HOTEL DISCOVERY INC, 10KSB, 1998-03-30

HOTEL DISCOVERY INC
10KSB, 1998-03-30
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-KSB

(Mark One)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 28, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
------- -------

Commission file number 0-23243
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HOTEL DISCOVERY, INC.
(Name of Small Business Issuer in its Charter)
MINNESOTA 31-1487885
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Indentification No.)

4801 W. 81ST STREET, SUITE 112 55437
BLOOMINGTON, MN 55437 (Zip Code)
(Address of principal executive offices)

612-837-9917
(Issuer's telephone number, including area code)

Securities Registered Under Section 12(b) of the Exchange Act:
NONE

Securities Registered Under Section 12(g) of the Exchange Act:
COMMON STOCK, PAR VALUE $.01
CLASS A WARRANTS TO PURCHASE ONE SHARE
OF COMMON STOCK
UNITS, CONSISTING OF ONE SHARE
OF COMMON STOCK AND ONE CLASS A WARRANT
(Title of each class)

Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the preceding 12 months (or for such
shorter period that the issuer 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 issuer'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 Issuer had total revenues of $3,546,695 for its fiscal year ended December
28, 1997.

As of March 20, 1998, the aggregate market value of the voting and non-voting
common equity held by non-affiliates (assuming for these purposes, but not
conceding, that all executive officers and directors are "affiliates" of the
Issuer) of the Issuer was $24,734,987 based upon the last reported sale price in
the Nasdaq SmallCap Market on March 20, 1998 of $3 1/2 per share.

As of December 28, 1997, the number of shares outstanding of the Issuer's Common
Stock was 8,000,189.

Transitional Small Business Disclosure Format: Yes [ ] No [X]

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DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Issuer's Proxy Statement for the Annual Meeting of
Shareholders scheduled to be held on May 21, 1998 are incorporated by reference
in Part III hereof.

FORWARD-LOOKING STATEMENTS

Certain of the matters discussed in the following pages, particularly
regarding estimates of the number and locations of new restaurants that the
Company intends to open during fiscal 1998 and 1999, constitute
"forward-looking statements" within the meaning of the Securities Act of 1933,
as amended and the Securities Exchange Act of 1934, as amended. Forward-looking
statements involve a number of risks and uncertainties, and, in addition to the
factors discussed in this Form 10-KSB, among the other factors that could cause
actual results to differ materially are the following: the Company's ability to
identify and secure suitable locations on acceptable terms, obtain additional
capital necessary for expansion on acceptable terms, open new restaurants in a
timely manner, hire and train additional restaurant personnel and integrate new
restaurants into its operations; the continued implementation of the Company's
strict business discipline over a growing restaurant base; the economic
conditions in the new markets into which the Company expands and possible
uncertainties in the customer base in these areas; changes in customer dining
patterns; competitive pressures from other national and regional restaurant
chains; business conditions, such as inflation or a recession, and growth in
the restaurant industry and the general economy; changes in monetary and fiscal
policies, laws and regulations; and other risks identified from time to time in
the Company's SEC reports, registration statements and public announcements.

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HOTEL DISCOVERY, INC.

INDEX

<TABLE>
<CAPTION>
Page
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PART I
<S> <C>
Item 1. Description of Business 4
Item 2. Description of Property 11
Item 3. Legal Proceedings 13
Item 4. Submission of Matters to a Vote of Security Holders 13

PART II
Item 5. Market for Common Equity and Related Stockholder Matters 14
Item 6. Management's Discussion and Analysis of Financial Condition and Plan of Operations 14
Item 7. Financial Statements 16
Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 16

PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a)
of the Exchange Act 17
Item 10. Executive Compensation 17
Item 11. Security Ownership of Certain Beneficial Owners and Management 17
Item 12. Certain Relationships and Related Transactions 17
Item 13. Exhibits, List, and Reports on Form 8-K 17
</TABLE>

Signatures
Financial Statement Schedules
Exhibits

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PART 1

ITEM 1. DESCRIPTION OF BUSINESS

GENERAL

Hotel Discovery, Inc. (the "Company") intends to develop, own and operate
restaurants with multiple themed dining rooms and a corresponding
retail component designed to appeal to the upscale casual dining market. The
Company has one restaurant operating under the name "Hotel Discovery" in the
Kenwood Shopping Center in Cincinnati, Ohio (the "Kenwood Restaurant"), which
opened on December 19, 1996. In addition, a second restaurant to be operated
under the name "Cafe Odyssey" is under development at the Mall of America in
Bloomington, Minnesota, a suburb of Minneapolis (the "Mall of America
Restaurant").

The Company began operations as Hotel Mexico, Inc. ("HMI"), which was
incorporated in Ohio in January 1994. The Kenwood Restaurant Limited
Partnership, an Ohio limited partnership (the "Kenwood Partnership") was formed
in June 1995 to own and operate the Kenwood Restaurant. HMI's operations and the
net assets of the Kenwood Partnership were combined in November 1996, and in
August 1997, HMI was reorganized as Hotel Discovery, Inc., a Minnesota
corporation. See "Reorganization."

On February 25, 1998, the Company changed the name of its restaurant concept
from Hotel Discovery to Cafe Odyssey. The Company believes that the new name
better reflects the concept's primary focus on award-winning food, served in a
unique environment of adventure, imagination, exploration and innovation. In
conjunction with this action, the Company's Board of Directors approved a change
in its corporate name from Hotel Discovery, Inc. to Cafe Odyssey, Inc., subject
to shareholder approval. The Cafe Odyssey name will be used for the planned Mall
of America Restaurant and all subsequent restaurants. The Kenwood Restaurant
will retain the name "Hotel Discovery" because of its already established and
well-received perception in the marketplace.

CONCEPT

The Company's existing restaurant provides award-winning food and excellent
service coupled with soft, sophisticated and subtle entertainment
technology. The Company's concept combines two contemporary trends within the
restaurant industry by incorporating the upscale casual food-driven attributes
of restaurants like Palomino and The Cheesecake Factory with a variation on the
entertainment features of restaurants such as Planet Hollywood, Rainforest Cafe
and Dave and Buster's. In the 1997 Taste of Cincinnati festival, Hotel
Discovery's Ebony Butterfly Medallions won "Best Entree" and its Pacific Rim Lo
Mein won "Award of Excellence". In addition, Cincinnati Magazine named
Hotel Discovery "Best Extravaganza" and the Portobello Mushroom Fajita
"Best Meatless Meal."

Based on the concepts of travel, discovery and adventure, each restaurant
provides guests with a dining experience in multiple themed environments that
capture the romance, passion and nature of exotic locations throughout the world
utilizing the state-of-the-art technology in sound, video, lighting, scenery and
decor. In the Kenwood Restaurant, these themes are embodied in the Safari Room,
the Artist Loft, the Observatory and the Mapping Room. The Mall of America
Restaurant will contain three dining rooms that replicate the environments of
the lost City of Atlantis, the ancient Incan ruins of Machu Picchu in the Andes
and the sweeping plains of the Serengeti desert in Tanzania, Africa.

The menu at each restaurant offers a broad range of cuisine from around the
world, including "cultural fusion" menu items such as Barcelona Spring Rolls and
Asian Tacos. Features include American, Asian, Jamaican, West Indian, Mexican
and European tastes and textures. Menu items are freshly made, using only the
highest quality fresh meats, produce, spices and other ingredients. The menu
mirrors the exploratory journey and adventure society themes of the restaurant
itself.

Each restaurant also has a retail area located at the entrance. The retail
component of the Kenwood Restaurant includes a collection of adult and
children's casual clothing, including T-shirts, sweatshirts, shirts and caps,
and a limited amount of other logo merchandise. The Mall of America Restaurant
will display a much larger selection of merchandise centered around the four
themes of imagination, invention, exploration and adventure as expressed in the
three dining rooms. Such merchandise is expected to include educational toys and
games, stationery, prints, telescopes, art materials, jewelry, primitive musical
instruments and other gift items.

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EXPANSION STRATEGY

Management believes the Cafe Odyssey concept is ideally positioned toward the
large and fast growing "baby boomer" segment. Future expansion opportunities for
Cafe Odyssey will be targeted towards high traffic upscale malls and resorts,
as well as urban retail and entertainment centers. In addition, the large size
of future Cafe Odyssey restaurants will often necessitate locations in areas
with significant tourist as well as local traffic. The Company is currently in
the process of negotiating with landlords for future sites, but there can be no
assurance that the Company will be able to enter into binding contracts for
these or any additional sites.

RESTAURANT OPERATIONS

The Company strives to maintain quality operations through extensive training
of its employees and careful supervision of personnel. The Company has
developed, and expects to implement at each of its restaurants, a detailed
operations manual containing specifications relating to food and beverage
preparation, maintenance of premises and employee conduct. Each restaurant is
expected to have a director of operations with a staff of five to seven
managers and a controller. Each director of operations reports directly to the
Company's vice president of operations.

The Company requires all kitchen and front-of-the-house managers to
complete an intensive six-week training program which includes two weeks of
food preparation training in the kitchen, as well as complete cross-training on
all other phases of the restaurant's operations. The Company's restaurant
management is then tested on the Company's philosophy, management strategy,
policies, procedures and operating standards. In addition, each prospective
guest service employee actually tastes, and is tested on, every food and
beverage item on the menu. Daily shift meetings are held prior to lunch and
dinner to re-educate the service staff on all menu items, to communicate daily
specials, to respond to feedback from comment cards and to reinforce service
standards.

MANAGEMENT AND FINANCIAL CONTROLS

The Company has implemented specific management control systems for employee
follow-up, customer satisfaction, and financial results. These controls are
described below.

Employee Follow-up. Shift schedules are posted weekly for each position. A
scheduled manager supervises every shift. Managers are responsible for executing
job functions and following a thorough and complete checklist for each category
of the restaurant's operations, including the appearance of the outside of the
restaurant, dining room, kitchen and rest rooms as well as dining room
service and food preparation. Regular one-on-one meetings are held with
employees and feedback as to their performance is given on a regular and
consistent basis. This feedback includes positive reinforcement as well as
redirection when a change in focus is needed. In addition, the restaurant's
director of operations holds a weekly circle luncheon for key employees from
each position. The president of the Company also holds a quarterly "town
meeting" with selected employees to ensure that strong communication continues
between the corporate office and each restaurant.

Customer Satisfaction. Management believes that continual guest feedback on the
key attributes of food quality, menu variety, service and ambiance is crucial to
the Company's success. It is currently obtained by weekly tabulation of comment
cards that are distributed with every guest check, an extensive mystery diner
program and periodic market research and telephone interviews. This constant
feedback helps the Company's management monitor guest response to all areas of
operations and react accordingly. Checklists are also used to ensure that guests
receive a high level of service and food quality. In addition,
front-of-the-house management is required to interact with guests in all peak
meal periods.

Management's incentives include a bonus based upon a percentage of either
restaurant-level or corporate cash flow and/or profitability as compared to an
annual budget which is approved by senior management. Through its
pay-for-performance incentive systems, the Company believes that it has
essentially mirrored its compensation system to that of an entrepreneurially
owned and operated business.

Financial Controls. Financial controls are monitored through management
information systems that track sales, customer counts, food costs, payroll costs
and guest lists. All data is reviewed on a daily, weekly and monthly basis, both
in the restaurant and in the corporate office. Profit and loss statements are
prepared weekly by the restaurant controller and reconciled monthly with the
corporate office financial statements. Management believes its systems allow for
a prompt reaction to correct deviations and to capitalize on trends.

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COMPETITION

The food service industry is intensely competitive with respect to food quality,
concept, location, service and price. In addition, there are many
well-established food service competitors with substantially greater financial
and other resources than the Company and with substantially longer operating
histories. The Company believes that it competes with other full-service dine-in
restaurants, take-out food service companies, fast-food restaurants,
delicatessens, cafeteria-style buffets and prepared food stores, as well as with
supermarkets and convenience stores. Competitors include national, regional and
local restaurants, purveyors of carryout food and convenience dining
establishments.

