U.S Securities and Exchange Commission
Washington, D.C. 20549
Form 10-KSB
[ ] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the year ended September 30, 2000
0-23545
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Commission File Number
Ultimate Franchise Systems, Inc. (formerly Jreck Subs Group, Inc.)
----------------------
(Exact name of small business issuer as specified in its charter)
Colorado 84-1317674
-------- ----------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
2101 West State Road 434, Suite 100, Longwood, Florida, 32779
--------------------------------------------------------------
(Address of principal executive offices)
(407) 682-6363
--------------
(Issuer's telephone number including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, No Par Value
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form and no disclosure will be contained, to
the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB [ ]
The Registrant's revenue for the fiscal year ended September 30, 2000:
$4,491,940.
The aggregate market value of the voting and non-voting common equity held by
non-affiliates (computed by reference to the price at which the common equity
was sold, or the average bid and asked price of such common equity) as of
January 5, 2001 was $3,309,447 (for purposes of the foregoing calculation only,
each of the registrant's officers and directors is deemed to be an affiliate).
There were 52,951,156 shares of the registrant's common stock outstanding as of
January 5, 2001.
DOCUMENTS INCORPORATED BY REFERENCE:
None
Transitional Small Business Disclosure Format: Yes [ ] No [X]
<PAGE>
PART I
Item 1. Description of Business.
Form and Year of Organization
In May, 1996 the Company concluded a reverse acquisition wherein all of its
capital stock was acquired by Circa Media, Inc., a Colorado corporation,
incorporated on July 19, 1995 and formerly engaged in reproducing archival,
public domain art and photographs in digital form. Pursuant to an agreement and
Plan of Reorganization between JRECK Subs, Inc. and Circa Media, Inc., Circa
Media, Inc. changed its name to JRECK Subs Group, Inc. (the Company) on May 7,
1996 and the former shareholders of JRECK Subs, Inc. received 5,000,000 common
shares of the Company in the transaction or 56% of the outstanding shares. In
addition the former Series A Preferred shareholders of JRECK Subs, Inc. received
700,000 shares of the Company's Series A Preferred stock. The former business of
Circa Media, Inc. was discontinued.
In June 2000, the Company changed the name of the corporation from Jreck Subs
Group, Inc. to Ultimate Franchise Systems, Inc. and changed its ticker symbol
from JSUB to UFSI.
The Company has primarily grown through acquisitions and now consists of
Ultimate Franchise Systems, Inc. (UFSI) and its wholly owned subsidiaries as
follows:
- ------------------------------------------------------------------------------
State of
Corporation Name Incorporation Predominant Restaurant Concept
- ---------------- ------------- -----------------------------
JRECK Subs, Inc. New York "JRECK Subs","Lox, Stox & Bagel"
Central Park of America, Inc. Delaware "Central Park"
SBK Franchise Systems, Inc. Florida "Sobik's"
Li'l Dino Corporation North Carolina "Li'l Dino"
Pastry Product Producers, LLC New York Bakery Operations
- ------------------------------------------------------------------------------
Recent Acquisition and Dispositions
In July of 2000 the Company acquired the franchising rights and certain
corporately owned restaurants from Central Park USA, Inc., a twenty-year old
60-unit hamburger restaurant franchisor located primarily in the Southeastern
United States and the state of Utah. The Company paid the purchase price of
$2,373,074 by issuing notes with a value of $1,433,874, $800,000 in cash and
435,000 shares of the Company's common stock with a value of $139,200. The
Company also entered into three non-compete agreements with a discounted value
of $364,020.
In April 2000, the Company sold its Mountain Mike's Pizza concept, a chain of
approximately 80 franchised restaurants to Concept Acquisitions, LLC ("COAC")
for $3,000,000 cash and two notes receivable with discounted value of $165,534
of $377,645, respectively. COAC is controlled by Bradley L. Gordon, the former
Chief Operating Officer and Director of the Company.
In August 2000, the Company sold the Seawest Subs sandwich chain, a chain of
approximately 30 franchised restaurants for a $55,000 note receivable plus the
assumption by the buyer of notes payable of approximately $207,000.
The Company continues to have financial interests in the Mountain Mike's Pizza
and Seawest Subs franchise concepts.
In October 2000, the Company formed a wholly-owned subsidiary, Bakery
Acquisition Corporation ("Bakery"). It is the Company's intention to merge
Pastry Products Producers, LLC into Bakery and for Bakery to issue 2,750,000
shares of its common stock to the current shareholders of the Company.
General Description of Business
The Company is a multiple concept franchisor of submarine sandwich restaurants
and drive-through hamburger restaurants. Through its concepts, Ultimate
Franchise Systems, Inc. offers a menu of high quality, fresh submarine
sandwiches, hamburgers, chicken sandwiches, french fries, soups and hot and cold
side order items, and a full line of bagel offerings at selected franchise
locations.
Submarine Sandwich Menu and Stores
Through three of its subsidiaries, UFSI offers a lunch and dinner menu of
different submarine sandwiches, soups and hot and cold side orders as well as a
line of bagels and additional breakfast items. UFSI's submarine shop philosophy
is to offer a wider selection of menu items and higher quality ingredients (such
as rib eye steak) cooked on the premises. The food preparation area is open to
customer view to engage customer interest and to showcase cleanliness and
freshness. The food preparation process is designed to deliver a completed food
order within 60 seconds. Sandwich menu prices range from $2.50-$5.95. In
addition, UFSI offers a selection of soft drinks, deep fried mushrooms, cheese
sticks and french fries as well as dessert items such as cookies. Certain
restaurant concepts also offer signature rolls baked fresh on the premises.
As of September 30, 2000 there was an aggregate of 102 franchised locations
under various submarine sandwich concepts as follows:
Concept: Number of Units Geographic Area
-------- --------------- ---------------
"JRECK Subs","Lox, Stox & Bagel" 44 Upstate New York
"Sobik's" 28 Central Florida
"Li'l Dino" 30 Central North Carolina
Each location is designed as a "dine in" location (with many offering a drive up
window). Restaurants range in size from 1,000 square feet to 2,000 square feet
(1,400 to 1,500 square feet being typical), and are located in strip shopping
centers, shopping malls and free standing buildings.
2
<PAGE>
As is typical in sandwich shops, the majority of store sales occur during lunch
with the balance during the dinner hours. Dine in and take out (including
delivery) comprise 60% and 40% of sales respectively. Individual franchisees may
also offer catering services for special events and also may provide a full line
of products on a temporary site basis by utilizing authorized mobile facilities.
Each franchisee leases or owns its own store facilities. Neither the Company,
nor any of its affiliates, engage in leasing any store premises to any
franchisees.
Hamburger Menu and Stores
Central Park provides its products under a fast service, double drive-through
restaurant format.
Central Park offers hamburgers, french fries, chicken sandwiches, hot dogs and
soft drinks. Central Park also offers a limited breakfast menu consisting of
breakfast sandwiches, hashed browns and pastries.
The Central Park locations are designed for drive-through with some walk-up
order service. Some restaurants provide limited outside seating. The approximate
size of the real property for the unit is 10,000 to 40,000 square feet to
accommodate parking and drive-through lanes. Restaurants generally range in size
from 500 to 600 square feet.
As of September 30, 2000 there were 60 locations under the hamburger concept (of
which 53 are franchised and 7 are corporately owned) and are as follows:
Concept: Number of Units Geographic Area
-------- --------------- ---------------
"Central Park" 60 Southeast United States
Franchise Programs
Through the terms of its "Franchise Agreement" the Company authorizes
individuals and/or companies to form or establish and operate concept
restaurants at approved locations. Under the agreement, the company is obligated
to provide certain services both for the opening of, and the ongoing support of,
each restaurant. Those services generally include:
-review and approval of restaurant location
-review and approval of plans and layout design
-identification of sources of supply of food purveyors and
other suppliers
-provide an operations manual with respect to service
guidelines and restaurant management techniques
-provide initial and ongoing training in acceptable methods of
operations, food preparation techniques, management controls,
accounting functions, legal framework of restaurant
operations, human resources, promotional programs and public
relations
-provide ongoing support with respect to maintaining quality
products and insuring such products are offered at competitive
prices
-perform ongoing consistency and quality inspections of
restaurants in order to maintain uniform acceptable standards
As of September 30, 2000 the Company had a combined 162 submarine sandwich and
hamburger restaurants, of which 155 are franchised and 7 are corporately owned.
Also, the Company continues to have financial interests in the recently sold
Mountain Mike's Pizza and Seawest Subs franchise concepts which have
approximately 80 restaurants and 30 restaurants, respectively.
UFSI obtains prospective franchisees primarily from the ranks of its current and
former franchisees and employees, referrals from existing franchisees and from
selected marketing efforts such as restaurant trade shows. The Company intends
to develop new franchise locations primarily through existing franchisees. The
primary selective criteria considered by the Company in the review and approval
of new franchisees is prior experience in operating restaurants or comparable
business acumen and the existence of sufficient capital resources to reasonably
insure success.
3
<PAGE>
Management believes the Company has a national presence which it intends to
strengthen by developing each of its regional concepts.
From time to time the Company will take over the operations of a store from a
franchisee before the contract term has expired. The Company may operate such
stores until a suitable franchisee can be found, at which time all or part of
the Company's investment in such operations may be recovered, or it may choose
to close the location.
Initial franchise fees are considered to be within industry norms and currently
range from $10,000-$12,500 for new locations in the sandwich segment and are
$20,000 in the hamburger segment. Initial franchise fees are due upon the
execution of the Franchise Agreement. Ongoing royalties are also considered to
be within industry norms ranging from 4%-7% of sales. In addition to ongoing
royalties, all franchisees are required to contribute 2%-4% of sales to a
concept based pooled marketing fund. The following table sets forth and
summarizes certain information about the Company's Concepts and current
franchise agreements:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------
No. of Avg. Royalty Royalty
Franchised Rate on Rate on Currently
Units at Avg. Yrs. Existing Current Price of Selling
Sept 30, Remaining Franchise Franchise New New
Concept 2000 On Contract Agreements Agreement Franchise Franchises
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
"JRECK Subs","Lox, Stox & Bagel" 44 8.2 4.3% 5.0% $ 10,000 Yes
"Sobik's" 28 5.8 4.6% 5.0% 12,500 Yes
"Li'l Dino" 30 14.0 5.9% 7.0% 12,500 Yes
"Central Park" 60 9.0 4.0% 4.0% 20,000 Yes
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
In connection with the Company's mandatory monitoring program, all franchisees
are required to adhere to the Company's specifications and standards on the
selection and purchase of products used in the operation of the restaurant. The
Company provides a detailed "product profile" of acceptable food, paper and
supply items for each concept. Franchisees requesting to use products not
falling under the concept "product profile" must first receive permission from
the Company.
Area Development Agreements
The Company offers to Area Developers a "Territory" within which to sell
franchised restaurants pursuant to the terms of an Area Development Agreement.
Territories are generally based on defined geographic areas and generally
require the Area Developer to increase the number of restaurants within that
territory and to provide continuing operational support.
As of September 30, 2000, the Company had five agreements with area developers
under the Li'l Dino's concepts covering areas of North Carolina.
Each Area Developer pays the Company a negotiated fee for the non-exclusive
right to sell and open franchises in its defined geographic territory and also
requires the Area Developer to be responsible for marketing, soliciting and
screening prospective franchisees as well as identifying possible site
selections, providing on-site opening assistance and providing ongoing
operational support. The agreements also require the Area Developer to open a
minimum number of new franchised restaurants each year or forfeit future rights
to the territory. In some situations, the Company requires the Area Developer to
own and operate at least one franchised restaurant in their territory.
The Area Development Agreement does not grant the Area Developer the exclusive
right to market or solicit franchisees in the territory. The Company reserves
the right, under the agreements, to market and sell franchises and/or establish
company owned restaurants in any territory.
The Company pays the area developer 50% of the initial franchise fee for any
franchises it sells in its respective territory. The Area Developers are also
entitled to an ongoing fee of 40% to 50% of continuing franchise royalties as
consideration for providing ongoing support. Ongoing support includes many of
the tasks required to be performed by the franchisor and are described above.
The company believes the shared ongoing revenue approach rewards the area
developer for selecting higher quality franchisees and higher quality locations
while discouraging the area developer from selecting sites that may have an
adverse effect on current locations.
4
<PAGE>
The Area Development Agreements set increasing "Minimum Performance Levels" that
require the area developer to sell and open a specified number of franchised
restaurants each year. The Company's experience with the area development
program indicates that while some area developers will exceed their development
schedules, others will fail. Delays in the sale and opening of restaurants can
occur for many reasons. The most common reasons are delays in locating desirable
sites, in negotiating acceptable site lease terms or in obtaining project
financing.
Suppliers
The Company has entered into distribution and pricing agreements with national
and regional food product manufacturers and distributors that allow owners to
obtain meat products, produce, cheeses, condiments, spices, paper products and
supplies at prices more favorable than those that could be obtained by
individual owners.
The Company believes that if such regional and national distributors could no
longer provide such goods and services, adequate alternate suppliers or
distributors are available to provide such goods and services without a
significant increase in costs.
Pastry Product Producers, LLC (PPPI) operates a bakery in Watertown, New York.
PPPI produces the Jreck Subs signature roll that is supplied fresh (never
frozen) to Jreck Subs franchisees in upstate New York. PPPI produces other baked
goods such as bagels and cookies, however the rolls supplied to Jreck Subs
franchisees account for 99% of sales. Currently, Jreck Subs franchisees have
committed to purchase their sub rolls exclusively from PPPI through 2007.
Government Regulation
The Company's principal activity of selling restaurant franchises is regulated
by the Federal Trade Commission (the "FTC") and various states. Such regulations
govern disclosure, performance and procedure in the sale and transfer of new and
existing franchises. In general the FTC's regulations require the Company to
timely furnish a franchise offering circular to prospective franchisees
containing prescribed information. Certain state laws also require registration
of the franchise offering circular with applicable state authorities. Other
states monitor or regulate the franchise relationship, particularly the sale,
renewal and termination of an agreement. The Company believes it is in
compliance with the applicable franchise disclosure and registration regulations
of the FTC and the various states that it operates in.
The Company is also subject to "Federal Fair Labor Standards Act", which governs
minimum wages, overtime, working conditions and other matters as well as the
"Americans With Disabilities Act".
From time to time the Company will operate company owned stores. While operating
stores, the Company is subject to a variety of federal, state and local laws
regarding minimum wage standards, sanitation, health, fire, alcoholic beverage
and safety codes.
While the Company believes it is in compliance with all applicable federal,
state and local laws and regulations, there can be no assurance that it will
continue to meet the requirements of such laws and regulations. Such a default
could result in a withdrawal of approval to market franchises in one or more
jurisdictions. Any such loss of approval may have a material adverse effect upon
the Company's ability to successfully market its franchises. Violations of
federal and state franchising laws and/or regulations regulating substantive
aspects of the Company's business activity could subject the Company and its
affiliates to rescission offers, monetary damages, penalties or injunctive
proceedings. In addition, under court decisions in certain states, absolute and
vicarious liability may be imposed upon franchisors based upon the facts and
circumstances of the claim. Current expected changes in federal and individual
state laws and regulations concerning the sale, termination and non-renewal of
franchises are not expected to have a material impact on the Company's
operation. There can be no assurance that existing or future franchise
regulations will not have an adverse effect on the Company's ability to maintain
and expand its franchise program.
Competition
The Company competes in the fast food sandwich and hamburger segments of the
restaurant industry. As a franchisor of fast food sandwich and double
drive-through hamburger restaurants, the company competes on two fronts. First
it must attract successful franchisees; and, second, it must assist its
franchisees in attracting customers in each of those two niches of the
restaurant industry. The Company and its franchisees compete with an increasing
number of national chains of quick service outlets, several of which have
dominant market positions, and possess substantially greater financial resources
and longer operating histories than the Company.
5
<PAGE>
The segments of the restaurant industry that the Company and its franchisees
compete in are highly competitive with respect to price, service, outlet
location, and food quality and are often affected by changes in consumer taste,
local and national economic conditions, population trends and local traffic
patterns.
The three most prolific submarine sandwich chains the Company and its
franchisees compete with are Subway, Blimpie and Quiznos. Subway currently has
approximately 14,000 units while Blimpie and Quiznos each have about 2,000 and
500 units respectively. The Company's franchisees operate 93 units. Both Subway
and Blimpie offer a low cost product in a fast food style environment while
Quiznos is positioned between the traditional fast food style of Subway and
Blimpie and full service dining. Through its regional concepts, the Company
offers a comfortable, fast food style, family atmosphere in which to dine on
higher quality food products.
Competitiors of the Company's Central Park hamburger chain include Checkers
Drive-In Restaurants and Back Yard Burgers. Checkers currently has approximately
440 units while Back Yard Burgers has about 90 units. The Company's franchisee
operates 53 units while the Company operates 7 corporately owned units. Both
Checkers and Back Yard Burgers offer a drive-through format, with a low cost
product in a fast food style environment.
A number of companies have adopted "value pricing" strategies in response to
flattening growth rates and/or declines in average sale per restaurant. Such
strategies could draw customers away from companies that do not engage in "value
pricing", or discount pricing, and could also negatively impact the operating
margins by attempting to match competition pricing points.
In addition to competing with these chains as restaurants, the Company also
competes with these and other fast food chains for qualified franchisees. Many
franchisors, including but not limited to, those in the restaurant industry,
have greater market recognition and financial resources than the Company. The
Company believes its well established regional concepts offer prospective
franchisees the balance of a moderately priced alternative with which to enter
the fast food restaurant industry and the pride of ownership in a well
established and recognized name.
Trademarks
The Company, through its affiliates, currently owns the following trademarks or
service marks, each of which is registered and listed on the Principal Register
of the United States Patent and Trademark Office:
<TABLE>
<CAPTION>
Registration
Number or Registration
Application or Renewal
Trademark Type Number Date
--------- ---- ------ ----
<S> <C> <C> <C>
"JRECK Subs" Service Mark 1,022,898 Oct 14, 1975
"Li'l Dino" Name, Service Mark & Design 1,411,762 Sept 30, 1986
"Li'l Dino Bagel Deli and Grille" Name, Service Mark & Design 2,101,316 Sept 30, 1997
"Sobik's Subs" Name, Service Mark & Design 2,087,639 Aug 12, 1997
"Central Park" Name, Service Mark & Design 1,240,692 May 31, 1983
"Central Park" Name, Service Mark & Design 1,278,181 May 15, 1984
"Central Park" Name, Service Mark 1,280,984 Jun 5, 1984
"Central Park" Name, Service Mark 1,290,349 Aug 14, 1984
"Central Park" Name, Service Mark & Design 1,297,136 Sept 18, 1984
"Drive Through the Park" Name & Service Mark 1,287,395 July 24, 1984
</TABLE>
Employees
As of September 30, 2000 the Company had approximately 144 employees
consisting of 22 administrative employees, 103 restaurant employees at the
Company's seven Central Park corporately owned restuarants and 19 employees at
the Watertown bakery of PPPI.
Item 2. Description of Property
The Company owns its bakery plant in Watertown, NY. The land and building that
comprise that facility include 2,064 square feet of office space and 8,651
square feet of bakery facilities. The remainder of the Company's office space is
leased at terms varying from month to month or monthly expiring on various dates
up to July 30, 2008.
