GENERAL FORM FOR REGISTRATION OF
SECURITIES OF SMALL BUSINESS ISSUERS
UNDER SECTION 12(B) OF THE SECURITIES EXCHANGE ACT OF 1934
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-SB/A
AMENDMENT NO. 4
SPORTS GROUP INTERNATIONAL, INC.
(formerly known as Secretarial Services of Orlando, Inc.)
(Name of Small Business Issuer in its Charter)
Florida 59-3474394
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(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
7730 East Greenway Road, Suite 203 Scottsdale, Arizona 85260
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number (480) 443-0200
Securities to be registered pursuant to Section 12(b) of the Act.
NONE.
Securities to be registered pursuant to Section 12(g) of the Act.
COMMON STOCK
$.001 par value
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED HEREIN, THE DISCUSSION IN
THIS FORM 10-SB CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS,
ASSUMPTION AND UNCERTAINTIES, WHICH ARE DIFFICULT TO PREDICT. WORDS SUCH AS
"BELIEVE," "MAY," "COULD," "EXPECT," "LIKELY," AND VARIATIONS OF THESE WORDS,
AND SIMILAR EXPRESSIONS, ARE INTENDED TO IDENTIFY SUCH FORWARD-LOOKING
STATEMENTS. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE
DISCUSSED HEREIN. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES
INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN THE SECTIONS ENTITLED
"MANAGEMENT DISCUSSION AND ANALYSIS" AND "RISK FACTORS," AS WELL AS THOSE
DISCUSSED IN THIS PART AND ELSEWHERE IN THIS FORM 10-SB.
BUSINESS OVERVIEW:
The Company was incorporated in the state of Florida in September 1997, as
Secretarial Services of Orlando, Inc. and in March 1999 changed its name to
Sports Group International, Inc. Prior to March 1999, the Company had no
significant operations. The term "Company" refers to Sports Group International,
Inc. and its subsidiaries. The Company trades over-the-counter on the Electronic
Bulletin Board under the symbol "SPGK". The Company has developed its business
through the acquisition of the Frullati Cafe and Bakery and the Surf City
Squeeze franchise businesses, as described in more detail below.
The Company operates and franchises, under the Frullati Cafe and Bakery and
the Surf City Squeeze brand names, juice bars and health food cafes that serve
blended fruit drinks and healthy foods and snacks in shopping malls, airports,
hospitals and health clubs throughout the United States and Canada. As of
December 31, 1999, the Company, through its subsidiaries, has approximately 209
total locations, of which 185 are either franchised or licensed by third parties
and 24 are directly owned and operated by the Company or its subsidiaries. The
Company's corporate stores operate under the Frullati Cafe and Bakery brand
name. The Company also sells proprietary smoothie mixes and other nutrients and
supplements to its franchisees and licensees through its wholly owned
subsidiaries.
The Company derives its revenues primarily from franchise and license fees,
sales from its company-owned stores, and sales of nutritional and health food
products to franchisees and licensees. The Company's long-term strategy is to
operate primarily as a franchisor, and through strategic acquisitions and
internal growth, to become one of the larger franchisors of juice bars, healthy
food cafes, and other retail food concepts in the United States and select
international markets that include Canada, the Middle East, Australia, and
certain Pacific Rim countries. The Company also plans to operate a limited
number of company-owned stores in certain key markets where the stores can be
geographically concentrated. Currently, the majority of the company-owned stores
are located in the Dallas-Ft. Worth metropolitan area. The Company has not yet
identified other areas where it may wish to operate company-owned stores.
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INDUSTRY OVERVIEW:
The U. S. market for juice and smoothie blended drinks is large, having
grown nearly 30% in the past year, according to the 1999 Juice and Smoothie Bar
Industry Analysis Report (the "Report"). The juice/smoothie segment of the
specialty-restaurant industry accounted for approximately $647 million in
revenue during the past year, with major chain operators (i.e., those with 30
units or more) posting roughly $450 million of the revenue and independent
operators accounting for about $197 million. The Report also found the
juice/smoothie segment's operators with 30 units or more are taking market share
from the independents operators. Specifically, the Report noted that the major
retail players, with approximately 1,817 stores in the smoothie segment, now
control 70 percent of the market, up from 55% in 1998 and 42% in 1997.
The Report stated that the growing smoothie-and-juice-bar segment is
quickly learning the importance of building a brand name, with most of the major
chains shifting their growth strategies to major franchise development
agreements and co-branding efforts. The Report also predicted that the major
chains, which are mainly based in the Pacific and Southeastern regions of the
country, will expand into other U.S. territories, where menu diversification
will be vital to success.
BUSINESS OF ISSUER:
The Company is an operator and franchisor of juice bars and health food
cafes that serve blended fruit drinks and healthy food and snacks. The Company
conducts its business through two operating divisions: Frullati Cafe and Bakery,
which commenced operations in 1985, and Surf City Squeeze, which commenced
operations in 1989.
The stores operating under the Frullati Cafe and Bakery brand name are
located primarily in shopping malls, airports and hospitals in the midwest,
southwest, and southeastern United States. The average Frullati Cafe and Bakery
store derives approximately 60% of its total revenue from blended fruit drinks
and other beverage sales and approximately 40% from the sale of sandwiches,
baked goods and other healthy food items. The stores operating under the Surf
City Squeeze brand name are located in shopping malls and health clubs primarily
in California, Arizona and Canada. The average Surf City store derives the
majority of its revenue from the sale of blended fruit drinks and other
beverages, and nutrients and supplements that are added to the drinks.
BUSINESS DEVELOPMENT AND CORPORATE STRUCTURE:
The Company's growth has been driven through acquisitions. On March 15,
1999, the Company purchased all of the outstanding common shares of Surf City
Acquisition Corporation II ("SCAC") by issuing 575,000 shares of its Series A
Convertible Preferred Stock ("Series A Preferred") and 2,000,000 shares of its
common stock par value $0.001 per share (the "Common Stock") in exchange for all
SCAC's issued and outstanding common stock, warrants, and the cancellation of a
Shareholder Voting Trust and Management Agreement among its shareholders. SCAC,
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in turn, owns all of the common shares of Surf City Squeeze, Inc. ("Surf City").
Surf City is a franchiser of juice bars that sell blended fruit drinks and other
nutritional products.
Surf City filed a voluntary petition under Chapter 11 of the United States
Bankruptcy Code on January 13, 1997, and emerged from bankruptcy when SCAC
purchased all of its Common Stock pursuant to the First Modified Joint Plan of
Reorganization Proposed by the Debtor and the Official Committee of Unsecured
Creditors in the United States Bankruptcy Court for the District of Arizona on
November 18, 1997 (the "Plan of Reorganization"). The Plan of Reorganization is
described in more detail below. See, BUSINESS DEVELOPMENT AND CORPORATE
STRUCTURE - SURF CITY'S PLAN OF REORGANIZATION, below.
On May 21, 1999, the Company issued, pursuant to a private placement exempt
from registration under the Securities Act of 1933, 650,000 shares of its Series
B Convertible Preferred Stock (the "Series B Preferred") to Robert E. Petersen
and Margaret M. Petersen, as Trustees of the R.E. & M. Petersen Living Trust
Dated January 17, 1983 (the "Petersen Trust"), at $10.00 per share and a warrant
to purchase 1,000,000 of the Company's Common Stock at $2.00 per share (the
"Petersen Transaction"). Simultaneously with the closing of the Peterson
Transaction, on May 21, 1999, the Company used the proceeds of the Petersen
Transaction to purchase all of the Common Stock of Selman Systems, Inc.
("Selman") for $6,500,000 in cash and the assumption of certain debt. Selman,
through its wholly owned subsidiaries, owns and operates Frullati Cafe & Bakery
("Frullati"), a chain of franchised and company-owned cafes and bakeries serving
blended fruit drinks and other healthy foods and snacks, at locations throughout
the United States.
On July 7, 1999, the Company, through Selman, purchased all of the
outstanding common stock and warrants of Fru-Cor, Inc ("Fru-Cor"), an owner of
eight Frullati Cafe & Bakery locations in Texas, Mississippi and Louisiana. The
total amount Selman paid for Fru-Cor was $1,200,000, evidenced by a promissory
note between Selman and the former shareholders of Fru-Cor (the "Fru-Cor Note").
The Fru-Cor Note is due on May 20, 2000. The Fru-Cor Note is secured by a pledge
of all of Selman's common stock to Kenneth L. Musgrave, Ltd., Tony Condor and
Larry Pearce (the "Selman Note Holders"). The Company is currently renegotiating
the payment terms of the Fru-Cor Note with the Selman Note Holders. The Company
anticipates the term of the Fru-Cor Note will be extended to the end of fiscal
year 2000, with the Company making payments of principal and interest on a
monthly basis during such term.
Except for Surf City's voluntary Chapter 11 bankruptcy discussed above,
there have been no bankruptcy, receivership, or similar proceedings in the
Company's history.
BUSINESS OF SUBSIDIARIES: FRULLATI CAFE & BAKERY AND SURF CITY SQUEEZE
The following is a description of the business and subsidiaries that
comprise the Company's two operating divisions, Frullati Cafe & Bakery and Surf
City Squeeze.
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THE FRULLATI DIVISION
The Frullati division operates through Selman Systems, Inc. ("Selman"),
which the Company acquired in May 1999. Selman was formed in 1992, and operates
exclusively as the holding company for its six wholly owned subsidiaries:
Frullati Enterprises, Inc., Frullati, Inc., Frullati Franchise Systems, Inc.,
Frullati Systems, Inc., Boosters, Inc., and Fru-Cor. Selman and each of its
wholly owned subsidiaries, are Texas corporations in good standing.
The key operating unit of the Frullati Division is the Frullati Cafe &
Bakery Store. The Company both franchises Frullati Cafe & Bakery Stores and owns
and operates several stores for its own account. Frullati Cafe & Bakery stores
offer smoothies and other blended fruit drinks, as well as an expanded food
menu, including, salads, sandwiches and other health food items.
FRULLATI ENTERPRISES, INC.
Frullati Enterprises, Inc. was formed in 1996 to act as a holding company
for 18 company-owned Frullati Cafe & Bakery stores, some of which were
separately incorporated and subsequently merged into Frullati Enterprises, Inc.
The stores are located throughout the Eastern half of the United States.
Frullati, Inc.
Frullati, Inc was formed in 1995 to act as a holding company for 15
company-owned Frullati Cafe & Bakery stores. These stores, some of which were
separately incorporated, were subsequently merged into Frullati Inc., and are
located in the Southeastern and Midwestern portion of the United States.
Frullati Franchise Systems, Inc.
Frullati Franchise Systems, Inc. ("Frullati Franchise") was formed in 1994
to act as a franchisor of Frullati Cafe & Bakery stores to third parties and to
provide continuing training and support for its franchisees. As of December 31,
1999, Frullati Franchise had 44 franchisees operating 55 locations in 13 states
across the United States. No single franchisee owns more than three Frullati
Cafe & Bakery locations. Frullati Cafe & Bakery franchisees typically pay an
initial $30,000 franchise fee to Frullati Franchise. Franchisees also agree to
pay a continuing royalty of 6% of gross revenues on a weekly basis and a weekly
advertising fee of a 0.25% of gross revenue. Frullati Franchise can increase the
advertising fee on 90 days notice, up to a maximum of 3% of gross revenues. The
typical term of a franchisee agreement is the lesser of ten years or the term of
the commercial real estate lease on the facility to be operated as a Frullati
Cafe & Bakery location by the franchisee.
Frullati Systems, Inc.
Frullati Systems, Inc. ("Frullati Systems") was formed in 1993 to act as
the real estate development arm of Selman. In this capacity, Frullati Systems
searches for new commercial sites throughout the United States for both
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franchisees and company-owned Frullati Cafe & Bakery stores. Frullati Systems
negotiates leases for new franchise sites; contracts, oversees and manages the
build-out or improvements for these sites; and frequently serves as the tenant
under the real estate lease of the site. The typical real estate lease for a
Frullati Cafe & Bakery site is ten years.
When Frullati Systems acts as the tenant, it subleases the location to a
franchisee, but usually remains liable to the landlord for the lease
obligations. If a franchisee defaults, Frullati Systems can evict the franchisee
and take possession of the site. In addition, Frullati Franchise or Frullati
Systems has guaranteed commercial real estate leases between landlords and its
franchisees. As of December 31, 1999, Frullati Franchise Systems, Inc. or
Frullati, Inc. was a tenant under 49 commercial real estate leases, which were,
in turn, subleased to the franchisees and is a guarantor for its franchisees on
three real estate leases. In addition, Frullati Systems, Inc or affiliated
entities are liable to the landlord for the lease obligations of all
company-owned stores.
Boosters, Inc.
Boosters, Inc., dba Tovali Products Corp. ("Tovali"), was formed in 1999 to
serve as the developer and distributor of proprietary smoothie mixes and other
nutritional products and supplements that are sold to Frullati Cafe & Bakery
franchisees and company-owned stores. Tovali formulates its own proprietary
smoothie mixes and other nutritional products. Tovali outsources the
manufacturing of its products. The finished product is shipped directly to
Tovali for distribution to franchisees and licensees and then shipped to
franchisees and licenses on a C.O.D. basis.
Fru-Cor, Inc.