Competition in the food service business is often affected by changes in
consumer tastes, national, regional, and local economic and real estate
conditions, demographic trends, traffic patterns, the cost and availability of
labor, purchasing power, availability of product, and local competitive factors.
The Company attempts to manage or adapt to these factors, but it should be
recognized that some or all of these factors could cause the Company to be
adversely affected. Management is of the opinion that quality food which is
pleasingly presented is an absolute requirement within the upscale casual
segment of the industry.

GOVERNMENT REGULATIONS

The Company is subject to federal, state and local laws affecting the operation
of its restaurants, including zoning, health, sanitation and safety regulation
and alcoholic beverage licensing requirements. Each restaurant is operated in
accordance with standardized procedures designed to assure compliance with all
applicable codes and regulations. The suspension of a food service or liquor
license would cause an interruption of operations at the affected restaurant.
The Company believes that it is in compliance with all licensing and other
regulations.

The Company is subject to "dram shop" statutes in certain states, including
Minnesota and Ohio, which generally provide a person injured by an intoxicated
person the right to recover damages from the establishment or establishments
that served alcoholic beverages to the intoxicated person. The Company has
obtained liability insurance against such potential liability.

The Company is also subject to the Fair Labor Standards Act, which governs
minimum wages, overtime and working conditions. A significant portion of the
Company's restaurant employees are paid at rates relating to either the federal
or state minimum wage. Accordingly, an increase in the minimum wage would
directly increase each restaurant's labor cost.

Obtaining alcoholic beverage licenses from various jurisdictions will require
disclosure of certain detailed information about directors, officers and greater
than 10% shareholders of the Company's equity securities, and will necessitate
that such persons be approved by the appropriate liquor licensing authority.

EMPLOYEES

As of December 28, 1997, the Company employed 122 persons, of whom 76 worked in
full-time positions and 46 were part-time. The Mall of America Restaurant is
expected to employ approximately 250 full- and part-time personnel when
operating at full capacity. No current employee is covered by a collective
bargaining agreement, and the Company has never experienced an organized work
stoppage, strike or labor dispute. The Company considers relations with its
employees to be excellent.

REORGANIZATION

The Company's predecessor, Hotel Mexico, Inc. ("HMI"), was originally
incorporated in January 1994 as an Ohio corporation. The Kenwood Restaurant
Limited Partnership, an Ohio limited partnership (the "Kenwood Partnership"),
was formed in June 1995 for the purpose of owning and operating the Kenwood
Restaurant. The Kenwood Partnership was dissolved in October 1997. The general
partner of the Kenwood Partnership was Kenwood Restaurant, Inc., an Ohio
corporation (the "General Partner"). Mr. King was the sole director and officer
of the General Partner and controlled the General Partner until his resignation
in September 1997. The Kenwood Partnership had 22 limited partners as a result
of a private placement in October 1995.

HMI's operations and the net assets of the Kenwood Partnership were combined on
November 14, 1996. On that date, the Kenwood Partnership contributed all of its
net assets totalling $1,567,197 to a newly formed corporation in exchange for
shares of such corporation. HMI, with total net assets of $631,966, then merged
with and into the newly formed corporation, the name of which remained Hotel
Mexico, Inc. (hereafter "Hotel Mexico"). Upon consummation of the merger,
outstanding shares of HMI were converted into an aggregate of 1,350,000 shares
of Common Stock of Hotel Mexico.

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In conjunction with the dissolution of the Kenwood Partnership in October 1997,
the shares of Hotel Mexico Common Stock received by the Kenwood Partnership in
the reorganization and other partnership assets were distributed to the general
and limited partners in accordance with the Partnership Agreement.

On June 24, 1997, the Board of Directors of Hotel Mexico approved its
reincorporation as a Minnesota corporation named Hotel Discovery, Inc. Following
approval of the transaction and of the name change by Hotel Mexico's
shareholders at a special meeting held on August 11, 1997, Hotel Mexico was
merged with and into Hotel Discovery, Inc., a newly formed Minnesota
corporation, on August 22, 1997. Hotel Discovery, Inc. has an authorized capital
stock of 100,000,000 undesignated shares, and each share of Common Stock of
Hotel Mexico was converted into one share of Common Stock of Hotel Discovery,
Inc.

RISK FACTORS

The following discussion should be read in connection with the Company's
financial statements and related notes thereto included elsewhere in this
report.

LACK OF SIGNIFICANT OPERATING HISTORY

The Company's first restaurant, the Kenwood Restaurant, opened on December 19,
1996. Accordingly, the Company faces all of the risks, expenses and
difficulties encountered in connection with the operation and development of a
new business enterprise, including the lack of a significant operating history.
Management anticipates net losses to continue for the foreseeable future. There
can be no assurance that the Company will be able to generate significant
revenues or operate profitably. Future revenues and profits, if any, will depend
upon various factors, including acceptance of the Hotel Discovery/Cafe Odyssey
concept, the quality of restaurant operations, the ability to expand and general
economic conditions. Furthermore, to the extent the Company's expansion strategy
is successful, there is no assurance that the Company will successfully manage
the transition to higher volume operations, control its operating expenses,
attract necessary additional personnel or procure the required capital. Unless
otherwise stated, all historical financial results for the Company are derived
solely from the Kenwood Restaurant, which may not be indicative of other
locations.

LIMITED BASE OF OPERATIONS

The Company currently operates one restaurant, the Kenwood Restaurant, and plans
to open the Mall of America Restaurant in the second quarter of 1998. During the
Company's initial development stage, the combination of a relatively small
number of locations and the significant investment associated with each new
restaurant may cause the operating results of the Company to fluctuate
significantly and adversely affect the profitability and cash flow of the
Company. Due to the small number of current and planned locations and the large
expenditure required to open each new restaurant, poor operating results at any
one restaurant or a delay in the planned opening of a restaurant would
materially affect the profitability and cash flow of the entire Company. Future
growth in revenues and profits will depend to a substantial extent on the
Company's ability to increase the number of its restaurants and on its choice of
locations. Because of the substantial financial requirements associated with
opening new restaurants, the investment risk related to any one Cafe Odyssey
restaurant is much larger than that associated with most other restaurant
companies' venues.

DEPENDENCE ON KEY PERSONNEL

The Company will be largely dependent upon the personal efforts and abilities of
Stephen D. King, Chairman of the Board, Ronald K. Fuller, President, Chief
Executive Officer and Chief Operating Officer and Anne Huemme, Vice
President-Finance, Chief Financial Officer and Corporate Secretary. The loss or
unavailability to the Company of any of these individuals could have a material
adverse effect upon the Company's business. The Company maintains a $1,000,000
key-man life insurance policy on Mr. Fuller.

NEED FOR ADDITIONAL MANAGEMENT

The success of the Company will depend in large part upon the Company's ability
to supplement its existing management team. While both Messrs. King and Fuller
have significant restaurant and multi-location restaurant management experience,
the Company will need to hire other corporate level and management employees to
help implement and operate its expansion plans. The failure to obtain, or delays
in obtaining, key employees could have a material adverse effect on the Company.

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DEPENDENCE ON DISCRETIONARY CONSUMER SPENDING

The success of the Company's operations depends to a significant extent on a
number of factors, including discretionary consumer spending, economic
conditions affecting disposable consumer income, the overall success of the
malls, entertainment centers and other venues where Hotel Discovery/Cafe Odyssey
restaurants are or will be located, and the continued popularity of themed
restaurants in general and the Company's concept in particular. Themed
restaurants are more susceptible to shifts in consumer preferences and
frequently experience a decline in revenue growth or of actual revenues due to
most restaurants opening near or at full capacity.

RISKS OF NEW CONSTRUCTION

Construction projects, including the opening of additional restaurants, entail
risks, including shortages of materials or skilled labor, unforeseen
environmental, engineering or geological problems, work stoppages, weather
interference, floods, difficulties with regulatory agencies and unanticipated
cost increases, any of which could give rise to delays and cost overruns.

LIMITED FINANCIAL RESOURCES; NEED FOR ADDITIONAL FINANCING

The Company's ability to execute its business strategy depends to a
significant degree on its ability to obtain substantial equity capital and
other financing to fund the development of additional restaurants. The total
cost of developing the Kenwood Restaurant was approximately $5.1 million, which
included approximately $3.2 million for building design and construction,
approximately $1.9 million for furniture, fixtures and equipment and net of
landlord contributions. The Company estimates that the total cost of developing
the planned Mall of America Restaurant will be approximately $4.9 million, net
of landlord contributions. There can be no assurance that future restaurants
can be developed at similar costs. For continued development of additional
restaurants, the Company may be required to seek additional funds through an
additional offering of the Company's equity securities or by incurring
indebtedness. If additional funds are required, there can be no assurance that
any additional funds will be available on terms acceptable to the Company or to
its shareholders. New investors may seek and obtain substantially better terms
than were granted to present investors and the issuance of such securities
would result in dilution to existing shareholders. Furthermore, as the Company
prepares to open additional restaurants, it will expend a relatively higher
amount on administrative expenses than would a mature company with similar
operations.

EXPANSION STRATEGY

The Company's ability to open and successfully operate additional restaurants
will also depend upon the hiring and training of skilled restaurant management
personnel and the ability to successfully manage growth, including monitoring
restaurants and controlling costs, food quality and customer service. The
Company anticipates that the opening of additional restaurants will result in
additional expenses associated with managing operations located in multiple
markets. Furthermore, the Company believes that competition for restaurant-level
management has become increasingly intense as additional restaurant chains
expand to new markets. Achieving consumer awareness and market acceptance will
require substantial efforts and expenditures by the Company. An extraordinary
amount of management's time may be drawn to such matters and may adversely
affect operating results. The Company is considering potential sites in several
major metropolitan areas, but there can be no assurance that the Company will be
able to enter into any other contracts for development of additional restaurants
on terms satisfactory to the Company or at all. Accordingly, there can be no
assurance that the Company will be able to open new restaurants or that, if
opened, those restaurants can be operated profitably.

RESTAURANT AND RETAIL INDUSTRY COMPETITION

The restaurant and specialty retail businesses are highly competitive. The
restaurant industry is highly competitive with respect to price, service,
quality and location and, as a result, has a high failure rate. There are
numerous well-established competitors, including national, regional and local
restaurant chains, possessing substantially greater financial, marketing,
personnel and other resources than the Company. There can be no assurance that
the Company will be able to successfully respond to various competitive factors
affecting the restaurant industry. The restaurant industry is also generally
affected by changes in consumer preferences, national, regional and local
economic conditions and demographic trends. The performance of restaurant
operations may also be affected by factors such as traffic patterns, demographic
considerations, and the type, number and location of competing operations. In
addition, factors such as inflation, increased labor and employee benefit costs,
and the availability of experienced management and hourly employees may also
adversely affect the restaurant industry in general and the Company in

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particular. Restaurant operating costs are further affected by increases in the
minimum hourly wage, unemployment tax rates and similar matters over which the
Company has no control.

The themed retail business is also highly competitive, particularly in locations
experiencing an oversupply of retail businesses. The Company would then compete
with a number of well-established specialty retailers possessing significantly
greater financial, marketing, personnel and other resources than the Company.

LONG-TERM, NON-CANCELABLE LEASES

The Company has entered into long-term leases relating to the Kenwood Restaurant
and the Mall of America Restaurant. These leases are non-cancelable by the
Company (except in limited circumstances) and range in term from 12 to 15 years.
Additional restaurants developed by the Company are likely to be subject to
similar long-term, non-cancelable leases. If the Kenwood Restaurant, the Mall of
America Restaurant, or any other future restaurant does not perform at a
profitable level and the decision is made to close that restaurant, the Company
may nonetheless be committed to perform its obligations under the applicable
lease, which would include, among other things, payment of the applicable base
rent for the balance of the respective lease term. If such a termination were to
occur at one or more of these locations, the Company could lose a restaurant
without necessarily receiving an adequate return on its investment. See
"Description of Leases."