A summary of all real estate locations owned or leased by the Company at
September 30, 2000 is as follows:
<TABLE>
<CAPTION>
If Owned: If Owned: If Leased: If Leased:
Owned Current Current Base Lease
or Square Book Value Mortgage Monthly Expiration
Address of Property Type Leased Footage Balance Rent Date
========================================================================================================================
<S> <C> <C> <C> <C> <C> <C> <C>
24685 NYS Rte 37 Office Owned 2,064 $ 280,131 $ 101,637
Watertown, NY 13601 Bakery 8,561
2101 W. State Road 434 Suite 100 Office Leased 3,604 $ 6,475 12/31/00
Longwood, FL 32779
5601 Roanne Way Suite 100 Office Leased 864 825 06/30/02
Greensboro, NC 27409
537 Market Street, Suite 301 Office Leased 1,748 2,331 05/31/04
Chattanooga, TN 37402
Central Park Restaurant Restaurant Leased 750 07/31/08
West Broadway Land
West Memphis, AR
Central Park Restaurant Restaurant Leased 775 07/31/08
4019 Jackson Avenue Land
Memphis, TN
Central Park Restaurant Restaurant Leased 1,467 07/31/08
1376 Highland Avenue Land
Selma, AL
Central Park Restaurant Restaurant Leased 1,500 07/31/08
6204 Lee Highway Land
Chattanooga, TN
Central Park Restaurant Restaurant Leased 2,400 07/31/08
7205 Waters Avenue Land
Savannah, GA
Central Park Restaurant Restaurant Leased 2,900 07/31/01
3855 Hickory Hill Road Land
Memphis, TN
------ --------- --------- --------
TOTALS 16,841 $ 280,131 $ 101,637 $ 19,723
====== ========= ========= ========
</TABLE>
The Company believes it has obtained, and currently carries, adequate liability
insurance on all the properties it owns or leases.
6
<PAGE>
Item 3. Legal Proceedings
On August 2, 1999, the shareholders of Li'l Dino Management Corporation filed a
complaint against the Company and two of its officers in the United States
District Court for the Middle District of North Carolina, Greensboro Division.
The Company was served with this complaint on August 5, 1999. This complaint
alleges damages of $4.5 million for securities fraud, misappropriation of
corporate opportunities and negligent misrepresentation and seeks treble
damages, interest and attorney's fees. The allegations in the complaint relate
to the Company's acquisition of substantially all the assets of Li'l Dino
Management Corporation.
The Company believes the claims made in the complaint are without merit and
intends to defend itself vigorously in this matter.
The Company may be involved in various other lawsuits and litigation, from time
to time, as a result of its day to day operations. Management does not believe
that any of these other threatened or pending lawsuits or litigation will have
an adverse effect on the Company's financial position or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
The Company held its annual shareholder meeting on May 16, 2000 in Orlando,
Florida. One matter was submitted to a vote of the common shareholders of record
on April 3, 2000. The matter was for approval of the corporate name change from
Jreck Subs Group, Inc. to Ultimate Franchise Systems, Inc. The corporate name
change was approved by the shareholders as follows:
Votes Cast For 16,993,241
Votes Cast Against 332,852
Votes Withheld 114,640
7
<PAGE>
PART II
Item 5. Market for Common Equity
The Company's Common Stock is listed on the OTC Bulletin Board under the symbol
"UFSI". The prices reported below reflect inter-dealer prices and are without
adjustments for retail markups, markdowns or commissions, and may not
necessarily represent actual transactions.
High Bid Low Bid
-------- -------
Fiscal Year Ended December 31, 1998 First Quarter 3 1/8 1 13/16
Second Quarter 2 11/16 1 3/4
Third Quarter 1 1/16 9/16
Fourth Quarter 7/8 1/4
Fiscal Year Ended September 30, 1999 First Quarter 17/32 1/16
(Transition Year from Change in Second Quarter 5/8 1/8
Fiscal Year End) Third Quarter 3/8 3/16
Fiscal Year Ended September 30, 2000 First Quarter 17/64 3/32
Second Quarter 7/16 3/32
Third Quarter 13/32 13/64
Fourth Quarter 11/32 9/64
Stockholders:
As of January 5, 2001 there were approximately 8,300 record holders of the
Company's common stock.
Dividends:
The Company has never paid any dividends on its Common Stock and does not expect
to pay any dividends on its common stock in the foreseeable future. Management
currently intends to retain all available funds for working capital and the
development of its business. Dividends, if declared, must be from funds legally
available after dividends are first paid to any senior series of equity
securities such as the Company's Preferred Stock. Currently no surplus exists.
Recent Sale of Unregistered Securities
On January 5, 1998 the Company concluded its Preferred "D" stock offering. The
Company raised $2,500,000 through the offering. Eighteen investors purchased
2,500 shares for $1,000 each. The holders of the Series "D" Preferred Stock have
no voting rights and are entitled to cumulative dividends of $80 per share, per
year, payable in cash or common stock. Holders of the Series "D" may convert a
portion or all of their holdings into common stock based upon a conversion rate
formula of 65% of the average five day closing bid price five trading days
before conversion. The conversion rate was further adjusted by two five percent
penalty increments for the Company's failure to file and make effective a Form
SB-2 within certain time parameters. As of June 10, 1999 the Company had issued
5,303,574 common shares as conversion shares under this agreement.
On June 10, 1999, the holders of the Preferred "D" converted their entire
holding to the Company's newly created Preferred "F" series. The Series D was
canceled and 197.5 shares of the Series F were issued in its place. The holders
of Series F are each entitled to receive an annual dividend of $1,000. The
dividend is payable quarterly beginning August 1, 1999. The holders may require
the Company to repurchase the outstanding shares at a 25% premium over the face
value of $10,000 no sooner than June 1, 2000 and no later than August 1, 2000.
The Company may also redeem the shares at any time prior to February 1, 2000 at
$12,500 per share. In the event of liquidation, dissolution, or winding up of
the Corporation, whether voluntary or involuntary, the Series F holders are
entitled to receive $13,000 per share. On December 28, 2000, the Company retired
all 197.5 outstanding shares of the Series F for $500,000 cash and the issuance
of 19,750,000 shares of its common stock. The issuance of these shares increased
the number of outstanding common shares by 61.9%.
In December 2000, the Company issued a Convertible Debenture for $575,000 which
calls for monthly interest payments at 12% interest and is due in January 2002.
The Convertible Debenture may be converted in whole or in part to common stock
of the Company at a conversion price equal to 65% of the three-day average
closing price prior to the date of conversion. In anticipation of the conversion
of the Convertible Debenture, the Company has placed in escrow 10,000,000 shares
of its common stock.
In December 2000, the Company increased its authorized shares of commons stock
from 50,000,000 shares to 100,000,000 shares.
8
<PAGE>
The following table sets forth information with respect to the sale or issuance
of unregistered securities by the Company over the last three fiscal years:
<TABLE>
<CAPTION>
Exempt From
1933 Act
Value or Registration
Shares Type of Consider- To Whom In
Issued Security Date ation Issued Business Purpose Reliance of:
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
2,500 Preferred "D" Jan 5, 1998 2,500,000 18 Investors Cash Investment Section 4(2)
25,000 Common Feb 5, 1998 25 Mitchell Day Exercise of Seawest Options Section 4(2)
11,550 Common Feb 9, 1998 30,319 Andrew Caffey Legal Services Section 4(2)
40,000 Common Mar 16, 1998 97,500 Allan Richman Consulting Services Section 4(2)
9,400 Common Mar 16, 1998 22,913 Francis Jenne Consulting Services Section 4(2)
52,631 Common Mar 26, 1998 125,000 Frmr Seawest Shhdrs Acquisition of "Seawest" Restaurant Section 4(2)
Chain
112,793 Common Apr 29, 1998 277,404 Sidney Wertheim etal Settlement of Debt Section 4(2)
735,294 Common May 18, 1998 2,000,000 Li'l Dino Shareholders Acquisition of "Li'l Dino" Restaurant Section 3(a)(10)
Chain
115,000 Common May 27, 1998 251,563 Pat Gerrard Consulting Services Section 4(2)
350,000 Common Jun 3, 1998 700,000 Preferred "B" Hldrs Conversion to Common Section 4(2)
43,290 Common Jun 16, 1998 100,000 R. Berg & S. Wemple Finder's Fee on Acquisition of Section 4(2)
"Li'l Dino"
660,000 Common Jul 6, 1998 1,320,000 Preferred "A" Hldrs Conversion to Common Section 4(2)
6,857 Common Jul 21, 1998 9,000 Interfoods of America Extend Due Date on Puts Section 4(2)
500,000 Common Jul 31, 1998 687,500 Bradley Gordon Issued for Promissory Note-Corp Officer Section 4(2)
300,000 Common Jul 31, 1998 412,500 Richard Silberman Issued for Promissory Note Section 4(2)
500,000 Common Jul 31, 1998 687,500 Michael Cronin Issued for Promissory Note-Corp Officer Section 4(2)
10,000 Common Aug 5, 1998 13,125 W. & C. Richey Extend Due Date on Puts Section 4(2)
70,000 Common Sep 16, 1998 70,000 5 Investors Loan Inducement Section 4(2)
33,333 Common Oct 1, 1998 29,166 Mitchell Day Acquisition of "Food Court" Concept Section 4(2)
20,000 Common Oct 31, 1998 10,000 JG Partners L.P. Consulting Services Section 4(2)
500,000 Common Nov 6, 1998 250,000 QFS Shareholders Acquisition of "Mtn Mike's" Restaurant Section 4(2)
Chain
615,384 Common Nov 25, 1998 150,000 Barry Seidman Conversion of 150 Sh of Preferred "D" Section 4(2)
39,727 Common Nov 25, 1998 25,652 Barry Seidman Dividends on Preferred "D" Section 4(2)
50,000 Common Dec 4, 1998 21,875 Interfoods of America Inducement to Extend Loan Due Date Section 4(2)
300,000 Common Dec 14, 1998 75,000 Sidney Wertheim etal Acquisition of "Little King" Restaurant Section 4(2)
Chain
75,000 Common Dec 22, 1998 75 Mitchell Day Exercise of Seawest Options Section 4(2)
- ----------------------------------------------------------------------------------------------------------------------------------
9
<PAGE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
Exempt From
1933 Act
Value or Registration
Shares Type of Consider- To Whom In
Issued Security Date ation Issued Business Purpose Reliance of:
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
491,980 Common Jan 6, 1999 139,810 Preferred "D" Holders Conversion of 80 shares of Preferred "D" Section 4(2)
361,766 Common Jan 25, 1999 52,546 Preferred "D" Holders Conversion of 30 shares of Preferred "D" Section 4(2)
1,346,463 Common Feb 19, 1999 254,731 Preferred "D" Holders Conversion of 145 shares of Preferred Section 4(2)
"D"
307,151 Common Feb 22, 1999 70,308 Preferred "D" Holders Conversion of 40 shares of Preferred "D" Section 4(2)
241,159 Common Mar 5, 1999 44,007 Preferred "D" Holders Conversion of 25 shares of Preferred "D" Section 4(2)
248,138 Common Apr 27, 1999 35,320 Preferred "D" Holders Conversion of 20 shares of Preferred "D" Section 4(2)
1,000,000 Common May 28, 1999 250,000 Norstarr Services Consulting Services Section 4(2)
1,456,679 Common May 10, 1999 194,868 Preferred "D" Holders Conversion of 110 shares of Preferred Section 4(2)
500,000 Common Apr 14, 1999 150,000 Three Investors Cash Investment Section 4(2)
96,154 Common May 14, 1999 25,000 Phoenix Capital Conversion of Debt Section 4(2)
96,154 Common May 14, 1999 25,000 C.A. Opportunidad Conversion of Debt Section 4(2)
130,000 Common May 29, 1999 48,100 Gulf Atlantic Publishng Consulting Services Section 4(2)
769,230 Common May 14, 1999 174,563 2 Investors Sale of Stock for cash Section 4(2)
37,500 Common May 14, 1999 0 P. Truax, R. Longely Exercise of Options Section 4(2)
197.5 Preferred "F" Jun 10, 1999 2,468,500 19 Investors Conversion of Preferred "D" to "F" Section 4(2)
700,187 Common Jun 11, 1999 329,088 Interfoods Modification of Terms of SBK acquisition Section 4(2)
20,000 Common Jun 21, 1999 4,400 Barry Seidman Penalty on Loan Default Section 4(2
50,000 Common Jun 24, 1999 12,500 Blaine Quick Consulting Services Section 4(2)
187,266 Common Jun 11, 1999 335,206 Interfoods Conversion from redeemable to fully Section 4(2)
issued
66,667 Common Jun 28, 0999 20,000 Thornbury Associates Consulting Services Section 4(2)
100,000 Common Aug 11, 1999 21,880 Preferred "A" Holders Preferred "A" conversion price Section 4(2)
adjustment
750,000 Common Aug 11, 1999 175,815 7 Individual Investors Price adjustments on previously issued Section 4(2)
stock
500,000 Common Aug 11, 1999 109,400 Tri-Emp Enterprises Loan Payment Section 4(2)
25,000 Common Sep 10, 1999 5,000 Robert Weiner Consulting Services Section 4(2)
195,127 Common Sep 20, 1999 44,793 Preferred "D" Holders Conversion of 25 shares of Preferred Section 4(2)
"D"
- ----------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
Exempt From
1933 Act
Value or Registration
Shares Type of Consider- To Whom In
Issued Security Date ation Issued Business Purpose Reliance of:
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
380,000 Common Oct 19, 1999 71,250 Compass Point Group Consulting Services Section 4(2)
500,000 Common Jan 19, 2000 110,200 Stockbroker Relations Consulting Services Section 4(2)
235,000 Common Jan 28, 2000 54,050 Compass Point Group Consulting Services Section 4(2)
300,000 Common Mar 21, 2000 105,000 2 Individuals Consulting Services Section 4(2)
894,911 Common Mar 31, 2000 223,728 Tri-Emp Enterprises Conversion of Debt Section 4(2)
848,831 Common Mar 31, 2000 212,208 Monterrey Corp. Conversion of Debt Section 4(2)
260,000 Common Apr 1, 2000 57,200 Stockbroker Relations Consulting Services Section 4(2)
150,000 Common May 12, 2000 48,000 Olympus Capital Consulting Services Section 4(2)
40,000 Common Jun 5, 2000 11,200 Dan Patterson Consulting Services Section 4(2)
40,000 Common Jun 28, 2000 9,200 Compass Point Group Consulting Services Section 4(2)
435,000 Common Jul 18, 2000 139,200 Various Acquisition of "Central Park" Section 4(2)
Restaurant Chain
1,000,000 Common Jul 27, 2000 260,000 E-Rex, Inc. Sale of Stock for Investment Security Section 4(2)
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Options and Warrants
In February 1999, the Company approved the 1998 Incentive Plan ("Incentive
Plan") to enable the Company to offer employees and its consultants equity
interests in the Company. There are 1,500,000 shares designated under the
Incentive Plan and are fully vested upon grant. Since January, 1997 the Company
has issued options and warrants to purchase its common stock outside of the
Incentive Plan. The following table describes selected data with respect to
unexercised options and warrants at September 30, 2000:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------------
Date Expiration Number of Exercise
of Grant Date Name Shares Price Business Purpose
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1998 Incentive Plan
Feb 10, 1999 Feb 10, 2002 Employees/nonemployee Director 720,000 0.20 Employee Stock Option Plan
Oct 15, 1999 Oct 10, 2002 Patricia Charles 35,000 0.16 Employee Stock Option Plan
------------
TOTAL 755,000
- --------------------------------------------------------------------------------------------------------------------------------
Outside of the Incentive Plan
May 23, 1997 Mar 1, 2002 Thomas Larcomb 60,000 0.50 Loan Inducement
May 23, 1997 Mar 1, 2002 Richard Deegan 60,000 0.50 Loan Inducement
Sep 15 1997 Sep 15, 2002 Tri-Emp Enterprises 225,000 0.75 Assignment of Other Rights
Sep 30, 1997 Feb 1, 2001 AB Laffer Canto & Assoc. 13,500 3.08 Acquisition of Mtn. Mike's
Dec 17, 1997 Dec 17, 2002 Business Advisors 375,000 1.92 Business Expansion Consulting Services
Dec 17, 1997 Dec 17, 2002 Business Advisors 375,000 2.56 Business Expansion Consulting Services
Dec 17, 1997 Dec 17, 2002 Business Advisors 375,000 3.20 Business Expansion Consulting Services
Dec 17, 1997 Dec 17, 2002 Business Advisors 125,000 3.84 Business Expansion Consulting Services
Dec 29, 1997 Dec 29, 2000 Christopher M. Swartz(a)(b) 1,000,000 0.29 Employee Compensation
Aug 3, 1998 Aug 3, 2001 Christopher M. Swartz(a) 1,000,000 0.29 Employee Compensation
Sep 30, 1998 Sep 30, 2003 Wall St. Group 114,285 0.50 Investment Banking Services
Sep 30, 1998 Sep 30, 2003 Dr. Sol Lizerbram 114,285 0.50 Investment Banking Services
Oct 15, 1999 Oct 15, 2004 Blaine Quick 645,000 0.29 Business Expansion Consulting Services
Oct 15, 1999 Oct 15, 2004 Dr. Sol Lizerbram 125,000 0.50 Business Expansion Consulting Services
Oct 15, 1999 Oct 15, 2004 Wall St. Group 125,000 0.50 Business Expansion Consulting Services
Oct 15, 1999 Oct 15, 2004 Richard Silberman 600,000 0.29 Business Expansion Consulting Services
Oct 15, 1999 Oct 15, 2004 Bradley Gordon 1,000,000 0.29 Employee Compensation
Oct 15, 1999 Oct 15, 2004 Michael Cronin 1,000,000 0.29 Employee Compensation
Oct 15, 1999 Oct 15, 2004 Richard Huey 500,000 0.29 Employee Compensation
Oct 15, 1999 Oct 15, 2004 Kelly Swartz 35,000 0.16 Business Expansion Consulting Services
Oct 15, 1999 Oct 15, 2004 Linda Patterson 35,000 0.16 Business Expansion Consulting Services
Jul 27, 2000 Jun 30, 2002 E-Rex, Inc. 3,000,000 0.278 Exchanged for Investment Security
Jul 31, 2000 Jul 31, 2007 Lloyd, Benton & Taylor 200,000 0.229 Business Expansion Consulting Services
------------
TOTAL 11,102,070
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Original options at $2.75 and $1.55 were repriced on October 1, 1999 at
$0.29 per share.
(b) These options expired on December 29, 2000 and were not extended.
The weighted average exercise price of these outstanding options is $0.20 and
$0.58 under the Incentive Plan and outside of the Incentive Plan, respectively.
The aggregate of all options under the Incentive Plan and outside the Incentive
Plan has a weighted average life until expiration of 29.9 months. Options
representing 225,000 shares (125,000 and 100,000 under the Incentive Plan and
outside of the Incentive Plan, respectively) expired in 2000 while the Company
granted additional options on 7,300,000 shares (35,000 and 7,265,000 under the
Incentive Plan and outside of the Incentive Plan respectively) during the year.
