half months ended August
15, 1997 and year ended December 31, 1996 depreciation expense was $10,730
and 21,878 respectively. Depreciation is computed using the straight-line
method over the estimated useful life of the related assets as follows:
Store Equipment 7 years
Improvements 39 years
Trucks 7 years
Expenditures for renewals and betterments are capitalized. Expenditures for
minor items, repairs and maintenance are charged to operations as incurred.
Gain or loss upon sale or retirement due to obsolescence is reflected in the
operating results in the period the event takes place.
Revenue Recognition
Sales are recognized when a immediately when product is sold at the cash
register and all material conditions relating to the sale have been
substantially performed.
Fair Value of Financial Instruments
Statements 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 August 15, 1997.
F-95
<PAGE>
Richey Enterprises, Inc.
Notes to Financial Statements
Seven and One Half Months Ended August 15, 1997
and Year Ended December 31, 1996
Fair Value of Financial Instruments (Cont'd)
The respective carrying value of certain on-balance sheet financial
instruments approximated their fair values. These financial instruments
include cash and cash equivalents, marketable securities, trade receivables,
accounts payable and accrued each expenses. 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 value of the Company's
notes payable is estimated based upon the quoted market prices for the same
or similar issues or on the current rates offered to the Company for debt of
the same remaining maturities. The carrying value approximates the fair
value of the notes payable.
Income Taxes
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes,"
("SFAS 109") which requires recognition of estimated income taxes payable or
refundable on income tax returns for the current year and for the estimated
future tax effect attributable to temporary differences and carry forwards.
Measurement of deferred income tax is based on enacted tax laws including
tax rates, with the measurement of deferred income tax assets being reduced
by available tax benefits not expected to be realized.
Impairment of Long Lived Assets
The Company adopted Statement of Financial Accounting Standards No, 121.
"Accounting for the Impairment of Long Lived Assets and for Long Lived
Assets to be Disposed of," ("SFAS 121") SFAS 121 requires impairment losses
to be recorded on long lived assets used in operations and goodwill when
indications of impairment are present and the undiscounted cash flows
estimated to be generated by those assets are less than the carrying amount
of the asset.
Recent Accounting Pronouncements
Effective for periods beginning after December 15, 1997, the Financial
Accounting Standards Board issued Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income," ("SFAS 130") and
Statement of Financial Accounting Standards No. 131, "Disclosure about
segment of an Enterprise and Related Information," ("SFAS 13 1"). SFAS 130
establishes standards for report reporting and displaying comprehensive
income, its components and accumulated balances. SFAS 131 establishes
standards for the way that public companies report information about
operating segments in annual financial statements and requires reporting of
selected information about operating statements in interim financial
statements issued to the public. The Company has not determined the impact
adoption of these new accounting standards will have on its future financial
statements and disclosures.
F-96
<PAGE>
Richey Enterprises, Inc.
Notes to Financial Statements
Seven and One Half Months Ended August 15, 1997
and Year Ended December 31, 1996
Intangible Assets
Goodwill represents the excess of cost over fair value of net tangible
assets acquired. It is not being amortized, however, the value is evaluated
periodically for impairment if events or circumstances indicate a possible
inability to recover the carrying amount. When any impairment exists, the
goodwill is written down to fair value. The Covenant Not to Compete is
amortized straight line over its five year life.
B. Income Taxes
The Company has elected to be taxed as an "S" corporation. "S" corporations,
acting as a flow through entity, normally do not incur any income tax. Therefore
no provision for income tax expense has been made.
C. Long Term Debt:
Long term debt consists of five separate financing arrangements, bearing
interest at 9%-12%, made for the acquisition of (and secured by) store equipment
and improvements. Monthly payments total approximately $ 3,900. A summary of
maturities is as follows:
================================================================================
Year Ended Amount
December 31, 1998 $ 31,548
December 31, 1999 28,142
December 31, 2000 23,800
December 31, 2001 25,344
December 31, 2002 & Later 41,047
---------
TOTAL $ 149,881
=========
================================================================================
D. Commitments:
The Company rents its restaurant locations under month to month agreements. Rent
expense the seven and one half months ended August 15, 1997 and year ended
December 31, 1996 was $28,657 and 52,921 respectively.
F-97