Fru-Cor, Inc. ("Fru-Cor") was acquired by Selman in July 1999. Fru-Cor was
formed in 1998 to act as the holding company for seven Frullati Cafe & Bakery
locations owned by unrelated third parties. These stores are all located in the
Southeastern United States. Selman currently manages and operates the Fru-Cor
locations as company-owned stores. Fru-Cor also owns all of the outstanding
shares of Texas Class, Inc., a Texas corporation, whose sole asset is a single
Frullati Cafe & Bakery location. It is the intention of the Company's management
to sell Fru-Cor's Frullati Cafe & Bakery sites to third party franchisees.
Selman Financing Activities
The Company has used the Common Stock of Selman to finance its purchase of
Selman, its purchase of Fru-Cor, and to finance certain other obligations.
Under a Pledge Agreement dated July 7, 1999, the Company pledged all of
Selman's Common Stock to the Selman Note Holders to secure the $1,200,000
promissory note given by Selman as part of the purchase price for Selman's
purchase of Fru-Cor, Inc. Fru-Cor was the owner of eight Frullati Cafe and
Bakery locations in Texas, Mississippi and Louisiana. The note is due May 20,
2000.
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In addition, the Company also pledged all of Selman's Common Stock to Ziad
S. Dalal ("Dalal") to secure its promissory note, dated May 21, 1999, to Dalal,
in the principal amount of $300,000 (the "Dalal Note"). The Dalal Note provides
for 36 monthly payments of principal and interest of $9,540 each, beginning on
February 1, 2000, and on the first of each month thereafter until the final
payment on December 31, 2002. The stock pledge between the Company and Dalal is
subordinate to the rights of the Selman Note Holders.
When the Company acquired Selman, it also agreed to remove Dalal from the
guaranty of a note to United Texas Bank in the original principal amount of
$576,000 and a note to Bank One in the original principal amount of $100,000.
The Company failed to remove Dalal timely from these guarantees and Dalal filed
suit against the Company. In early January, the Company paid the United Texas
Bank and Bank One notes in full and in February 2000 entered into a settlement
of the Dalal claims. See, LIQUIDITY AND CAPITAL RESOURCES - RISK FACTORS AND
LEGAL PROCEEDINGS.
THE SURF CITY SQUEEZE DIVISION:
The Company's Surf City Squeeze division offers primarily smoothies and
other nutritional drinks and supplements. Surf City Squeeze stores are almost
entirely operated by franchisees and offer a more limited food menu than
Frullati Cafe and Bakery, but offer a greater variety of nutritional drinks and
supplements.
Surf City Acquisition Corporation II
The Company acquired Surf City Acquisition Corporation II ("SCAC") in March
1999; SCAC owns all of the stock of Surf City. Surf City, in turn, has three
wholly owned subsidiaries: Surf City Franchising Corporation ("SCSFC"), Malibu
Smoothie Franchising Corporation ("Malibu Smoothie"), and Kona Coast Provisions,
Inc. ("Kona Coast"). SCAC, Surf City and each of its three wholly owned
subsidiaries are Arizona corporations in good standing.
SCAC is the holding company of Surf City and its subsidiaries. SCAC was
formed in 1997 to acquire all of the outstanding stock of Surf City under the
Plan of Reorganization approved by the United States Bankruptcy Court.
Surf City Squeeze, Inc.
Surf City Squeeze, Inc. ("Surf City") was formed in 1989 to operate juice
bars for its own account and to license the Surf City Squeeze juice bar concept
to third parties. The Surf City Squeeze juice bar concept seeks to take
advantage of the current interest in health food by providing the retail sale of
blended fruit drinks and healthy snacks through strategically located stores in
high traffic areas. Prior to 1995 and when existing company-owned locations were
sold pursuant to the Plan of Reorganization, Surf City granted the purchaser of
a company-owned store a license, rather than a franchise, to continue operating
the location as a Surf City Squeeze juice bar. The license charge in these
situations is included in the total sales price for the property, and the term
of the license is the lesser of ten years or the remaining term of the
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commercial real estate lease. Under a license, the licensee pays no ongoing
royalty or advertising fees to Surf City, and the support provided to the
operator, by Surf City, is likewise limited. As of December 31, 1999, Surf City
had 34 locations operated by licensees.
In early 1995, Surf City ceased its licensing activities and turned its
focus to operating company-owned Surf City Squeeze stores and franchising juice
bars through a wholly owned subsidiary.
In late 1995, after receiving financing from Weider Health & Fitness
("Weider"), Surf City initiated a rapid expansion of its company-owned stores in
prime locations throughout the United States. As part of this expansion, Surf
City secured leases for numerous retail sites, with the intention of using the
revenue from existing company-owned stores to finance further expansion. When
Weider declined to fund the remaining $ 3 million of a $6.5 million line of
credit, Surf City did not have the financial ability to open new stores for
which it previously had signed lease commitments. The convergence of Weider's
failure to fund the line of credit and the liability for store leases, forced
Surf City to file for Chapter 11 bankruptcy reorganization on January 13, 1997.
During its bankruptcy reorganization, Surf City continued to operate and
manage its business as a debtor-in-possession. Surf City emerged from bankruptcy
when SCAC purchased all of its stock pursuant to the Plan of Reorganization. The
required majority of creditors approved the Plan of Reorganization and Surf City
is now operating under the Plan of Reorganization. The Plan of Reorganization
allowed Surf City to restructure its financial obligations with creditors and
landlords, and to assume or reject the leases on its stores throughout the
United States.
As part of its Plan of Reorganization, Surf City has either closed or sold
all company-owned stores. When selling company-owned stores, as part of the
selling price, Surf City, through a wholly owned subsidiary, grants the buyer a
franchise to operate as a Surf City Squeeze location for a set period of time.
The franchise term is usually the lesser of ten years or the remaining term of
the commercial real estate lease for the Surf City Squeeze location assumed by
the new franchisee. After the sale has closed, SCSFC provides support for the
new franchisee, and receives monthly royalty payments based on the gross revenue
of the new franchisee. Surf City Squeeze Franchising Corporation.
Surf City Franchising Corporation ("SCSFC") was formed in 1995 to franchise
Surf City Squeeze stores to third parties. As of December 31, 1999, SCSFC had 64
franchisees operating 79 locations in 11 states throughout the United States and
Canada. No single franchisee owns more than four Surf City Squeeze locations.
Franchisees pay an initial $30,000 franchise fee upon entering into the
franchise agreement with SCSFC. Franchisees also pay a continuing royalty of 6%
of gross revenues on a monthly basis. SCSFC occasionally pledges the monthly
royalty payments from certain franchisees as security for various SCSFC
financial obligations. The term of a Surf City franchise agreement is the lesser
of ten years or the term of the commercial real estate lease for the facility
being operated as a Surf City Squeeze location by the franchisee.
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On July 7, 1998, SCSFC entered into a Master Franchise Agreement with
1238176 Ontario, Inc. (the "Master Franchisee"). The Master Franchise Agreement
grants the Master Franchisee the exclusive right to set-up, create, establish
and operate Master Franchisee-owned stores and to grant franchises for stores to
qualified persons in the country of Canada. Under the Master Franchise
Agreement, SCSFC receives a royalty 6% of monthly revenues for stores owned and
operated by the Master Franchisee and a reduced royalty of 2% of monthly
revenues for stores operated by third party franchisees. As of December 31,
1999, 14 stores have been opened and are operating in Canada under this Master
Franchise Agreement, with only one store owned and operated by the Master
Franchisee.
As part of its franchising business, SCSFC or Surf City commonly enter into
leases directly with the landlord for the Surf City Squeeze locations intended
to be franchised, and then sublease the location to the new franchisee.
Consequently, SCSFC or Surf City is frequently a tenant under, and thus liable
and responsible for, various real estate leases for the benefit of its
franchisees. In subleasing a Surf City Squeeze location, Surf City or SCSFC may
increase the rent to compensate for the lease risk they assume. As of December
31, 1999, SCSFC or Surf City were tenants under 70 real estate leases, which, in
turn, were sub-leased to franchisees. SCSFC or Surf City, as a sublessor, has
the right to evict a defaulting franchisee from the premises and relet the site.
SCSFC, Surf City, or other affiliates of the Company have and will likely
continue to "guarantee" real estate leases between landlords and its franchisees
and licensees. As of December 31, 1999, SCSFC or Surf City was guarantors for
its franchisee's or licensee's obligations on six real estate leases. The
typical commercial real estate lease for a Surf City location, whether SCSFC or
Surf City is the tenant or a guarantor, is five to eight years.
As of April 1998, SCSFC ceased to sell Surf City Squeeze franchises to new
franchisees and is currently restricting its operations to supporting its
existing franchisees at their respective locations. All new franchises for Surf
City Squeeze locations will be sold by Malibu Smoothie, which is discussed
below.
Malibu Smoothie Franchising Corporation
Malibu Smoothie Franchising Corporation ("Malibu Smoothie") was formed in
1998 to act as a franchisor for new Surf City Squeeze franchises and to simplify
the preparation of the franchisor's audited financial statements included in its
Uniform Franchise Offering Circular ("UFOC") during the period Surf City was
operating under the Plan of Reorganization. The franchise terms, royalties, and
treatment of the commercial real estate leases are substantially the same as
employed by SCSFC described above, except that the royalty payments are
collected from franchisees on a weekly basis.
Kona Coast Provisions, Inc.
Kona Coast Provisions, Inc. ("Kona Coast") was formed in 1994 to act as the
developer, and distributor of smoothie mixes and other nutritional products and
supplements. Kona Coast sells its proprietary nutritional products to
franchisees and licensees of Surf City Squeeze juice bars. Kona Coast outsources
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all of the manufacturing of its products, which are shipped directly from the
manufacturer to Kona Coast's warehouse in Scottsdale, Arizona. Kona Coast
receives orders for its products directly from franchisees and licensees, and
ships its product directly to them on a C.O.D. basis.
Surf City's Plan of Reorganization
Surf City is currently operating under the Plan of Reorganization approved
by the United States Bankruptcy Court and the required majority of Surf City's
creditors. As part of the Plan of Reorganization, Surf City entered into
numerous stipulations and settlements with various creditors, including
landlords, that required either cure payments and, in certain cases, payments
made to creditors over time. The terms of the general unsecured claims under the
Plan of Reorganization require minimum aggregate payments of $1,225,000.
Specifically, beginning with the calendar year 1998, Surf City is required to
pay into an unsecured creditor distribution account, on the twentieth (20th) day
of each calendar quarter and continuing for seven years thereafter, the
following amounts: (i) $43,750; (ii) twenty-five percent (25%) of the first
$50,000 of Net Cash Flow (defined in the Plan of Reorganization as the net
consolidated cash flow of Surf City and its subsidiaries based on generally
accepted accounting principles) for the preceding calendar quarter on a
cumulative basis, taking into account the $43,750 payment in (i); and (iii)
forty percent (40%) of the Net Cash Flow in excess of $50,000 for the preceding
calendar quarter on a cumulative basis (items (ii) and (iii) are collectively
referred to as the "Contingency Payments"). At this time, Surf City cannot
reasonably estimate the amount of Contingency Payments that will ultimately be
payable to the unsecured creditor distribution account because of uncertainties
in the ability of Surf City and its subsidiaries to generate Net Cash Flow and
the Company's inability to estimate the timing of any such Net Cash Flow if it
does occur. As of December 31, 1999, Surf City has not made any Contingency
Payments to the unsecured creditors pool.
Under the Plan of Reorganization, beginning February 1, 1998, and
continuing for seven years thereafter, the salaries of certain Surf City
executives are limited to $100,000 each per calendar year, plus a percentage of
Net Cash Flow. The Plan of Reorganization defines "Executive Salaries" as all
cash received by executives from Surf City, Kona Coast, and SCSFC, in the form
of salaries, exclusive of health, dental, life, disability, and similar
benefits. The percentage of Net Cash Flow available for Executive Salaries is
determined and paid on a quarterly basis, as follows: (i) seventy-five percent
(75%) of the first $50,000 of the Net Cash Flow for the preceding calendar
quarter; and (ii) thereafter, forty percent (40%) of the Net Cash Flow in excess
of $50,000 for the preceding calendar quarter. Net Cash Flow is defined as the
net consolidated cash flow of Surf City and its subsidiaries, based upon
generally accepted accounting principles. The Plan of Reorganization defines
"Executives" as Kevin Blackwell, President of Surf City, and David Guarino,
Chief Financial Officer of Surf City, or their respective successors. The Plan
of Reorganization does not restrict the payment of compensation by Sports Group
International, Inc. or any of the Company's Frullati subsidiaries.
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Surf City is current with all payments due under the Plan of Reorganization
and is in substantial compliance with the Plan of Reorganization terms, except
as discussed further below and for certain creditors of Surf City who were
awarded claims under the Plan of Reorganization, but who have not yet demanded
the payment of those claims. All of these amounts are reflected on Surf City's
financial statements as current liabilities. It is Surf City's intention to
reflect these liabilities in its financial statements until the creditor demands
payment from Surf City (at which time the payment would be made) or the closing
of the Plan of Reorganization, estimated for late 2004.
MARKETING:
In franchising its stores, the Company seeks locations that are heavily
trafficked which are likely to produce customers for the Company's healthy food
products, for example, airports, shopping malls, health clubs and hospitals. The
Company prefers to locate its stores on corners, in kiosks or in other highly
visible areas. The Company's stores are built so that its primary products are
displayed with large backlit or front-lit pictures.