10
<PAGE>
Item 6. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Transition Period Due to Change in Fiscal Year
During 1999, the Company changed its fiscal period from December 31 to September
30. Accordingly, the audited financial statements included in item 7 of this
Form 10-KSB reflect operating results and cash flows for a twelve month period
and a nine month period ended September 30, 2000 and September 30, 1999,
respectively. Management has elected to present this discussion and analysis on
a twelve month comparative basis with the unaudited results as disclosed on the
third quarter Form 10-QSB filed with the S.E.C. on November 19, 1998 and Form
10-KSB filed in August 1999. Readers are suggested to supplement a reading of
this discussion and analysis with a review of those financial statements as well
as review the following comparative table of results of operations and cash
flows:
<TABLE>
<CAPTION>
Account Description Twelve Months Ended Twelve Months Ended
Sept 30, 2000 Sept 30, 1999
-------------- -------------
<S> <C> <C>
Total Franchising Revenue $ 3,144,956 $ 3,591,216
Franchising Costs 1,419,548 1,701,348
----------- -----------
Net Franchising Income 1,725,408 1,889,868
Bakery Sales 825,237 734,868
Bakery Cost of Sales and Expenses 816,376 710,014
----------- -----------
Net Bakery Income 8,861 24,854
Retail Sales of Company Owned Stores 521,747 110,878
Cost of sales and Expenses 594,905 117,561
----------- -----------
Net Income (Loss) From Company Owned Stores (73,158) (6,683)
Net Operating Line Profit 1,661,111 1,908,039
Other Expenses:
Business Expansion and Investor Relations 1,417,263 775,392
General Corporate Expenses 1,415,752 1,497,151
Interest Expense 318,633 542,946
Write Off of Uncollectible Accounts 25,442 379,924
Amortization and Depreciation 745,692 964,681
Loss on disposals of franchise concepts 843,092 39,606
Loss on sale of investment security - 58,596
Loss on sale of property & equipment - 465,032
Write-down of property & equipment 70,101 725,078
Long-lived asset write-down - 1,177,212
Other Expense (Income) (169,171) (52,203)
----------- -----------
Net Loss $(3,005,693) $(4,665,376)
=========== ===========
Net Loss Per Share $ (0.11) $ (0.23)
Weighted Average Shares Outstanding 30,102,278 21,517,608
Cash Consumed by Operating activities $ (239,547) $ (162,952)
Cash Provided (Consumed) by Financing Activities (1,434,237) (624,013)
Cash Provided by Investing Activities 1,700,564 655,073
----------- -----------
Net Change in Cash $ 26,780 $ (131,892)
=========== ===========
</TABLE>
Forward Looking Statements
The following discussion contains certain forward looking statements subject to
the safe harbor created by the "Private Securities Litigation Reform Act of
1995". These statements use such words as "may," "will," "expect," "believe," "
plan," "anticipate" and other similar terminology. These statements reflect
management's current expectations and involve a number of risks and
uncertainties. Actual results could differ materially due to changes in global
and local business and economic conditions; legislation and government
regulation; competition; success of operating initiatives including advertising
and promotional efforts; changes in food, labor and other operating costs;
availability and cost of land and construction; adoption of new or changes in
accounting policies and practices; changes in consumer preferences, spending
patterns and demographic trends and changes in the political or economic
climate.
Overview
The Company derives its revenue from several sources: royalties, franchise fees,
developer fees, company owned restaurants sales and other franchise related
activities as well as a bakery acquired to supply sandwich rolls to certain
franchisees.
Royalties
Royalties are based on a percentage of franchisees' net sales and are recognized
by the Company in the same period that the franchise store sales occur.
Generally royalties are earned at the rate of 4%-7% of sales. Royalties earned
under newer franchise agreements are paid by means of weekly automatic drafts by
the Company drawn on franchisee bank accounts. Royalties earned under older
agreements are generally paid by the remittance of a check payable to the
Company on a weekly, bi-weekly or monthly basis. A portion of the royalties
received by the Company are paid to its area developers as royalty service costs
for providing on-going services to franchisees in their respective territories
(see Item 1. Business-Franchising-Area Developers).
Franchise Fees
Franchise Fees are payments received by the Company from franchisees and are
recognized as revenue in the period in which the store opens. The franchise fee
for a franchisee's initial store is currently $10,000-$12,500 for submarine
sandwich restaurants and $20,000 for hamburger restaurants. Expenses associated
with the sale of franchises also include area developer fees and are included in
franchise servicing costs. Generally, area developers are paid one half of the
franchise fees received or collected in their territory.
11
<PAGE>
Area Developer Fees
The Company charges area developers a non refundable fee for the exclusive right
to develop and market a defined territory for a specified period of time.
Typically, a portion of the developer fee is paid in cash and the balance is
paid with a promissory note (see Item 1. Business-Franchising-Area Developers).
When the Company has fulfilled substantially all of its contractual obligations
such as training, providing manuals, and reasonable efforts to obtain and retain
trademark registrations, the Company recognizes, as revenue, the cash portion of
the fee and the value of the promissory note. Certain performance obligations
are ongoing. On these the income has been deferred to future periods in which
the services will be substantially performed.
Restaurant Sales
Restaurant sales are reported from Company owned stores. Since July 2000, the
Company had operated seven Company owned stores from its Central Park
acquisition. From time to time the Company will take over the operations of a
store from a franchisee before the contract term has expired. Management's
intent is to resell these stores to prospective franchisees as soon as
practicable. Management does not believe that the operating costs of its Company
owned stores are indicative of costs for franchised stores on a systemwide
basis. Store sales are expected to vary widely from year to year and reflect the
uncertainty of when, where and how long a store may be operated by the Company
before being returned to the franchising system.
Year Ended September 30, 2000 Compared to Year Ended September 30, 1999
Revenue: Total Revenue increased $54,978 in 2000 over 1999 from $4,436,962
to $4,491,940.
Royalties decreased $587,431, or 21.8%, from $2,695,768 in 1999 to
$2,108,337 in 2000. The primary reason for the decrease was from the sale of the
Mountain Mike's Pizza concept in April 2000 and thus only seven months of
royalty income of $822,049 from this concept was included for the year ended
September 30, 2000 compared to $1,350,853 for the year ended September 30, 1999,
a decrease of $528,804. This decrease was offset by $176,226 in royalty income
as the result of the acquisition of the Central Park hamburger chain in July
2000.
Franchise fees decreased $48,916 or 43.7% from $111,916 in 1999 to $63,000 in
2000.
The Company added six new stores during the year ended September 30, 2000. The
new restaurants were primarily opened by existing franchisees. This reflects the
Company's policy of growth through existing franchisees. The decrease in
franchise fees is primarily from the Company having fewer restaurant concepts
from the disposal of the Mountain Mike's Pizza and Seawest Subs franchise
concepts.
Retail restaurant sales in Company owned stores increased $410,869 or 370.6%
from $110,878 in 1999 to $521,747 in 2000. In 1999, retail restaurant sales
reflected the Company's attempt to dispose all corporately owned restaurants and
all Company owned stores were sold by the year ended September 30, 1999. The
retail restaurant sales for the year ended September 30, 2000 resulted from the
Company's acquisition of the Central Park hamburger chain which included seven
corporately owned restaurants and only reflects activity from July 19, 2000 to
September 30, 2000 (less than 2.5 months). The Company's intention is to dispose
of these seven restaurants in fiscal year 2001.
Bakery sales for the bakery owned and operated by the Company increased $90,369
or 12.3% from $734,868 in 1999 to $825,237 in 2000 which reflected an increase
in per restaurant sale.
12
<PAGE>
Costs and Expenses
The Company segregates its operating expenses into six general categories as
follows:
Ongoing Franchise Servicing
Retail Company Owned Store Cost of Sales and Expenses
Bakery Cost of Sales and Expenses
General Corporate Operating Expenses
Consulting and Investor Relations
Non-Cash
Other
Franchise servicing costs, including ongoing area developer fees, decreased
$281,800 or 16.6% from $1,701,348 in 1999 to $1,419,548 in 2000. The primary
reason for the decrease was from the sale of the Mountain Mike's Pizza chain in
April 2000 offset by the addition of $258,067 of franchise servicing costs from
the Company's Central Park acquisition in July 2000. The other chains
experienced a slight decrease in franchise servicing costs. These reductions are
the result of management's ongoing efforts to assimilate and combine functions
previously performed at each division level. Many of the purchasing,
administrative, accounting and regulatory tasks previously performed by the
divisional employees are now being handled at the corporate level. The effect of
this was to reduce the staff necessary to perform these functions at the
divisional level. The Company continues to focus its efforts on franchise
royalty management with the result that despite the sale of the Mountain Mike's
Pizza chain, the operating profit from this activity decreased only $164,460 or
8.7% $1,889,868 in 1999 to $1,725,408 in 2000.
Retail cost of sales and operating expenses from company owned stores increase
from $117,561 in 1999 to $594,905 in 2000. Retail cost of sales and operating
expenses as a percentage of retail sales increased from 106.0% in 1999 to 114.0%
in 2000. The increase in cost reflected transitioning the Central Park
restaurants which included the sale and closure of two restaurants.
Bakery cost of sales and expenses increased $106,362 or 15.0% from $710,014 in
1999 to $816,376 in 2000. The increase is consistent with the increase in bakery
sales.
General corporate operating expenses generally include: officers and office
support staff payroll and payroll costs; legal, audit and other professional
fees; office occupancy costs and other general administrative costs. These
administrative costs decreased 81,399 or 5.4% from $1,497,151 to $1,415,752 in
2000 which was partially attributable to the Company's Chief Operating Officer
resigning in April 2000.
Consulting and investor relations costs increased $641,871 or 82.8% from
$775,392 in 1999 to $1,415,752 as the Company entered into several consulting
agreements for capital raising efforts and identifying potential acquisition
candidates.
Routine or recurring non-cash charges such as depreciation, amortization (of
goodwill and non-compete covenants) and the write off of uncollectible
receivables was $1,344,605 in 1999 compared to $771,134 in 2000. Of these
amounts $379,924 and $25,442 was attributable to bad debt expense for the years
ended September 30, 1999 and 2000, respectively. The bad debt expense in 1999
was due to the write-down of certain notes receivable. Amortization and
depreciation was $964,681 in 1999 compared to $745,692 in 2000, a decrease of
218,989 or 22.7%. The primary reason for the decrease was the decrease in
goodwill amortization from the Mountain Mike's Pizza chain in April 2000 and the
amortization of the non-compete covenant pertaining to Seawest Subs which was
fully amortized in early 2000. Amortization of goodwill decreased $87,472 or
41.7% from $209,957 in 1999 to $122,475 in 2000 for Mountain Mike's.
Amortization of goodwill and the non-compete covenant decreased $57,865 or 26.8%
from $216,144 in 1999 to $158,279 in 2000 for Seawest Subs.
13
<PAGE>
Non-routine or non-recurring non-cash charges such as losses on disposal of
franchise concepts, asset valuation charges and losses on the sale of assets
totaled $913,193 in 2000 and was $1,552,331 less than the $2,465,524 aggregate
charge for those items in 1999. The loss on the disposal of franchise concepts
was $843,092 in 2000 resulting from a loss of $535,506 from the sale of the
Mountain Mike's Pizza franchise concept and $307,586 from the sale of the
Seawest Subs franchise concept compared to a loss of $39,606 from the sale of
the Georgio's franchise concept in 1999. Write-down of property & equipment was
$70,101 in 2000 compared to $725,078 in 1999. The 1999 charge was a result of
the Company writing down the value of some of its bakery equipment to reflect
current market value for such equipment. Also in 1999, the Company recognized a
goodwill impairment of $1,177,212 with respect to its Little King franchise
concept prior to its sale.
Net interest expense was $318,633 in 2000 compared to $542,946 in 1999, a
decrease of $224,313. The decrease in interest expense reflects the Company's
payment on related party and long-term debt of $1,267,013 and the conversion of
$343,291 of related party and long-term debt for common stock during the year
ended September 30, 2000. There was less than 3 months of interest expense
incurred in 2000 from the long-term debt issued and assumed of approximately
$2,400,000 on the Central Park acquisition in July 2000.
Liquidity and Capital Resources
Net cash used in operating activities was $239,547 in 2000. Net cash of
$1,700,564 was provided by investing activities. $2,682,130 of cash proceeds was
primarily received from the sale of the Company's Mountain Mike's Pizza
franchised concept while $925,595 was expended on the acquisition of the Central
Park franchise concept. Net cash of $1,434,237 was used on financing activities,
primarily from the payments on related party and long-term debt of $1,267,013
and dividend payments of $213,100.
At September 30, 2000 the Company had $3,189,248 in debt and $2,468,750 in
redeemable preferred stock outstanding. The Company issued or assumed
approximately $2,400,000 in debt relating to its Central Park acquisition in
July 2000. In December 2000, the Company issued $575,000 in convertible debt and
redeemed the entire $2,468,750 in preferred stock through the payment of
$500,000 in cash and the issuance of 19,750,000 shares of common stock.
The Company believes that cash flow from operations and the sale and subsequent
refranchising of its seven corporate Central Park restaurants will continue to
fund its operations as well as generate all the capital necessary to meet the
Company's obligations of $417,140 in the current portion of its long term debt.
The Company may seek other sources of financing, restructure and/or pay off all
its current obligations in 2001. There is no assurance that additional funding
will be available, or if available, it can be obtained on terms favorable to the
company. Failure to obtain such funding could adversely affect the Company's
financial condition.
Working capital at September 30, 2000 was a deficit of $1,490,301 compared with
a deficit of $1,879,446 on September 30, 1999, a decrease of $389,145. The
decrease in deficit is reflected in a $1,188,901 reduction in the current
portion of long term debt and an increase of $622,532 in accounts payable and
accrued expenses.
14
<PAGE>
Nine Months Ended September 30, 1999 Compared to Nine Months Ended September 30,
1998
During 1999, the Company changed its fiscal period from December 31 to September
30. Accordingly, the audited financial statements included in item 7 of this
Form 10-KSB reflect operating results and cash flows for a twelve month period
and a nine month period ended December 31, 1998 and September 30, 1999,
respectively. Management has elected to present this discussion and analysis on
a nine month comparative basis with the unaudited results as disclosed on the
third quarter Form 10-QSB filed with the S.E.C. on November 15, 1998 and Form
10-QSB/A filed in January 2000. Readers are suggested to supplement a reading of
this discussion and analysis with a review of those financial statements as well
as review the following comparative table of results of operations and cash
flows:
<TABLE>
<CAPTION>
Account Description Nine Months Ended Nine Months Ended
Sept. 30, 1999 Sept 30, 1998
-------------- -------------
<S> <C> <C>
Total Franchising Revenue $ 2,724,534 $ 2,652,781
Franchising Costs 1,296,506 1,484,583
----------- -----------
Net Franchising Income 1,428,028 1,168,198
Bakery Sales 571,844 736,171
Bakery Cost of Sales and Expenses 541,014 680,363
----------- -----------
Net Bakery Income 30,830 55,808
Retail Sales of Company Owned Stores 0 1,353,366
Cost of sales and Expenses 0 1,460,087
----------- -----------
Net Income From Company Owned Stores 0 (106,721)
Net Operating Line Profit 1,458,858 1,117,285
Other Expenses:
Business Expansion and Investor Relations 722,541 852,486
Central Corporate Expenses 1,177,276 1,257,656
Interest Expense 356,192 248,830
Write Off of Uncollectible Accounts 254,507 0
Amortization and Depreciation 670,442 865,678
Penalty Charge on Preferred "D" 0 718,272
Other 45,999 (46,522)
----------- -----------
Net Loss $(1,768,099) $(2,779,115)
=========== ===========
Net Loss Per Share $ (0.08) $ (0.17)
Weighted Average Shares Outstanding 22,796,417 16,378,836
Cash Consumed by Operating activities $ (429,270) $(1,256,394)
Cash Provided by Financing Activities 103,137 1,613,908
Cash Consumed by Investing Activities 136,847 (531,748)
----------- -----------
Net Change in Cash $ (189,286) $ (174,234)
=========== ===========
</TABLE>
Revenue: Total Revenue decreased $1,445,940 in 1999 over 1998 from $4,742,318
to $3,296,378.
Royalties increased $49,835, or about 2.5%, from $1,996,445 in 1998 to
$2,046,280 in 1999. An increase of $84,857 was the result of the acquisition of
the Li'l Dino chain in March of 1998 and reporting only six months of revenues
in 1998 compared to a full nine months of operations in 1999. This increase was
offset by overall lower royalty revenues in the other concepts of $35,022.
Franchise fees decreased $48,750 from $127,000 in 1998 to $78,250 in 1999.
$47,500 of the decrease was recognized through the Mountain Mike's Pizza chain
and was the result of scheduled openings being pushed into the next reporting
period. The Company began 1999 with 273 franchised restaurants. During the
current nine month period the Company added an additional 6 new stores and
closed or terminated franchise agreements on 42 stores. These closings were the
result of voluntary terminations due to competitive conditions in the Company's
market segment and to the cancellation or rescission of franchise agreements of
certain franchisees that were not fulfilling their contract obligations. The
Company ended the year with 209 franchised units after the sale of 28 Little
King restaurants, or a pro-forma decrease of 13.2%. The six new stores were
primarily opened by existing franchisees. This reflects the Company's policy of
growth through existing franchisees with the belief that this will contribute to
a high rate of new store successes.
Developer fees were $24,896 in 1998 compared to none in 1999. This was due to
the recognition of the deferred performance amounts on existing contracts. The
Company has not sold development rights in any territories in 1999 or 1998. The
Company anticipates that developer fees received in the future will primarily be
the result of re-marketing existing agreements.
Retail restaurant sales in Company owned stores decreased from $1,353,366 in
1998 to $0 in 1999. The decrease was the result of operating 10-11 stores in the
Little King chain for most of 1998. All Company owned stores were sold in 1999
and no new stores were acquired or operated by the Company in 1999. Comparative
average store sales volume for these stores remained substantially unchanged
from the previous year. The Company also discontinued its Hymie's retail bagel
sales efforts in Tampa in early 1998.
Bakery sales for the bakery owned and operated in 1999 remained about the same
as 1998's sales at $566,329 and $571,844, respectively. The Company also closed
the Tampa bakery in 1998. This operation generated $159,843 in 1998 sales before
it was closed.
15
<PAGE>
Costs and Expenses
The Company segregates its operating expenses into six general categories as
follows:
Ongoing Franchise Servicing
Retail Company Owned Store Cost of Sales and Expenses
Bakery Cost of Sales and Expenses
General Corporate Operating Expenses
Non-Cash
Other
Franchise servicing costs, including ongoing area developer fees, decreased
$188,077 to $1,296,506 in 1999. The addition of L'il Dino operations in late
March of 1998 accounted for an increase in current period expenses of $49,125
over 1998 while all the other chains, combined, experienced a decrease of
$237,202. These reductions are the result of management's ongoing efforts to
assimilate and combine functions previously performed at each division level.
Many of the purchasing, administrative, accounting and regulatory tasks
previously performed by the divisional employees are now being handled at the
corporate level. The effect of this was to reduce the staff necessary to perform
these functions at the divisional level. The Company continues to focus its
efforts on franchise royalty management with the result that the operating
profit from this activity increased $259,830 from 1998 to 1999 or from
$1,168,198 in 1998 to $1,428,028 in 1999.
Retail cost of sales and operating expenses from company owned stores was
eliminated in 1999 as the Company neither owned or operated any stores during
that period.
Bakery cost of sales and expenses decreased $139,349 in 1999 from 1998's level
of $680,363. The decrease is primarily due the closing of the Tampa bakery in
1998 which amounted to a $127,393 cost elimination.
General corporate operating expenses generally include: officers and office
support staff payroll and payroll costs; legal, audit and other professional
fees; office occupancy costs and other general administrative costs. These
administrative costs decreased 6.4% in 1999 to $1,177,276 from $1,257,656 in
1998. This decrease was the result of non-recurring charges of $160,843 in 1998
for additional legal and accounting fees in connection with the audit of its
1997 financial statements and the filing of its S.E.C. registration statements
on forms 10-SB and SB-2.