CONTROL BY MANAGEMENT

As of December 28, 1997, Stephen D. King controlled approximately 11.2% of the
Company's Common Stock. Thus, Mr. King has the ability to substantially
influence the election of members of the Board of Directors and to direct the
operations and financial affairs of the Company.

GOVERNMENT REGULATION

The restaurant business is subject to various federal, state and local
government regulations, including those relating to the sale of food and
alcoholic beverages. The failure to maintain food and liquor licenses would have
a material adverse affect on the Company's operating results. In addition,
restaurant operating costs are affected by increases in the minimum hourly wage,
unemployment tax rates, sales taxes and similar costs over which the Company has
no control. Many of the Company's restaurant-level personnel will be paid at
rates based on either the federal or the state minimum wage. Increases in the
minimum wage would result in an increase in the Company's labor costs.

TRADEMARKS

The Company's ability to successfully implement the Hotel Discovery/Cafe Odyssey
concept will depend in part upon its ability to protect its trademarks. The
Company has filed a trademark application with the United States Patent and
Trademark Office to register both the "Hotel Discovery" and the "Cafe Odyssey"
marks and designs. There can be no assurance that the Company will be granted
trademark registration for any or all of the proposed uses in the Company's
applications. In the event the Company's marks are granted registration, there
can be no assurance that the Company can protect such marks and designs against
prior users in areas where the Company conducts or will conduct operations.
There is no assurance that the Company will be able to prevent competitors from
using the same or similar marks, concepts or appearance.

ABSENCE OF DIVIDENDS

At the present time, the Company intends to use earnings, if any, to finance
further growth of the Company's business. Accordingly, the Company does not
anticipate the payment of dividends in the foreseeable future.

LIMITED LIQUIDITY

Although the Company's Common Stock is currently listed on the Nasdaq SmallCap
Market, there can be no assurance that an active public market will be developed
or be sustained. In addition, the Nasdaq SmallCap Market may be significantly
less liquid than the Nasdaq National Market. If the Company fails to maintain
the standards for quotation, the Company's securities could be removed from the
market and traded in the over-the-counter market. As a result, investors would
find it more difficult to dispose of, or obtain accurate quotations as to the
price of, the securities.

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In addition, if the Company fails to maintain its qualification for the Units,
Common Stock or Class A Warrants to trade on the Nasdaq SmallCap Market, the
Units, Common Stock and Class A Warrants will be subject to certain rules of the
Securities and Exchange Commission relating to "penny stocks." Such rules
require broker-dealers to make a suitability determination for purchasers and to
receive the purchaser's prior written consent for a purchase transaction, thus
restricting the ability of purchasers and broker-dealers to sell the stock in
the open market.

CURRENT PROSPECTUS AND STATE REGISTRATION REQUIRED TO EXERCISE WARRANTS;
POSSIBLE REDEMPTION OF WARRANTS

Holders of Units and Class A Warrants will be able to exercise the Warrants only
if a current prospectus relating the shares of Common Stock underlying the Class
A Warrants is then in effect and only if such securities are qualified for sale
or exempt from qualification under the applicable securities laws of the states
in which the various holders of Class A Warrants reside. Although the Company
will use its best efforts to (i) maintain the effectiveness of a current
prospectus covering the shares of Common Stock underlying the Class A Warrants
and (ii) maintain the registration of such Common Stock under the securities
laws of the states in which the Company initially qualified the Units for sale
in the initial public offering, there can be no assurance that the Company will
be able to do so. The Company will be unable to issue shares of Common Stock to
those persons desiring to exercise their Class A Warrants if a current
prospectus covering the shares issuable upon the exercise of the Class A
Warrants is not kept effective or if such shares are not qualified nor exempt
from qualification in the states in which the holders of the Warrants reside.

The Class A Warrants are subject to redemption at any time by the Company at
$.01 per Warrant, on 30 days' prior written notice, if the average closing bid
price of the Common Stock shall exceed $7.00 (subject to adjustment), for 14
consecutive trading days, at any time prior to such notice and provided a
current prospectus covering the shares is then effective under federal
securities laws. If the Class A Warrants are redeemed, Warrant holders will lose
their right to exercise the Warrants except during such 30-day redemption
period. Redemption of the Class A Warrants could force the holders to exercise
the Class A Warrants at the then market price or accept the redemption price,
which is likely to be substantially less than the market value of the Class A
Warrants at the time of redemption.

UNDESIGNATED STOCK

The Company's authorized capital consists of 100,000,000 shares of capital
stock. The Board of Directors, without any action by the Company's stockholders,
is authorized to designate and issue shares in such classes or series (including
classes or series or preferred stock) as it deems appropriate and to establish
the rights, preferences and privileges of such shares, including dividends,
liquidation and voting rights. The Company currently has 8,000,189 shares of
Common Stock outstanding. As of March 20, 1998, a further 3,639,955 shares of
Common Stock have been reserved for the following: (i) 2,600,000 shares issuable
upon the exercise of the Class A Warrants issued as part of the Company's
initial public offering and the partial exercise of the underwriter's
over-allotment; (ii) 214,955 shares issuable upon the exercise of warrants;
(iii) 750,000 shares for issuance under the Company's 1997 Stock Option and
Compensation Plan, of which options relating to 722,666 shares are currently
outstanding, and (iv) 75,000 shares issuable upon exercise of certain directors'
stock options. In addition, the Company currently plans, subject to shareholder
approval, to designate an additional 500,000 shares of Common Stock for its 1997
Stock Option and Compensation Plan and an additional 250,000 shares of Common
Stock for the 1998 Director Stock Option Plan. The rights of holders of
preferred stock and other classes of common stock that may be issued may be
superior to the rights granted to holders of the Units issued in the Company's
initial public offering. The ability of the Board of Directors to designate and
issue such undesignated shares could impede or deter an unsolicited tender offer
or takeover proposal regarding the Company. Further, the issuance of additional
shares having preferential rights could adversely affect the voting power and
other rights of holders of Common Stock.

SHARES ELIGIBLE FOR FUTURE SALE

The future sale, or availability for sale, of substantial amounts of Common
Stock in the public market may adversely affect the prevailing market price of
Common Stock and may impair the Company's ability to raise additional capital by
the sale of equity securities. The Company and its directors, executive officers
and 5% shareholders have agreed that they will not sell nor grant any option for
the sale of or otherwise dispose of any shares of Common Stock for 180 days
after November 3, 1997 (the "Effective Date") without the prior written consent
of the R.J. Steichen & Company (the "Representative"). In addition, 5,399,289
shares of the Company's Common Stock which were sold in reliance on "private
placement" exemptions under the Securities Act of 1933, as amended (the "1933
Act") became eligible for sale pursuant to Rule 144 under the 1933 Act as
follows: 2,880,401 shares on November 3, 1997 (except that holders of 2,857,826
of such shares agreed not to sell or otherwise dispose of such shares without
the prior written consent of the Representative for a period ranging from 90 to
180 days after the Effective Date), 1,092,400 shares in the fourth quarter of
1997 (except that the holders of such 1,092,400 shares agreed not to sell or
otherwise dispose of such shares

10
<PAGE> 11

without the prior written consent of the Representative for 90 days after the
Effective Date), 13,200 shares in the first quarter of 1998, 570,685 shares in
the second quarter of 1998, 692,603 shares in the third quarter of 1998, and the
remaining 150,000 shares thereafter. In connection with the Company's initial
public offering, certain officers and directors of the Company have agreed to
escrow a portion of their shares of Common Stock with the State of Minnesota for
three years or until (i) the Company meets certain earnings requirements
established by the State of Minnesota, or (ii) the State of Minnesota determines
that the escrow agreement is no longer necessary.

MINNESOTA ANTI-TAKEOVER LAW

The Company is subject to Minnesota statutes regulating business combinations
and restricting voting rights of certain persons acquiring shares of the
Company, which may hinder or delay a change in control of the Company.

ITEM 2. DESCRIPTION OF PROPERTY

THE KENWOOD RESTAURANT

LOCATION

The Kenwood Restaurant is approximately 17,000 square feet in size on three
levels and is located at the northeast corner of the recently refurbished
Sycamore Plaza at Kenwood Shopping Center in Cincinnati, Ohio. The Kenwood
Restaurant opened on December 19, 1996. The Company leases the land upon which
the Kenwood Restaurant is constructed. For the 52 weeks ended December 28, 1997,
the Kenwood Restaurant had total sales of $3,546,695.

DESCRIPTION OF LEASE

The initial term of the lease is 15 years. In addition, the Company has the
option to extend the term of the lease for two additional periods of five years
each, exercisable not earlier than 12 months nor later than six months prior to
the expiration of the initial term or first option period, as applicable.

The lease provides for the payment of both a monthly fixed minimum rent and a
percentage rent based on gross sales in excess of an escalating base amount. The
monthly fixed minimum rent is $12,833 for the first five years of the initial
lease term, $14,117 for the sixth through tenth years of the initial lease term,
$15,400 for the eleventh through fifteenth years of the initial lease term,
$16,683 during the first five-year option term and $17,967 during the second
five-year option term.

In addition to the fixed minimum rent, the lease provides for the payment of a
percentage rent equal to 4% of the gross sales from the restaurant in excess of
the following annual gross sales amounts: $3,850,000 for the first five years
of the initial lease term, $4,235,000 for the sixth through tenth years of the
initial lease term, $4,620,000 for the eleventh through fifteenth years of the
initial lease term, $5,005,000 for the first five-year option term and
$5,390,000 for the second five-year option term. In addition to the fixed
minimum rent and percentage rent, the Company is required to pay its
proportionate share of taxes, insurance, and maintenance and operating costs.
Initially, the estimated annual amount payable with respect to taxes,
insurance, and maintenance and operating costs is $4.15 per square foot, or
approximately $32,000 per year.

The landlord agreed to reimburse the Company an amount up to $200,000 as a
construction allowance for the completion of the building and leasehold
improvements within 30 days of the opening of the Kenwood Restaurant. The
Company received this reimbursement during 1997. In addition, the landlord
agreed that it will not construct any permanent facility within a designated
"no-build" area, as defined. This "no-build" area allows for unimpaired
visibility of the Kenwood Restaurant from both Kenwood Road and Montgomery Road.

FINANCING

The total cost of the Kenwood Restaurant, including the cost of the initial
construction and additional features, was approximately $5.1 million, net of
landlord contributions. Approximately $2,475,000 of this cost was funded by the
proceeds of a private placement in October 1995. Another $1,425,000 was financed
by a private placement which was concluded in June 1997, $850,000 of which was
spent on additional features. An additional $1,000,000 was funded by a leasehold
mortgage loan (the "Loan") which was incurred by the Kenwood Restaurant Limited
Partnership and subsequently assumed by the Company.

11
<PAGE> 12

The Loan is collateralized with a leasehold mortgage and lien on the
assets of the restaurant and is personally guaranteed by the Company's
Chairman of the Board. The Loan bears interest at a floating rate, which was
9.06% as of December 28, 1997, and provides for monthly payments of principal
in the amount of $5,785 plus interest through February 1999, at which time the
remaining balance is due in full.

THE MALL OF AMERICA RESTAURANT

LOCATION

The Mall of America Restaurant will consist of approximately 16,215 square feet
located on the third floor of the Mall of America in Bloomington, Minnesota, a
suburb of Minneapolis and is leased pursuant to a lease agreement dated
August 4, 1997.