The Company does not engage in any general media or print advertising for
either its company-owned or its franchised or licensed stores. However,
individual franchisees and licensees use a wide variety of advertising and
marketing techniques, including coupons, frequent customer discounts and
hand-distributed flyers to promote individual locations.
The Company is not currently advertising for new prospective franchisees
for either of its divisions, nor does the Company currently engage outsider
brokers or intermediaries to locate prospective franchisees.
COMPETITION AND THE COMPANY'S POSITION IN THE INDUSTRY:
The business of operating and franchising juice bars serving blended drinks
and healthy food cafes is highly competitive and fragmented. Other operators of
juice bars and healthy food cafes compete for market share on a multitude of
factors, the primary ones of which include strategic retail store locations and
the variety and breadth of products offered. Management believes that the
Company's largest competitor is Jamba Juice. Jamba Juice has approximately the
same number of outlets as the Company; however, Jamba Juice's outlets are
primarily located in strip centers and street locations. Consequently, the
Company believes its store locations provide access to a more diverse and
concentrated traffic flow of potential customers than do Jamba Juice's strip
centers and street locations. There are also numerous smaller chains of juice
bars serving blended drinks and health food cafes throughout the United States
that operate in both strip centers and street locations and specialty locations
within airports and shopping malls. The Company's competitive strategy includes
offering what the Company believes is a better tasting, blended fruit drink,
offering healthy food and snacks that utilize fresh ingredients, and locating
its stores in high density traffic flow specialty retail locations that are
convenient for the customer.
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SOURCES AND AVAILABILITY OF RAW MATERIALS & PRINCIPAL SUPPLIERS:
Kona Coast and Tovali both use multiple manufacturers and suppliers to
produce their smoothie mixes, nutritional products and supplements. Neither
entity has experienced difficulty finding sources for its raw ingredients.
Additionally, neither Kona Coast nor Tovali are dependent upon any one
manufacturer or supplier.
The Company uses various food service distribution companies to supply
fruit, bakery products, other food supplies, and cleaning products to its
franchisees, licensee, and company-owned stores. The Company has not experienced
any difficulties finding available sources for these products. The Company also
periodically solicits bid requests for its food service programs to ensure the
best prices, service, and selection for its outlets.
INTELLECTUAL PROPERTY AND AGREEMENTS:
The Company holds no patents or copyrights, and the Company does not
copyright its recipes for the proprietary smoothie mixes and other supplements
manufactured and distributed by Kona Coast and Tovali. The Company protects its
recipes through trade secret agreements and internal security measures, which
management believes are adequate.
The Company has registered numerous service marks and has applied for the
registration of various service marks with the United States Patent and
Trademark Office. The following table summarizes the status of the Company's
service marks:
Registration No. Service Mark Description Registration Date
74/679438 Surf City Squeeze
Name & Design March 12, 1996
2,255,749 Frullati Cafe & Bakery June 22, 1999
1,731,865 Frullati Name November 10, 1992
1,731.867 Frullati Name & All
Natural Design November 10, 1992
1,989,162 Frullati Cafe and Design July 23, 1996
75/455272 Malibu Smoothie Name Pending (filed March 2, 1998)
75/462365 Malibu Smoothie Mark and Logo Pending (filed March 2, 1998)
The Company is currently in the process of registering each of these
service marks in Canada.
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FRANCHISE AGREEMENTS:
The Company has approximately 134 franchise agreements currently in effect
providing for royalties on both a weekly and monthly basis. Of these, four
franchise agreements are currently in default. The remaining franchise
agreements are currently in full force and effect, and to the Company's
knowledge, are not in default. Additionally, Surf City has 34 license agreements
in effect with third party purchasers of former company-owned Surf City Squeeze
locations. One license agreement is currently in default. To the Company's
knowledge, the remaining license agreements are currently in full force and
effect.
GOVERNMENTAL APPROVALS OR REGULATIONS:
Except for complying with state and federal franchising regulations and
with state and local ordinances governing land use and the health and safety of
food service operations, the Company's principal products of fruit smoothie
drinks and other healthy foods and supplements are not subject to governmental
approval, nor does management know of any existing or proposed regulations of
its business that could have a material effect on its operations.
The Company's primary business is the sale of franchises. Accordingly, the
Company is required to comply with state and federal laws governing the sale of
franchises. The Company prepares, updates and distributes to its franchisees a
Uniform Franchising Circular, which complies with applicable state and federal
law.
The Company's corporate-owned stores and the stores of its franchisees are
subject to federal, state and local health regulation. The most material
governmental regulations the Company is subject to are local health department
requirements and regulations. The Company's operations are not directly
regulated by the FDA, but the manufacturers and suppliers of its food products
may be subject to FDA regulations.
The Company has not been involved in any judicial or regulatory proceedings
involving any alleged violation of environmental laws, and, to the best of
management's knowledge, the Company believes it is in compliance with all
applicable environmental laws.
INSURANCE:
The Company and its subsidiaries maintain general liability and workers
compensation insurance at levels which management believes are adequate.
Additionally, all franchised and licensed Frullati and Surf City locations where
a subsidiary of the Company is either the tenant or a guarantor of the
commercial real estate lease for the location, maintain individual policies of
general liability coverage in accordance with the requirements of the applicable
real estate lease.
RESEARCH & DEVELOPMENT:
All of the Company's research and development activities are performed by
Kona Coast and Tovali. These research and development activities are focused
primarily on the development of new nutritional products recipes and include the
development of improved fructose and Nutrasweet-based smoothie mixes; vitamin
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fortified smoothie mixes; shelf-stable smoothie mix (liquid) available for
grocery store distribution; frozen (liquid) smoothie mix for institutional use;
and pre-flavored smoothie mixes sold in individual packets for home use. The
Company's expenses relating to these research and development activities are
insignificant.
EMPLOYEES:
As of December 31, 1999, the Company had a total of 74 full-time employees
and 157 part-time employees. Neither the Company nor any of its subsidiaries is
a party to any labor contracts with their employees.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED HEREIN, THE DISCUSSION
IN THIS FORM 10-SB CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS,
ASSUMPTION AND UNCERTAINTIES, WHICH ARE DIFFICULT TO PREDICT. WORDS SUCH AS
"BELIEVE," "MAY," "COULD," "EXPECT," "LIKELY," AND VARIATIONS OF THESE
WORDS, AND SIMILAR EXPRESSIONS, ARE INTENDED TO IDENTIFY SUCH
FORWARD-LOOKING STATEMENTS. THE COMPANY'S ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THOSE DISCUSSED HEREIN. FACTORS THAT COULD CAUSE OR
CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE
DISCUSSED IN THE SECTIONS ENTITLED "MANAGEMENT DISCUSSION AND ANALYSIS,"
"RISK FACTORS," AS WELL AS THOSE DISCUSSED IN THIS PART AND ELSEWHERE IN
THIS FORM 10-SB.
MANAGEMENT DISCUSSION AND ANALYSIS
The Company's audited consolidated financial statements as of December 31,
1999, include the accounts and results of operations of the Company and its
wholly owned subsidiaries for the twelve months then ended. The results of
operations include that of Selman and Fru-Cor, respectively, for the period May
21, 1999, and July 7, 1999 (the dates for the Company's acquisition of Selman
and Fru-Cor) through December 31, 1999, respectively. The Company's acquisition
of SCAC was effected through an exchange of Common Stock and Preferred Stock,
which resulted in 100% of the Common stock of SCAC being held by the Company and
the existing shareholders of SCAC owning approximately 69% of the Company's
issued and outstanding shares. For financial accounting purposes, the
acquisition was a reverse merger and was treated as a recapitalization with SCAC
as the acquirer.
The Company is the holding company for its operating subsidiaries. The
results of operations are dependent upon the sales volumes at both company-owned
and franchised stores. The Company earns royalties based on a percentage of the
revenues of the franchised operations. It also earns revenue from direct sales
at the company-owned stores and from sales of proprietary products to
franchisees. The Company also earns franchise fees through the sale of new
franchised stores.
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The Company is subject to seasonality in its business. Volume is generally
higher from the middle of spring through the summer and again in December. These
variances in volume can be attributed to the increased volume in shopping malls
and airports where a majority of the Company's stores are located.
The Company has closed the administrative offices of Selman and Fru-Cor,
which it acquired in 1999. The Company may sell certain company-owned locations,
as it deems appropriate, in order to focus on franchising. The Company also
intends to seek additional acquisitions that provide operating synergies
compatible with its current operations. The Company will attempt to implement
certain cost reductions through bulk buying of its raw materials and managing
store locations in certain geographic clusters.
The success of the stores is dependent upon the selection of appropriate
store sites. The Company evaluates numerous criteria when selecting store sites.
However, even after careful analysis, there can be no assurances that a store
location will be successful.
The Company is named as the lessee on the majority of its store locations.
The Company then subleases the store to the franchisee, typically for a rental
amount commensurate with the amount of its rent to the lessor. The Company is
subject to ongoing commitments without sublease rentals if a store location is
not successful.
The Company has continuing obligations under Surf City's Plan of
Reorganization. See BUSINESS DEVELOPMENT AND CORPORATE STRUCTURE - SURF CITY'S
PLAN OF REORGANIZATION, above. Repayment of these obligations will require the
Company to carefully manage its growth and monitor its profitability.
The Company's plan of operation for the next 12 months is to continue to
expand the development of franchised stores under the "Surf City Squeeze" and
"Frulatti Cafe" names and to develop master franchise arrangements with
financially sound franchisees in selected areas of the United States and in
selected international markets.
RESULTS OF OPERATIONS: 1999 TO 1998
Comparison of historical operating results is presented on a pro forma
basis because of the significance of the acquisitions of Selman and Fru-Cor.
There were no significant operations in Sports Group International, Inc. prior
to its merger with SCAC. The Sports Group International, Inc. and SCAC
transaction was accounted for as a recapitalization of SCAC, with SCAC as the
acquirer.
Consolidated revenues for the twelve months ended December 31, 1999, were
$10,213,469. Revenues on a pro forma basis for the twelve months ended December
31, 1999, were $16,099,672, assuming the acquisitions of Selman and Fru-Cor had
occurred at the beginning of the year. For the year ended December 31, 1998,
revenues on a combined basis were $16,947,000; and revenues on a pro forma basis
for the year ended December 31, 1998, assuming the acquisitions of Selman and
Fru-Cor had occurred at January 1, 1998, would have been $16,805,000 The change
in revenue between 1999 and 1998 is due to the Company's 1999 revenue including
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that of SCAC for the entire period, and Selman Systems and Fru-Cor from their
respective dates of acquisition; the Company's 1998 revenues are those of SCAC
only. The decrease on a pro forma basis is mainly attributable to the reduction
in company owned stores. The Company sold 12 Frullati stores after the
acquisition of Selman and Fru-Cor.
The Company's consolidated operating loss decreased to $4,674 for the
twelve months ended December 31, 1999, from an operating loss of $434,000 on a
combined basis for the year ended December 31, 1998. Operating loss on a pro
forma basis for the twelve months ended December 31, 1999, was $82,882, assuming
that the acquisitions of Selman and Fru-Cor had occurred at the beginning of
1999. On a pro forma basis for the year ended December 31, 1998, assuming the
acquisitions of Selman and Fru-Cor occurred at January 1, 1998, the Company
would have had an operating loss of $370,684. On a pro forma basis, the
Company's operating loss was less in 1999 due to reductions in rent and overhead
items resulting from the consolidation of the administrative functions of Surf
City, Selman and Fru-Cor.
Cost of product sales remained constant at approximately 32% of product
sales on a pro forma basis, for the twelve months ended December 31, 1999,
compared to the year ended December 31, 1998.
Personnel costs were $3,191,415 for the twelve months ended December 31,
1999, compared to $5,081,000 on a combined basis for the year ended December 31,
1998. Personnel costs on a pro forma basis for the twelve months ended December
31, 1999, were $5,158,519, assuming the acquisitions of Selman and Fru-Cor had
occurred at the beginning of the year. Personnel costs were slightly higher on a
pro forma basis because of some duplicative functions prior to the combination
of the administrative activities.
General and administrative expenses were $1,722,913 for the twelve months
ended December 31, 1999, compared to $3,446,000 on a combined basis for the year
ended December 31, 1998. General and administrative expense, on a pro forma
basis for the twelve months ended December 31, 1999, was $2,146,100, assuming
the acquisitions of Selman and Fru-Cor had occurred at the beginning of 1999.
General and administrative expenses, on a pro forma basis for the year ended
December 31, 1998, assuming the acquisitions of Selman and Fru-Cor had occurred
at January 1, 1998, would have been $3,445,000. Overall, general and
administrative expenses have decreased for the twelve months ended December 31,
1999, due to expense reductions related to the consolidation of operations of
Selman, Fru-Cor and Surf City. The Company has experienced an increase in
professional fees for the twelve months ended December 31, 1999 due to its
mergers and acquisitions and legal proceedings.