Routine or recurring non-cash charges such as depreciation, amortization (of
goodwill and non-compete covenants), write off of uncollectable receivables, and
the amortization of certain prepaid expenses (interest and consulting) over
their contractual terms was $1,544,695 in 1999 compared to $865,678 in 1998. The
increase of $679,017 in 1999 was principally the result of an increase of
$254,507 in bad debts expense due to write downs of certain notes receivable;
increased amortization of $185,715 in prepaid consulting agreements; and an
increase of $117,088 in goodwill and non compete covenant amortization.
16
<PAGE>
Non-routine or non-recurring non-cash charges such as stock and options issued
for services, asset valuation charges, losses on the sale of assets, deferred
taxes and a preferred stock conversion penalty totaled $337,797 in 1999 and was
$786,055 less than the $1,123,852 aggregate charge for those items in 1998. The
net decrease was due to a combined mix of several factors. A portion of the
decrease was due to a $105,635 reduction in stock and stock options issued for
services while the balance of the decrease was the elimination of a one time
charge of $718,272 due to a penalty feature imposed on the Company by the
preferred "D" class of stock issued January 5, 1998.
Total non cash expenses decreased $107,038 in 1999 to $1,882,492 from 1998's
level of $1,989,530.
Interest expense of $356,192 and $248,830 for 1999 and 1998 respectively,
increase by $107,362 over 1998. The increase in interest expense reflects a full
nine months of interest charges in 1999 of the $400,000 note assumed in late
March upon the acquisition of Li'l Dino and new borrowings of $300,000 in August
of 1998.
Liquidity and Capital Resources
Net cash used in operating activities was $429,270 in 1999. Accounts payable and
accrued liabilities decreased $561,174. Net cash of $136,847 was generated by
investing activities, primarily through $149,370 generated by the sale of
assets. Net cash of $103,137 was generated by financing activities. This was
primarily the result of $250,000 in additional capital raised through the sale
of the Company's common stock and Series F preferred stock. Debt payments of
$90,546 and dividend payments of $56,317 on the preferred stock offset cash
generated by financing activities.
Net cash used in operating activities was $1,256,394 in 1998. Accounts payable
and accrued liabilities decreased $760,506. Net cash of $531,748 was used in
investing activities. The substantial portion being $402,636 paid out in
connection with notes receivable. Net cash of $1,613,908 was generated by
financing activities. This was primarily the result of $1,817,490 raised through
the successful offering of the Company's preferred stock. New borrowings of
$550,000 matched against debt payments of $740,350 also contributed to an
application of $190,350 to the net change in cash generated by financing
activities.
At September 30, 1999 the Company had $5,084,235 in debt and redeemable
preferred stock outstanding. No new debt was incurred during the period. The
Company did, however, convert all holders of the preferred D stock to preferred
F stock. The preferred F carries a mandatory redemption feature in 2001 and is
therefore carried as a $2,468,750 liability.
During 1998, the Company borrowed $550,000 to finance its operations and assumed
$400,000 in connection with its acquisition of L'il Dino.
Working capital at September 30, 1999 was a deficit of $1,879,446 compared with
a deficit of $2,157,280 on December 31, 1998 a decrease of $277,834. The
decrease in deficit is reflected in a $397,157 reduction in the current portion
of long term debt and a $661,434 reduction in accounts payable and accrued
expenses which were offset by a $189,286 reduction in cash.
17
<PAGE>
Item 7. Financial Statements
Attached hereto and filed as part of this Form 10-KSB are the consolidated
financial statements listed in the index to the Consolidated Financial
Statements at page F-1.
Item 8. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure
(a) Effective October 24, 2000 the Company appointed Berman, Hopkins, Wright and
LaHam, CPA's, LLP as independent accountants for the fiscal year ended on
September 30, 2000. The decision to dismiss Pender, Newkirk and Company was
approved by the audit committee acting pursuant to the authority delegated by
the Company's Board of Directors.
Pender, Newkirk and Company's report on the consolidated financial of Ultimate
Franchise Systems, Inc. (formerly JRECK Subs Group, Inc.) as of and for the nine
months ended September 30, 1999 contained no adverse opinion or disclaimer of
opinion, and were not qualified or modified as to uncertainty, audit scope or
accounting principles.
During the nine months ended September 30, 1999 and in the subsequent period to
the date hereof, there were no disagreements between Ultimate Franchise Systems,
Inc. and Pender, Newkirk and Company on any matters of accounting principles or
practices, financial statement disclosure or auditing scope or procedure, which
disagreements, if not resolved to the satisfaction of Pender, Newkirk and
Company would have caused it to make a reference to the subject matter of the
disagreements in connection with its reports.
The Company has provided Pender, Newkirk and Company, prior to the filing of
Form 8-K with the Commission, a copy of the disclosures made in Item 4(a) on
Form 8K.
(b) Effective October 24, 2000 the Company engaged Berman, Hopkins, Wright and
LaHam, CPA's, LLP as its new independent accountants to audit the Company's
financial statements. During the period that Pender, Newkirk and Company served
as independent auditor, including all interim periods, the Company (or someone
on its behalf) never consulted Berman, Hopkins, Wright and LaHam, CPA's, LLP
regarding any matter.
18
<PAGE>
PART III
Item 9. Directors, Executive Officers and Control Persons
The following table sets forth certain information with respect to the
executive officers and directors of the Company. Each director holds such
position until the next annual meeting of the Company's shareholders and until
his successor has been duly qualified and elected. Any of the Company's officers
may be removed, with or without cause, by the company's board of directors.
- ------------------------------------------------------------------------------
Name Age Director/Date Office or Position
Elected
- ------------------------------------------------------------------------------
Christopher M. Swartz 30 Yes/ Apr 1996 Chairman, President and Chief
Executive Officer
S. Elliott Davenport 41 Yes/ Jul 2000 Director
Eric T. Swartz 34 Yes/ Apr 1996 Secretary
Michael F. Cronin 44 Yes/ Apr 2000 Chief Financial Officer/Treasurer
and Chief Operating Officer
- ------------------------------------------------------------------------------
Christopher M. Swartz has been Chairman, President and Chief Executive Officer
of the Company since April, 1996 and Chairman, President and Chief Executive
Officer of JRECK Subs, Inc. since September, 1995. From 1992 to 1995, he was
Director of Operations of Lox, Stox & Bagels of Liverpool, Inc. Mr. Swartz is a
graduate of Syracuse University. He is the second generation of his family to be
involved with JRECK. Mr. Swartz is also the general partner of Tri-Emp
Enterprises, a limited family partnership and the brother of Eric Swartz.
S. Elliott Davenport has been a Director of the Company since July 2000. From
February 1997 up to joining the Company in July 2000, he was Chairman, President
and Chief Executive Officer of Central Park USA, Inc. (the franchisor of the
Central Park hamburger chain). He was Vice President and Chief Operating Officer
of Central Park USA, Inc. from September 1986 to July 2000.
Eric T. Swartz has been a Director and Secretary of the Company since April,
1996. He was awarded his J.D. degree and undergraduate degree from Syracuse
University College of Law and Syracuse University respectively. From October,
1993 to the present he has been a partner in the Swartz Law Firm, P.C. and was
associated with the law firm of Pease and Willer after graduating from law
school in 1992. Mr. Swartz is the brother of Christopher M. Swartz.
Michael F. Cronin has been Chief Financial Officer of the Company since March 8,
1998, Treasurer since January 1, 1999 and a director since April 2000. He also
became Chief Operating Officer of the Company in May 2000 after the resignation
of this position by Bradley L. Gordon. He is a Certified Public Accountant who
has managed his own practice, specializing in S.E.C audits and business and tax
planning, since February, 1985. He has been licensed in New York State for 17
years. Mr. Cronin is a graduate of St. John Fisher College. From 1979 to 1985
Mr. Cronin was employed as a staff accountant and partner in a regional public
accounting firm in Rochester, NY. Mr. Cronin served in the United States Marine
Corps for three years and was honorably discharged in 1976.
In April 2000, Bradley L. Gordon resigned as Chief Operating Officer and
Director of the Company, positions he assumed in September 1997. From September
1993 up to joining the company in 1997, he was president of Quality Franchise
Systems, Inc. (the franchisor of Mountain Mike's Pizza), Quality Franchise
Systems, Inc.'s Chief Executive Officer since 1992 and one of its directors
since January, 1993. Before joining Quality Franchise Systems, Inc., he held
various positions at Pace Membership Warehouse, Inc. in Denver, Co. from 1983
forward as an Executive Vice President-Sales; Senior Vice President-Operations
and Vice President-Human Resources.
19
<PAGE>
Item 10. Executive Compensation
The following table sets forth the cash compensation of the Company's executive
officers and directors during each of the last three fiscal years. The
remuneration described in the table does not include the cost to the company of
benefits such as health insurance premiums, and other benefits, furnished to the
named executive officers, that are extended in connection with the ordinary
conduct of the Company's business. The value of such benefits cannot be
precisely determined, however no executive officer named below received any such
benefits in excess of the lesser of $25,000 or 10% of such officer's cash
compensation.
<TABLE>
<CAPTION>
Summary Compensation Table
- -----------------------------------------------------------------------------------------------------------------------
Annual Compensation Long Term Compensation
- -----------------------------------------------------------------------------------------------------------------------
Name & Principal Other Annual Awards Awards Payouts All Other
Position Year Salary Bonus Compensation ----------------------------------------------
Restricted Options LTIP
Stock in $ SARS (#) Payouts
($)
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
2000 $ 175,000 $ 0 $ 0 $ 0 0 $ 0 $ 0
-----------------------------------------------------------------------------------------------
Christopher M. Swartz 1999(c) $ 96,154 $ 0 $ 0 $ 0 0(d) $ 0 $ 0
President & CEO -----------------------------------------------------------------------------------------------
1998 $ 175,000 $ 0 $ 0 $ 0 1,000,000 $ 0 $ 0
- -----------------------------------------------------------------------------------------------------------------------
2000 $ 85,000(a) $ 0 $ 150,000(b) $ 0 1,000,000 $ 0 $ 0
-----------------------------------------------------------------------------------------------
Bradley L. Gordon 1999(c) $ 102,500 $ 0 $ 0 $ 0 0 $ 0 $ 0
Chief Operating Officer -----------------------------------------------------------------------------------------------
1998 $ 150,000 $ 0 $ 60,000(e) $ 0 0 $ 0 $ 0
- -----------------------------------------------------------------------------------------------------------------------
2000 $ 130,625 $ 0 $ 0 $ 0 1,000,000 $ 0 $ 0
-----------------------------------------------------------------------------------------------
Michael F. Cronin 1999(c) $ 84,615 $ 0 $ 0 $ 0 0 $ 0 $ 0
Chief Financial Officer -----------------------------------------------------------------------------------------------
& Chief Operating Officer 1998 $ 93,750 $ 0 $ 0 $ 0 0 $ 0 $ 0
- -----------------------------------------------------------------------------------------------------------------------
2000(f) $ 25,412 $ 0 $ 0 $ 0 0 $ 0 $ 0
-----------------------------------------------------------------------------------------------
S. Elliott Davenport 1999(c) $ 0 $ 0 $ 0 $ 0 0 $ 0 $ 0
Director -----------------------------------------------------------------------------------------------
1998 $ 0 $ 0 $ 0 $ 0 0 $ 0 $ 0
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Mr. Gordon resigned as Chief Operating Officer and Director in April 2000
and his salary was for seven months.
(b) Payment received upon termination of services to the Company.
(c) Due to a change in fiscal years, 1999 compensation covers only a nine month
period.
(d) Options on 2,000,000 shares granted to Mr. Swartz in 1997 and 1998 were
modified and regranted in 1999.
(e) Relocation expense reimbursement.
(f) Mr. Davenport joined the Company in July 2000.
Employment Contracts:
<TABLE>
<CAPTION>
Mr. Cronin and Mr. Davenport have employment contracts with the Company. The following table
summarizes the significant terms of these agreements:
- -----------------------------------------------------------------------------------------------------------------
Termination
Clause
Initial Salary Change in
Commencement Annual Continuation Control
Name Position Date Term Compensation Period Arrangement
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Michael F. Cronin Director, July 31, 1998 3 Years $ 125,000 12 Months No
Chief Financial Officer
& Chief Operating Officer
S. Elliott Davenport Director July 19, 2000 1 Year $ 125,000 None No
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
Options and Rights Granted to Purchase Common Stock:
The following table summarizes options and rights to purchase common stock that
were granted or issued to executive officers and directors over each of the last
two fiscal years:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
Number Percent of
of Number of Total
Options Shares of Date of Exercise Options
Granted Common Grant Price of Granted to
(in Stock or Expiration Purchase Employees
Name Position Shares) Purchased Purchase Date Price During Year
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Bradley L. Gordon(a) Chief Operating 1,000,000 Oct 15, 1999 Oct 15, 2004 $ 0.29 13.7%
Officer/Director
Michael F. Cronin Chief Financial 1,000,000 Oct 15, 1999 Oct 15, 2004 $ 0.29 13.7%
Officer and Chief
Operating Officer
- ---------------------------------------------------------------------------------------------------------------------------
(a) Mr. Gordon resigned as Chief Operating Officer and Director in April 2000.
</TABLE>
The following table sets forth information regarding the value of Options and
Stock Appreciation Rights granted to officers of the Company during 2000:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------
Number of Securities Underlying Value of In-The-Money
Unexercised Options and SAR's Options and SAR's
at September 30, 2000 at September 30, 2000
- ----------------------------------------------------------------------------------------------------------------------------
Shares Acquired
Name and Position on Exercise Value Realized Exercisable Unexercisable Exercisable Unexercisable
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Bradley L. Gordon None None 1,000,000 None None None
Chief Operating
Officer (a)
Michael F. Cronin None None 1,000,000 None None None
Chief Financial
Officer and Chief
Operating Officer
- ----------------------------------------------------------------------------------------------------------------------------
(a) Mr. Gordon resigned as Chief Operating Officer and Director in April 2000.
</TABLE>
20
<PAGE>
Other:
The Company does not carry officers & directors liability insurance or
disability benefits in excess of statutorily mandated amounts. Directors receive
no compensation for their duties.
The Company maintains, and is the beneficiary of, a $3,000,000 key man term
life insurance policy on Mr. Christopher Swartz.
Item 11. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth information relating to the beneficial ownership
of the Company's Common Stock by those persons beneficially holding more than 5%
of the Company's common stock or held by the company's executive officers and
directors, and by all the Company's executive officers and directors as a group
as of September 30, 2000. The address of each person is in care of the Company
unless noted.
As used in the table, The term "beneficial ownership" means the sole or shared
power to vote, or to direct the voting of a security, or the sole or shared
investment power with respect to a security (i.e. the power to dispose of, or to
direct the disposition of, a security). In addition, for purposes of this table,
a person is deemed to have "beneficial ownership" of any security if such person
has the right to acquire such security within sixty days.
- ------------------------------------------------------------------------------
Name and Amount and
Address of Officer Nature of
Title of Beneficial or Beneficial Percent of
Class Owner Director Owner Class
- ------------------------------------------------------------------------------
Common Stock Christopher M. Swartz Yes (a) 5,816,711 12.81 %
Common Stock Michael F. Cronin Yes (b) 1,500,000 3.31 %
Common Stock Eric Swartz Yes (c) 150,000 0.33 %
Common Stock S. Elliott Davenport Yes 0 0.00 %
All Officers and Directors as a Group 7,466,711 16.45 %
(a) Includes 4,139,211 shares of common stock owned by Tri-Emp
Enterprises, a limited family partnership. Mr. Swartz is the general partner of
Tri-Emp Enterprises, and as such, is deemed to have beneficial ownership of the
shares of the Company owned by Tri-Emp Enterprises. It also includes 1,000,000
shares subject to options currently exercisable by Mr. Christopher Swartz and
225,000 shares subject to options exercisable by Tri-Emp Enterprises. It
excludes 1,000,000 shares subject to options by Mr. Christopher Swartz which
expired on December 29, 2000.
(b) Includes 1,000,000 shares subject to options currently exercisable
by Mr. Cronin.
(c) Includes 150,000 shares subject to options currently exercisable by
Mr. Eric Swartz
21
<PAGE>
Item 12. Certain Relationships and Related Transactions
In March 2000, the Company issued 894,211 shares of its common stock to Tri-Emp
Enterprises, Inc. for the retirement of a note payable of $166,815 and accrued
interest of $56,913. Tri-Emp Enterprises, Inc. received 500,000 shares of the
Company's common stock on August 11, 1999 in a partial payment of $109,400
toward an outstanding debt obligation of the Company to Tri-Emp of $343,000.
In April 2000, the Company sold the Mountain Mike's Pizza franchise concept to
Concept Acquisitions, LLC ("COAC") for $3,000,000 cash and two notes receivable
with discounted values of $165,534 and $377,645, respectively. COAC is
controlled by Bradley L. Gordon, the Company's former Chief Operating Officer
and Director who resigned in April 2000.
Mr. Bradley Gordon, the Company's former Chief Operating Office and Director,
purchased 500,000 shares of the Company's Common Stock in each of two separate
transactions to obtain an aggregate of 1,000,000 shares. One transaction
occurred in September, 1997 and the other transaction occurred on July 30, 1998.
The Company received a promissory note from Mr. Gordon on each agreement for the
full amount of each purchase price of $1,500,000 and $687,500 respectively. The
notes each beared interest at 9.5% per annum and were due three years from the
date of issuance. Mr. Gordon had the right to require the Company to repurchase
the
shares as consideration for the cancellation of the underlying promissory note.
In April 2000, Mr. Gordon required the Company to repurchase the 1,000,000 for
cancellation of the two promissory notes totaling $2,187,500. All accrued
interest under these notes through the date of cancellation in April 2000 had
been waived by the Board of Directors.
Mr. Gordon received options to acquire an additional 1,000,000 shares at $0.29
per share on October 15, 1999. These options expire on October 15, 2004. Mr.
Gordon has not exercised his rights to acquire any shares under this agreement.
Mr. Richard Silberman, a shareholder of the Company, purchased 300,000 shares of
the Company's Common Stock in each of two separate transactions to obtain an
aggregate of 600,000 shares. One transaction occurred in September, 1997 and the
other transaction occurred on July 30, 1998. The Company received a promissory
note from Mr. Silberman on each agreement for the full amount of each purchase
price of $900,000 and $412,500 respectively. The notes each beared interest at
9.5% per annum and were due three years from the date of issuance. Mr. Silberman
had the right to require the Company to repurchase the shares as consideration
for the cancellation of the underlying promissory note. In April 2000, Mr.
Silberman required the Company to repurchase the 600,000 for cancellation of the
two promissory notes totaling $1,312,500. All accrued interest under these notes
through the date of cancellation in April 2000 had been waived by the Board of
Directors.
Mr. Silberman received options to acquire an additional 600,000 shares at $0.29
per share on October 15, 1999. These options expire on October 15, 2004. Mr.
Silberman has not exercised his rights to acquire any shares under this
agreement.
Mr. Michael F. Cronin, Chief Financial Officer, Treasurer, Chief Operating
Officer and Director of the Company, purchased 500,000 shares of the Company's
Common Stock. The transaction occurred on July 30, 1998. The Company received a
promissory note from Mr. Cronin on the agreement for the full amount of the
purchase price of $687,500. The note bears interest at 9.5% per annum and is due
three years from the date of issuance. Mr. Cronin has the right to require the
Company to repurchase the shares as consideration for the cancellation of the
underlying promissory note. Mr. Cronin received options to acquire an additional
1,000,000 shares at $0.29 per share on October 15, 1999. These options expire on
October 15, 2004. Mr. Cronin has not exercised his rights to acquire any shares
under this agreement. All accrued interest under these notes through September
30, 2000 has been waived by the Board of Directors.