The Mall of America opened in August 1992 with 266 tenants and now holds
approximately 520 stores, merchandise carts and attractions, including four
large anchor tenants (Macy's, Bloomingdale's, Sears and Nordstrom). The mall
encompasses 4.2 million square feet on four enclosed floors, of which 2.5
million square feet are leasable, and employs 11,000 to 13,000 people, depending
on the season. More than 93% of the leasable space is under contract, up from
71% five years ago. The mall draws an estimated 40 million visitors per year.
Tourists account for 35% to 39% of annual mall traffic, but increases up to 50%
in the summer months.

According to an August 26, 1997 article in the Minneapolis Star Tribune, the
industry benchmark for success in prime shopping malls is $325 in annual sales
per square foot. Stores in the Mall of America with fewer than 15,000 square
feet (which includes most of the mall's tenants) average $450 in annual sales
per square foot. This figure is partially offset by higher-than-average
expenses, including property taxes and charges for common areas such as the
rotunda and broad hallways. Mall development will increasingly focus on
entertainment in order to maintain a strong flow of visitors to the mall. Since
it opened in 1992, the mall has emerged as a laboratory for new retail and
development concepts, including:

- Knott's Camp Snoopy, the country's first indoor amusement park combined
with a shopping center,

- The first Rainforest Cafe, a tropical-themed restaurant with related
entertainment and merchandise which has undergone three expansions since
its 1994 opening and through December 28, 1997 has opened 12 other
domestic locations and three international locations;

- Postmark America, the U.S. Postal Service's only retail store, and

- Chrysler's Great Cars Great Trucks, a prototype showcase where shoppers
can inspect vehicles and use touchscreen computers to price customized
vehicles.

DESCRIPTION OF LEASE

The term of the lease is for 12 years, commencing on the earlier of (i) the day
following the last day allowed to the Company for completion of remodeling of
the leased space or (ii) the date on which the restaurant opens for business.
The lease does not provide for renewal terms.

The lease provides for the payment of either a minimum annual rent or a
percentage rent based on gross sales. The minimum annual rent is $25 per square
foot, or $405,375 per year based on approximately 16,215 square feet of leased
area. The percentage rent is the amount by which 6% of gross sales exceeds
minimum rent. The lease provides for waiver of the minimum annual rent for the
first year of the lease. The landlord will also reimburse the Company for up to
$1.6 million in leasehold improvements.

In addition to the fixed minimum rent and percentage rent, the Company
is required to pay its proportionate share of taxes, insurance, and maintenance
and operating costs.

12
<PAGE> 13

ITEM 3. LEGAL PROCEEDINGS

The Company is involved in routine legal actions in the ordinary course of its
business. Although outcomes of any such legal actions cannot be predicted, in
the opinion of management there is no legal proceeding pending against or
involving the Company for which the outcome is likely to have a material adverse
effect upon the financial position or results of operations of the Company.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted for a vote of security holders during the fourth
quarter of 1997.

13
<PAGE> 14

PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The Company completed its initial public offering on November 3, 1997 by issuing
Units consisting of one share of Common Stock and one Class A Warrant for $5.00
per unit. Since that date, the Company's Units, Common Stock and Class A
Warrants have been traded on the Nasdaq SmallCap Market under the symbols
"HOTDU", "HOTD" and "HOTDW", respectively. The table below sets forth the high
and low sales prices of the Company's Common Stock, as reported on the Nasdaq
SmallCap Market, during the periods indicated.

FISCAL YEAR ENDED DECEMBER 28, 1997 HIGH LOW
----------------------------------- ---- ---
<S> <C> <C>
FOURTH QUARTER
Units $5 5/16 $3
Common Stock $3 13/16 $2 1/8
Class A Warrants $1 1/16 $ 13/16

</TABLE>

On March 20, 1998, the last reported sale price for the Units, Common Stock and
Class A Warrants was $4 1/4, $3 1/2 and $1, respectively. As of March 20, 1998,
there was one holder of record of the Company's Units, 319 holders of record of
the Company's Common Stock and 43 holders of record of the Company's Class A
Warrants.

The Company has never declared or paid any cash dividends or distributions on
its capital stock. The Company does not intend to pay any cash dividends on its
Common Stock in the foreseeable future, as the current policy of the Company's
Board of Directors is to retain all earnings, if any, to support operations and
finance expansion. See "Management's Discussion and Analysis or Plan of
Operations - Liquidity and Capital Resources." Future declaration and payment of
dividends, if any, will be determined in light of then current conditions,
including the Company's earnings, operations, capital requirements, financial
condition, restrictions in financing arrangements and other factors deemed
relevant by the Board of Directors.

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND PLAN OF
OPERATIONS

The following discussion should be read in connection with the Company's
financial statements and related notes thereto included elsewhere in this
report.

OVERVIEW

The Company was formed in January 1994 as an Ohio corporation to develop, own
and operate upscale, casual themed restaurants under the name "Hotel Mexico".
The Company opened its first restaurant in the Kenwood Shopping Center in
Cincinnati, Ohio (the "Kenwood Restaurant") in December 1996. Prior to opening
the Kenwood Restaurant, the Company had no revenues and its activities were
devoted solely to development. The Company is presently developing a restaurant
in the Mall of America (the "Mall of America Restaurant") in Bloomington,
Minnesota, a suburb of Minneapolis.

Future revenue and profits, if any, will depend upon various factors, including
market acceptance of the Hotel Discovery/Cafe Odyssey concept, the quality of
the restaurant operations, the ability to expand to multi-unit locations and
general economic conditions. The Company's present source of revenue is limited
to its existing restaurant. There can be no assurances the Company will
successfully implement its expansion plans, in which case it will continue to be
dependent on the revenues from the existing restaurant. The Company also faces
all of the risks, expenses and difficulties frequently encountered in connection
with the expansion and development of a new and expanding business. Furthermore,
to the extent the Company's expansion strategy is successful, it must manage the
transition to multiple-site operations, higher volume operations, the control of
overhead expenses and the addition of necessary personnel.

The Company uses a 52- or 53-week fiscal year ending on the Sunday nearest
December 31. All references herein in this Management's Discussion and Analysis
to "1997" and "1996" represent the 52-week fiscal years ended December 28, 1997
and December 29, 1996, respectively.

14
<PAGE> 15

RESULTS OF OPERATIONS FOR THE FISCAL YEARS ENDED DECEMBER 28, 1997 AND DECEMBER
29, 1996

The Company had no revenues or operations during the period from January 13,
1994 (Inception) to December 19, 1996 (the opening of the Kenwood Restaurant).
Accordingly, comparisons to periods prior to December 19, 1996 are not
meaningful.

For 1997, the Company had net sales of $3,546,695 compared to $104,129 for 1996.
In August 1997, the Company began retail sales at the Kenwood Restaurant.

For 1997, food, beverage and retail costs were $1,122,313 or 31.6% of sales
compared to $43,324 or 41.6% of sales for the period from the commencement of
the Kenwood Restaurant's operations (December 19, 1996) to December 29, 1996.
The improvement in food, beverage and retail costs as a percentage of sales is
due primarily to improved operating efficiencies.

For 1997, labor, benefits and other direct restaurant operating expenses were
$2,835,157 or 79.9% of sales compared to $241,239 or 231.7% of sales for the
period from the commencement of the Kenwood Restaurant's operations (December
19, 1996) to December 29, 1996. This improvement in restaurant operating
expenses as a percentage of sales is due primarily to improved labor management
and other operating efficiencies.

Although no assurances can be given, management believes that the Kenwood
Restaurant's current level of sales, trained workforce and general operation
will continue to improve restaurant-level performance in future periods.

For 1997, the Company had a net loss of $3,974,576 compared to a net loss of
$2,327,602 for 1996. The net loss for 1997 is largely attributable to continued
concept development and pre-opening costs of approximately $800,000,as well as
additional general and administration expenses as the Company increased its
corporate overhead structure for the development of additional restaurants. The
net loss for 1996 was largely attributable to concept development and
pre-opening costs totaling approximately $2.0 million. Continued
increases in the Company's corporate overhead will impact general and
administrative expenses on an ongoing basis.

LIQUIDITY AND CAPITAL RESOURCES

Since Inception, the Company's principal capital requirements have been
(i) the development of the Company and the Hotel Discovery/Cafe Odyssey concept,
(ii) the construction of the Kenwood Restaurant and the acquisition of
furniture, fixtures and equipment therein and (iii) the development of the Mall
of America Restaurant. Total capital expenditures for the Kenwood Restaurant
were approximately $5.1 million, net of landlord contributions.

When completed, the Company estimates that capital expenditures for the Mall of
America Restaurant will be approximately $4.9 million, net of landlord
contributions of $1.6 million. The Mall of America Restaurant is expected to be
complete in the second quarter of 1998.

The Company's primary sources of working capital have been proceeds from the
sale of Common Stock to and borrowings from its principal shareholder, Stephen
D. King, the private placement of Common Stock and debt, as well as the proceeds
from the Company's initial public offering of Units in November 1997. For 1997
and 1996, the Company used $3,769,796 and $1,024,187, respectively, in cash flow
for operating activities. As of December 28, 1997 and December 29, 1996, the
Company had working capital of $8,092,735 and a working capital deficit of
$1,596,718, respectively.

During 1997 and 1996, the maximum amount of borrowings from Mr. King outstanding
at any one time was $1,148,430 and $1,213,469, respectively. As of December 28,
1997, there was no outstanding indebtedness. The amount of outstanding
indebtedness as of December 29, 1996 was $447,787. Included in these amounts
were concept development costs reimbursed to a demonstration restaurant owned
and operated by Mr. King in the amount of $278,101 for 1996. The Company paid
interest of 11.5% on all such advances.

In October 1995, Kenwood Restaurant Limited Partnership, an Ohio limited
partnership formed in June 1995 (the "Kenwood Partnership"), raised $2.5 million
in a private placement of 250 shares of Common Stock of the Company's
predecessor (which shares were split 825-to-1 in November 1996, and now
represent 206,250 shares of the Company) and limited partnership interests in
the Kenwood Partnership. The Kenwood Partnership was dissolved in October 1997.
The general partner of the Kenwood Partnership was Kenwood Restaurant, Inc., an
Ohio corporation that was controlled by Stephen D. King until his resignation as
an officer and director in September 1997. In a reorganization of the Company
which occurred in November 1996, the Kenwood

15
<PAGE> 16

Partnership contributed all of its net assets to the Company's predecessor,
including the Kenwood Restaurant, in exchange for 1,350,000 shares of Common
Stock of the Company.

The Company borrowed $1.0 million under a leasehold mortgage term loan from a
bank, which is personally guaranteed by Mr. King. This financing was used for
the Kenwood Restaurant. Principal and interest are due monthly through February
1999, at which time the remaining balance is due in full. This loan had an
outstanding principal balance of $921,585 on December 28, 1997. In December
1996, the Company borrowed an additional $2.5 million under a mortgage term loan
from a bank. Payments of interest only were due through January 1998, at which
time the entire principal balance was due. This loan was paid in full on January
31, 1997. In May 1997, the Company borrowed $2.0 million on a 13-month term
note, with interest only payable monthly at the rate of 7.15%. This note was
guaranteed by Mr. King and was collateralized by substantially all of the
Company's assets. This note was repaid in full in July 1997. On June 23, 1997,
the Company borrowed $800,000, also collateralized by substantially all of
the Company's assets. The loan was personally guaranteed by Mr. King and was
repaid in full in July 1997.

From November 1996 through July 1997, the Company's predecessor completed
private placements of an aggregate of 2,392,889 shares of Common Stock at $3.00
per share. The net proceeds were approximately $6.1 million. Such proceeds have
been, and will be, used for new and additional features for the Kenwood
Restaurant, repayment of indebtedness, working capital and development of the
planned Mall of America Restaurant.