Interest expense was $258,336 for the twelve months ended December 31,
1999, compared to $252,000 on a combined basis for the year ended December 31,
1998. Interest expense on a pro forma basis for the twelve months ended December
31, 1999 was $374,755, assuming the acquisitions of Selman and Fru-Cor had
occurred at the beginning of 1999. Interest expense, on a pro forma basis for
the year ended December 31, 1998, assuming the acquisition of Selman and Fru-Cor
had occurred at January 1, 1998, would have been $387,202. The increase in
interest expense is due to the additional borrowings of $322,500 from the holder
of the Company's Series B Preferred Stock and the $1,200,000 indebtedness the
Company incurred to purchase Fru-Cor. See FRULLATI CAFE & BAKERY - SELMAN
FINANCING ACTIVITIES.
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RESULTS OF OPERATION: 1998 TO 1997
The following discusses matters related to the results of operations of
SCAC taking into consideration material variances in the 1998 amounts compared
to the 1997 amounts.
Revenues for the year ended December 31, 1998, were $2,668,000 compared to
$3,316,000 for the year ended December 31, 1997, a decrease of approximately
$648,000 or 19.54%. The largest component of that decrease was the $656,000
decrease in product sales. As SCAC was restructuring through the bankruptcy in
1997, it was selling or converting and closing company-owned stores. There were
no Surf City company-owned stores at December 31, 1998, compared to six stores
at December 31, 1997. "Net product sales" included revenue generated from
company-owned stores. Franchise fees and royalties increased to $1,205,000 for
the year ended December 31, 1998, compared to $977,000 for the year ended
December 31, 1997. The increase is primarily due to the converting of several
company-owned stores to franchised stores. Also, as Surf City emerged from its
bankruptcy in early 1998, it became more active in selling new franchises.
The cost of product sales for the year ended December 31, 1998, was
approximately 42% of product sales compared to approximately 30% for the year
ended December 31, 1997. The increase in margin was due to the change in mix of
revenue. The 1997 margin includes material revenues generated as company-owned
stores which produce margins lower than those revenue amount from
non-company-owned stores. Prospectively, the margins on Surf City product sales
should more likely approximate the 1998 margins rather than those in 1997,
because there are no longer any Surf City company-owned stores.
Store operating costs were $164,000 for the year ended December 31, 1998,
compared to $373,000 for the year ended December 31, 1997, a decrease of
$209,000, or 56.03%. Store operating costs includes numerous expense categories
including maintenance, utilities, and the like. The primary reason for the
decrease is the elimination in company-owned stores during 1998.
Personnel costs were $721,000 for the year ended December 31, 1998,
compared to $1,199,000 for the year ended December 31, 1997, a decrease of
$478,000. Personnel costs decreased due to the reduction in the company-owned
stores. The elimination of front-line employees, store managers and regional
managers significantly reduced payroll. Also, certain office personnel were
terminated when Surf City restructured as it emerged from bankruptcy.
Rent expense was $655,000 for the year ended December 31, 1998, compared to
$929,000 for the year ended December 31, 1997, a decrease of $274,000 or 29.49%.
The decrease in rent expense is primarily due to the reduction in the
company-owned stores. Surf City also rejected numerous leases in its bankruptcy
plan.
General and administrative expenses were $495,000 for the year ended
December 31, 1998, compared to $662,000 for the year ended December 31, 1997, a
decrease of $167,000 or 25.23%. The decrease is due primarily to SCAC's
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reduction in numerous expense categories in 1998, including marketing, travel
and professional fees.
Interest expense was $177,000 for the year ended December 31, 1998,
compared to $76,000 for the year ended December 31, 1997, an increase of
$101,000 or 132.89%. The increase is due to the terms of debt confirmed in the
bankruptcy plan in January, 1998. Interest was imputed on scheduled repayment
terms for much of the bankruptcy liabilities.
Other income in the year ended December 31, 1998, primarily consists of a
gain of $98,000 on the sale of a store.
Reorganization items of $1,180,000 in the year ended December 31, 1997,
consist of impairment write-offs and professional fees associated with the
bankruptcy. These expenses are nonrecurring.
LIQUIDITY AND CAPITAL RESOURCES
The Company anticipates that it will have sufficient liquidity to sustain
its operations over the next 12 months. In early January 2000, the Company
obtained the $1,000,000 credit facility described below. The Company has drawn
the full amount of the $1,000,000 credit facility to satisfy current
obligations. The Company is currently evaluating offers to sell certain
company-owned stores to raise additional cash for operating and financing
purposes.
The Company historically has had a working capital deficiency. The Company
believes that many companies in its industry operate with working capital
deficiencies. The Company had a net working capital deficit of $3,576,461 at
December 31, 1999, compared to a deficiency on a pro forma basis of $1,827,000
at December 31, 1998. The Company has borrowed $322,500 from the holder of its
Series B Preferred Stock, and borrowed $1,200,000 under a promissory note
related to the Company's acquisition of Fru-Cor; these amounts are reflected in
the Company's December 31, 1999 balance sheet as current liabilities.
In January 2000, the Company obtained a $1,000,000 line of credit from a
bank. The credit facility bears interest at the Federal Funds Rate, plus 0.42%
per annum (5.17% at December 31, 1999), is due and payable January 31, 2004, and
was guaranteed by the Company's largest shareholder, the REM Petersen Living
Trust (the "Petersen Trust"). Mr. Kevin Blackwell and Mr. David Guarino,
officers, directors and major shareholders at the Company, also personally
guaranteed the credit facility. As compensation for the Petersen Trusts'
guaranty of the credit facility, the Company agreed to reduce the exercise price
of the Petersen Trust's warrant to purchase 1,000,000 shares of Common Stock
from $2.00 per share to $0.40 per share. Mr. Blackwell and Mr. Guarino received
no additional compensation for their guarantees. See, CERTAIN RELATIONSHIPS AND
TRANSACTIONS, below.
As of February, the Company also entered into a settlement agreement that
restructured the $300,000 Dalal Note to provide for 36 monthly payments of
$9,540 per month and paid in full the balance of all loans due United Texas Bank
and Bank One (a total principal amount of $546,000) with funds received from the
Company's $1,000,000 credit facility. See LEGAL PROCEEDINGS, below. The Company
is currently renegotiating the payment terms of the Fru-Cor Note with the Selman
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Note Holders. The Company anticipates the term of the Fru-Cor Note will be
extended to the end of fiscal year 2000, with the Company making payments of
principal and interest on a monthly basis during such term. The Company
anticipates the proceeds from sales of company owned stores discussed below will
be sufficient to meet the repayment obligations under these notes.
To enhance its liquidity, the Company intends to sell certain company-owned
stores that do not fit its current business plan. The Company is uncertain over
the longer term about the number of company-owned stores it will continue to
operate. Sales prices for the company-owned stores are expected to range from
$100,000 to $1,500,000 per store, depending on the sales volume and
profitability of each store. If successful, cash raised from the sale of these
stores will be used to pay the Fru-Cor Note. The Company believes that if it is
able to sell company-owned store locations that are not part of its business
plan, its working capital position will be improved. The Company may sell from
ten to 15 company-owned locations over the next year. The Company does not
consider the strategy of selling certain stores as a down-sizing. Rather it
believes that it is selecting and keeping the locations that best suit its
business plan and allow it to expand future operations. The Company will retain
the franchise rights and the related royalty revenue stream on any of the stores
it may sell. A preliminary plan to sell stores has been approved by the
Company's Board of Directors. If the Company is not successful in selling the
stores planned for liquidation, it would be required to seek additional funds
from other sources. See, RISK FACTORS, below.
The Company has not experienced material losses on trade receivables from
its customers who are primarily franchisees. Notes receivable principally result
from the financing of the initial franchise fees required from franchisees and
the sale of company-owned stores. The notes are generally guaranteed by the
franchisee or purchaser and are collateralized by the related juice bar business
and related equipment and leasehold improvements. The Company intends to
eliminate this practice and thereby reduce its requirement for capital to carry
these notes. The Company does not believe that this change in practice will
adversely affect the volume of new franchises it seeks to sell. The Company has
experienced credit losses under notes receivable and has generally foreclosed on
the related stores and attempted to re-franchise those locations. If the Company
is able to expand through the franchising of new stores, as it will seek to do,
cash will be required for lease deposits and leasehold improvements. Much of
this cash requirement should be provided directly by the new franchisee.
The Company does not anticipate the need for significant capital
expenditures in the near future. However, if certain prospective store locations
would be better as company-owned stores rather than franchised locations, the
Company may require significant capital to build and open those prospective
stores.
The Company's trade accounts payable decreased to $952,455 at December 31,
1999, compared to $1,115,000 on a pro forma basis at December 31, 1998. The
decrease is due primarily to the reduction in the number of company owned stores
at the end of 1999.
Accrued liabilities increased to $1,054,074 at December 31, 1999, compared
to $510,000 on a pro forma basis at December 31, 1998. The increase is
attributable to higher professional fees and accrued expenses related to certain
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legal proceedings. See LEGAL PROCEEDINGS, below. Components of the accrued
liabilities include deferred rent, accrued interest and accrued payroll.
Inventories decreased to $118,908 at December 31, 1999, compared to
$210,000 on a pro forma basis at December 31, 1998. The decrease is due
primarily to the reduction in the number of company owned stores at the end of
1999.
The Company continues to reduce the confirmed bankruptcy liabilities of
Surf City. Surf City's bankruptcy liabilities decreased to $1,427,444 at
December 31, 1999, from $1,900,000 at December 31, 1998. The Company believes
that it will be able to generate adequate cash flow from operations to meet the
bankruptcy obligations on a timely basis. The Company must manage Surf City's
operations to produce operating cash flows that are sufficient to pay the
bankruptcy liabilities. The Company's strategy is to reduce Surf City costs and
enhance collection of franchise royalties. The Company intends to analyze the
effect of all opportunities for new Surf City store locations and prospective
Surf City acquisitions to ensure such transactions do not adversely affect
operating cash flows. Although the Company believes it will meet its bankruptcy
obligations on a timely basis, if it does not, creditors could petition the
Bankruptcy Court to reopen the Plan of Reorganization for modification. Such an
event could adversely affect the Company's ability to attract new investment and
meet its growth plan. See LIQUIDITY AND CAPITAL RESOURCES--RISK FACTORS, below.
The Company has an annual Preferred Stock dividend obligation of
$1,225,000. During the twelve months ended December 31, 1999, the Company paid
its dividend obligation through the issuance of Common Stock. Because the
holders of the Preferred Stock are significant owners of the Company, it is
anticipated that the holders will continue to elect to take Common Stock as the
dividend payment or that the Preferred Stock will be converted to Common Stock.
If holders of Preferred Stock should demand that dividends be paid in cash, the
Company's liquidity could be adversely affected.
The Company believes that it can effectively implement its growth plans for
the current fiscal year's operations with the $1,000,000 credit facility
discussed above. Nevertheless, the Company is seeking additional debt or equity
financing from various sources, including investment banks and private
investors, to fund future expansion and for potential future acquisitions.
The Company must also be successful in selling certain Frulatti store
locations to pay the Fru-Cor Note and may be required to apply a portion of the
cash realized from the sale of company-owned stores to meet other obligations.
The Company may also require additional capital to continue expanding sales
volume, which would require higher levels of inventory, accounts receivable, and
greater operating expenses for marketing. There can be no assurances that the
Company will be successful in obtaining such capital.
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YEAR 2000
The Company has assessed its computerized systems to determine their
ability to correctly identify the year 2000 and is devoting the internal and
external resources to replace, upgrade or modify all significant systems related
to the year 2000. The Company's assessment, purchase of new equipment,
installation of new software, conversion and testing of data are substantially
completed. The Company has not encountered significant internal year 2000
problems, because most of the Company's critical records are manually
maintained.
The Company does not anticipate difficulties with vendors relative to the
year 2000 issue. The Company's relationship with its vendors is such that it is
not materially dependent upon their information technology systems.
The Company believes that any year 2000 impact on its franchisee base
should have no material effect on the Company because sales information is not
currently communicated through computer systems. Through the assessment of the
Company's non-information technology systems, management has determined that no
modifications are required for year 2000 compliance in this area.
RISK FACTORS:
There are a number of factors over which the Company has little or no
control that may adversely affect the Company's operating results. The price and
availability of the raw materials used in the Company's stores, particularly
frozen fruits and supplements, are governed by economic factors over which the
Company has little or no control. The Company's ability to both find and enter
into favorable leases in prime retail locations throughout the United States
could adversely affect the Company's ability to grow and attract new
franchisees. The growth of the Internet and its use by consumers for shopping as
an alternative to visiting local malls and retail centers could result in a
decrease in mall traffic, which in turn could lead to a decrease in the
Company's sales in stores located in shopping malls. A decline in the popularity
of blended fruit drinks and healthy snacks could also adversely affect the
companies' financial performance.
Because the Company's franchising strategy requires that it lease franchise
sites and sublease those sites to franchisees or guarantee franchisees' leases,
the Company has significant liabilities to various landlords, if franchisees
should default under their lease agreements. By subleasing to franchisees, the
Company assumes a lease risk, but ensures that it continues to control the
franchise premise in the event of default by the franchisee. Defaults by
franchisees under subleases from the Company would require the Company to pay
the lease obligations and seek a new franchisee for the location.
The Company's future growth plans contemplate the acquisition of juice bars
and health food cafe operations. The Company's ability to execute this plan is
dependent on the availability of cost-effective financing to make the
acquisitions. The current availability of financing, through either third party
sources or the issuance of the Company's Common Stock, is uncertain, and Surf
City Squeeze's prior bankruptcy or the Company's failure to achieve current
profitability, could adversely affect its ability to obtain such financing.