22
<PAGE>
Mr. Christopher M. Swartz, Chairman of the Company and its President and Chief
Executive Officer, was granted options to purchase 2,000,000 shares of the
Company's Common Stock. The options were granted in the amount of 1,000,000
shares each on December 29, 1997 and August 3, 1998. The exercise prices were
$2.75 and $1.55, respectively, and expire three years from the date of grant..
These options to acquire were repriced at $0.29 per share on October 1, 1999.
Mr. Swartz has not exercised his rights to acquire any shares under these
agreements. On December 29, 2000, options for 1,000,000 shares of the Company's
common stock expired.
On January 5, 1998 the Company concluded its Preferred "D" stock offering. The
Company raised $2,500,000 through the offering. Eighteen investors purchased
2,500 shares for $1,000 each. The holders of the Series "D" Preferred Stock had
no voting rights and were entitled to cumulative dividends of $80 per share, per
year, payable in cash or common stock. Holders of the Series "D" may convert a
portion or all of their holdings into common stock based upon a conversion rate
formula of 65% of the average five day closing bid price five trading days
before conversion. The conversion rate was further adjusted by two five percent
penalty increments for the Company's failure to file and make effective a Form
SB-2 within certain time parameters. As of June 10, 1999 the Company has issued
5,303,574 common shares as conversion shares under this agreement.
On June 10, 1999, the holders of the Preferred "D" converted their entire
holding to the Company's newly created Preferred "F" series. The Series D was
canceled and 197.5 shares of the Series F were issued in its place. The holders
of Series F were each entitled to receive an annual dividend of $1,000. The
dividend was payable quarterly beginning August 1, 1999. The holders could
require the Company to repurchase the outstanding shares at a 25% premium over
the face value of $10,000 no sooner than June 1, 2001 and no later than August
1, 2001. The Company could also redeem the shares at any time prior to February
1, 2001 at $12,500 per share. In the event of liquidation, dissolution, or
winding up of the Corporation, whether voluntary or involuntary, the Series F
holders were entitled to receive $13,000 per share.
In December 2000, the Company redeemed all 197.5 shares of the Series F for
$500,000 cash and 19,750,000 shares of the Company's common stock. This issuance
of these shares increased the number of outstanding common shares by 61.9%.
In December 2000, the Company issued Convertible Debentures of $575,000. The
Convertible Debentures call for monthly interest payments at 12% and are due in
January 2002. The Convertible Debentures may be converted in whole or in part to
common stock of the Company at a conversion price equal to 65% of the three day
average closing price prior to the date of conversion. In anticipation of the
conversion of the Convertible Debentures, the Company has placed into escrow
10,000,000 shares of its common stock.
In December 2000, the Company increased its authorized shares of common stock
from 50,000,000 shares to 100,000,000 shares.
Item 13. Exhibits and Reports on Form 8-K
Schedule of Exhibits:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------
Reserved
for Incorporated
Exhibit Future by Date of
Item No. Description of Exhibit Use Reference in: Filing
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
2.0 Plans of purchase, sale, reorganization, arrangement, liquidation or
succession:
2.1 Repurchase Agreement between Paul Truax and Robin Longley and JRECK Subs, Form 10-SB 02/17/99
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. Form 10-SB 02/17/99
and Admiral's Fleet, Inc. and Quality Franchise Systems, Inc. Quality
Agreement)
2.3 Amendment to Quality Agreement Form 10-SB 02/17/99
2.4 Agreement between JRECK Subs Group, Inc. and CHAI Enterprises, Inc. ("Hymie's") Form 10-SB 02/17/99
2.5 Agreement and Plan of Reorganization among JRECK Subs Group, Inc., Li'l Dino Form 10-SB 02/17/99
Management Corporation and Li'l Dino Corporation dated December 18, 1997
2.6 Purchase agreement among JRECK Subs Group, Inc., Interfoods of America, Inc. Form 10-SB 02/17/99
and SBK Franchise Systems, Inc. dated December 4, 1997
2.7 Agreement between JRECK Subs Group, Inc. and Little King, Inc. dated July Form 10-SB 02/17/99
23, 1997
2.8 Agreement between JRECK Subs Group, Inc. and Mitchell R. Day and Julie A. Form 10-SB 02/17/99
Day to purchase Seawest Sub Shops, Inc.
2.9 Stock Option Grants to acquire Seawest Sub Shops, Inc. Form 10-SB 02/17/99
2.10 Representation and Warranty Agreement among Mitchell R. Day and Julie A. Day Form 10-SB 02/17/99
and Admiral Subs of Washington, Inc. dated May 19, 1997.
2.11 Purchase and Sale Agreement between Admiral's Fleet, Inc, JRECK Form 10-SB 02/17/99
Subs Group, Inc., and Richey Enterprises, Inc.
2.12 Repurchase Agreement by Paul Truax and Robin Longley Form 10-SB 02/17/99
23
<PAGE>
- ----------------------------------------------------------------------------------------------------------------------------
Reserved
for Incorporated
Exhibit Future by Date of
Item No. Description of Exhibit Use Reference in: Filing
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
3.0 Articles of Incorporation and Bylaws:
3.1 Articles of Incorporation-Circa Media, Inc. Form 10-SB 02/17/99
3.2 Articles of Amendment of Circa Media dated May 2, 1996 and filed May 7, 1996 Form 10-SB 02/17/99
3.3 Articles of Amendment of Jreck Subs, Inc. filed May 7, 1997 Form 10-SB 02/17/99
3.4 Certificate of Correction to Articles of Amendment filed July 24, 1996 Form 10-SB 02/17/99
3.5 Articles of Amendment to Articles of Incorporation regarding Certificate of Form 10-SB 02/17/99
Description of JRECK Subs Group, Inc. Series C Preferred Stock dated Sept. 27, 1997
3.6 Articles of Amendment to Articles of Incorporation regarding Certificate of Form 10-SB 02/17/99
Description of JRECK Subs Group, Inc. Series D Preferred Stock dated
January 5, 1998
3.7 Bylaws of JRECK Subs Group, Inc. dated August 23, 1998 Form 10-SB 02/17/99
10.0 Material Contracts:
10.1 Form of Franchise Agreement Form 10-SB 02/17/99
10.2 Facility Lease agreement between Springs Equity, Ltd. and JRECK Subs Group, Form 10-SB 02/17/99
Inc. dated December 16, 1997
10.3 Quality Franchise Systems, Inc. Area development Agreements: Form 10-SB 02/17/99
(a) MKJ Holdings, Inc.
(b) Master Franchising and Development Systems, Inc.
(c) John E. and Ann M. Maddox
(d) Alex Golshanara
10.4 Promissory Note from Bradley L. Gordon to JRECK Subs Group, Inc. dated Form 10-SB 02/17/99
September 24, 1997
10.5 Promissory Note from Richard T. Silberman to JRECK Subs Group, Inc. dated Form 10-SB 02/17/99
September 24, 1997
10.6 Promissory Note from Michael F. Cronin to JRECK Subs Group, Inc. dated July Form 10-SB 02/17/99
31, 1998
10.7 Promissory Note from Richard T. Silberman to JRECK Subs Group, Inc. dated Form 10-SB 02/17/99
July 31, 1998
10.8 Promissory Note from Bradley L. Gordon to JRECK Subs Group, Inc. dated July Form 10-SB 02/17/99
31, 1998
10.9 Employment Agreement between Bradley L. Gordon and JRECK Subs, Group, Inc. Form 10-SB 02/17/99
effective September 24, 1997
10.10 Employment Agreement between Michael F. Cronin and JRECK Subs, Group, Inc. Form 10-SB 02/17/99
effective July 31, 1998
10.11 Stock Option Grant between JRECK Subs Group, Inc. and Christopher M. Swartz Form 10-SB 02/17/99
dated August 3, 1998
10.12 Stock Option Grant between JRECK Subs Group, Inc. and Christopher M. Swartz Form 10-SB 02/17/99
dated December 29, 1997
10.13 Resale agreement of Little King, Inc. back to its previous owners dated Form 8-K 10/08/99
September 29, 1999
16.0 Letter of change in certifying accountants Form 8-K 11/08/99
16.1 Former accountants letter to Commission Form 10-SB 02/17/99
16.2 Former accountants letter to Commission Form 8-K 11/08/99
21 Subsidiaries of Registrant Form 10-SB 02/17/99
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
Reports filed on form 8-K:
24
<PAGE>
Financial
Date of Filing Items Reported Statements
-------------- -------------- ----------
June 22, 2000 Change in Legal Corporate Name No
November 1, 2000 Change in Certifying Accountants No
SIGNATURES
In accordance with all the requirements of the Exchange Act, the registrant has
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Ultimate Franchise Systems, Inc.
- ------------------------
(Registrant)
President & Duly Authorized
Officer Member of
01/12/01 Christopher M. Swartz Board of Directors /s/ Christopher M. Swartz
- -------- --------------------- ------------------- -----------------------
Date Print Name Title Signature
Chief Financial Officer
Treasurer & Chief
01/12/01 Michael F. Cronin Operating Officer /s/ Michael F. Cronin
- -------- --------------------- ------------------- -----------------------
Date Print Name Title Signature
25
<PAGE>
Consolidated Financial Statements
Ultimate Franchise Systems, Inc. and Subsidiaries
(formerly Jreck Subs Group, Inc.)
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
Independent Auditors' Reports
F-1
<PAGE>
Ultimate Franchise Systems, Inc. and Subsidiaries
Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
Contents
Independent Auditors' Reports on Consolidated Financial Statements.....F-3 - F-4
Consolidated Financial Statements:
Consolidated Balance Sheets............................................F-5 - F-6
Consolidated Statements of Operations........................................F-7
Consolidated Statements of Cash Flows..................................F-8 - F-9
Consolidated Statements of Stockholders' Equity......................F-10 - F-11
Notes to Consolidated Financial Statements...........................F-12 - F-48
F-2
<PAGE>
Independent Auditors' Report
Board of Directors and Stockholders
Ultimate Franchise Systems, Inc.
Longwood, Florida
We have audited the accompanying consolidated balance sheet of Ultimate
Franchise Systems, Inc. (formerly JRECK Subs Group, Inc.) and subsidiaries as of
September 30, 2000 and the related consolidated statements of operations,
stockholders' equity and cash flows for the year then ended. These consolidated
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 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 Ultimate Franchise
Systems, Inc. and subsidiaries as of September 30, 2000, and the results of its
operations and its cash flows for the year then ended in conformity with
generally accepted accounting principles.
/s/ Berman Hopkins Wright & LaHam, CPA's, LLP
Berman Hopkins Wright & LaHam, CPA's, LLP
Melbourne, Florida
December 12, 2000
F-3
<PAGE>
Independent Auditors' Report
Board of Directors and Stockholders
JRECK Subs Group, Inc.
Longwood, Florida
We have audited the accompanying consolidated balance sheet of JRECK Subs Group,
Inc. and subsidiaries as of September 30, 1999 and the related consolidated
statements of operations, stockholders' equity and cash flows for the nine
months then ended. These consolidated 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 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. and subsidiaries as of September 30, 1999, and the results of its
operations and its cash flows for the nine months then ended in conformity with
generally accepted accounting principles.
/s/ Pender Newkirk & Company, CPAs
Pender Newkirk & Company, CPAs
Tampa, Florida
November 12, 1999
F-4
<PAGE>
<TABLE>
<CAPTION>
Ultimate Franchise Systems, Inc. and Subsidiaries
Consolidated Balance Sheets
September 30, September 30,
2000 1999
-------------- --------------
Assets
<S> <C> <C>
Current assets:
Cash and cash equivalents, including restricted cash of
$0 and $35,086 for 2000 and 1999, respectively $ 148,072 $ 121,292
Accounts receivable trade, net of allowance for
doubtful accounts of $85,436 and $152,886 for 2000
and 1999, respectively 272,107 365,618
Prepaid expenses 277,416 456,883
Inventory 85,390 -
Current portion of notes receivable 63,584 80,000
-------------- --------------
Total current assets 846,569 1,023,793
-------------- --------------
Property and equipment, net 1,116,837 726,667
-------------- --------------
Other assets:
Goodwill, net of accumulated amortization of $736,243
and $984,817 for 2000 and 1999, respectively 7,094,183 8,987,076
Covenants not to compete, net of accumulated
amortization of $36,402 and $388,458 for 2000 and
1999, respectively 327,618 113,542
Deferred loan costs, net 310,943 376,403
Notes receivable, net of allowance for doubtful
accounts of $0 and $180,000 for 2000 and 1999,
respectively 736,503 -
Investment securities 789,430 -
Other 108,801 106,750
-------------- --------------
Total assets $ 11,330,884 $ 11,334,231
============== ==============
Read independent auditors' reports. The accompanying notes
are an integral part of the consolidated financial statements
F-5
<PAGE>
<CAPTION>
Ultimate Franchise Systems, Inc. and Subsidiaries
Consolidated Balance Sheets, Continued
September 30, September 30,
2000 1999
-------------- --------------
Liabilities and Stockholders' Equity
<S> <C> <C>
Current liabilities:
Current portion of long-term debt $ 417,140 $ 1,606,041
Accounts payable 708,767 496,553
Accrued liabilities 963,199 552,881
Accrued preferred stock dividends 247,764 247,764
-------------- --------------
Total current liabilities 2,336,870 2,903,239
Long-term debt, less current portion 2,772,108 763,505
Note payable to related party - 245,939
-------------- --------------
Total liabilities 5,108,978 3,912,683
-------------- --------------
Redeemable common stock 293,000 293,000
-------------- --------------
Redeemable Series F Preferred Stock, no par value, 250
shares authorized, 197.5 shares issued and outstanding 2,468,750 2,468,750
-------------- --------------
Commitments and contingencies - -
Stockholders' equity:
Series C Convertible Preferred Stock, no par value, 120
shares authorized, issued and outstanding 120,000 120,000
Common stock, no par value, 50,000,000 shares authorized,
31,887,182 and 28,403,440 shares issued and outstanding
for 2000 and 1999, respectively 26,830,014 28,394,179
Accumulated deficit (22,885,674) (19,666,881)
Less: Stock subscriptions receivable (687,500) (4,187,500)
Accumulated other comprehensive income 83,316 -
-------------- --------------
Total stockholders' equity 3,460,156 4,659,798
-------------- --------------
Total liabilities and stockholders' equity $ 11,330,884 $ 11,334,231
============== ==============
</TABLE>
Read independent auditors' reports. The accompanying notes
are an integral part of the consolidated financial statements
F-6
<PAGE>
<TABLE>
<CAPTION>
Ultimate Franchise Systems, Inc. and Subsidiaries
Consolidated Statements of Operations
Year Ended Nine Months Ended
September 30, September 30,
2000 1999
-------------- --------------
Revenues:
<S> <C> <C>
Continuing royalty revenues $ 2,108,337 $ 2,046,280
Initial royalty revenues 63,000 78,250
Retail sales company-owned stores 521,747 -
Retail sales bakery and other products 825,237 571,844
Other revenues 973,619 600,004
-------------- --------------
4,491,940 3,296,378
Operating costs and expenses:
Franchise servicing costs 1,419,548 1,296,506
Cost of retail sales and operating costs - stores 594,905 -
Cost of retail sales and operating costs - bakery 816,376 541,014
General and administrative 1,415,752 1,177,276
Consulting and investor relations 1,417,263 722,541
Bad debt expense 25,442 254,507
Amortization and depreciation 745,692 670,442
-------------- --------------
6,434,978 4,662,286
-------------- --------------
Loss from operations (1,943,038) (1,365,908)
Other income (expense):
Interest, net (318,633) (356,192)
Write-down of property and equipment (70,101) -
Loss on disposals of franchise concepts (843,092) (39,606)
Loss on sale of investment securities - (58,596)
Other, net 169,171 52,203
-------------- --------------
Net loss (3,005,693) (1,768,099)
Preferred stock dividends (213,100) (146,940)
Net loss applicable to common stock $ (3,218,793) $ (1,915,039)
============== ==============
Weighted average of common shares outstanding 30,102,278 22,796,417
============== ==============
Net loss per common share - basic and diluted $ (.11) $ (.08)
============== ==============
</TABLE>
Read independent auditors' reports. The accompanying notes
are an integral part of the consolidated financial statements
F-7
<PAGE>
<TABLE>
<CAPTION>
Ultimate Franchise Systems, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Year Ended Nine Months Ended
September 30, September 30,
2000 1999
------------- -------------
Operating activities:
<S> <C> <C>
Net loss $ (3,005,693) $ (1,768,099)
Adjustments to reconcile net loss to net cash
used by operating activities:
Amortization and depreciation 745,692 670,442
Write down of property, plant and equipment 70,101 -
Bad debts 25,442 254,507
Loss on disposals of franchise concepts 843,092 39,606
Loss on sale of investment securities - 58,596
Stock and stock options issued for services 227,569 239,595
Prepaid interest, amortized discounts and loan fees
charged to interest 8,997 75,502
Amortization of deferred loan costs 65,460 56,889
Prepaid consulting fees amortized to consulting and investor
relations expense 732,720 487,356
(Increase) decrease in:
Accounts receivable (8,178) 32,184
Prepaid expenses 52,083 (14,674)
Inventory (6,256) -
Increase (decrease) in:
Accounts payable (199) (362,255)
Accrued liabilities 9,623 (198,919)
------------- -------------
Net cash used by operating activities (239,547) (429,270)
------------- -------------
Investing activities:
Proceeds from sale of investment securities - 115,967
Purchase of investment securities (20,915) -
Proceeds from disposal of property and equipment 7,462 -
Purchase of property and equipment - (2,059)
Proceeds from disposals of franchise concepts 2,682,130 33,403
Payments on acquisition of franchise concept (925,595) -
Advances made on notes receivable (35,000) (12,185)
(Increase) decrease in other assets (7,518) 1,721
------------- -------------
Net cash provided by investing activities 1,700,564 136,847
------------- -------------
Financing activities:
Proceeds from the sale of common stock - 150,000
Proceeds from the sale of Series E preferred stock - 200,000
Payments to repurchase Series E preferred stock - (100,000)
Borrowings from related party debt 45,876 -
Payments on related party debt (125,000) -
Payments on long-term debt (1,142,013) (90,546)
Payment of preferred stock dividends (213,100) (56,317)
------------- -------------
Net cash provided (used) by financing activities (1,434,237) 103,137
------------- -------------
Net increase (decrease) in cash and cash equivalents 26,780 (189,286)
Cash and cash equivalents, beginning of year 121,292 310,578
------------- -------------
Cash and cash equivalents, end of year $ 148,072 $ 121,292
============= =============
Read independent auditors' reports. The accompanying notes
are an integral part of the consolidated financial statements
F-8
<PAGE>
<CAPTION>
Ultimate Franchise Systems, Inc. and Subsidiaries
Consolidated Statements of Cash Flows, Continued
Certain supplemental disclosure of cash flow information and non-cash investing
and financing activities is as follows:
Year Ended Nine Months Ended
September 30, September 30,
2000 1999
------------- -------------
<S> <C> <C>
Cash paid for interest $ 219,187 $ 223,801
Cash paid for income taxes 999 650
============= =============
Stock and stock options issued in exchange for prepaid expenses $ 447,931 $ 298,100
Conversion of Series D preferred to common stock - 791,983
Conversion of Series D and E preferred to redeemable Series F preferred - 3,226,288
Common shares issued to satisfy dispute with prior owners of SBK - 664,294
Common shares issued for price adjustments - 97,695
Common shares received from sale of Little King and Richey Enterprises - 1,111,031
Conversion of long-term debt and related party debt into common stock 343,291 159,400
Conversion of accrued interest into common stock 92,645 -
Stock and stock options issued in exchange for investment securities 685,199 -
Preferred stock dividends paid in common stock - 44,399
Preferred stock dividends accrued - 114,023
Cancellation of stock subscriptions receivable 3,500,000 -
============= =============
</TABLE>
In addition to the above non-cash items, the following is a summary of non-cash
transactions entered into for the acquisition of the franchise concept described
in Note 3 for the year ended September 30, 2000. There were no acquisitions for
the nine months ended September 30, 1999:
<TABLE>
<CAPTION>
Year Ended
September 30,
2000
-------------
<S> <C>
Common stock issued $ (139,200)
Long-term debt issued (1,433,874)
-------------
Total non-cash consideration paid (1,573,074)
-------------
Accounts receivable 84,895
Prepaid expenses 47,205
Inventory 79,134
Property, plant and equipment 622,169
Goodwill acquired 2,940,289
Covenant not to compete 364,020
Notes receivable 147,337
-------------
Total non-cash acquisition of assets 4,285,049
-------------
Accounts payable (352,939)
Accrued expenses (444,040)
Long-term debt assumed (989,401)
-------------
Total non-cash assumption of liabilities (1,786,380)
-------------
Net cash paid $ (925,595)
=============
</TABLE>
Read independent auditors' reports. The accompanying notes
are an integral part of the consolidated financial statements
F-9
<PAGE>
<TABLE>
<CAPTION>
Ultimate Franchise Systems, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
Common Preferred Series C Preferred Series D
Shares Amount Shares Amount Shares Amount
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1998 19,503,596 $26,225,338 120 $120,000 2,350 $3,918,271
Conversion of debt to equity 692,308 159,400 - - - -
Stock issued for current and
prepaid services 1,291,667 340,000 - - - -
Exercise of options for common stock 37,500 - - - - -
Stock issued for investment security 769,230 174,563 - - - -
Conversion of preferred Series D to
common stock 4,250,499 791,983 - - (475) (791,983)
Conversion of preferred Series D
stock dividend 397,966 44,399 - - - -
Acquisition and retirement of common
stock (776,779) (1,111,031) - - - -
Other stock sales 500,000 150,000 - - - -
Stock issued for price adjustments 850,000 197,695 - - - -
Stock issued on acquisition
restructuring 887,453 664,294 - - - -
Issuance of preferred E shares - - - - - -
Repurchase of preferred E shares - - - - - -
Conversion of preferred Series D
and Series E to Series F redeemable
preferred stock - 757,538 - - (1,875) (3,126,288)
Preferred dividends - - - - - -
Net loss - - - - - -
-----------------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 1999 28,403,440 28,394,179 120 120,000 - -
Conversion of debt to equity 1,743,742 435,936 - - - -
Stock issued for current and
prepaid services 1,905,000 465,900 - - - -
Issuance of options for services - 209,600 - - - -
Stock issued for investment security 1,000,000 260,000 - - - -
Options issued for investment security - 425,199 - - - -
Common stock issued for acquisition 435,000 139,200 - - - -
Cancellation of stock subscriptions
receivable (1,600,000) (3,500,000) - - - -
Preferred dividends - - - - - -
Net loss - - - - - -
Unrealized gain on investment
securities - - - - - -
-----------------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 2000 31,887,182 $26,830,014 120 $120,000 - $ -
===================================================================================================================================
</TABLE>
Read independent auditors' reports. The accompanying notes
are an integral part of the consolidated financial statements
F-10
<PAGE>
<TABLE>
<CAPTION>
Ultimate Franchise Systems, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity, Continued
Preferred Series E Accumulated Other
Accumulated Subscription Comprehensive Total
Shares Amount Deficit Notes Income Equity
----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
- $ - $(17,751,842) $(4,187,500) $ - $ 8,324,267
- - - - - 159,400
- - - - - 340,000
- - - - - -
- - - - - 174,563
- - - - - -
- - (44,399) - - -
- - - - - (1,111,031)
- - - - - 150,000
- - - - - 197,695
- - - - - 664,294
20 200,000 - - - 200,000
(10) (100,000) - - - (100,000)
(10) (100,000) - - - (2,468,750)
- - (102,541) - - (102,541)
- - (1,768,099) - - (1,768,099)
----------------------------------------------------------------------------------------------------------------
- - (19,666,881) (4,187,500) - 4,659,798
- - - - - 435,936
- - - - - 465,900
- - - - - 209,600
- - - - - 260,000
- - - - - 425,199
- - - - - 139,200
- - - 3,500,000 - -
- - (213,100) - - (213,100)
- - (3,005,693) - - (3,005,693)
- - - - 83,316 83,316
----------------------------------------------------------------------------------------------------------------
- $ - $(22,885,674) $ (687,500) $83,316 $ 3,460,156
================================================================================================================
</TABLE>
Read independent auditors' reports. The accompanying notes
are an integral part of the consolidated financial statements
F-11
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
1. Background Information
Ultimate Franchise Systems, Inc. (formerly JRECK Subs Group, Inc.) (the
"Company"), a Colorado corporation, was formerly known as Circa Media, Inc.