On August 12, 1997, the Company borrowed $200,000 from Provident Bank at an
annual rate of interest of 2% over Provident's reference rate. The loan was
personally guaranteed by Mr. King and was repaid in full in November 1997. On
September 8, 1997, the Company borrowed $200,000 from BankWindsor at an annual
rate of 1.125% over BankWindsor's reference rate. The loan is payable on demand
and had an outstanding principal balance of $200,000 on December 28, 1997. This
loan was repaid in full in January 1998. On October 3, 1997, the Company
borrowed $200,000 from Trakehner Holdings, Inc., which loan bore interest at
8.75% and was due on demand or no later than the Effective Date of the Company's
initial public offering. This loan was repaid in full in November 1997.

In November 1997, the Company completed an initial public offering of 2,500,000
Units, each Unit consisting of one share of Common Stock and one redeemable
Class A Warrant at an initial public offering price of $5.00 per Unit. In
December 1997, the Company issued an additional 100,000 Units to its principal
underwriter, R.J. Steichen & Company, pursuant to the underwriter's decision to
exercise a portion of its over-allotment. The Company received net proceeds of
approximately $11.2 million in conjunction with the initial public offering and
the partial exercise of the underwriter's over-allotment.

The Class A Warrants are subject to redemption by the Company at any time, on
not less than 30 days' written notice, at a price of $0.01 per Warrant at any
time following a period of 14 consecutive trading days where the per share
average closing bid price of the Company's Common Stock exceeds $7.00 (subject
to adjustment), provided that a current prospectus covering the shares issuable
upon the exercise of the Class A Warrants is then effective under federal
securities laws. For these purposes, the closing bid price of the Common Stock
shall be determined by the last reported sale price on the primary exchange on
which the Common Stock is traded.

The Company intends to open one restaurant in 1998 and 1-3 restaurants in
1999. The Company estimates that its capital expenditures (net of estimated
landlord contributions) will be approximately $10-15 million in fiscal 1998 and
$10-20 million in fiscal 1999. The Company expects to finance its concept
development and expansion through cash flow from operations, the exercise of
its Class A Warrants and other forms of financing such as the sale of
additional equity and debt securities, capital leases and other credit
facilities. There are no assurances that such financing will be available on
terms acceptable or favorable to the Company.

ITEM 7. FINANCIAL STATEMENTS

The financial statements of the Company are included herein following the
signatures, beginning at page F-1.

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

On February 4, the Company, with the approval of its Board of Directors and
Audit Committee, engaged Arthur Andersen LLP as the independent public
accountants for Hotel Discovery, Inc. Prior to the engagement of Arthur
Andersen LLP, Ernst & Young LLP had served as the independent public
accountants for the Company. The report prepared by Ernst & Young LLP as of
December 29, 1996 contained no adverse opinion or disclaimer of opinion and was
not qualified or modified as to uncertainty of audit scope or accounting
principles. In connection with the audit of December 29, 1996, and through
February 4, 1998, there were no disagreements with Ernst & Young LLP on any
matter of accounting principles or practices, financial statement disclosure or
auditing scope or procedure, which disagreements, if not resolved to the
satisfaction of Ernst & Young LLP, would have caused Ernst & Young LLP to make
reference to the subject matter of the disagreements in its reports.

16
<PAGE> 17

PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(a) OF THE EXCHANGE ACT

Information in response to this Item is incorporated herein by reference to the
Company's definitive proxy statement to be filed pursuant to Regulation 14A
within 120 days after the end of the fiscal year covered by this form 10-KSB.

ITEM 10. EXECUTIVE COMPENSATION

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

ITEM 13. EXHIBITS, LIST AND REPORTS ON FORM 8-K

(A) EXHIBITS

1.1 Form of Underwriting Agreement (with form of Underwriter's Warrant)
(incorporated herein by reference to Exhibit 1.1 to the Company's
Registration Statement on Form SB-2 as filed on August 22, 1997, as
amended (File No. 333-34235)) (the "1997 SB-2")

3.1 Articles of Incorporation (incorporated herein by reference to
Exhibit 3.1 to the 1997 SB-2)

3.2 By-laws (incorporated herein by reference to Exhibit 3.2 to the 1997
SB-2)

4 Form of Warrant Agreement (incorporated herein by reference to
Exhibit 4 to the 1997 SB-2)

10.1 Indenture of Lease dated November 9, 1994 between Phillip E.
Stephens, Trustee and Kenwood Restaurant, Inc.; First Amendment to
Lease dated May 3, 1995 by and between Phillip E. Stephens, Trustee
and Kenwood Restaurant, Inc.; by Second Amendment to Lease dated
_____, 1996 between Phillip E. Stephens, Trustee and Kenwood
Restaurant Limited Partnership; Second Amendment to Agreement dated
October 18, 1996 between Phillip E. Stephens, Trustee and Kenwood
Restaurant Limited Partnership; and Addendum to Second Amendment to
Lease dated October 18, 1996 between Phillip E. Stephens, Trustee
and Kenwood Restaurant Limited Partnership (Kenwood Restaurant)
(incorporated herein by reference to Exhibit 10.1 to the 1997 SB-2)

10.2 Lease dated August 4, 1997 between Mall of America Company and Hotel
Mexico, Inc. (Mall of America Restaurant) (incorporated herein by
reference to Exhibit 10.2 to the 1997 SB-2)

10.3 Loan Agreement dated October 9, 1996 by and among Kenwood Restaurant
Limited Partnership and PNC Bank, Ohio, National Association
(incorporated herein by reference to Exhibit 10.3 to the 1997 SB-2)

17
<PAGE> 18

10.4 Company's 1997 Stock Option and Compensation Plan (incorporated
herein by reference to Exhibit 10.4 to the 1997 SB-2)

10.5 Employment Agreement between the Company and Ronald K. Fuller dated
March 17, 1997 (incorporated herein by reference to Exhibit 10.5 to
the 1997 SB-2)

10.6 Amendment to Company's 1997 Stock Option and Compensation Plan
(incorporated herein reference to Exhibit 10.6 to the 1997 SB-2)

10.7 Second Amendment to Company's 1997 Stock Option and Compensation
Plan (incorporated herein by reference to Exhibit 10.7 to the 1997
SB-2)

10.8 First Loan Assumption Agreement dated December 31, 1996 by and among
PNC Bank, Ohio, National Association, Kenwood Restaurant Limited
Partnership, Stephen D. King, Kenwood Restaurant, Inc. and Hotel
Mexico, Inc.

10.9 Second Loan Assumption Agreement dated October 16, 1997 by and among
PNC Bank, Ohio, National Association, Stephen D. King and the
Company

10.10 Employment Agreement between the Company and Anne D. Huemme dated
December 15, 1997

24 Powers of Attorney (included on signature page)

27 Financial Data Schedules

(B) REPORTS ON FORM 8-K

None.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the issuer has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

HOTEL DISCOVERY, INC.

By: /s/ ANNE D. HUEMME
-------------------------------------------
Anne D. Huemme
Vice President - Finance and Chief
Financial Officer

Date: March 30, 1998

POWER OF ATTORNEY

Each person whose signature below constitutes and appoints Anne D. Huemme as
such person's true and lawful attorney-in-fact and agent with full power of
substitution and resubstitution for such person and in such person's name, place
and stead, in any and all capacities, to sign any and all amendments to this
Annual Report on Form 10-KSB and to file the same, with all exhibits thereto,
and other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorney-in-fact and agent full power and
authority to do and perform each and every act and thing necessary or desirable
to be done in and about the premises, as fully to all intents and purposes as
such person, hereby ratifying and confirming all that said attorney-in-fact and
agent, or her substitute or substitutes, may lawfully do or cause to do done by
virtue hereof.

18
<PAGE> 19

In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates stated.

Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Stephen D. King Chairman of the Board March 30, 1998
--------------------------------
Stephen D. King

/s/ Ronald K. Fuller President, Chief Executive Officer, March 30, 1998
-------------------------------- Chief Operating Officer and Director
Ronald K. Fuller (Principal Executive Officer)

/s/ Anne D. Huemme Vice President - Finance and March 30, 1998
-------------------------------- Chief Financial Officer
Anne D. Huemme (Principal Financial and Accounting
Officer)

/s/ Michael H. Krienik Director March 30, 1998
--------------------------------
Michael H. Krienik

/s/ Martin J. O'Dowd Director March 30, 1998
--------------------------------
Martin J. O'Dowd

/s/ Thomas W. Orr Director March 30, 1998
--------------------------------
Thomas W. Orr

</TABLE>

<PAGE> 20

HOTEL DISCOVERY, INC.

INDEX TO FINANCIAL STATEMENTS

Page
----
<S> <C>
Report of Independent Public Accountants F-2

Report of Independent Auditors F-3

Balance Sheets as of December 28, 1997 and December 29, 1996 F-4

Statements of Operations for Years Ended December 28, 1997 and December 29, 1996 F-5

Statements of Shareholders' Equity for Years Ended December 28,1997 and December 29, 1996 F-6

Statements of Cash Flows for Years Ended December 28,1997 and December 29, 1996 F-7

Notes to Financial Statements for Years Ended December 28, 1997 and December 29, 1996 F-8

</TABLE>

F-1
<PAGE> 21

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Hotel Discovery, Inc.,

We have audited the accompanying balance sheet of Hotel Discovery, Inc. as of
December 28, 1997 and the related statements of operations, shareholders'
equity, and cash flows for the year then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.

We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also 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 financial statements referred to above present fairly, in
all material respects, the financial position of Hotel Discovery, Inc. at
December 28, 1997 and the results of its operations and its cash flows for the
year then ended in conformity with generally accepted accounting principles.

ARTHUR ANDERSEN LLP

Minneapolis, Minnesota,
February 13, 1998

F-2
<PAGE> 22

REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and
Shareholders of Hotel Discovery, Inc.,

We have audited the accompanying balance sheet of Hotel Discovery, Inc. as of
December 29, 1996 and the related statements of operations, shareholders'
equity, and cash flows for the year then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Hotel Discovery, Inc. at
December 29, 1996 and the results of its operations and its cash flows for the
year then ended in conformity with generally accepted accounting principles.

ERNST & YOUNG, LLP

Cincinnati, Ohio
August 20, 1997

F-3
<PAGE> 23
HOTEL DISCOVERY, INC.

Balance Sheets

<TABLE>
<CAPTION>
December 28, December 29,
1997 1996
---- ----
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 9,222,174 $ 2,707,561
Inventories 41,766 138,757
Other current assets 250,043 91,575
------------ ------------
Total current assets 9,513,983 2,937,893

PROPERTY AND EQUIPMENT, net 5,270,160 4,230,516

OTHER ASSETS, net 55,908 51,841
------------ ------------
$ 14,840,051 $ 7,220,250
============ ============

LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term notes payable $ 200,000 $ 2,500,000
Accounts payable 669,380 803,885
Salaries and wages payable 366,674 174,882
Other accrued expenses 115,773 538,637
Advances payable to principal shareholder -- 447,787
Current portion of long-term debt 69,420 69,420
------------ ------------
Total current liabilities 1,421,247 4,534,611

LONG-TERM DEBT, less current portion 852,165 924,795

CONVERTIBLE PROMISSORY NOTES PAYABLE 150,000 150,000
------------ ------------
Total liabilities 2,423,412 5,609,406
------------ ------------

COMMITMENTS & CONTINGENCIES (Note 7)

SHAREHOLDERS' EQUITY:
Common stock, $.01 par value, 100,000,000 shares authorized;
8,000,189 and 3,945,400 shares issued and outstanding 80,002 39,454
Additional paid-in capital 20,152,949 5,013,126
Less: Common stock subscribed (400,000) --
Accumulated deficit (7,416,312) (3,441,736)
------------ ------------
Total shareholders' equity 12,416,639 1,610,844
------------ ------------
$ 14,840,051 $ 7,220,250
============ ============

</TABLE>

The accompanying notes are an integral part of these balance sheets

F-4
<PAGE> 24
HOTEL DISCOVERY, INC.