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If the Company's plans for growth through the acquisition of other health
food operations are successful, the Company will also need to attract and retain
qualified individuals to manage that growth, and the Company's performance could
be adversely affected if it is unable to attract and retain such managerial
talent.
The Company also faces competition from other juice and health food vendors
and franchisors throughout the United States, including subsidiaries of other
national successful retail businesses. The Company's ability to continue to
attract capital and qualified franchisees, and find favorable retail locations
and qualified management personnel will be affected by competitors seeking these
same resources. The healthy food and snack business is also highly fragmented
and competitive.
Surf City is currently operating under a Plan of Reorganization
administered by the United States Bankruptcy Court for the District of Arizona.
Under the Plan of Reorganization and related settlement agreements with
creditors, Surf City is obligated to make periodic payments to creditors. If
Surf City should fail to make those payments, then the Company may loan Surf
City the funds to enable it to make those payments, although the Company is not
obligated to do so. Additionally, creditors or other parties subject to the Plan
of Reorganization could petition the Bankruptcy Court to reopen the Plan of
Reorganization for modification, if Surf City does not substantially perform
under the terms of the Plan of Reorganization. The specific terms of the Plan of
Reorganization could also hinder the Company's ability to grow and attract
capital.
The Company has pledged the common stock of Selman to secure amounts owed
by the Company to the Selman Note Holders and the holder of the Dalal Note. See,
BUSINESS AND DEVELOPMENT OF CORPORATE STRUCTURES - SELMAN FINANCING ACTIVITIES,
ABOVE. These obligations total $1,500,000. The Company has repaid in full the
$450,000 balance due United Texas Bank and the $96,000 balance due Bank One for
loans to Selman and has restructured the $300,000 Dalal Note to provide for 36
monthly payments, each in the amount of $9,540. The balance of the debt,
$1,200,000, is Fru-Cor acquisition debt for the Company's purchase of eight
Frullati locations. To pay these remaining obligations, the Company obtained a
credit facility of $1,000,000 in early January 2000 which is fully drawn and, in
addition, plans to sell Company-owned stores or obtain new franchisees, or both.
See LIQUIDITY AND CAPITAL RESOURCES, above. If for any reason the Company should
be unable to repay these remaining obligations , the Company could lose
ownership of the Frullati Cafe & Bakery stores it acquired through its purchase
of Selman and Fru-Cor. If a default on both the Fru-Cor Note or the Dalal Note
should occur, it could result, among other things, in the loss of stores, in
material write-offs of assets, including goodwill of approximately $55,000 and
other intangible assets of approximately $164,000. These write-offs, to the
extent they exceed any debt forgiveness, could result in adverse changes to the
Company's results of operations for future years. Further, default under these
notes could expose the Company to litigation and related liabilities.
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ITEM 3. DESCRIPTION OF PROPERTY
The Company owns no real property. Locations for all of the Company's
franchised, licensed or company-owned Surf City Squeeze or Frullati Cafe &
Bakery stores are leased from independent third parties. The information set
forth below is as of December 31, 1999.
RETAIL OPERATIONS:
Frullati Cafe & Bakery stores are either owned and operated by independent
franchisees or owned and operated directly by the Company through its
subsidiaries. Franchisees pay an initial franchise fee of $30,000, plus weekly
royalty and advertising fees to the Company of 6% and .25% of gross revenue,
respectively. The advertising fee can be increased up to a maximum of 3%.
Franchisees receive ongoing training and support from the Company. The term of a
franchise is the lesser of ten years or the remaining term of the commercial
real estate lease for the locations.
For Surf City Squeeze juice bars, the Company structures its operations
primarily in two ways. The retail outlets are either owned and operated by
independent franchisees or owned and operated by independent licensees.
Franchisees pay the Company a one-time franchise fee of $30,000, plus a royalty
fee of 6% of gross revenue on a monthly or weekly basis. Licensees pay a
one-time license fee to operate a Surf City Squeeze juice bar; this fee is
usually part of the total purchase price of an existing store. After payment of
the license fee, the licensees have no additional financial obligation to the
Company. For both franchisees and licensees, the term of the franchise or
license is the lesser of ten years or the remaining term of the commercial real
estate lease for the juice bar locations.
As of December 31, 1999, approximately 64% of the Company's worldwide units
were operated by franchisees, approximately 16% were operated by licensees, and
approximately 20% were owned and operated by the Company. The Company is in the
process of selling some of the Frullati Cafe & Bakery stores owned by the
Company through franchise agreements.
The Company's retail outlets, described by ownership type, as of December
31, 1999, are summarized below:
Company
Franchised Licensed Owned Total
---------- -------- ----- -----
Surf City Squeeze Juice Bar 79 34 -- 113
Frullati Cafe & Bakery 55 17 24 96
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Geographical Distribution of the Company's Retail Outlets as of December
31, 1999:
Surf City Frullati Cafe
Squeeze & Bakery
------- --------
Arizona 7 --
Arkansas -- 3
California 61 --
Colorado 1 --
Connecticut 2 --
Florida 1 8
Idaho 1 --
Illinois 8 14
Indiana -- 4
Kentucky -- 1
Louisiana -- 6
Michigan 5 2
Minnesota -- 3
Mississippi -- 1
Missouri -- 4
New Mexico -- 1
New York 2 --
North Carolina -- 1
Ohio 2 5
Oklahoma -- 2
Pennsylvania 2 --
Tennessee -- 2
Texas -- 37
Virginia 2 2
Washington 5 --
Canada 14 --
--- ---
Totals 113 96
Of the Company's 24 Frullati Cafe & Bakery stores that are company-owned,
24, or 13% of the Company's total outlets, operate under commercial real estate
leases under which Selman, or one of its wholly owned subsidiaries, is the
tenant. Of the Company's 55 Frullati Cafe and Bakery franchised outlets, 49, or
24% of the Company's total outlets, are operated under commercial real estate
leases with third party landlords under which Selman (or one of its wholly-owned
subsidiaries) is the tenant and the franchisee is the sub-tenant. Of the
remaining five franchised Frullati Cafe and Bakery outlets, Selman, or one of
its wholly owned subsidiaries, is a guarantor of three of the commercial real
estate leases between the third party landlord and a Selman franchisee.
Of the Company's 113 Surf City Squeeze locations, 70, or 34% of the
Company's total outlets, operate under commercial real estate leases under which
either Surf City or SCSFC is the tenant and the franchisee is a sub-tenant. Surf
City is a guarantor of six commercial real estate leases, or 3% of the Company's
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total retail outlets, between the franchisee or licensee and the landlord. Of
the remaining 37 Surf City Squeeze locations, the Company is not a party to the
commercial lease.
Of the Company's 209 total outlets, 21, or 10% are operated in retail space
leased from the Simon Group and its related entities; 22, or 11%, are operated
in retail space leased from the Taubman Companies and its related entities; 16,
or 8%, are operated in space leased from the Bally Total Fitness Corporation;
and 15, or 7%, are operated in space leased from 24-hour Fitness Corporation.
COMMERCIAL OFFICE SPACE AND WAREHOUSING:
SCSFC currently leases 2,794 square feet of commercial office space in a
building located at 7730 E. Greenway Road, Suite 203, Scottsdale, Arizona 85260,
which serves as the Company's corporate headquarters. The modified gross rent is
$5,133.98 per month. The lease expires on August 31, 2000, and the Company
intends to relocate its corporate offices at that time to a new, larger facility
in Scottsdale, Arizona, which has not yet been identified.
The Company's Kona Coast subsidiary currently leases 2,997 square feet of
commercial office and warehouse space located at 8350 East Evans Road, Suite
D-1, Scottsdale, Arizona 85260. The triple net rent is $2,466.83 per month. The
current lease expires on December 31, 1999. Kevin Blackwell and his wife,
Kathryn Blackwell (the "Blackwells") renewed this lease on April 23, 1999, in
their own name for an additional two years, thereby extending the lease term to
December 31, 2001. Under the extension, Kona Coast will pay the rent directly to
the landlord, with the Blackwells receiving no compensation or additional
consideration for serving as tenants under the lease.
The Blackwells currently lease 2,225 square feet of warehouse and storage
space located at 7626 E. Greenway Road, Suite 102, Scottsdale, Arizona, 85260.
Under an agreement with the Blackwells, Kona Coast sublets this facility from
the Blackwells for storage and distribution of smoothie mixes and other
nutritional supplements. The monthly rent is $1,869, and it is paid directly by
Kona Coast to the landlord with the Blackwells receiving no compensation or
additional consideration for serving as tenants under the lease. The lease
expires on January 31, 2000. When the lease expires, the Company intends to
renew a portion of the leased space in the name of Kona Coast, for an additional
six month term.
Frullati, Inc. leased 4,409 square feet of commercial office space located
at 5720 LBJ Freeway, Suite 370, Dallas, Texas 75240, which served as the
corporate headquarters for Selman Systems, Inc. The monthly triple net rent was
$5,445.11. The lease expired on November 30, 1999. The Company has vacated these
premises and consolidated the Selman Systems, Inc. corporate offices with the
Company's corporate headquarters in Scottsdale, Arizona.
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ITEM 4. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth each person known by the Company to be the
beneficial owner of more than 5% of the Common Stock of the Company, assuming
the Company's Series A and B Preferred Stock are converted to Common Stock at
their respective conversion ratios. Shares owned include shares for which
options or warrants are exercisable currently or within 60 days. Each person has
sole voting and investment power with respect to the shares, as indicated.
Name and Address of Amount of Beneficial Percentage
Beneficial Owner Ownership of Class
- - ---------------- --------- --------
R.E.M. Petersen Living Trust(1)(2) 8,625,137 36.9%
6420 Wilshire Boulevard, 20th Floor
Los Angeles, CA 90048
Weider Health &Fitness Corporation(3) 1,333,334 5.7%
21100 Erwin Street
Woodland Hills, CA 91367
Kevin Blackwell(3) 3,775,355 16.1%
7730 E. Greenway Rd., Suite 203
Scottsdale, AZ 85260
David Guarino(3) 3,952,227 16.9%
7730 E. Greenway Rd., Suite 203
Scottsdale, AZ 85260
- - ----------
(1) Mr. Robert E. Petersen, and his wife, Margaret M. Petersen, are the
beneficiaries of the R.E.M. Petersen Living Trust, (the "Petersen Trust").
(2) The Petersen Trust owns 650,000 of Series B Preferred Stock that is
convertible into the Company's Common Stock at the ratio of 10 common
shares for each share of Series B Preferred Stock. The Petersen Trust also
holds an immediately exercisable warrant to purchase 1,000,000 common
shares of the Company at the price of $0.40 per share (the "Petersen
Warrant") at any time prior to May 20, 2007. The Petersen Trust's
beneficial ownership shown here assumes its Series B Preferred Stock is
converted into Common Stock and that the Petersen Warrant is fully
exercised.
(3) There are 575,000 shares of Series A Preferred Stock that are convertible
into the Company's Common Stock at the ratio of 13 1/3 common shares for
each share of Series A Preferred Stock. The Series A Preferred Stock is
owned as follows: Mr. Blackwell (225,000 shares), Mr. Guarino (237,500
shares), Weider Health & Fitness Corporation (100,000 shares) and Mr.
Corliss (12,500 shares). The beneficial ownership reported above assumes
the Series A Preferred Stock is converted into the Company's Common Stock.
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Name and Address of Amount of Beneficial Percentage
Beneficial Owner Ownership of Class
- - ---------------- --------- --------
Robert Corliss(3) 171,599 0.7%
The Athlete's Foot Group, Inc.
1950 Vaughn Road
Kennesaw, Georgia 30144
All Executive Officers and
Directors as a Group (4 persons) 8,052,979 34.4%
ITEM 5. DIRECTORS AND EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
The following are the companies' directors, officers and key employees:
Name Age Positions and Offices Held
- - ---- --- --------------------------
Kevin Blackwell 44 President and Director
Kathryn Blackwell 34 Secretary, Treasurer, and Director
David Guarino 35 Vice-President, Chief Financial
Officer and Director
Gerald Conklin 46 President of Selman Systems, Inc.
Robert Corliss 47 Director
Don Plato 44 Director
All of the Company's directors were elected by a majority vote of the
shareholders of the Company at an annual meeting of shareholders held on October
12, 1999, and, unless a director resigns, will remain in office until the next
annual meeting of shareholders or until a successor is duly qualified and
elected. From March 15, 1999 until October 12, 1999, Mr. Kevin Blackwell and Ms.
Kathryn Blackwell served as the Company's sole directors. Messrs. Guarino,
Corliss, and Plato were first elected to the Company's Board of Directors on
October 12, 1999. Mr. Guarino was elected to his current position of
Vice-President-Chief Financial Officer by the Company's Board of Directors on
October 12, 1999. Ms. Blackwell was elected as Secretary of the Company on March
15, 1999, by the Company's Board of Directors. There are no agreements that a
director will resign at the request of another person and none of the above
named directors are acting on behalf of another person.
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BIOGRAPHICAL INFORMATION:
The following briefly summarize the experience of each of the Companies'
directors, officers, and key employees, during the past five years.