which was organized on July 19, 1995. On May 7, 1996, Circa Media, Inc. acquired
100% of JRECK Subs, Inc. For financial reporting purposes, the acquisition was
accounted for as a reverse merger, whereby JRECK Subs, Inc. was deemed to be the
acquiring entity. In June 2000, the shareholders of the Company approved a
corporate name change from JRECK Subs Group, Inc. to Ultimate Franchise Systems,
Inc.
The wholly-owned subsidiaries of the Company include Jreck Subs Inc., a New York
corporation, SBK Franchise Systems, Inc., a Florida corporation, Li'l Dino
Corporation, a North Carolina corporation, Central Park of America, Inc., a
Delaware corporation and Pastry Products Producers, LLC, a New York limited
liability company. Also, prior to the subsidiaries' disposition or sale, the
Company included Admiral Subs of Washington, Inc., a Washington corporation and
Admiral's Fleet, Inc., a Washington corporation.
The Company is a multi-concept franchisor of sandwich shops and hamburger
restaurants located throughout the United States. Its headquarters are located
in Longwood, Florida. Currently, the Company serves as the franchisor to 162
stores operating under various trade names. Franchise arrangements include a
license to operate under the applicable trade name and generally provide for the
receipt of initial royalty revenues, as well as continuing royalty revenues
based upon a percentage of sales. In addition, the Company offers guidance and
assistance to the franchisees in areas such as product preparation, equipment
purchasing, marketing, administrative support and employee training.
The Company also operates a bakery and from its acquisition of the Central Park
hamburger chain in July 2000 (see Note 3), seven company-owned restaurants. The
bakery is the supplier of bread products to certain franchisees of the Company.
For the year ended September 30, 2000 and the nine months ended September 30,
1999, all bakery sales were to franchisees (18.4% and 17.3% of total revenues,
respectively).
As indicated in the accompanying consolidated financial statements, the
Company's net loss has increased from approximately $1.8 million for the nine
months ended September 30, 1999 to approximately $3.0 million for the year ended
September 30, 2000. Cash used by operations for the year ended September 30,
2000 was approximately $240,000 compared to approximately $429,000 used for the
nine months ended September 30, 1999. Working capital deficit decreased from
approximately $1.9 million at September 30, 1999 to approximately $1.5 million
at September 30, 2000.
F-12
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
1. Background Information (continued)
Management believes the following steps are important to the Company's future:
1. The sale of the Company's seven company-owned restaurants with proceeds used
to reduce indebtedness;
2. The continuation of the positive trends indicated above, including the
continuation of the decline in franchise expenses, reduction of payroll costs
and reduction of corporate general and administrative expenses; and
3. The conversion or redemption of the Company's Series F preferred stock (see
Note 14).
Management believes, based on its plans outlined above, that the Company's
operating cash flow deficit, operating losses before non-cash charges and
negative working capital can be reduced or eliminated based on the extent that
its business strategies are realized. As of the date of these financial
statements (and subsequent to September 30, 2000), the Company entered into
agreements to dispose of five of the company-owned restaurants and to fully
convert its Series F preferred stock. Regardless of the improvement of the
Company's financial position and the initiation of management's plan indicated
above, no assurance can be given that its financial position will continue to
improve and the detrimental financial trends will be corrected.
2. Significant Accounting Policies
The significant accounting policies of the Company are as follows:
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.
F-13
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
2. Significant Accounting Policies (continued)
Principles of Consolidation
The consolidated financial statements include the accounts of Ultimate Franchise
Systems, Inc. and its wholly-owned subsidiaries. All significant accounts and
transactions have been eliminated in consolidation.
Change in Accounting Year
Beginning January 1, 1999, the Company changed its accounting reporting period
from a calendar year ending December 31st to a fiscal year ending September
30th. Thus the consolidated financial statements present results of operations,
changes in stockholders' equity and cash flows for the year ended September 30,
2000 and the nine months ended September 30, 1999, respectively.
Cash and Cash Equivalents
For financial presentation purposes, the Company considers those short-term,
highly liquid investments with original maturities of three months or less to be
cash and cash equivalents.
Inventory
Inventory consists primarily of food and beverage stock at the company-owned
restaurants. Inventory is stated at the lower of cost (generally on an average
basis) or market.
Property and Equipment
Property and equipment are recorded at cost. Maintenance and repairs are charged
to operations as incurred. Betterments and renewals are capitalized. When
property and equipment are sold or otherwise disposed of, the asset account and
the related accumulated depreciation accounts are relieved, and any gain or loss
is included in operations. Depreciation is calculated using the straight-line
method over the estimated useful lives of the assets, generally ranging from
five to 40 years. For the year ended September 30, 2000 and the nine months
ended September 30, 1999, depreciation expense amounted to $137,286 and $96,114,
respectively.
F-14
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
2. Significant Accounting Policies (continued)
Asset Impairment
When the Company has long-lived assets which have a possible impairment
indicator, the Company estimates the future cash flows from the operation of
these assets. If the estimated cash flows recoup the recorded value of the
assets, they remain on the books at that value. If the net recorded value cannot
be recouped, the assets are written down to their fair market value if lower
than the recorded value. For the year ended September 30, 2000, the Company
wrote off equipment with a net book value of $70,101 as a result of an
impairment in value.
Deferred Loan Costs
Deferred loan costs are amortized ratably over the terms of the related loans.
For the year ended September 30, 2000 and the nine months ended September 30,
1999, amortization of deferred loan costs amounted to $65,460 and $56,889,
respectively.
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
realization 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 using the straight-line method over the
estimated useful lives of the underlying agreements, ranging from three to six
years.
Revenue Recognition
Continuing franchise royalty revenue is recognized monthly as earned. Initial
franchise royalty revenue is recognized when all services or conditions relating
to the sale of the individual franchise has been substantially performed.
Revenues from company-owned stores and bakery products are recognized upon the
sale of products.
F-15
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
2. Significant Accounting Policies (continued)
Advertising Costs
Advertising costs are expensed as incurred. Advertising expenses were $251,237
and $76,535 for the year ended September 30, 2000 and the nine months ended
September 30, 1999, respectively.
Accounting for Stock-Based Compensation
The Financial Accounting Standards Board issued Statement 123 ("FAS 123"),
"Accounting for Stock-Based Compensation", which provides that expense equal to
the fair value of all stock-based awards on the date of the grant be recognized
over the vesting period.
Alternatively, this statement allows entities to continue to apply the
provisions of Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting
for Stock Issued to Employees", whereby compensation expense is recorded on the
date the options are granted equal to the excess of the market price of the
underlying stock over the exercise price. The Company applies APB 25 and related
interpretations in accounting for employee stock options.
Investment Securities
The Company's investment securities have been classified entirely as
available-for-sale securities. Available-for-sale securities are recorded at
cost and adjusted to fair market value on each subsequent balance sheet date.
Any change in fair market value between the purchase date and all subsequent
balance sheet dates is excluded from earnings. Rather, this amount is included
as a component of other comprehensive income.
Upon disposal, the entire amount of a security's accumulated other comprehensive
gain or loss is reclassified into the statement of operations as a component of
the realized gain or loss on disposal. Realized gains or losses on the sale of
investment securities are determined on the first-in, first-out ("FIFO") basis.
F-16
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
2. Significant Accounting Policies (continued)
Fair Value of Financial Instruments
Financial Accounting Standards Board Statement No. 107 ("FAS 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 September 30, 2000.
The respective carrying value of certain on-balance-sheet financial instruments
approximates their fair values. These financial instruments include cash and
equivalents, accounts receivables, prepaid expenses, accounts payable, accrued
liabilities and accrued preferred stock dividends. Fair values were assumed to
approximate carrying values for these financial instruments since they are short
term in nature and their carrying amounts approximate fair values or they are
receivable or payable on demand. The fair values of the Company's notes
receivable and long-term debt are estimated based upon the quoted market prices
for the same or similar issues or on the current rates offered for instruments
of the same remaining maturities. The carrying value of the Company's notes
receivable and long-term debt approximates their fair market value. Investment
securities are stated at fair market value which are determined by quoted market
prices.
Net Loss Per Common Share
The Company adopted the provisions of Financial Accounting Standards Board
Statement No. 128 ("FAS 128"), "Earnings per Share". FAS 128 replaces the
previously reported primary and fully diluted earnings per share with basic and
diluted earnings per share. Unlike primary earnings per share, basic earnings
per share exclude any dilutive effects of options, warrants and convertible
securities. Diluted earnings per share are computed similarly to fully diluted
earnings per share.
Contingently issuable shares are included in basic earnings (loss) per share as
of the date all necessary conditions have been satisfied. Contingently issued
shares are included in diluted earnings (loss) per share based on the number of
shares, if any, that would be issuable under the terms of the acquisition
agreements if the end of the reporting period were the end of the contingency
period.
F-17
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
2. Significant Accounting Policies (continued)
The Company's basic and diluted earnings per share are the same since the
Company has a loss for both years presented, and the impact of potential common
shares is antidilutive. Potential common shares at September 30, 2000 and 1999
include 11,857,070 and 4,782,070 stock options and warrants, 15,986 and 15,986
shares underlying the convertible preferred stock and 1,150,000 and 48,803
shares from convertible notes payable, respectively. The Company also has a
liability to issue 490,000 shares of common stock at September 30, 2000. This
liability to issue common stock of $112,700 is included in the accrued
liabilities total of $963,199 at September 30, 2000.
Income Taxes
The Company accounts for income taxes using the liability method. Under this
method, deferred tax assets and liabilities are determined based on differences
between financial reporting and tax bases of assets and liabilities. Measurement
of deferred income tax is based on enacted tax rates and laws that will be in
effect when the differences are expected to reverse, with the measurement of
deferred income tax assets being reduced by available tax benefits not expected
to be realized.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards Board Statement No. 133 ("FAS 133"), "Accounting
for Derivative Instruments and Hedging Activities". FAS 133 requires companies
to recognize all derivative contracts as either assets or liabilities in the
balance sheet and to measure them at fair value. If certain conditions are met,
a derivative may be specifically designated as a hedge, the objective of which
is to match the timing of gain or loss recognition on the hedging derivative
with the recognition of (i) the changes in the fair value of the hedged asset or
liability that are attributable to the hedged risk or (ii) the earnings effect
of the hedged forecasted transaction. For a derivative not designated as a
hedging instrument, the gain or loss is recognized in income in the period of
change. FAS 133 was subsequently amended by Statement of Financial Accounting
Standards No. 137 ("FAS 137"), "Accounting for Derivative and Hedging Activities
- Deferral of the Effective Date of FAS 133". FAS 133 is now effective for all
fiscal quarters or fiscal years beginning after July 1, 2000.
Historically, the Company has not entered into derivatives contracts to hedge
existing risks or for speculative purposes. Accordingly, the Company does not
expect adoption of the new standard on October 1, 2000 to affect its financial
statements.
F-18
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
2. Significant Accounting Policies (continued)
Risk and Uncertainties
The primary uncertainty which the Company faces is its ability to locate
knowledgeable franchisees who also have the financial resources to successfully
operate the stores. In addition, the Company needs to be able to identify
appropriate locations for its newly franchised stores. The Company believes that
it has taken the steps necessary to minimize these risks.
Reclassifications
Certain amounts in the 1999 financial statements have been reclassified to
conform to the 2000 presentation.
3. Acquisition and Disposition of Subsidiaries
Changes in goodwill and accumulated amortization for the year ended September
30, 2000 and the nine months ended September 30, 1999 are as follows:
<TABLE>
<CAPTION>
Accumulated Net
Goodwill Amortization Goodwill
-------------- ------------ --------------
<S> <C> <C> <C>
Balance, December 31, 1998 $ 11,870,322 $ (767,385) $ 11,102,937
Disposition of Richey Enterprises, Inc. (150,322) 25,858 (124,464)
Disposition of Little King, Inc. (1,897,401) 188,322 (1,709,079)
Settlement related to SBK Franchise Systems, Inc. 149,294 - 149,294
Amortization expense for the nine months ended
September 30, 1999 - (431,612) (431,612)
-------------- ------------ --------------
Balance, September 30, 1999 9,971,893 (984,817) 8,987,076
Disposition of Mountain Mike's Pizza (4,199,133) 542,388 (3,656,745)
Disposition of Seawest Subs (882,623) 156,515 (726,108)
Acquisition of Central Park 2,940,289 - 2,940,289
Amortization expense for the year ended
September 30, 2000 - (450,329) (450,329)
-------------- ------------ --------------
Balance, September 30, 2000 $ 7,830,426 $ (736,243) $ 7,094,183
============== ============ ==============
</TABLE>
F-19
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
3. Acquisition and Disposition of Subsidiaries (continued)
Changes in covenants not to compete and accumulated amortization for the year
ended September 30, 2000 and the nine months ended September 30, 1999 are as
follows:
<TABLE>
<CAPTION>
Non-compete Accumulated Net
Convenants Amortization Amount
------------- ------------ --------------
<S> <C> <C> <C>
Balance, December 31, 1998 $ 602,000 $ (283,039) $ 318,961
Disposition of Little King (100,000) 31,197 (68,803)
Amortization expense for the nine months
ended September 30, 1999 - (136,616) (136,616)
------------- ------------ --------------
Balance, September 30, 1999 502,000 (388,458) 113,542
Disposition of Seawest Subs (502,000) 502,000 -
Acquisition of Central Park 364,020 - 364,020
Amortization expense for the year
ended September 30, 2000 - (149,944) (149,944)
------------- ------------ --------------
Balance, September 30, 2000 $ 364,020 $ (36,402) $ 327,618
============= ============ ==============
</TABLE>
During the year ended September 30, 2000, the Company formed its Central Park of
America, Inc. subsidiary and acquired the franchising assets and certain
corporately-owned restaurants from Central Park USA, Inc. The Company also
disposed its Seawest Sub Shops sandwich chain and Mountain Mike's Pizza chain
during the year ended September 30, 2000 and its Georgio's Subs sandwich chain
during the nine months ended September 30, 1999. The acquisitions 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.
Richey Enterprises, Inc.
On August 15, 1997, the Company, through its wholly-owned subsidiary, Admiral's
Fleet, Inc., 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.
In February 1999, the Company executed an agreement to sell the Georgio's
franchise concept back to the prior owners. Per the agreement, the prior owners
surrendered 89,986 of their Company shares, paid $35,000 cash and assumed
certain liabilities. For the nine months ended September 30, 1999, the Company
recorded a loss on the disposal of the Georgio's franchise concept in the amount
of $39,606.
F-20
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
3. Acquisition and Disposition of Subsidiaries (continued)
Quality Franchise Systems, Inc.