Statements of Operations

<TABLE>
<CAPTION>
Year ended Year ended
December 28, December 29,
1997 1996
---- ----
<S> <C> <C>
NET SALES $ 3,546,695 $ 104,129
----------- -----------
COSTS AND EXPENSES:
Food, beverage and retail costs 1,122,313 43,324
Labor and benefits 1,687,803 85,407
Restaurant operating expenses 1,147,354 155,832
Selling, general and administrative expenses 2,073,028 138,209
Depreciation and amortization 614,000 25,000
Pre-opening and development costs 792,397 1,970,452
----------- -----------
Total costs and expenses 7,436,895 2,418,224
----------- -----------

LOSS FROM OPERATIONS (3,890,200) (2,314,095)
----------- -----------
OTHER INCOME (EXPENSE):
Interest expense (173,332) (13,507)
Interest income 88,956 --
----------- -----------
Total other expense (84,376) (13,507)
----------- -----------
NET LOSS $(3,974,576) $(2,327,602)
----------- -----------
BASIC AND DILUTED WEIGHTED AVERAGE OUTSTANDING SHARES 5,204,835 3,119,474
=========== ===========
BASIC AND DILUTED NET LOSS PER SHARE $ (0.76) $ (0.75)
=========== ===========

</TABLE>

The accompanying notes are an integral part of these financial statements

F-5
<PAGE> 25
HOTEL DISCOVERY, INC.

Statements of Shareholders' Equity
<TABLE>
<CAPTION>

Common Stock Additional Common
------------- paid-in stock Accumulated
Shares Amount capital subscribed Deficit Total
------ ------ ------- ---------- ------- -----
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1995 3,000,000 $30,000 $ 2,470,000 $ (945,500) $ (1,114,134) $ 440,366
Issuance of shares pursuant to 945,400 9,454 2,543,126 -- -- 2,552,580
private placements
Cash received on stock subscribed -- -- -- 945,500 -- 945,500
Net loss -- -- -- -- (2,327,602) (2,327,602)
--------- ------- ----------- ---------- ---------- ----------

BALANCE, December 29, 1996 3,945,400 39,454 5,013,126 -- (3,441,736) 1,610,844
Initial public offering, net of offering 2,600,000 26,000 11,201,967 -- -- 11,227,967
costs
Sale of common stock pursuant to 1,447,489 14,475 3,916,029 (690,000) -- 3,240,504
private placements
Issuance of shares in lieu of 7,300 73 21,827 -- -- 21,900
compensation
Cash received on stock subscribed -- -- -- 290,000 -- 290,000
Net loss -- -- -- -- (3,974,576) (3,974,576)
--------- ------- ----------- ---------- ------------ -----------
BALANCE, December 28, 1997 8,000,189 $80,002 $20,152,949 $ (400,000) $ (7,416,312) $12,416,639
========= ======= =========== ========== ============ ===========

</TABLE>

The accompanying notes are an integral part of these financial statements

F-6
<PAGE> 26
HOTEL DISCOVERY, INC.

Statements of Cash Flow

<TABLE>
<CAPTION>
Year Ended
------------------------------
December 28, December 29,
1997 1996
---- ----
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss ($ 3,974,576) ($ 2,327,602)
Adjustments to reconcile net loss to net cash flows used in
operating activities -
Depreciation and amortization 614,000 25,000
Common stock issued in lieu of compensation 21,900 --
Change in operating assets and liabilities -
Inventories 96,991 (138,757)
Other current assets (158,468) (71,575)
Other assets (4,067) --
Accounts payable (134,505) 775,228
Accrued expenses (231,072) 713,519
------------ ------------
Net cash used in operating activities (3,769,797) (1,024,187)
------------ ------------
INVESTING ACTIVITIES:
Purchases of property and equipment (1,653,644) (3,443,544)
------------ ------------
FINANCING ACTIVITIES:
Net borrowings/(payments) on short-term notes payable (2,300,000) 2,500,000
Net payments to shareholder (447,787) (415,103)
Proceeds from issuance of long-term debt -- 1,000,000
Issuance of convertible notes payable -- 150,000
Proceeds from issuance of stock 14,468,471 2,552,580
Principal repayments on long-term debt (72,630) (5,785)
Payments received on stock subscriptions 290,000 945,500
------------ ------------
Net cash provided by financing activities 11,938,054 6,727,192
------------ ------------
INCREASE IN CASH AND CASH EQUIVALENTS 6,514,613 2,259,461
CASH AND CASH EQUIVALENTS, beginning of year 2,707,561 448,100
------------ ------------
CASH AND CASH EQUIVALENTS, end of year $ 9,222,174 $ 2,707,561
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 173,332 $ 45,000
Cash paid for income taxes -- --

</TABLE>

The accompanying notes are an integral part of these financial statements

F-7
<PAGE> 27

HOTEL DISCOVERY, INC.

NOTES TO THE FINANCIAL STATEMENTS
DECEMBER 28, 1997 AND DECEMBER 29, 1996

1. DESCRIPTION OF THE BUSINESS AND FORMATION OF THE COMPANY

Hotel Discovery, Inc. (the Company) owns and operates one restaurant in
Cincinnati, Ohio (the Kenwood Restaurant), which opened under the name "Hotel
Mexico" on December 19, 1996. Prior to the opening of this restaurant, the
Company was in the development stage.

The Company's predecessor, Hotel Mexico (HMI), was originally incorporated in
January 1994 as an Ohio corporation. The Kenwood Restaurant Limited Partnership,
an Ohio limited partnership (the Kenwood Partnership), was formed in June 1995
for the purpose of owning and operating the Kenwood Restaurant. HMI's operations
and the net assets of the Kenwood Partnership were combined on November 14,
1996. On that date, the Kenwood Partnership contributed all of its net assets
totalling $1,567,197 to a newly formed corporation, in exchange for shares of
such corporation. HMI, with total net assets of $631,966 then merged with and
into the newly formed corporation, the name of which remained Hotel Mexico,
Inc. (hereafter, Hotel Mexico). Upon consummation of the merger, all outstanding
shares of Hotel Mexico were converted into an aggregate of 1,350,000 shares of
Common Stock of the newly formed corporation.

The shares of Hotel Mexico Common Stock received by the Kenwood Partnership in
the reorganization were retained by the Kenwood Partnership until the effective
date of the Company's initial public offering, at which time the shares of
Common Stock and all other partnership assets were distributed to the general
and limited partners in accordance with the partnership agreement and the
Kenwood Partnership was dissolved.

On August 22, 1997, Hotel Mexico merged with and into Hotel Discovery, Inc., a
newly formed Minnesota corporation. The Company has an authorized capital stock
of 100,000,000 undesignated shares, and each share of Common Stock of Hotel
Mexico was converted into one share of the Company's Common Stock.

The Company incurred a net loss of $3,974,576 in 1997 and $2,327,602 in 1996.
The losses for these periods are primarily attributable to costs and expenses
incurred in the development and start-up of operations at the Kenwood
Restaurant and at the Company's second restaurant to be located at the Mall of
America in Bloomington, Minnesota. The 1997 losses are also attributable to
the costs associated with the hiring of senior corporate management to position
the Company for its future expansion plans. The Company has a limited
operating history, and future revenues and results from operations will depend
upon various factors including market acceptance of its concept and general
economic conditions. The Company's ability to meet its expansion plans and
achieve profitability depends on its ability to obtain financing for the
development of additional restaurants. There are no assurances that such
financing will be available on terms acceptable or favorable to the Company.

2. SIGNIFICANT ACCOUNTING POLICIES

FISCAL YEAR

The Company has adopted a 52-53-week year ending on the Sunday nearest December
31 of each year. All references herein to "1997" and "1996" represent 52-week
fiscal years ended December 28, 1997 and December 29, 1996, respectively.

CASH AND CASH EQUIVALENTS

The Company includes as cash and cash equivalents cash on hand, bank deposits
and all liquid money market investments with original maturities of three months
or less when purchased, which are recorded at the lower of cost or market.

INVENTORIES

Inventories consist primarily of restaurant food and beverages and are stated at
the lower of cost or market as determined by the first-in first-out method.

PRE-OPENING AND DEVELOPMENT COSTS

The direct and incremental costs associated with opening a new restaurant, which
consist of hiring and training the initial workforce, mock service and other
direct costs are charged to operations when incurred.

F-8
<PAGE> 28

PROPERTY AND EQUIPMENT

Property and equipment acquired are recorded at cost. The Company capitalized
interest on funds borrowed to finance construction of $0 in 1997 and $45,000
in 1996. Improvements are capitalized, while repair and maintenance expenses are
charged to operations as incurred. Leasehold improvements are amortized using
the straight line method over the shorter of the estimated useful life or the
lease term. Furniture and equipment are depreciated on a straight-line method
over their estimated useful lives of 5 to 15 years.

Property and equipment consisted of the following as of:

<TABLE>
<CAPTION>
December 28, December 29,
1997 1996
------------ -----------
<S> <C> <C>
Building and leasehold improvements $ 3,182,160 $ 3,353,182
Equipment and fixtures 2,294,503 902,334
Construction in progress 432,497 --
----------- -----------
5,909,160 4,255,516
Less: accumulated depreciation and
amortization (639,000) (25,000)
----------- -----------
Total property and equipment, net $ 5,270,160 $ 4,230,516
=========== ===========
</TABLE>

INCOME TAXES

The Company accounts for income taxes using the liability method to recognize
deferred income tax assets and liabilities. Deferred income taxes are provided
for differences between the financial reporting and tax bases of the Company's
assets and liabilities at currently enacted tax rates.

NET LOSS PER COMMON SHARE

The Company adopted in fiscal 1997, Statement of Financial Accounting Standard
(SFAS) No. 128 "Earnings per Share", which requires disclosure of basic earnings
per share (EPS) and diluted EPS, which replace the existing primary EPS and
fully diluted EPS, as defined by Accounting Principles Board (APB) No. 15. Basic
EPS is computed by dividing net income by the weighted average number of shares
of Common Stock outstanding during the year. Diluted EPS is computed similarly
to primary EPS as previously reported provided that, when applying the treasury
stock method to common equivalent shares, the Company must use its average share
price for the period rather than the more dilutive greater of the average share
price or end-of-period share price required by APB No. 15.

As a result of the adoption of SFAS No. 128, the Company's reported loss per
share for 1996 was restated. The effect of this accounting change on previously
reported EPS data was as follows:

Primary EPS as reported $(0.53)
Effect of SFAS No. 128 (0.22)
-------
Basic EPS as restated $(0.75)
=======
Fully diluted EPS ---
Effect of SFAS No. 128 (0.75)
-------
Diluted EPS as restated $(0.75)
=======

USE OF ESTIMATES

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Ultimate results could differ from the estimates.

F-9

<PAGE> 29

3. DEBT

The Company borrowed $1,000,000 in August 1996 under a leasehold
mortgage term loan from a bank. The loan bears interest at a variable rate
(9.06% at December 28, 1997) and requires monthly payments of principal and
interest of $5,785 through February 1999, at which time the remaining balance
is due in full.

In December 1996, the Company borrowed an additional $2,500,000 under a mortgage
term loan from a bank. The loan bore interest at 5.94% and had payments of
interest only due through January 1998, at which time the entire principal was
due. The loan was classified as short-term as of December 29, 1996 as it was
repaid in full in January 1997.

In May and June 1997, the Company borrowed an aggregate of $2,800,000 under
loan agreements with banks. The loans were both repaid in full in July 1997.

The outstanding loan is collateralized by the leasehold mortgage and
substantially all of the assets of the Kenwood Restaurant. Additionally,
the principal shareholder has personally guaranteed the loan. The
related loan agreement contains certain covenants, as defined, which require,
among others, minimum working capital, tangible net worth and debt coverage
ratios and restrict additional indebtedness or asset sales. As of December 28,
1997, the Company was in compliance with all such covenants. The fair value of
the Company's debt approximates market.