KEVIN BLACKWELL has been President and a Director of the Company since
March 15, 1999. Prior to March 1999, Mr. Blackwell was President and Director of
Surf City for more than five years. Mr. Blackwell, and his wife Kathryn, founded
the Surf City juice bar concept in 1981. Mr. Blackwell also serves on the
Company's Compensation Committee. Mr. Blackwell attended Eastern Washington
University, where his studies emphasized mathematics and business law.
KATHRYN BLACKWELL has been Secretary and a Director of the Company since
March 15, 1999. Prior to March 1999, Ms. Blackwell was Vice-President and
Secretary of Surf City for more than five years, and a director of Surf City
from its inception to January 1998. Ms. Blackwell completed four years of study
at San Jose University in 1988, where she concentrated on business management
and international business.
ROBERT CORLISS has been President and CEO of Athlete's Foot Group, Inc.
from August 1998 to the present. Prior to August 1998, he was President and CEO
of Infinity Sports, and prior to that, he was President and CEO of Herman's
Sporting Goods, Inc. Mr. Corliss is also serves as a director of Xdogs.com (OTC:
SNOW). Mr. Corliss also serves on the Company's Audit and Compensation
Committees.
DAVID GUARINO is currently Vice-President-Chief Financial Officer and a
director of the Company. From March 15, 1999 to October 12, 1999, Mr. Guarino
was a consultant to the Company. From April 1997 to March 1999, and again from
December 1995 to July 1996, Mr. Guarino served as Vice-President-Chief Financial
Officer of Surf City. Mr. Guarino was also a director of Surf City from January
1998 to March 1999, and from December 1995 to July 1996. Prior to his employment
with Surf City, Mr. Guarino served as Senior Vice-President - Principal
Financial Officer of TLC Beatrice International Holdings, Inc. Mr. Guarino
graduated from the University of Denver in 1985 with a Masters and a Bachelors
of Science degree in accounting.
DON PLATO has been Chairman of Builder's National, Inc., a commercial and
residential general contractor, for more than five years. Mr. Plato and his wife
founded Builders National in 1993. Mr. Plato was also a member of Surf City's
Official Committee of Unsecured Creditors ("Unsecured Committee") from January
1997 to November 1997. Since November 1997, Mr. Plato has been a member of Surf
City's Creditors' Representative Committee, which is the successor to the
Unsecured Creditor's Committee. Mr. Plato also serves on the Company's Audit and
Compensation Committees.
GERALD CONKLIN has served as President of Selman Systems, Inc. since May
1999. From July 1998 to May 1999, Mr. Conklin served as Vice President of
Operations and Business Development for Selman Systems, Inc. From December 1995
to June 1998, Mr. Conklin was President of Custom Resources Management in
Frisco, Texas. From January 1994 to December 1995, Mr. Conklin was Director of
Marketing, Development and Operations for Allied-Domecq in Richardson, Texas.
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Kevin and Kathryn Blackwell are husband and wife. Otherwise, there are no
family relationships among the directors, officers and significant employees of
the Company. Except for the Chapter 11 Bankruptcy of Surf City, none of the
directors, officers, and significant employees have had any bankruptcy petition
filed by or against any business of which the person was a general partner or
executive officer either at the time of the bankruptcy or within two years prior
to the bankruptcy.
COMMITTEES OF THE BOARD OF DIRECTORS
The Board of Directors, on October 12, 1999, established two committees of
the Board, an Audit Committee and a Compensation Committee. Prior to that date,
the Board of Directors had no committees. The Audit Committee has held no
meetings to date. The Compensation Committee has held two meetings to date. The
first meeting, on November 17, 1999, was to approve the Company's grants of
stock options to key employees, other than Mr. Blackwell and Mr. Guarino. The
second meeting, on December 10, 1999, was to approve the Company's granting of
stock options to Mr. Blackwell and Mr. Guarino, and to approve and ratify their
respective employment agreements with the Company. Mr. Robert Corliss and Mr.
Don Plato are members of each Committee, with Mr. Kevin Blackwell also serving
on the Compensation Committee.
ITEM 6. EXECUTIVE COMPENSATION
Long-Term and Other
Annual Compensation Compensation
----------------------------------- ------------
Option 401(k) Plan
Name and Position Year Salary Bonus Shares Contribution
- - ----------------- ---- ------ ----- ------ ------------
Kevin Blackwell 12/31/98 $109,375 $0 0 $ 0
President and CEO 12/31/99 $100,000 $0 300,000 $ 0
- - ----------
The Company had no operations, employees or paid executive officers during
fiscal year 1998. Mr. Kevin Blackwell, the President and CEO of the Company
since March 15, 1999, served as President and CEO of SCAC during all of fiscal
year 1998. The Company purchased SCAC on March 15, 1999, with Mr. Blackwell and
his management team immediately succeeding to the day-to-day control of the
Company. Accordingly, SCAC is the entity for which Executive Compensation is
disclosed for the 1998 fiscal year. Mr. Blackwell, as President and CEO of SCAC,
received $109,375 in compensation during fiscal year 1998. All of Mr.
Blackwell's compensation for fiscal year 1998 was paid by Surf City, a wholly
owned subsidiary of the Company. No other employee of SCAC received more than
$100,000 in annual compensation during fiscal year 1998. Additionally, other
than Mr. Blackwell, no other employee of the Company received more than $100,000
in annual compensation during fiscal year 1999.
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OPTION INFORMATION FOR FISCAL 1999 RELATING TO THE NAMED OFFICERS IS SET FORTH
BELOW:
Option Grants in Fiscal 1999 were as follows:
Number of
Shares of Percentage of
Common Stock Total Options
Underlying Granted to
Options Employees in
Granted in Fiscal Exercise Expiration
Name Fiscal 1999 1999 Price Date
---- ----------- ---- ----- ----
Kevin Blackwell 300,000 24% $1.00 09/30/04
Jerry Conklin 125,000 10% $0.50 09/30/09
David Guarino 300,000 24% $1.00 09/30/04
One-third of all options granted to the Named Officers above and others in
1999 vest on each of the first, second and third anniversary of the grant date
if the optionee is still employed by the Company on that date. Vested options
terminate if not exercised ten years after grant (or five years in the case of
an optionee who controls more than 10% of the total combined voting power of all
classes of stock of the Company) or 90 days after an employee leaves the
Company.
<TABLE>
<CAPTION>
Number of Shares Value of Unexercised
Underlying Unexercised In-the-Money Options
Options at Year-End at Year-End (1)
Shares Value ----------------------------- ----------------------------
Name Exercised Realized Exercisable Unexercisable Exercisable Unexercisable
---- --------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Kevin Blackwell 0 0 0 300,000 0 0
Gerald Conklin 0 0 0 125,000 0 0
David Guarino 0 0 0 300,000 0 0
</TABLE>
- - ----------
(1) The dollar values are calculated by determining the difference between
$0.25 per share, the fair market value of the Common Stock at December 31,
1999, and the exercise price of the respective options.
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The Company adopted the 1999 Sports Group International, Inc. Stock Option
Plan (the "Option Plan") on October 12, 1999. A total of 2,000,000 shares of the
Company's Common Stock have been reserved for issuance under this Option Plan.
On November 17, 1999, the Compensation Committee of the Company's Board of
Directors granted options to purchase 640,000 shares of the Company's Common
Stock pursuant to the Option Plan to key employees at an exercise price of
$0.50. On December 10, 1999, the Compensation Committee of the Company's Board
of Directors granted options to purchase 300,000 shares of the Company's Common
Stock to both Mr. Blackwell and Mr. Guarino at an exercise price of $1.00 per
share.
The independent members of the Company's Board of Directors (directors who
are not employees or 10% shareholders of the Company) automatically receive, as
compensation for their services, a nonqualified stock option to purchase 10,000
shares of the Company's Common Stock at a price equal to 85% of the Common
Stock's fair market value on the date the option is granted. This option grant
is made upon the independent director's election to the Board of Directors. The
independent directors are also paid all reasonable travel expenses to attend the
Company's quarterly Board meetings, wherever held. Otherwise, directors of the
Company receive no additional compensation for their service, including
participation on committees and special assignments.
The Company currently has two employment agreements in effect with its
Executive Officers. The Company is party to a three-year employment contract,
beginning as of October 1, 1999, with Mr. Kevin Blackwell (the "Blackwell
Contract") for his services as President and CEO of the Company.
The Company is also party to a three-year employment contract, beginning as
of October 1, 1999, with Mr. David Guarino (the "Guarino Contract") for his
services as Vice President-Chief Financial Officer of the Company.
The Blackwell Contract and Guarino Contract both provide for an annual base
salary of $150,000, of which $100,000 is paid by Surf City pursuant to the Plan
of Reorganization, an automobile allowance set by the Company's Board of
Directors, and other fringe benefits that are also made available to other
employees of the Company. The Blackwell Contract and Guarino Contract also both
provide for two years of severance pay upon termination of the employment
agreements for any reason other than "for cause," as defined in the employment
agreements, in exchange for restrictive covenants regarding the confidentiality
of the Company's Proprietary Information and the return of such information to
the Company upon termination. Both the Blackwell Contract and Guarino Contract
are attached as Exhibits to this Form 10-SB.
ITEM 7. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On January 10, 2000, the Company obtained a $1,000,000 line of credit from
Wells Fargo, N.A. which bears interest at the Fed Funds Rate, plus 0.42%, and is
payable January 31, 2004. The line of credit is personally guaranteed by the
Petersen Trust, which is also a major shareholder of the Company. See, SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT, above. The Company
compensated the Petersen Trust for its guaranty of the $1,000,000 line of credit
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by reducing the exercise price of the Petersen Trust's warrant to purchase
1,000,000 shares of the Company's Common Stock from $2.00 to $0.40 per share.
The Company could not have obtained the line of credit without the Petersen
Trust's guaranty. The line of credit was also guaranteed by Mr. Kevin Blackwell
and Mr. Davis Guarino, each of whom is an officer, director, and major
shareholder of the Company. Mr. Blackwell and Mr. Guarino received no additional
compensation for their guarantees. Management believes that the compensation
paid for the Petersen Trust guaranty was on terms as favorable to the Company as
could have been obtained with respect to a comparable transaction from an
unrelated third party.
On February 22, 1999, the Petersen Trust loaned SCAC $332,500 pursuant to a
promissory note (the "Petersen Note"). The note bears interest at 10% per annum,
matures March 1, 2001, and provides for monthly principal and interest payments.
As of December 31, 1999, the outstanding principal balance on the Petersen Note
was $194,140. Messrs. Blackwell and Guarino have personally guaranteed SCAC's
obligations under the Petersen Note, but have received no additional
compensation for their guarantees. The Company's management believes the terms
of the Petersen Note are as favorable or more favorable to the Company as those
terms the Company could have obtained for a loan of the same size and maturity
from an unrelated third party through arm's length negotiation.
Mr. Kevin Blackwell, the Company's President and a Director, loaned one of
the Company's wholly owned subsidiaries the sum of $30,000 during October 1999.
The loan, which has since been repaid in full, accrued no interest and had no
stated maturity. As of December 31, 1999, there were no outstanding loans
between Mr. Kevin Blackwell and the Company or its wholly owned subsidiaries.
Mr. Eugene Blackwell, the father of Mr. Kevin Blackwell, a Director and
President of the Company, loaned one of the Company's subsidiaries the sum of
$20,000 during December 1998. The loan, which has since been repaid in full,
accrued no interest, and had no stated maturity. As of December 31, 1999, there
were no outstanding loans between Mr. Eugene Blackwell and the Company or its
wholly owned subsidiaries.
Mr. Guarino, the Vice President-Chief Financial Officer and a Director of
the Company, made multiple loans to one of the Company's wholly owned
subsidiaries between April 1998 and March 1999. These loans, which have been
repaid by the Company, ranged in principal amounts from $2,000 to $60,000,
accrued no interest, and had no stated maturities. As of December 31, 1999,
there were no outstanding loans between Mr. Guarino and the Company or its
wholly owned subsidiaries.
The Blackwells and Mr. Guarino have periodically personally guaranteed
financial obligations of the Company and its subsidiaries. Items personally
guaranteed include commercial office and storage facility leases for the
Company, commercial real estate leases with 24-Hour Fitness under which Company
franchisees are the tenants, a promissory note to a vendor of the Company, and
various equipment leases. Mr. Kevin Blackwell and Ms. Kathryn Blackwell are also
the tenants of record under the commercial real estate warehouse and storage
lease used by Kona Coast described above. It is the Company's intent to have
Messrs. Blackwell and Guarino's personal guarantees released as soon as
practicable.
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Mr. Plato, an independent director of the Company, is a shareholder of a
corporation that is an unsecured creditor in Surf City's Chapter 11 Bankruptcy
and subsequent Plan of Reorganization. Mr. Plato's corporation has an unsecured
claim of approximately $109,000, and is currently receiving payments from the
unsecured creditors distribution account pursuant to the terms of the Plan of
Reorganization. See, BUSINESS OF SUBSIDIARIES: FRULLATI CAFE & BAKERY AND SURF
CITY SQUEEZE - THE SURF CITY SQUEEZE DIVISION - SURF CITY'S PLAN OF
REORGANIZATION.