On September 30, 1997, the Company, through its wholly-owned subsidiary,
Admiral's Fleet, Inc., 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.
Effective April 28, 2000, the Company sold the Mountain Mike's Pizza franchise
concept to Concept Acquisitions, LLC ("COAC") for a total of $3,543,179
consisting of $3,000,000 cash, a non-interest bearing note due on September 30,
2002 with a discounted value of $165,534 and other consideration with a
discounted value of $377,645. The other consideration represents an 18% equity
interest in COAC or at the Company's discretion in April 2008, the Company may
convert this equity interest into a note receivable of $800,000 with interest at
3% above the five-year government bond rate, payable quarterly with all
principal and any accrued but unpaid interest due and payable in five years from
the date of conversion by the Company. Since it currently is the Company's
intention to convert the equity interest into a note receivable, the Company is
currently carrying this consideration as a note receivable with a discounted
value of $377,645. COAC is controlled by the former chief operating officer and
director of the Company who resigned from the Company in April 2000. For the
year ended September 30, 2000, the Company recorded a loss on the disposal of
the Mountain Mike's Pizza franchise concept in the amount of $535,506 as
follows:
Total consideration received $ 3,543,179
Net goodwill (3,656,745)
Net tangible assets sold (156,255)
Liabilities assumed 48,627
Transaction costs (314,312)
-----------
Loss on disposal of franchise concept $ 535,506
===========
Central Park of America, Inc.
On July 19, 2000, the Company, through its Central Park of America, Inc.
("Central Park") subsidiary, purchased the franchising assets and certain assets
pertaining to corporately-owned restaurants from Central Park U.S.A., Inc.
Central Park is the franchisor of the Central Park hamburger sandwich restaurant
chain located in Tennessee, Alabama, Georgia and Utah.
F-21
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
3. Acquisition and Disposition of Subsidiaries (continued)
The purchase price of Central Park consisted of the issuance of notes payable
with a discounted value of $1,433,874, cash of $800,000 and 435,000 shares of
the Company's common stock valued at $0.32 per share ($139,200). Additionally,
the Company entered into three separate noncompete agreements with former
shareholders and/or officers with a discounted valued of $364,020. Payments
under the noncompete agreements commence on July 19, 2005 with aggregate monthly
payments of $10,000 for sixty months. The transaction was recorded as follows:
Total consideration paid $ 2,373,074
Less fair value of assets acquired (994,904)
Value of noncompete agreements (364,020)
Liabilities assumed 1,786,380
Transaction costs 139,759
-----------
Excess of cost over net assets acquired $ 2,940,289
===========
Seawest Sub Shops, Inc.
On June 30, 1997, the Company, through its wholly-owned subsidiary, Admiral Subs
of Washington, Inc., acquired all of the outstanding shares of Seawest Sub
Shops, Inc. ("Seawest"). Seawest is a franchisor of sandwich restaurants in
Seattle, Washington.
Effective August 31, 2000, the Company sold the Seawest Sub Shops chain to Clark
Retail Development Company ("Clark") for a note receivable of $55,000. Clark
also assumed certain indebtedness of the Company of approximately $207,000. For
the year ended September 30, 2000, the Company recorded a loss on the disposal
of the Seawest Sub Shops franchise concept in the amount of $307,586 as follows:
Total consideration received $ 55,000
Net goodwill (726,108)
Net tangible assets sold (28,095)
Notes payable assumed 207,400
Other liabilities assumed or
extinguished 184,217
------------
Loss on disposal of franchise concept $ 307,586
============
F-22
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
3. Acquisition and Disposition of Subsidiaries (continued)
Pro Forma Financial Information (Unaudited)
The following summarized unaudited pro forma consolidated results of operations
for the year ended September 30, 2000 have been prepared as if the preceding
acquisition occurred at the beginning of the year and includes pro forma
adjustments for interest, depreciation and amortization:
2000
----
Revenue $ 7,614,000
Net loss $ (3,790,000)
Net loss per share - basic and diluted $ (.13)
-------------
Weighted average number of common shares outstanding 30,450,000
=============
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 period
presented, nor do they purport to be indicative of the results that will be
obtained in the future.
F-23
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
4. Notes Receivable
Notes receivable are comprised of the following at September 30, 2000 and 1999:
<TABLE>
<CAPTION>
2000 1999
----------- -------------
<S> <C> <C>
$200,000 note receivable from COAC from sale of Mountain Mike's Pizza;
non-interest bearing due on September 30, 2002, net of unamortized
discount of $27,286 at September 30, 2000. $ 172,714 $ -
$800,000 note receivable from COAC from sale of Mountain Mike's Pizza;
non-interest bearing through April 2008, then payable in quarterly
interest only installments at 3% above the five-year government bond rate
for five years with all amounts due on April 2003, net of unamortized
discount of $407,298 at September 30, 2000. 392,702 -
$55,000 note receivable from Clark from sale of Seawest. 55,000 -
11 notes receivable from franchisees; payable in various monthly principal
and interest installments with various maturity dates. 179,671 -
$321,342 note receivable from a franchisee; payable in equal monthly
installments of principal and interest at 15% through September 2013;
this note was secured by the underlying franchise rights. This note was
written-off during the year ended September 30, 2000 - 180,000
$130,000 note receivable from an area developer; payable in annual
installments of $50,000 plus interest at 8-1/4%. This note was
written-off during the year ended September 30, 2000 - 80,000
----------- -------------
800,087 260,000
Less current portion (63,584) (80,000)
Less allowance for doubtful accounts - (180,000)
----------- -------------
$ 736,503 $ -
=========== =============
</TABLE>
F-24
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
5. Investment Securities
As of September 30, 2000, the Company's portfolio of investment securities
consisted of the following:
Marketable equity securities, at cost $ 706,114
Gross unrealized gains 83,316
-----------
Fair market value $ 789,430
===========
The Company's entire portfolio of investment securities was purchased during the
year ended September 30, 2000. There were no dispositions during the ended
September 30, 2000. During the nine months ended September 30, 1999, the Company
acquired an investment security for $174,563 and disposed of it for $115,967
resulting in a realized loss of $58,596.
It is the Company's intention to hold the investment securities for an
indefinite period of time, and therefore has classified the investment
securities as a non-current asset.
Changes in unrealized holding gains on investment securities, which are reported
in accumulated other comprehensive income, are as follows:
Balance at October 1, 1999 $ -
Unrealized holding gains for the year ended
September 30, 2000 83,316
----------
Balance at September 30, 2000 $ 83,316
==========
F-25
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
6. Property and Equipment
Property and equipment are comprised of the following at September 30, 2000 and
1999:
2000 1999
------------ -----------
Land and buildings $ 912,633 $ 371,771
Machinery and equipment 867,700 372,201
Office and computer equipment 174,413 147,034
Vehicles 92,636 92,636
Leasehold improvements 385,019 83,291
------------ -----------
2,432,401 1,066,933
Less accumulated depreciation (1,315,564) (340,266)
------------ -----------
Net property and equipment $ 1,116,837 $ 726,667
============ ===========
7. Accrued Liabilities
Accrued liabilities are comprised of the following at September 30, 2000 and
1999:
2000 1999
------------ -----------
Deferred revenue $ 202,049 $ 166,195
Accrued payroll and payroll-related items 120,939 106,442
Accrued interest 118,813 161,730
Accrued marketing expenses 118,111 -
Liability to issue common stock 112,700 -
Accrued sales tax payable 59,546 -
Other accrued expenses 231,041 118,514
------------ -----------
$ 963,199 $ 552,881
============ ===========
F-26
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
8. Note Payable to Related Party
Note payable to related party consisted of a working capital borrowing facility
with a company controlled by the Company's president. The related party note
agreement calls for payments of interest-only at 9% payable monthly through
January 1999, monthly principal and interest payments of $3,121 through December
2008, at which time any remaining unpaid balances are due. During the nine
months ended September 30, 1999, the Company issued 500,000 shares of its common
stock to this company in satisfaction of $109,400 of principal and at September
30, 1999 the note had an outstanding balance of $245,939. In March 2000, the
Company issued 894,911 shares of its common stock to this company for full
satisfaction of the remaining principal balance of $166,815 and accrued interest
of $56,913.
Interest expense on the related party debt totaled $13,625 and $24,525 during
the year ended September 30, 2000 and the nine months ended September 30, 1999,
respectively.
F-27
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
9. Long-Term Debt
Long-term debt consists of the following at September 30, 2000 and 1999:
<TABLE>
<CAPTION>
2000 1999
------------ -----------
<S> <C> <C>
Note payable to former owners of acquired subsidiary, payable in monthly
installments of interest only at the prime lending rate less 0.5% (7.75%
at September 30, 2000) through July 2002 and then payable in equal
monthly principal and interest installments of $12,387 through July 2005;
collateralized by certain accounts receivable, real and personal property
and inventory. $ 396,759 $ -
Note payable to former owner of acquired subsidiary, monthly interest only
payments at the greater of the prime lending rate plus 3% (11.25% at
September 30, 2000) or 12% through July 2002 and then payable in equal
monthly principal and interest installments of $11,625 through July 2005;
collateralized by certain accounts receivable, real and personal property
and inventory. 350,000 -
Note payable to former owner of acquired subsidiary, monthly interest only
payments at the greater of the prime lending rate plus 3% (11.25% at
September 30, 2000) or 12% through July 2002 and then payable in equal
monthly principal and interest installments of $6,321 through July 2005;
collateralized by certain accounts receivable, real and personal property
and inventory. 100,000 -
Convertible note payable in the face amount of $950,000; non-interest
bearing for the first two years until July 2002 and then monthly
principal and interest payments at 7% until July 2010 of $12,952; net of
unamortized discount of $78,810 at September 30, 2000. The note is
convertible into Company common stock at $1.00 per share beginning July
2001. This note is uncollateralized. 871,190 -
Convertible note payable to former owners of acquired subsidiary, interest
accrues at 7% until July 2005 and then monthly principal and interest
payments of $3,960 until July 2010. The note is convertible into Company
common stock at $1.00 per share beginning July 2001. This note is
uncollateralized. 200,000 -
Three notes payable in the cumulative face amount of $600,000 issued in
connection with the Central Park acquisition for non-compete agreements,
these notes are non-interest bearing until July 2005 and then payable in
equal aggregate monthly payments of $10,000 until July 2010; net of
unamortized discount of $230,082 at September 30, 2000. These notes are
uncollateralized. 369,918 -
Note payable with quarterly interest only payments at 7% until maturity at
July 2002. This note is uncollateralized. 50,000 -
F-28
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
9. Long-Term Debt (continued)
<CAPTION>
2000 1999
------------ -----------
<S> <C> <C>
Seventeen convertible notes payable with an aggregate face amount of
$530,000; quarterly interest-only payments at 12.75% due through December
1999; all unpaid principal and interest due March 2000; collateralized by
royalty revenues generated by the Mountain Mike's franchises; convertible
into Company common stock at $10.86 per share. The notes contained a
requirement to maintain restricted cash to be held on deposit with a bank
for interest payments. These notes were retired in April 2000 upon the
disposal of the Mountain Mike's Pizza franchise concept. - 530,000
Note payable to former owner of acquired subsidiary; monthly interest-only
payments at 7% through July 2000; thereafter monthly principal and
interest payments of $3,019 are due through July 2007; collateralized by
royalty revenues generated by the Sobik's franchises. 196,285 200,000
Note payable to bank assumed upon the Li'l Dino's acquisition; payable in
monthly principal installments of $6,012 plus interest at the bank's
prime lending rate plus 1% (10.50% at September 30, 2000) through
February 2004; collateralized by the Company's cash deposit at the bank
and a personal guarantee of the prior owners of Li'l Dino's. 255,890 314,284
Note payable to financial institution; principal and interest at 10%
payable upon demand; note is uncollateralized. - 257,583
Four notes payable to individuals with an aggregate face amount of
$350,000; all unpaid principal and interest at 8% currently past-due;
collateralized by a personal guarantee of the Company's chief executive
officer. 100,000 285,000
Two notes payable to former owners of Seawest with an aggregate face amount
of $700,000; non-interest bearing; monthly principal payments of $4,000
are due through April 2004, at which time any remaining unpaid principal
is due; these notes are uncollateralized. These notes were assumed by the
new owners of Seawest. - 259,900
Note payable to franchisee; monthly interest-only payments at 9% due
through December 1999; thereafter monthly principal and interest payments
of $2,236 are due through December 2009; this note is uncollaterlized.
This note was retired in full through the conversion into 848,831 shares
of the Company's common stock - 176,476
Three notes payable to individuals; monthly interest-only payments at 15%
due through November 2004, at which time any remaining unpaid principal
and interest is due; these notes are uncollateralized and are net of
unamortized loan costs of $114,000 and $138,000, respectively. The
Company is in arrears with respect to the interest payments and thus has
classified these notes as currently due. 66,000 42,000
F-29
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
9. Long-Term Debt (continued)
<CAPTION>
2000 1999
------------ -----------
<S> <C> <C>
Mortgage note payable to former owner of Pastry Products Producers, LLC;
monthly payments of $2,494 including principal and interest at 10% due
through November 2004, at which time any remaining unpaid principal and
interest is due; collateralized by real property. 101,637 120,369
Various uncollateralized notes payable; due with various monthly principal
and interest payments; maturing at various dates through July 2005. 131,569 183,934
-------------- -------------
3,189,248 2,369,546
Less current portion (417,140) (1,606,041)
-------------- -------------
Total long-term debt $ 2,772,108 $ 763,505
============== =============
</TABLE>
Interest expense on long-term debt during the year ended September 30, 2000 and
the nine months ended September 30, 1999 amounted to $351,984 and $331,667,
respectively.
The annual maturities of long-term debt for the five years subsequent to
September 30, 2000 are as follows:
Total
2001 $ 417,140
2002 188,115
2003 431,555
2004 430,668
2005 408,896
Thereafter 1,312,874
-------------
$ 3,189,248
=============
F-30
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
10. Stockholders' Equity
The following is a synopsis of significant transactions involving the Company's
stockholders' equity accounts:
Preferred Series C
In September 1997, the Company designated and issued 120 shares of no par value
Series C convertible preferred stock ("Preferred Series C") in connection with
the acquisition of QFS. The Preferred Series C stock is entitled to cumulative
dividends at a rate of $32.50 per share per quarter and is convertible into
common stock at a rate of 133.22 shares of common stock for each preferred share
with a face amount of $1,000. The stock is redeemable at the option of the
Company or in liquidation at a rate of $1,000 per share.
Preferred Series D
In January 1998, the Company sold 2,500 shares of no par value Series D
convertible preferred stock ("Preferred Series D") under a private placement
offering at a stated face value of $1,000 per share. The net proceeds to the
Company were $1,817,500 after deducting the placement agent commission and
expenses. In addition, $250,000 of long-term debt was extinguished through the
issuance of 250 shares of the Preferred Series D stock. Each share of the
Preferred Series D stock was convertible, at the option of the shareholder at
any time, into a number of shares of common stock of the Company at a conversion
rate which shall be a number of shares of common stock equal to $1,000 divided
by the lower of 55% of the average market price of the common stock for the five
trading days immediately prior to the conversion date or $1.96875. The
conversion price was based on 55% of the fair market value of the Company's
common stock at the date of conversion. The holders of the Preferred Series D
stock were entitled to receive cumulative yearly dividends at a rate of 8% of
the face value in cash or, at the option of the Company, in shares of common
stock. The Preferred Series D shares were entitled to a liquidation preference
of $1,300 per share.
Since the Preferred Series D stock was convertible at a discount, a Preferred
Series D stock dividend of $1,382,601 was recorded for the year ended December
31, 1998 for the difference between the discounted conversion price of the
Preferred Series D stock and the fair market value of the Company's common stock
at the time of issuance.
F-31
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
10. Stockholders' Equity (continued)
Pursuant to the terms of the private placement agreement, the Company was
required to register with the Securities and Exchange Commission the shares of
common stock underlying the Preferred Series D stock within 30 days of the final
closing of the private placement. In addition, the registration was required to
be declared effective within 120 days of the closing date. Since those events
did not occur, the Company was required to increase the discount rate by 10%
from 35% to 45% to the purchasers of the private placement during 1998. This
additional discount was valued at $718,272 (the difference between the original
discounted conversion price and the fair market value of the common stock) and
was recorded for the year ended December 31, 1998. As of December 31, 1998,
there were 2,350 shares of Preferred Series D stock outstanding after holders of
150 shares of Preferred Series D stock converted their shares into 615,384
shares of the Company's common stock.
During the nine months ended September 30, 1999, holders of 475 shares of
Preferred Series D stock converted their shares into 4,250,499 shares of the
Company's common stock and holders of 1,875 shares of Preferred Series D stock
converted their shares into 187.5 shares of the Company's Redeemable Preferred
Series F stock. As of September 30, 1999 there were no Preferred Series D shares
outstanding.
Preferred Series E
In February 1999, the Company designated 135 shares of no par value Series E
voting nonredeemable cumulative convertible preferred stock ("Preferred Series
E") and issued 20 shares of its Preferred Series E stock at $10,000 per share
for a total consideration of $200,000. Each share of the Preferred Series E
stock was convertible, at the option of the shareholder at any time, into a
number of shares of common stock of the Company at a conversion rate which shall
be a number of shares of common stock equal to $10,000 divided by the lower of
65% of the average market price of the common stock for the five trading days
immediately prior to the conversion date or $1.96875. The Preferred Series E
stock was entitled to cumulative, preferential dividends at a rate of $800 per
share. The Preferred Series E stock was redeemable in liquidation at $12,000 per
share. In June 1999, the Company reacquired 10 shares of Preferred Series E
stock for $100,000. Also in June 1999, the holder of the remaining 10 shares of
Preferred Series E stock converted into 10 shares of the Company's Redeemable
Preferred Series F stock. As of September 30, 1999, there were no Preferred
Series E shares outstanding.
F-32
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
10. Stockholders' Equity (continued)
Redeemable Preferred Series F
In June 1999, the Company designated 250 shares of no par value Series F
non-voting redeemable cumulative preferred stock ("Redeemable Preferred Series
F"). The Redeemable Preferred Series F stock is entitled to cumulative,
preferential dividends at a rate of $1,000 per share. The holders of the
Redeemable Preferred Series F stock may require the Company to repurchase the
stock at $12,500 per share anytime between June 1, 2001 and August 1, 2001. In
June 1999, holders of 1,875 shares of the Company's Preferred Series D stock
converted their shares into 187.5 shares of Redeemable Preferred Series F stock.
Also in June 1999, holders of 10 shares of the Company's Preferred Series E
stock converted their shares into 10 shares of Redeemable Preferred Series F
stock. The carrying value of the 1,875 shares of Preferred Series D stock was
$3,126,288 and the carrying value of the 10 shares of Preferred Series E stock
was $100,000 for a total conversion carrying value of $3,226,288. The redemption
value of the 197.5 shares of Redeemable Preferred Series F stock is $2,468,750.
The difference of $757,538 between the total carrying value (of the Preferred
Series D and Preferred Series E stocks) and the redemption value of the
Redeemable Preferred Series F stock was credited to common stock.
In December 2000, the Company redeemed all the outstanding Redeemable Preferred
Series F stock through the payment of $500,000 and the issuance of 19,750,000
shares of its common stock (see Note 14).
Redeemable Common Stock
In connection with the Company's acquisition of Seawest, the prior owner of
Seawest has the right to require the Company to repurchase 90,000 shares at a
purchase price of $3.25 per share for a total repurchase value of $293,000.