Aggregate maturities of long-term debt as of December 28, 1997 are as follows:

1998 $ 69,420
1999 852,165
--------
$921,585
========

CONVERTIBLE PROMISSORY NOTES PAYABLE

In June and July 1996, the Company executed three convertible promissory notes
totalling $150,000. The notes mature on July 1, 1999, and bear interest at
8.01%. The notes are convertible into 39,600 shares of the Company's Common
Stock at maturity, at the payee's option.

4. SHAREHOLDERS' EQUITY

CAPITAL STOCK

In June 1997, in connection with the Company's reincorporation in Minnesota, the
authorized capital of the Company increased to 100,000,000 shares. As allowed
under Minnesota law, the Board of Directors is authorized to designate and issue
shares in such classes or series (including classes or series of preferred
stock) as it deems appropriate and to establish the rights, preferences, and
privileges of such shares.

PRIVATE PLACEMENTS

From November 1996 through July 1997, the Company completed private placement
offerings of an aggregate of 2,392,889 shares of Common Stock at $3.00 per
share. The Company received net proceeds of approximately $6.1 million after
the payment of approximately $700,000 in related offering costs. The proceeds
were used to pay off certain debt and will be used for additional development
costs and working capital pruposes.

INITIAL PUBLIC OFFERING

During the fourth quarter of 1997, the Company consummated an intial public
offering of 2,600,000 units at an offering price of $5.00 per unit, including
100,000 units from the exercise of the underwriters' over-allotment option,
which occurred in December 1997. Each unit consisted on one share of Common
Stock and one Redeemable Class A Warrant. The Company received net proceeds of
approximately $11.2 million after payment of approximately $1.8 million in
related underwriting discount and offering costs.

WARRANTS

In 1997, the Company granted 214,955 warrants. The warrants are immediately
exercisable at a price of $3.75 per share and expire in five years.

F-10
<PAGE> 30

5. STOCK OPTIONS

STOCK OPTION PLAN

The Board of Directors has adopted the 1997 Stock Option and Incentive
Compensation Plan (the "Plan") and reserved 750,000 common shares for issuance
under the Plan. The Plan is administered by a stock option committee of the
Board of Directors which has the discretion to determine the number of shares
granted, the price of the option, the term of the option and the time period
over which the option may be exercised. Also during 1997, the Company granted
75,000 options to its outside directors outside of the Plan.

A summary of the status of the Company's Plan as of and for the year ended
December 28, 1997 is presented in the table and narrative below:

Year ended
December 28, 1997
-----------------
Weighted Average
Shares Exercise Price
------ --------------
<S> <C> <C>
Outstanding, beginning of Period ---- $ ----
Granted 707,666 $ 3.11
------- -------
Outstanding, end of Period 707,666 $ 3.11
======= =======
Exercisable, end of Period 50,000
Weighted average fair value of options =======
granted $ 2.38
=======
</TABLE>

The Company accounts for these plans under APB Opinion No. 25, under which no
compensation cost has been recognized. Had compensation cost for these plans
been determined consistent with SFAS No. 123, "Accounting for Stock-Based
Compensation," the Company's net loss and loss per share would have been
increased to the following pro forma amounts for 1997:

Net Loss As Reported $(3,974,576)
Pro Forma (4,093,576)
Diluted EPS As Reported (0.76)
Pro Forma (0.79)

The fair value of each option is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions used for grants in 1997: risk-free interest rate of 6.01%; no
expected dividend yield; expected lives of 7 years; and expected volatility of
80%.

6. INCOME TAXES

As of December 28, 1997 and December 29, 1996, the Company's deferred taxes
consisted primarily of net operating loss carryforwards, preopening costs not
currently deductible and accelerated methods of depreciation. The Company has
recorded a full valuation allowance against the net deferred tax asset due to
the uncertainty of realizing the related benefits.

As of December 28, 1997, the Company had net operating loss carryforwards of
approximately $2.3 million, which, if not used, will expire through 2012.

F-11
<PAGE> 31

The following is a reconciliation of the tax expense recorded in these financial
statements to the federal and state tax rate based on statutory rates.

<TABLE>
<CAPTION>
FOR THE YEARS ENDED
-------------------
DECEMBER 28, DECEMBER 29,
1997 1996
--------------- ------------
<S> <C> <C>
Net loss............................. $(3,974,576) $(2,327,602)
Expected rate........................ 40% 40%
----------- ---------
Expected tax benefit................. (1,589,831) (931,000)
Valuation allowance.................. 1,589,381 931,000
----------- ---------
Tax benefit recognized............... $ --- $ ---
=========== ===========

</TABLE>

7. COMMITMENTS AND CONTINGENCIES

OPERATING LEASES

The Company has entered into various operating leases for its existing and
future restaurant which have an initial lease term of ten to fifteen
years with an option for renewal. All of these leases contain provisions for
contingent rentals based on a percentage of gross revenues, as defined, and
contain provisions for payments of real estate taxes, insurance and common area
costs. In addition, certain of these leases provide for tenant inducements and
rent abatement. Total rent expense, including common area costs, real estate
taxes and percentage rent, was $236,642 and $2,683, for the years 1997 and 1996,
respectively.

Future minimum rental payments (including one restaurant which is not yet open
and excluding percentage rent) are as follows as of December 28, 1997:

1998 $ 284,162
1999 524,640
2000 688,256
2001 559,371
2002 574,779
Thereafter 5,418,897
----------
$8,050,105
==========

LITIGATION

The Company is involved in various legal actions rising in the ordinary course
of business. In the opinion of management, the ultimate disposition of these
matters will not have a material adverse effect on the Company's financial
position or the results of its operations.

8. RELATED PARTY TRANSACTIONS

The principal shareholder, director and executive officer provided essentially
all of the Company's working capital in the development stage. During the year
ended December 29, 1996 the maximum amount of such indebtedness outstanding was
$1,213,469. At December 29, 1996, the amount outstanding of such indebtedness
was $447,787. Included in these amounts were concept development costs to be
reimbursed for a demonstration restaurant owned and operated by the principal
shareholder in the amount of $278,101. The Company paid interest at 11.5% on
these advances. There were no fixed repayment terms on the advances. All
amounts were repaid in November 1997 from the proceeds of the Company's initial
public offering.

During 1997, Krienik Advertising Inc., an Ohio corporation whose President,
Chief Executive Officer and 100% shareholder is a director of the Company,
provided marketing and advertising services to the Company. Fees paid for
these services (including payments for subcontracted media, printing,
production and research services) amounted to $565,287 for the year ended
December 28, 1997.

F-12

<PAGE> 32
9. SUBSEQUENT EVENT

F-13

<PAGE> 1

EXHIBIT 10.8

Return to:
Multi-State Title Agency
201 East Fifth St., PNC Center
Cincinnati, Ohio 45202-4182
(513) 651-6170

RECORDING INFORMATION:

REGISTERED LAND CERTIFICATE NO. 160105

This instrument was prepared by:

Frederick W. Kindel, Esq.
Frost & Jacobs
2500 PNC Center
201 East Fifth Street
Cincinnati, Ohio 45202
(513) 651-6800

- ------------------------------------------------------------------------------

LOAN ASSUMPTION AGREEMENT

This Agreement made effective as of December 31, 1996, by and among PNC
BANK, OHIO, NATIONAL ASSOCIATION ("Lender"), KENWOOD RESTAURANT LIMITED
PARTNERSHIP, an Ohio limited partnership ("Original Borrower"), STEPHEN D. KING,
an individual and resident of the State of Ohio, and KENWOOD RESTAURANT, INC.,
an Ohio corporation (singularly, the "Original Guarantor" and collectively, the
"Original Guarantors"), and HOTEL MEXICO, INC., an Ohio corporation formerly
known as "KRLP ACQUISITION CORP." (the "New Borrower").

RECITALS:

A. Lender extended a secured loan in the amount of $1,000,000.00 to the
Original Borrower with respect to certain premises, more particularly described
in Schedule "A" hereto and made a part hereof (the "Property"), the obligations
of which were guaranteed by the Original Guarantors and which loan is described
herein as the "Loan."

<PAGE> 2

B. The Loan is evidenced and/or secured by the documents listed in
Schedule B hereto (collectively, the "Loan Documents"). All terms used herein,
but not defined, shall have the same definitions as used in the Loan Agreement
identified in Schedule "A" hereto.

C. The Original Borrower desires to transfer all of its right, title and
interest in the Property to New Borrower.

D. The Original Borrower and the New Borrower desire to obtain the prior
consent of Lender to the aforesaid transactions, and Lender has required that
the parties hereto enter into this Agreement as a condition precedent to such
approval.

E. New Borrower further has requested, and Lender has approved, certain
changes to the Loan Documents as hereinafter provided.

NOW, THEREFORE, in consideration of the premises and other good and valuable
consideration, the receipt and sufficiency of which are hereby acknowledged, the
parties hereto agree as follows:

1. Assumption

The New Borrower, with the consent of Lender, hereby assumes, all of
the duties and obligations of the Original Borrower under the Loan Documents,
and the New Borrower agrees to make all payments in accordance with, and to keep
and perform all of the covenants, obligations and conditions of, the Loan
Documents, and now is principally liable for such duties and obligations.
Notwithstanding the foregoing assumption of liability under the Loan Documents,
the Original Borrower also remains principally liable, jointly and severally
with the New Borrower, for all of its duties and obligations under the Loan
Documents and each Original Guarantor continues to remain liable for all of its
duties and obligations under their respective Guarantees of Performance and
Payment dated October 9, 1996, executed by Original Guarantors for the benefit
of the Lender with respect to the Loan (the "Guarantees"). Except as otherwise
expressly provided in this Agreement, nothing contained herein shall amend,
waive, extend or release any of the respective duties and obligations of
Original Borrower, Original Guarantors or the New Borrower contained in the Loan
Documents or the Guarantees. Nothing contained herein shall constitute a
novation of liability of the Original Borrower under the Loan Documents.

2. Waivers

The obligations of the New Borrower under the Loan Documents will
extend to and cover any number of renewals or extensions of the time for payment
of the Loan Documents and will not be affected by any surrender, exchange,
acceptance, or release by Lender of any other guarantee or any security held by
it for the payment of the Loan Documents. The New Borrower hereby waive notice
of default, presentment, protest, demand for payment, notice of demand or
protest. Lender in its sole discretion may determine the reasonableness of the
period which may elapse prior to the making of demand upon the New Borrowers for
payments under the Loan Documents and need not

-2-

<PAGE> 3

pursue any of its remedies against any collateral, Original Borrower or Original
Guarantors before having recourse against the New Borrower. If any demand is
made at any time upon Lender for the repayment or recovery of any amount
received by it in payment or on account of the Loan Documents and if Lender
repays all or any part of such amount by reason of any judgment, decree or order
of any court or administrative body or by reason of any settlement or compromise
of any such demand, the New Borrowers will be and remain liable hereunder for
the amount so paid or recovered to the same extent as if such amount had never
been received originally by Lender.

3. Acknowledgment of Loan Terms

Original Borrower and New Borrower acknowledge the following:

(a) Original Borrower and New Borrowers are currently indebted to
Lender in the outstanding principal amount of $1,000,000.00 under the Loan.

(b) The current annual rate of interest payable under the Loan is
acknowledged to be 9.06% per annum and shall remain at such rate until October
1, 1999.

(c) The monthly installment payment of principal currently in effect
under the Loan is acknowledged to be $5,785.00, plus accrued interest.

(d) The maturity date of the Loan is October 1, 1999.