On March 15, 1999, the Company pledged one hundred percent (100%) of its
right, title and interest in the stock of SCAC to Mr. Kevin Blackwell
("Blackwell"), the current chief executive officer of the Company, as security
for the Company's obligations to Blackwell and SCAC under a Share Purchase
Agreement of even date between Blackwell and the Company. Events of Default, as
defined in the Share Purchase Agreement, have occurred that would allow
Blackwell to proceed against the shares of SCAC. However, as ofDecember 31,
1999, Blackwell had waived each Event of Default and entered into a cancellation
agreement with the Company to release the pledged SCAC shares.
In the Company's merger with SCAC, the 575,000 shares of the Company's
Series A Preferred were issued to the shareholders of SCAC for 100% of its
outstanding common stock. Additionally, two million shares of the Company's
Common Stock were issued to Apache Peak Capital, L.L.C., an Arizona limited
liability company ("Apache Peak") for 100% of the membership interest in Apache
Peak and other consideration. Apache Peak is controlled by Mr. David Guarino,
the Company's Vice President and Chief Financial Officer. Apache Peak's sole
asset is Mr. Guarino's interest in the Shareholder Voting Trust and Management
Agreement (the "Voting Agreement") dated May 19, 1997, by and between Mr.
Guarino and Mr. Kevin Blackwell, the Company's Chief Executive Officer. The
Company's issuance of the 2,000,000 shares of its Common Stock to Apache Peak
for a 100% membership interest in Apache Peak was effected to cancel the Voting
Agreement between Messrs. Blackwell and Guarino and thus facilitate the merger
between SCAC and the Company. Apache Peak has no other assets or operations, and
it is the intent of the Company to dissolve Apache Peak simultaneously with this
filing.
FUTURE TRANSACTIONS:
The Company has adopted a policy that future transactions with affiliated
persons or entities will be on terms no less favorable to the Company than those
that could be obtained from unaffiliated third parties on an arm's length basis,
and that any such transactions must be reviewed and approved by the Company's
independent directors.
ITEM 8. DESCRIPTION OF SECURITIES
The authorized capital stock of the Company consists of 100,000,000 shares
of Common Stock, par value $.001 per share, and 2,000,000 shares of Preferred
Stock, par value $.001 per share, of which 575,000 issued and outstanding shares
have been designated as Series A Preferred Stock and 650,000 issued and
outstanding shares have been designated as Series B Preferred Stock. The
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material terms of the Company's Common and Preferred Stock are set forth below.
The following descriptions are qualified in their entirety by reference to the
Company's Amended and Restated Articles of Incorporation and Bylaws, all of
which are set forth in the Exhibits to this Form 10-SB.
COMMON STOCK:
Each holder of Common Stock is entitled to one vote for each share standing
in his name on the books of the Company for those matters properly presented to
shareholders for consideration and action. Holders of Common Stock have no
preemptive rights, and share ratably in dividends, if any, when and if declared
by the Board of Directors in its discretion from funds or stock legally
available. Common Stock holders are entitled to share pro-rata in all net assets
of the Company, in the event of dissolution, after all creditors and the rights
of the holders of Series A and Series B Preferred Stock are satisfied.
PREFERRED STOCK:
The Company's Amended and Restated Articles of Incorporation authorize
2,000,000 shares of Preferred Stock, which may be issued in series. Of this
amount, 575,000 shares are issued and outstanding and have been designated as
Series A Preferred Stock, par value $10.00 per share, and 650,000 shares are
issued and outstanding and have been designated as Series B Preferred Stock, par
value $10.00 per share.
Series A Preferred Stock
The dividend rate for Series A Preferred Stock is ten percent (10%) per
annum of the par value for each share. Dividends on the Series A Preferred Stock
are payable, at the Holder's election, either in cash or Series A Preferred at
the $10.00 par value beginning on June 1, 1999, and quarterly thereafter each
calendar year. Dividends on the Series A Preferred Stock are cumulative from the
date of its issuance. No dividends shall be paid or set apart for payment on any
shares ranking junior to the Series A Preferred Stock unless and until all
accrued and unpaid dividends on the Series A Preferred Stock shall have been
declared and paid or a sum sufficient for payment thereof set apart. For
purposes of this dividend provision, Series A Preferred Stock ranks on a parity
with the Series B Preferred Stock. As of December 1, 1999, the holders of the
Series A Preferred Stock have always elected to receive the ten percent (10%)
annual dividend, which is payable quarterly, in shares of Common Stock in the
Company, and not cash, at the Series A Preferred Stock conversion ratio of 13
1/3 shares of Common Stock for each share of Preferred Series A Stock held.
Until May 20, 1999, the Series A Preferred Stock had a redemption and
security feature that is currently referenced in the Company's Amended and
Restated Articles of Incorporation. This redemption and security feature was
waived by the holder of the Series A Preferred Stock on May 20, 1999, in
consideration for the stock conversion rights described below. In addition,
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holders of Series A Preferred Stock were granted piggy-back registration rights
in the event the Company makes a registered offering of its equity securities.
Options to purchase the Company's Common Stock previously granted in exchange
for this waiver are now included as part of the existing grant of stock options
under the Company's 1999 Stock Option Plan, more fully described above.
In the event of any voluntary or involuntary liquidation, dissolution or
winding up of the Company, the holders of Series A Preferred Stock then
outstanding are entitled to be paid out of the assets of the Company available
for distribution to its shareholders, an amount per share equal to $10.00 per
share, plus an amount equal to unpaid cumulative dividends, without interest,
before any payment shall be made to the holders of any Common Stock or stock of
the Company ranking junior to the Series A or Series B Preferred Stock. For
purposes of liquidation, Series A Preferred Stock ranks on a parity with the
Series B Preferred Stock.
The holders of Series A Preferred Stock have the right, at their option, to
convert their shares into Common Stock at any time after the date of issue, in
the ratio of one share of Series A Preferred Stock to 13 1/3 shares of Common
Stock. A minimum of 1,000 shares of Series A Preferred Stock must be converted,
with no maximum share limitations.
Holders of shares of Series A Preferred Stock have a general right to vote
and are entitled to notice of the meetings of stockholders of the Company, and
to participate in such meetings. Holders, of Series A Preferred Stock are
entitled to 13 1/3 votes for each share of Series A Preferred Stock held.
In addition to their general voting rights, holders of shares of Series A
Preferred Stock have certain special voting rights. If any shares of the Series
A Preferred Stock are outstanding, the Company shall not (i) without the
affirmative vote of at least one-half of the votes entitled to be cast by all
shares of the Series A Preferred Stock at the time outstanding, amend or change
any terms of the Series A Preferred Stock in Article IV of the Amended and
Restated Articles of Incorporation of the Company or other provisions of the
Amended and Restated Articles of Incorporation generally applicable to the
Series A Preferred Stock, so as to affect materially and adversely any such
terms; (ii) without the affirmative vote of at least one-half of the votes
entitled to be cast by shares of the Series A Preferred Stock at the time
outstanding, (a) increase the authorized number of shares of Series A Preferred
Stock in excess of 575,000; (b) authorize shares of any other class of stock
ranking on a parity with shares of Series A Preferred Stock as to dividends or
assets; or (c) change the conversion features of the Series A Preferred Stock.
Series B Preferred Stock
The dividend rate for Series B Preferred Stock is ten percent (10%) per
annum of the $10.00 par value each share. Dividends on the Series B Preferred
Stock are be payable at the Holder's election, either in cash or Series B
Preferred Stock at the $10.00 par value beginning on June 1, 1999 and quarterly
thereafter each calendar year. Dividends on the Series B Preferred Stock are
cumulative from the date of its issuance. No dividends may be paid or set apart
for payment on any shares ranking junior to the Series B Preferred Stock unless
and until all accrued and unpaid dividends on the Series B Preferred Stock shall
have been declared and paid or a sum sufficient for payment thereof set apart.
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For purposes of this dividend provision, Series B Preferred Stock ranks on a
parity with the Series A Preferred Stock. As of December 1, 1999, the holder of
the Series B Preferred Stock has always elected to receive the ten percent (10%)
annual dividend, which is payable quarterly, in shares of Common Stock in the
Company, and not cash, at the Series B Preferred Stock conversion ratio of 10
shares of Common Stock for each share of Preferred Series B Stock held.
In the event of any voluntary or involuntary liquidation, dissolution or
winding up of the Company, the holders of Series B Preferred Stock then
outstanding shall be entitled to be paid out of the assets of the Company
available for distribution to its shareholders, an amount per share equal to
$10.00 per share, plus an amount equal to the unpaid cumulative dividends,
without interest, before any payment shall be made to the holders of any Common
Stock or stock of the Company ranking junior to the Series B Preferred Stock.
For purposes of liquidation, Series B Preferred Stock ranks on a parity with the
Series A Preferred Stock.
The holders of Series B Preferred Stock shall have the right, at their
option, to convert their shares into Common Stock at any time after the date of
issue, in the ratio of one share of Series B Preferred Stock to 10 shares of
Common. A minimum of 1,000 shares of Series B Preferred Stock must be converted;
there are no maximum limitations.
Holders of shares of Series B Preferred Stock shall have a general right to
vote and are entitled to notice of the meetings of stockholders of the Company,
and to participate in such meetings. Shareholders of Series B Preferred Stock
are entitled to 10 votes for each share of Series B Preferred Stock held. In
addition to these general voting rights, holders of Series B Preferred Stock
have special voting rights. If any shares of the Series B Preferred Stock are
outstanding, the Company may not (i) without the affirmative vote of at least
one-half of the votes entitled to be cast by all shares of the Series B
Preferred Stock at the time outstanding, amend or change any terms of the Series
B Preferred in Article IV of the Amended and Restated Articles of Incorporation
of the Company or other provisions of the Amended and Restated Articles of
Incorporation generally applicable to the Series B Preferred Stock, so as to
affect materially and adversely any such terms; (ii) without the affirmative
vote of at least one-half of the vote entitled to be cast by shares of the
Series B Preferred Stock at the time outstanding, (a) increase the authorized
number of shares of Series B Preferred Stock in excess of 650,000; (b) authorize
shares of any other class of stock ranking on a parity with shares of Series B
Preferred Stock as to dividends or assets; or (c) change the conversion features
of the Series B Preferred Stock.
OTHER PREFERRED STOCK VOTING RIGHTS
Under Florida corporate law, holders of Preferred Stock also have the
statutory right to vote as a class with respect to any amendment to the
Company's Articles of Incorporation that would materially affect the rights of
such class, including increasing or decreasing the aggregate number of
authorized shares of such class; exchanging or reclassifying such class;
changing the designations, rights or privileges of such class; creating a new
class of shares having preferential rights to such class; or canceling or
otherwise affecting rights to dividends or distributions of such class. Voting
by class is also required for a plan of merger if it would result in an
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amendment to the Company's Articles of Incorporation that would otherwise
require class voting and on any plan of share exchange if the Preferred Shares
would be converted under the plan, and in certain other circumstances.
The Company has issued no debt securities.
There are no provisions in the Company's Amended and Restated Articles of
Incorporation or the Bylaws that would delay, defer or prevent a change of
control. However, the issuance of additional shares of or additional series of
Preferred Stock could have the effect of delaying or preventing a change in
control of the Company without further action by the shareholders and could
adversely affect the voting or other rights of the holders of Common Stock.
PART II
ITEM 1. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
MARKET INFORMATION:
The Company's Common Stock is traded on the Over the Counter Market of the
NASDAQ Bulletin Board (OTC BB) under the symbol "SPGK." The Company's Common
Stock began trading on the Over the Counter Bulletin Board Market in March of
1999. In general, shares of the Company's Common Stock are highly illiquid due
to the lack of volume and any known market makers.
The high and low bid (sales) prices for each quarter are as follows:
Quarter(1) High Low Close
---------- ---- --- -----
03/31/99 3.75 2.00 2.25
06/30/99 2.25 0.44 0.56
09/30/99 0.63 0.13 0.28
12/31/99 0.63 0.06 0.25
There is an established trading market for the Common Stock being presented
in this registration statement.
- - ----------
(1) The Company's Common Stock began trading on the Over the Counter Bulletin
Board Market in March 1999. Consequently, the high and low bid (sales)
price, for each quarter during the past two years are only available
beginning with the quarter ending March 31, 1999.
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HOLDERS:
There are approximately 374 holders of the Common Stock of the Company as
of December 31, 1999.
DIVIDENDS:
The Company has neither paid nor declared any cash or stock dividends on
its Common Stock during the past fiscal year and does not anticipate doing so in
the immediate future. There are no restrictions that limit the Company's ability
to pay dividends on its Common Stock other than the availability of Company
revenues and earnings, cash flow, payment of the Series A and Series B Preferred
Stock dividends and the Company's overall financial condition. Except for
dividends required to be paid on the Company's Preferred Stock, it is the
current intention of the Company's Board of Directors to retain earnings to
finance the growth of the Company's business rather than to pay cash dividends.
ITEM 2. LEGAL PROCEEDINGS.
The Company is party to routine litigation incidental to its business
involving primarily litigation with franchisees and landlords. The litigation
discussed below, if resolved adversely to the Company, could materially and
adversely affect the Company's results of operations and financial condition.