In connection with the Company's acquisition of SBK, the prior owners of SBK had
the right to require the Company to repurchase 187,266 shares at a purchase
price of $2.67 per share for a total repurchase value of $500,000. During 1998,
the Company repurchased 74,906 shares of the redeemable common stock for
$200,000. In June 1999, the Company entered into a settlement with the prior
owners of SBK whereby the Company issued 187,266 shares of its common stock for
the remaining 112,360 outstanding shares of redeemable common stock with a value
of $300,000 held by the prior owners of SBK.
F-33
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
10. Stockholders' Equity (continued)
Stock Subscriptions Receivable
During 1998, the Company sold the following common shares in exchange for
subscription notes receivable: (1) 500,000 shares valued at $687,500 to the
Company's Chief Operating Officer, (2) 500,000 shares valued at $687,500 to the
Company's Chief Financial Officer, and (3) 300,000 shares valued at $412,500 to
a consultant. Each of the underlying stock subscription agreements bear interest
at 9.5% per annum and are due on or before July 2001. The shareholders also
retain the right to require the Company to repurchase the shares within three
years of their issuance in exchange for the cancellation of the notes.
During 1997, the Company sold the following common shares in exchange for
subscription notes receivable: (1) 500,000 shares valued at $1,500,000 to the
Company's Chief Operating Officer and (2) 300,000 shares valued at $900,000 to a
consultant of the Company. Each of the underlying stock subscription agreements
bear interest at 9.5% 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 within three years of their issuance in exchange for
cancellation of the notes.
On April 28, 2000, the Company's Chief Operating Officer resigned from the
Company and returned his total of 1,000,000 shares to the Company in
satisfaction of the $2,187,500 notes due for the stock. The consultant also
returned his total of 600,000 shares to the Company in satisfaction of the
$1,312,500 notes due for the stock.
The fair value of each subscription was based on the quoted market price of the
Company's common stock on the date of issuance. Stock subscriptions receivables
were $687,500 and $4,187,500 at September 30, 2000 and 1999, respectively. All
accrued interest through September 30, 2000 has been waived by the Board of
Directors.
Stock Issued for Services
For the year ended September 30, 2000 and the nine months ended September 30,
1999, the Company issued 1,905,000 and 1,291,667 shares of its common stock,
respectively, in exchange for consulting and legal services. The aggregate fair
value of these shares was $465,900 and $340,000, respectively, based on the
market value of the stock on the date of issuance. Of these amounts, $301,700
and $298,100 were classified as prepaid consulting fees, respectively, and are
being amortized over the lives of the agreements.
F-34
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
10. Stockholders' Equity (continued)
Conversion of Debt to Equity
During the year ended September 30, 2000, the Company issued 848,831 shares of
its common stock with a fair value of $212,208 in exchange for the
extinguishment of long-term debt and accrued interest. Also, as described in
Note 8, the Company issued 894,911 shares of its common stock with a fair value
of $223,728 in exchange for the extinguishment of related party debt and accrued
interest.
During the nine months ended September 30, 1999, the Company issued 192,308
shares of its common stock with a fair value of $50,000 in exchange for
extinguishment of long-term debt. Also, as described in Note 8, the Company
issued 500,000 shares of its common stock as satisfaction of $109,400 of related
party debt.
Private Placement of Common Stock
For the nine months ended September 30, 1999, the Company sold to accredited
investors a total of 769,230 shares of the Company's freely-traded common stock
at a purchase price of $0.23 per share in a private transaction exempt from
registration under applicable Federal securities laws. The Company collected
proceeds of $174,563 in connection with this transaction. No offering costs were
incurred as part of the transaction. In addition, during the nine months ended
September 30, 1999, the Company sold 500,000 shares of its common stock at a
purchase price of $0.30 per share. The Company collected proceeds of $150,000
with no offering costs incurred.
Common Stock Issued in Conjunction with Prior Year Subsidiary Acquisitions
In June 1999, the Company entered into a settlement with the prior owners of SBK
whereby the Company issued 187,266 shares of its common stock for the remaining
112,360 outstanding shares of redeemable common stock owned by the prior owners
of SBK. Also, the Company issued 700,187 shares of its common stock to the prior
owners of SBK to settle disputes on the amount of liabilities in existence at
the date of acquisition of SBK by the Company and for a principal reduction of
$300,000 of a note due to the former owners of SBK which reduced the principal
balance from $500,000 to $200,000.
Authorized Number of Common Shares
In December 2000, the Company increased its authorized shares of common stock
from 50,000,000 shares to 100,000,000 shares (see Note 14).
F-35
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
10. Stockholders' Equity (continued)
Common Stock Options and Warrants
In February 1999, the Company approved the 1998 Incentive Plan ("Incentive
Plan") to enable the Company to offer employees and its consultants equity
interests in the Company. There are 1,500,000 shares designated under the
Incentive Plan and are fully vested upon grant. In February 1999, the Company
granted options to purchase a total of 745,000 shares of common stock to
non-officer employees and an option to purchase a total of 150,000 shares of
common stock to one of the Company's non-employee directors under the Incentive
Plan. The options were issued at an exercise price of $0.20 per share, the
quoted market price of the underlying shares on the date of grant and expire in
February 2002. In October 1999, the Company granted options to purchase a total
of 35,000 shares of common stock to a non-officer employee with an exercise
price of $0.16 per share with an expiration date of October 2002.
The Company also grants stock options outside of the Incentive Plan. In October
1999, the Company granted options to purchase a total of 4,065,000 shares of its
common stock to ten individuals including 2,535,000 shares to two officers and
two employees of the Company. The options were issued at an exercise price of
$0.29 per share and expire in October 2004.
In July 2000, the Company issued options to purchase a total of 3,000,000 shares
of its common stock as part of the consideration paid for its investment in
marketable equity securities. The options were issued at an exercise price of
$0.27875 per share and expire in June 2002.
In July 2000, the Company issued options to purchase a total of 200,000 shares
of its common stock in exchange for consulting services. The exercise price was
$0.2288 per share and the options expire in July 2007.
During the nine months ended September 30, 1999, options to purchase 37,500
shares of the Company's common stock were exercised by grantees in connection
with the Company's acquisition of Pastry. The Company waived the exercise price,
which was based on 50% of the fair market value on the date of exercise.
F-36
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
10. Stockholders' Equity (continued)
In August 1998 and December 1997, the Company granted options to purchase
1,000,000 shares each of its common stock to the President and Chief Executive
Officer. The options were issued with an exercise price of $1.55 per share and
$2.75 per share, respectively, with expiration dates of August 2001 and December
2000, respectively. The President has yet to exercise any portion of these
options and in December 2000 his option to purchase 1,000,000 shares of common
stock expired. In September 1999, the Company adjusted the exercise price of
both option grants to $0.29 per share which was equal to or greater than the
fair value of the Company's common stock. In December 2000, the first traunch of
1,000,000 options were allowed to expire.
The Company had 11,857,070 options outstanding at September 30, 2000 consisting
of 755,000 outstanding options under the Incentive Plan and 11,102,070 options
issued outside of the Incentive Plan. Changes in options outstanding for the
year ended September 30, 2000 and the nine months ended September 30, 1999 under
the Incentive Plan and options issued outside of the Incentive Plan are
summarized as follows:
<TABLE>
<CAPTION>
Incentive Plan
Weighted-
Weighted- Average
Average Fair Value
Exercise of Options
Shares Price Granted
--------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, December 31, 1998 - $ - $ -
Granted 895,000 .20 .20
Less options exercised - - -
Less options expired (50,000) .20 -
Balance, September 30, 1999 845,000 .20 -
Granted 35,000 .16 .16
Less options exercised - - -
Less options expired (125,000) .20 -
--------------------------------------------------------------------------------------------
Balance, September 30, 2000 755,000 $ .20 -
============================================================================================
F-37
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
10. Stockholders' Equity (continued)
<CAPTION>
Options Outside of the Incentive Plan
Weighted-
Weighted- Average
Average Fair Value
Exercise of Options
Shares Price Granted
--------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, December 31, 1998 4,274,570 $ 1.24 $ -
Granted - - -
Less options exercised (37,500) - -
Less options expired (300,000) 3.21 -
Balance, September 30, 1999 3,937,070 1.10 -
Granted 7,265,000 .29 .29
Less options exercised - - -
Less options expired (100,000) 3.93 -
--------------------------------------------------------------------------------------------
Balance, September 30, 2000 11,102,070 $ .58 -
============================================================================================
</TABLE>
The following table summarizes information about options outstanding at
September 30, 2000:
<TABLE>
<CAPTION>
Options Outstanding and Exercisable
Weighted- Weighted-
Average Average
Range of Remaining Exercise
Exercise Prices Shares Contractual Life Price
-------------------------------------------------------------------------------------
<S> <C> <C> <C>
$0.16 to $0.75 10,593,570 31.2 months $0.30
$1.92 to $3.93 1,263,500 22.1 months $2.69
-------------------------------------------------------------------------------------
11,857,070 29.9 months $0.55
=====================================================================================
</TABLE>
F-38
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
10. Stockholders' Equity (continued)
The Financial Accounting Standards Board issued Statement No. 123 ("FAS 123"),
"Accounting for Stock-Based Compensation", which provides that expense equaled
to the fair value of all stock based awards on the date of the grant over the
testing period be recognized.
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.
FAS 123 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 FAS 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 for the year ended
September 30, 2000 and the nine months ended September 30, 1999: no dividend
yield; an expected life of five years; expected volatility of 64%, and risk-free
interest rate of 5.5%.
Under the accounting provisions of FAS 123, the Company's net loss and loss per
share would have increased to the pro forma amounts indicated below for the year
ended September 30, 2000 and the nine months ended September 30, 1999:
2000 1999
--------------------------------------------------------------------------------
Net loss applicable to common stock
As reported $ (3,218,793) $ (1,915,039)
Proforma $ (3,592,967) $ (1,968,285)
Loss per share - basic and diluted
As reported $ (.11) $ (.08)
Proforma $ (.12) $ (.09)
================================================================================
F-39
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
11. Commitments and Contingencies
Operating Leases
The Company leases office space and restaurant land space under certain
operating leases which expire in various dates through 2008. Total rent expense
for the year ended September 30, 2000 and the nine months ended September 30,
1999 was $156,324 and $88,848, respectively.
Future annual minimum lease payments due under these operating leases for the
five year subsequent to September 30, 2000 are as follows:
2001 $ 142,812
2002 118,101
2003 110,676
2004 101,352
2005 82,704
-----------
$ 555,645
===========
Legal Issues
On August 2, 1999, shareholders of Li'l Dino Management Corporation (the prior
owners of Li'l Dino Corporation) filed a complaint against the Company and some
of its officers in the United States District Court for the Middle District of
North Carolina. The Company was served with this complaint on August 5, 1999.
This complaint alleges damages of $4.5 million for securities fraud,
misappropriation of corporate opportunities and negligent misrepresentation, and
seeks treble damages, interest and attorney's fees. The allegations in the
complaint relate to the Company's acquisition of substantially all of the assets
of Li'l Dino. The Company believes that the claims made in the complaint are
without merit. The Company intends to defend itself vigorously in this matter.
The Company is involved in various other lawsuits and litigation matters on an
ongoing basis as a result of its day-to-day operations. However, the Company
does not believe that any of these other or any threatened lawsuits and
litigation matters will have a material adverse effect on the Company's
financial position or results of operations.
F-40
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
11. Commitments and Contingencies (continued)
Franchise Agreements
Under the terms of the various franchise agreements, which are for terms ranging
from 10 to 15 years and contain various renewal options, the franchisees are
obligated for the payment of the following fees to the Company:
* Franchise Fees - In accordance with the terms of the franchise
agreements, the Company receives an initial franchise fee of
$10,000 to $20,000.
* Royalties - The Company receives royalties ranging from 4% to
7% 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.
Employment Agreement
The Company is a party to an employment agreement with its Chief Financial
Officer and Chief Operating Officer. Pursuant to the agreement, this officer is
to receive an annual salary of approximately $125,000 through July 2001. In
addition, the Company is a party to a consulting agreement with a member of the
Board of Directors. Pursuant to this agreement, this director is to receive
annual compensation of $125,000 through July 2001.
F-41
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
12. Income Taxes
The components of income tax expense (benefit) for the year ended September 30,
2000 and the nine months ended September 30, 1999 are as follows:
2000 1999
-----------------------------------------------------------------------------
Current:
Federal $ - $ -
State 999 650
-----------------------------------------------------------------------------
999 650
-----------------------------------------------------------------------------
Deferred:
Federal 194,650 (72,250)
State 34,350 (12,750)
-----------------------------------------------------------------------------
229,000 (85,000)
-----------------------------------------------------------------------------
Total current and deferred income taxes 229,999 (84,350)
-----------------------------------------------------------------------------
Increase (decrease) in valuation allowance (229,000) 85,000
-----------------------------------------------------------------------------
Total income taxes $ 999 $ 650
=============================================================================
F-42
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
12. Income Taxes (continued)
The Company's deferred tax asset is comprised of the following at September 30,
2000 and 1999:
2000 1999
Current deferred tax asset:
Allowance for doubtful accounts $ 33,000 $ 125,000
Accrued expenses - 20,000
-----------------------------------------------------------------------------
33,000 145,000
Less, valuation allowance (33,000) (145,000)
Net current deferred tax asset $ - $ -
Non-current deferred tax asset:
Net operating loss carryforwards $ 2,796,000 $ 2,092,000
Intangibles 129,000 69,000
Property and equipment 71,000 51,000
Stock and stock options issued for services 160,000 874,000
Investment securities (187,000) -
-----------------------------------------------------------------------------
2,969,000 3,086,000
Less, valuation allowance (2,969,000) (3,086,000)
-----------------------------------------------------------------------------
Net non-current deferred tax asset $ - $ -
-----------------------------------------------------------------------------
Net deferred tax asset $ - $ -
=============================================================================
The following summary reconciles differences from taxes at the federal statutory
rate with the effective rate:
2000 1999
-----------------------------------------------------------------------------
Income taxes at federal statutory rates (34.0)% (34.0)%
Operating loss with no tax benefit 34.0 34.0
-----------------------------------------------------------------------------
Income tax at effective rates 0.0% 0.0%
=============================================================================
F-43
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
12. Income Taxes (continued)
At September 30, 2000, the Company has net operating loss carryforwards of
approximately $7,200,000 for federal income tax purposes that expire as follows:
2012 $ 3,800,000
2018 1,700,000
2019 700,000
2020 1,000,000
-------------
$ 7,200,000
=============
13. Operating Segments
The Company defines segments as each separate franchising concept it operates.
It clearly views each business as a separate segment and makes decisions based
on the activity and profitability of that particular segment.
The reportable segments are defined as follows:
* The franchise operations segment is engaged in the franchising
of various quick-service restaurants located throughout the
United States. These restaurants feature submarine sandwiches,
pizza, soups and hot and cold side order items. The Company
assists the franchisees with selecting suitable locations,
advises on the negotiation of lease terms and store design,
assists with securing of food product supply and purchase of
furniture and fixtures.
* The bakery and restaurant operations segment is comprised of a
bakery that primarily serves the JRECK restaurant franchises
and corporately-owned restaurants from the Central Park
acquisition.
F-44
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
13. Operating Segments (continued)
The table below shows certain financial information by business segment for the
year ended September 30, 2000 and the nine months ended September 30, 1999:
<TABLE>
<CAPTION>
Bakery and
Segment Reporting Franchise Restaurant Consolidated
September 30, 2000 Operations Operations Total
----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenue from external customers $ 3,094,956 $ 1,346,984 $ 4,441,940
Interest expense - net 333,690 - 333,690
Depreciation and amortization 651,961 93,731 745,692
Segment loss (2,783,991) (221,702) (3,005,693)
Segment assets 9,104,228 1,833,954 10,938,182
==========================================================================================================
<CAPTION>
Bakery and
Segment Reporting Franchise Restaurant Consolidated
September 30, 1999 Operations Operations Total
----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenue from external customers $ 2,724,534 $ 571,844 $ 3,296,378
Interest expense - net 356,192 - 356,192
Depreciation and amortization 565,642 104,800 670,442
Segment loss (1,674,185) (93,914) (1,768,099)
Segment assets 9,777,453 1,556,778 11,334,231
Expenditures for segment assets 2,059 - 2,059
==========================================================================================================
</TABLE>
14. Subsequent Events
Convertible Debenture
In December 2000, the Company issued a Convertible Debenture for $575,000 which
calls for monthly interest payments at 12% and is due in January 2002. The
Convertible Debenture may be converted in whole or in part to common stock of
the Company at a conversion price equal to 65% of the three-day average closing
price prior to the date of conversion. In anticipation of the conversion of the
Convertible Debenture, the Company has placed into escrow 10,000,000 shares of
its common stock.
F-45
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
14. Subsequent Events, (continued)
Redemption of Series F Preferred Stock
In December 2000, the Company redeemed all the outstanding Redeemable Preferred
Series F stock with a value of $2,468,750 through the payment of $500,000 and
the issuance of 19,750,000 shares of its common stock. The issuance of these
shares increased the number of outstanding common shares by 61.9%.
Increase in Authorized Common Shares Outstanding
In December 2000, the Company increased its authorized shares of common stock
from 50,000,000 shares to 100,000,000 shares.
Reorganization of Subsidiary
In October 2000, the Company formed a wholly-owned subsidiary, Bakery
Acquisition Corporation ("Bakery"). It is the Company's intention to merge
Pastry Products Producers, LLC into Bakery and for Bakery to issue 2,750,000 of
its common stock to the current shareholders of the Company.
F-46
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
15. Transition Period Due to Change in Fiscal Year
During 1999, the Company changed its fiscal period from December 31 to September
30. Accordingly, the consolidated financial statements presented reflect
operating results and cash flows for a twelve-month period and nine month period
ended September 30, 2000 and December 31, 1999, respectively. For comparative
purposes, the unaudited operating results and cash flows for the twelve months
ended September 30, 1999 are as follows:
Twelve Months Ended
September 30, 1999
(Unaudited)
-----------------------------------------------------------------------
Revenues:
Franchising royalties $ 2,695,768
Initial franchise revenue 111,916
Retail sales - company-owned stores 110,878
Retail sales - bakery and other products 734,868
Other revenues 783,532
-----------------------------------------------------------------------
4,436,962
Operating costs and expenses:
Franchise servicing costs 1,701,348
Cost of retail sales and operating costs - stores 117,561
Cost of retail sales and operating costs - bakery 710,014
General and administrative 1,497,151
Consulting and investor relations 775,392
Bad debt expense 379,924
Amortization and depreciation 964,681
-----------------------------------------------------------------------
6,146,071
-----------------------------------------------------------------------
Loss from operations (1,709,109)
Other expense - interest (542,946)
Long-lived asset write-down (1,177,212)
Write-down of property and equipment (725,078)
Loss on sale of assets (523,628)
Loss on disposal of franchise concept (39,606)
Other, net 52,203
-----------------------------------------------------------------------
Net loss (4,665,376)
Preferred stock dividends (199,840)
-----------------------------------------------------------------------
Net loss applicable to common stock (4,865,216)
=======================================================================
Weighted average of common shares outstanding 21,517,608
=======================================================================
Net loss per common share - basic and diluted $ (.23)
=======================================================================
F-47
<PAGE>
Notes to Consolidated Financial Statements
For the Year Ended September 30, 2000
and the Nine Months Ended September 30, 1999
15. Transition Period Due to Change in Fiscal Year, (continued)
Net cash used by operating activities $ (162,952)
Net cash provided by investing activities 655,073
Net cash used by financing activities (624,013)
-----------------------------------------------------------------------
Net decrease in cash and cash equivalents $ (131,892)
=======================================================================
F-48