4. Modification of Loan Agreement

All of the parties hereto acknowledge and agree that the Loan Agreement
is hereby amended as follows:

(a) Section 6 of the Loan Agreement is hereby modified by the addition
of the following new Section 6.25:

6.25 CONTROL AND OWNERSHIP OF BORROWER. 51% or more of the underlying
control of the Borrower shall be vested in, and held by, Stephen D. King, a
Guarantor, it being understood that Stephen D. King must continue to control,
directly or indirectly, at least a 51% interest in the Borrower, and 25% of the
underlying ownership of the Borrower shall be vested in, and held by, Stephen D.
King, a Guarantor, it being understood that Stephen D. King must continue to
own, directly or indirectly, at least 25% interest in the Borrower.

(b) Section 6 of the Loan Agreement is hereby modified by the addition
of the following Section 6.26:

6.26 TANGIBLE NET WORTH. Shall maintain a Tangible Net Worth, as
hereinafter defined, of at least $3,500,000.00 verified by compiled and reviewed
financial statements of Borrower as,

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from time to time, furnished to Lender. For the purpose of this Agreement, the
term "Tangible Net Worth" shall mean stockholders' equity in the Borrower less
any advances to third parties and all items properly classified as intangibles,
in accordance with generally accepted accounting principles, consistently
applied ("GAAP").

6.27 TOTAL LIABILITIES - TANGIBLE NET WORTH. Shall maintain a ratio of
Total Liabilities, as hereinafter defined, to Tangible Net Worth of 1:1 or less.
For the purpose of this Agreement, the term "Total Liabilities" shall mean the
sum of all current liabilities, plus long term debt with maturity of longer than
twelve (12) months, as determined by GAAP.

(d) Clause 7. l(iii) contained in the Loan Agreement which reads
"except for the rental payable under the Restaurant Lease, rental and lease
payments for real or personal property whose aggregate rental payments would
exceed $25,000.00 when added to Borrower's rental or lease agreements existing
on the date hereof" is modified to read "except for the rental payable under the
Restaurant Lease, rental and lease payments for real or personal property whose
aggregate rental payments would exceed $50,000.00 when added to Borrower's
rental or lease agreements existing on the date hereof."

(e) The last sentence contained in Section 7.11 which reads "The
occurrence of any of the following events (each, a "Transfer") without Lender's
prior written consent will be deemed a violation of the foregoing covenant: (i)
the transfer, conveyance, contract for sale, assignment or pledge of any
partnership interest in Borrower, (ii) the failure of Kenwood Restaurant, Inc.
at any time to remain the sole general partner of Borrower, or (iii) the
dissolution of Borrower or any Guarantor." is hereby amended to read as follows:
"The occurrence of any of the following events (each, a "Transfer") without
Lender's prior written consent will be deemed a violation of the foregoing
covenant: (i) the transfer, conveyance, contract for sale, assignment or pledge
of any stock, warrant or other securities in Borrower, except in connection with
the current private placement offering of 1,500,000 shares in Borrower so long
as Borrower remains in compliance with the negative covenant contained in
Section 6.25 hereof; or (ii) the dissolution or merger of Borrower or any
Guarantor."

5. Inducements

As an inducement for the Lender to enter into this Agreement, Original
Borrower, Original Guarantors and New Borrower represent and warrant to Lender
the following:

(a) The Loan Documents constitute valid, legal and binding obligations
of the Original Borrower and are now the valid, legal and binding obligations of
the New Borrower, enforceable in accordance with their terms; the liens and
security interests of the security documents comprising the Loan Documents are
valid and substituting liens and interests against the collateral described

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<PAGE> 5

therein, first in priority of title, except for matters disclosed in that
certain Loan Policy of Title Insurance No. 36 0138 010 00004177 issued by
Chicago Title Insurance Company to Lender.

(b) The New Borrower acknowledge that they have received and reviewed a
copy of the Loan Documents.

(c) The New Borrower, the Original Borrower and Original Guarantors
hereby acknowledge that as of the date hereof there are no claims, causes of
action, defenses or rights of set-off against Lender with respect to the Loan
Documents or Guarantees.

(d) The Original Borrower and Original Guarantors are currently not in
default under the Loan Documents or the Guarantees, respectively, and have fully
performed all of their respective duties and obligations thereunder through and
including the effective date of this Agreement.

(e) The Guarantees are in full force and effect and constitute a valid
and binding obligations of the Original Guarantors thereunder, which is
enforceable in accordance with their terms.

(f) The consummation of this Agreement by Original Borrower, Original
Guarantors and New Borrower are their voluntary and free deed and act, without
any misapprehension as the effect hereof, and without any coercion, duress, or
overreaching or other misconduct by the Lender or any of its employees,
representatives or agents.

(g) This Agreement and the consummation of the transaction contemplated
hereby constitute the valid, enforceable and binding obligation of the Original
Borrower, Original Guarantors and New Borrower, respectively.

(h) Neither the execution of this Agreement nor the consummation of any
of the transactions contemplated hereby will constitute a violation of, be in
conflict with or constitute a default under (or with the passage of time or
delivery of notice, or both), or will constitute a default under any term or
provision of any agreement which the Original Borrower, Original Guarantors or
the New Borrower, individually or collectively, are a party to or bound by.

(i) Concurrent with the signature and delivery of this Agreement by the
parties hereto, the New Borrower own full, absolute and complete title to the
Property, subject to the lien of the security documents comprising the Loan
Documents and the fee simple or reversionary interest of Phillip E. Stephens,
Trustee.

(j) Lender has acted at all times in a fair, reasonable, good faith
manner in connection with its administration and enforcement of the Loan
Documents, its dealings with the parties hereto with respect to the Loan, and
all other transactions related to this Agreement or the Loan.

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<PAGE> 6

(k) All of the representations and warranties of the Original Borrower
contained in the Loan Agreement are incorporated and restated herein by the New
Borrower as of the effective date of this Agreement, without condition or
exception, as though fully stated in this Agreement, and such representations
and warranties are true and accurate.

6. General

(a) The New Borrower shall be responsible for the out-of-pocket
expenses incurred by the Lender in connection with this Agreement.

(b) This Agreement will be governed by and construed in accordance with
the laws of the State of Ohio. This Agreement will be recorded at the New
Borrower's expense.

(c) This Agreement will be binding upon each of the parties hereto and
each of their respective personal representatives, heirs, successors and assigns
and will inure to the benefit of Lender and its successors and assigns, but all
duties and obligations of the Original Borrower, Original Guarantors, and New
Borrower shall not be delegated unto any other party, except as provided herein.

(d) Notwithstanding anything to the contrary, the duties and
obligations of the Original Borrower are not deemed restated or preempted by
this Agreement, except to the extent modified herein, and the lien and security
interests of the security documents comprising the Loan Documents shall retain
their original priority of title.

7. Consent to Jurisdiction; Waiver of Jury Trial. This Agreement has been
executed, delivered and accepted at and will be deemed to have been made at
Cincinnati, Ohio and will be interpreted and the rights and liabilities of the
parties hereto determined in accordance with the laws of the State of Ohio, and
the Original Borrower, New Borrower and Original Guarantors hereby agree to the
exclusive jurisdiction of any state or federal court located within Hamilton
County, Ohio and consents that all service of process to Original Borrower, New
Borrower and Original Guarantors shall be sent in the manner, and at the
address, set forth in the Loan Documents; provided that nothing herein contained
will prevent the Lender from bringing any action or exercising any rights
against any property of the Borrower within any other state or nation to enforce
any award or judgment obtained in the federal or state court located within
Hamilton County, Ohio. The Original Borrower, New Borrower and Original
Guarantors waive any objection based on forum non-conveniens and any objection
to venue or any action instituted hereunder. The Original Borrower, New Borrower
and Original Guarantors and the Lender each waive any right to trial by jury in
any action or proceeding related to this Agreement, the Loan Documents or any
transaction contemplated in any of such documents.

8. Miscellaneous.

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<PAGE> 7

This Agreement may be executed in counterparts. This Agreement,
together with the Loan Documents, contain the entire agreement among the parties
hereto.

9. CONFESSION OF JUDGMENT. ANY ATTORNEY-AT-LAW MAY APPEAR IN ANY COURT
OF RECORD SITUATED IN THE COUNTY WHERE THE ORIGINAL BORROWER, EITHER NEW
BORROWER OR EITHER GUARANTOR THEN RESIDES OR CONDUCTS BUSINESS, OR IN THE
COUNTY WHERE BORROWER SIGNED THIS WARRANT, OR IN ANY OTHER COURT IN THE STATE
OF OHIO OR IN ANY OTHER STATE OR TERRITORY OF THE UNITED STATES, AT ANY TIME
AFTER THE DEBT HEREBY EVIDENCED SHALL BECOME DUE, EITHER AT ITS STATED MATURITY
OR BY ACCELERATION OR OTHERWISE, AND MAY WAIVE THE ISSUING AND SERVICE OF
PROCESS AND CONFESS JUDGMENT AGAINST BORROWER, JOINTLY AND SEVERALLY, IN FAVOR
OF LENDER, FOR THE AMOUNT THEN OWING HEREIN, TOGETHER WITH THE COSTS OF SUIT,
AND THEREUPON RELEASE ALL ERRORS AND WAIVE ALL RIGHTS OF APPEAL AND STAYS OF
EXECUTION. NO SUCH JUDGMENT OR JUDGMENTS AGAINST LESS THAN ALL OF THE
UNDERSIGNED SHALL BE A BAR TO A SUBSEQUENT JUDGMENT OR JUDGMENTS AGAINST ANY
ONE OR MORE OR THE UNDERSIGNED AGAINST WHOM JUDGMENT HAS NOT BEEN OBTAINED
HEREON, THIS BEING A JOINT AND SEVERAL WARRANT OF ATTORNEY TO CONFESS JUDGMENT.

Executed as of December 20, 1996.

ORIGINAL BORROWER:

WARNING: BY SIGNING THIS PAPER YOU GIVE UP YOUR RIGHT TO NOTICE AND COURT TRIAL.
IF YOU DO NOT PAY ON TIME A COURT JUDGMENT MAY BE TAKEN AGAINST YOU WITHOUT YOUR
PRIOR KNOWLEDGE AND THE POWERS OF A COURT CAN BE USED TO COLLECT FROM YOU
REGARDLESS OF ANY CLAIMS YOU MAY HAVE AGAINST THE CREDITOR WHETHER FOR RETURNED
GOODS, FAULTY GOODS, FAILURE ON HIS PART TO COMPLY WITH THE AGREEMENT, OR ANY
OTHER CAUSE.

KENWOOD RESTAURANT LIMITED PARTNERSHIP

WITNESSES: By: Kenwood Restaurant, Inc., its
General Partner

/s/ Gregory E. Land
Print Name: Gregory E. Land By: /s/ Stephen D. King
Print Name: Stephen D. King
/s/ Suzanne P. Land Title: President
Print Name: Suzanne P. Land

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<PAGE> 8

WITNESSES: ORIGINAL GUARANTOR:

/s/ Gregory E. Land
Print Name: Gregory E. Land By: /s/ Stephen D. King
STEPHEN D. KING
/s/ Suzanne P. Land
Print Name: Suzanne P. Land

/s/ Gregory E. Land KENWOOD RESTAURANT LIMITED PARTNERSHIP,
Print Name: Gregory E. Land an Ohio limited partnership
By: /s/ Stephen D. King
/s/ Suzanne P. Land Print Name: Stephen D. King
Print Name: Suzanne P. Land

HOTEL MEXICO, INC.,
F.K.A. KRLP ACQUISITION, CORP.

/s/ Gregory E. Land
Print Name: Gregory E. Land By: /s/ Stephen D. King
Print Name: Stephen D. King
/s/ Suzanne P. Land Title: President
Print Name: Suzanne P. Land

APPROVED AND AGREED:

WITNESSES: LENDER:

/s/ Tammy Johnson PNC BANK, OHIO, NATIONAL ASSOCIATION
Print Name: Tammy Johnson

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<PAGE> 9
/s/ Frederick W. Kindel By: /s/ Wendy Gaskin
Print Name: Frederick W. Kindel Title: Loan Officer