SGI AND RELATED LITIGATION:
On March 15, 1999, the Company entered into a Merger Agreement and Plan of
Reorganization ("Merger Agreement") with Sports Group International, Inc., a
Delaware Corporation ("SGI"). According to the terms of the Merger Agreement,
the merger was to close on or before May 30, 1999, if certain conditions were
met. The merger, if completed, would have required the Company to exchange its
shares for shares of SGI held by approximately 300 SGI shareholders. The Merger
Agreement did not require the shares of the surviving corporation to be
registered with the Securities and Exchange Commission or under applicable state
law prior to the consummation of the merger. The merger was subject to certain
conditions, including the truth of all representations and warranties in the
Merger Agreement, and no substantial adverse change in the financial condition
or operations of SGI. On June 25, 1999, the Company's legal counsel sent a
letter to the Board of Directors of SGI notifying SGI that the Merger Agreement
was terminated because SGI had failed to comply with certain conditions of the
Merger Agreement in a timely fashion. Following receipt of the letter, the SGI
Board of Directors notified the Company that SGI contended that the Merger
Agreement between the Company and SGI had been "completed."
On July 29, 1999, the Company filed a Complaint for Declaratory Relief
against SGI in the Superior Court of the State of California, in the County of
San Diego, case no. GIC 733034. The Company has requested entry of an order
declaring that: (1) the Merger Agreement expired under its own terms and
conditions on May 30, 1999, due to SGI's failure to satisfy the condition
precedent to the consummation of the merger; (2) the Company properly terminated
the Merger Agreement; (3) SGI has no interest in or right to shares of the
Company; and (4) the Company has no liability to SGI, its creditors or
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shareholders. On September 14, 1999, SGI and certain individual SGI shareholders
filed a cross-complaint against the Company, alleging breach of the Merger
Agreement and seeking declaratory and injunctive relief. SGI also seeks monetary
damages in an unspecified amount.
The court denied SGI's request for temporary injunctive relief. In late
March, 2000, the matter was tried before a judge in San Diego Superior Court. On
April 14, 2000, the court ruled in the Company's favor on its declaratory relief
action against SGI. The court found that the Company and SGI did not merge in
1999, and that the Company was justified in rejecting the proposed merger with
SGI. The court's decision establishes that the Company and SGI are separate and
independent entities. The court also ruled in the Company's favor on SGI's cross
complaint for breach of contract, determining that the Company did not breach
the plan of merger when it rejected the proposed merger with SGI.
The SGI litigation described above has also resulted in ancillary
litigation. For the most part, the claims against the Company associated with
this litigation assert that the Company is obligated for certain liabilities of
SGI which the Company would have assumed if the SGI merger had been consummated.
Since the court has now ruled that the Company and SGI did not merge and are
independent entities, the Company believes that the following ancillary
litigation will be resolved in its favor because it has no legal responsibility
for the debts and other obligations of SGI.
In FISCH, SPIEGLER, GINSBURG, LADNER & ATTERIAN V. SPORTS GROUP
INTERNATIONAL, INC., the plaintiff has asserted a claim for $42,000, plus
pre-judgment interest, attorneys' fees and costs, alleging that the Company
assumed all of SGI's liabilities pursuant to the merger agreement described
above. In JEFF KUDLA V. SPORTS GROUP INTERNATIONAL, INC., the plaintiff asserts
that the Company is liable for $25,000, plus interest, attorneys' fees and costs
relating to alleged bridge loans made to SGI in March 1999. In MAKO CAPITAL,
INC. V. SPORTS GROUP INTERNATIONAL, INC., the plaintiff alleges a breach of
contract arising out of loans made by Mako Capital to SGI in the approximate
amount of $250,000.
In addition, the Company has been notified that Spalding Sports Worldwide,
Inc. ("Spalding") has threatened to assert a claim against the Company in the
amount of $275,000 in connection with royalties allegedly owed to Spalding
pursuant to a license agreement between Spalding and SGI.
The Company has advised Spalding that it is not a party to the license
agreement and that it has not assumed any of SGI's liabilities in connection
with the Merger Agreement discussed above. As of this date, Spalding has not
filed suit against the Company. Given the court's recent decision in the SGI
litigation discussed above, the Company believes it is highly unlikely Spalding
will commence any legal action against the Company over royalties arising from
SGI's license with Spalding.
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FRANNET:
On December 31, 1998, FranNet Southern California, Inc., a California
corporation, and Allan S. Craven, an individual, doing business as Franchise
Resource/Franchise Network (hereinafter, "FranNet") filed a complaint against
SCSFC alleging that SCSFC is liable for certain debts of Surf City that were
discharged in bankruptcy. The lawsuit arises out of a contract between FranNet
and Surf City for the acquisition of franchisees. Surf City believes that
FranNet billed and was paid for its work. In 1997, FranNet filed a demand for
arbitration for sums it claims it was due from Surf City's sale of franchises.
Shortly after the arbitration hearing, Surf City filed its Chapter 11 Bankruptcy
Petition. FranNet obtained an order lifting the Bankruptcy Court's stay order
and the arbitrator ruled in favor of FranNet and awarded FranNet Southern
California $67,159.15 and Franchise Resource $28,056.25 in commissions. In
addition, the arbitrator ordered Surf City to pay FranNet's attorneys' fees of
$17,000.00, administrative fees of $1,950.00 and the arbitrator's compensation
of $1,350.00. As a result of Surf City's bankruptcy, FranNet's award was treated
as an unsecured claim and included in Surf City's Plan of Reorganization.
FranNet's attempt to amend the Demand to include SCSFC as a party was denied by
the arbitrator.
FranNet is currently seeking to enforce the arbitration award against SCSFC
in the Orange County Superior Court, under a statute which permits a party who
has a contract with another party to sue a related party who "received all of
the benefits of the underlying contract." FranNet's Motion for Summary Judgment
was denied on November 30, 1999
The FranNet matter was tried in mid-February, 2000. After FranNet presented
its case, the court granted judgment in favor of SCSFC on several grounds. SCSFC
is currently filing a motion with the court to recover its attorneys' fees and
costs incurred in the defense of this matter.
ROYAL MARKETING INTERNATIONAL, INC.:
Royal Marketing International, Inc., a Frullati Cafe and Bakery franchisee,
has sued Frullati Franchise Systems, Inc. and Frullati, Inc. for a breach of
contract, breach of the implied covenant of good faith and fair dealing,
tortuous interference with contract, violation of the Texas Unfair Trade &
Deceptive Practices Act, fraud in the inducement, common law fraud,
misrepresentation, negligent misrepresentation and rescission, in District Court
for Dallas County, Texas. The franchisee seeks damages of approximately
$400,000. The franchisee alleges that it purchased the right to open two
franchises in the Miami, Florida area, and was responsible for the
construction/build-out of the stores. The franchisee alleges that the cost of
construction ran over what was estimated by Frullati and that the stores did not
perform to the franchisee's expectations or the "estimate" the plaintiff alleges
it received from Frullati. Subsequent to the filing of the complaint, Frullati
was able to negotiate reductions in the cost of construction, bringing the final
cost within the initially projected amount. The Company believes that the
franchisee owes Frullati approximately $ 135,000 for the cost of construction,
past due rent and royalties, and has filed a cross-complaint against Royal
Marketing in the district court action for that amount. In early January, 2000,
Royal Marketing, Inc., Frulatti Franchise Systems, Inc. and Frulatti, Inc.
settled this lawsuit for a nominal payment and the case has been dismissed with
prejudice.
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ZIAD S. DALAL:
Mr. Dalal ("Dalal") was the sole shareholder of Selman prior to the
Company's purchase of Selman in May 1999. Under the Company's agreement to
purchase the stock of Selman, the Company assumed: (i) a loan evidenced by a
note between Selman and United Texas Bank in the original principal amount of
$576,000 ("United Texas Note"); (ii) a loan between Selman and Bank One in the
original principal amount of $100,000 ("Bank One Note"), (iii) a promissory note
between Selman and Fru-Cor in the amount of $1,200,000, and (iv) a promissory
note between Selman and Dalal in the amount of $300,000 ("Dalal Note").
On the day following the closing of the Company's purchase of Selman's
stock, Dalal's attorney requested that the Company execute a Closing Agreement
which provided that the Company and Selman were to have Dalal removed as a
guarantor on the United Texas Note and the Bank One Note. The Company executed
the Closing Agreement. The Closing Agreement provided that if the Company and
Selman did not obtain a release of Dalal's personal guarantee on these two bank
notes within forty-five days of the closing, that failure would be an event of
default under the Dalal Note, causing the entire $300,000 balance to be
immediately due and payable.
The Company and Selman failed to obtain Dalal's personal guarantee release
on the Bank One Loan and United Texas Note within forty-five (45) days of the
closing, and Dalal subsequently sued Selman and the Company in District Court
for Dallas County for full payment of the Dalal Note, and for interest and
related costs. The Company, by obtaining a $1,000,000 credit facility, paid the
United Texas Note and Bank One Note in full and, on February 1, 2000, settled
the Dalal suit. Under the settlement agreement, the Dalal Note was restructured
to provide for 36 monthly payments, beginning February 1, 2000, each in the
amount of $9,540. The Dalal suit will remain pending in Dallas County District
Court subject to the Company performing as agreed under the restructured Dalal
Note.
LANDLORDS CLAIMS UNDER THE PLAN OF REORGANIZATION:
The Company is involved in litigation with three of its landlords,
Westfield Corporation, Inc., The Macerich Company and Donahue Schriber (the
"Landlords"), who among themselves own nine properties in which Surf City
Squeeze franchises are operated.
On June 15, 1999, the Landlords filed a motion in Bankruptcy Court seeking
an order compelling Surf City to pay all amounts alleged to be due the Landlords
under nine leases plus interest, attorneys fees, and costs. The total amount of
these claims exceeded $76,000. Surf City responded to the Landlord's claims
contending that the Landlords were bound by the cure amounts listed in Surf
City's Plan of Reorganization, because the Landlords had failed to object to the
Plan of Reorganization or the Confirmation Order, which listed the pre and
post-petition cure amounts.
On September 9, 1999, the Bankruptcy Court ruled that the Landlords were
bound by the pre- and post-petition cure amounts Surf City set forth in its Plan
of Reorganization, and the Court declined to award the Landlords their
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attorneys' fees. In January 2000, Surf City paid the Landlords approximately
$41,000 pursuant to the Bankruptcy Court's ruling on the Landlords' claims. The
Bankruptcy Court has retained jurisdiction to resolve any further claims between
Surf City and the Landlords.
ITEM 3. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS.
The Company has had no disagreements with its accountants nor has the
Company changed its accountants.
ITEM 4. RECENT SALES OF UNREGISTERED SECURITIES.
During the past year, the Company has issued the following securities,
which were not registered and are restricted. The shares were issued in reliance
upon the exemption from registration under Section 4(2) the Securities Act of
1933, and comparable provisions of state law. Each placement of the Company's
securities described in the table below was privately negotiated with an
investor whom the Company had reasonable grounds to believe was an accredited
investor under Regulation D. All shares issued were restricted so that the
shares cannot be transferred unless registered or unless an exception from
registration is available.
Date Name No. of Shares Consideration
- - ---- ---- ------------- -------------
03/15/99 Kevin Blackwell 575,000 Series A 100% of SCAC's
Preferred Stock Outstanding Shares(5)
04/01/99 Scott Levine 75,000 Common Stock Legal Fees(1)
04/01/99 William Naumann 75,000 Common Stock Legal Fees(1)
05/21/99 R.E.M. Petersen 650,000 Series B Cash (4)
Living Trust Preferred Stock
and Warrants
09/15/99 Kenneth Sharkey 75,000 Common Stock Arbitration Settlement(2)
10/30/99 Coffin Associates 50,000 Common Stock Public Relations Firm(3)
- - ----------
(1) The Company issued a total of 150,000 shares of unregistered Common Stock
to the shareholders of Naumann & Levine, LLP in satisfaction of outstanding
legal fees totaling approximately $47,000.
(2) The Company issued 75,000 shares of unregistered Common Stock to Kenneth
Sharkey in settlement of an action pending before the American Arbitration
Association entitled Surf City Squeeze Franchising Corp. Inc. et al. v.
Kenneth A. Sharkey, et al., Case no 76 114 00299 97.
(3) The Company retained Coffin & Associates ("Coffin") as its public relations
Firm on October 27, 1999. As part of the retainer agreement, Coffin agreed
to purchase from the Company 50,000 shares of its Common Stock at $.16 per
share, the average market price calculated during a two-week period in
October 1999.
(4) The Company issued 650,000 shares of its Series B Preferred Stock to the
R.E.M. Petersen Trust on May 21, 2000, in exchange for $6,500,000 in cash
and a warrant to purchase 1,000,000 shares of the Company's Common Stock at
an exercise price of $2.00 per share. The exercise price for the warrants
was subsequently adjusted to $0.40 per share as compensation for the
Peterson Trust's guaranty of a $1,000,000 line of credit for the Company.
See CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, above.
(5) The Company issued 575,000 shares of its Series A Preferred Stock to Kevin
Blackwell on March 15, 1999, in exchange for 100% of the issued and
outstanding common shares of SCAC held by Mr. Blackwell. See BUSINESS
DEVELOPMENT AND CORPORATE STRUCTURE, above.
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In addition to the securities offerings described above, the Company made
three offerings of its common stock under Regulation D. In the first offering,
completed in October, 1998, the Company sold 104,967 shares of its Common Stock
for $15,745. These funds were used by the Company for general corporate
purposes.
The Company completed two additional offerings of its Common Stock in
March, 1999 under Regulation D. In these offerings, the Company issued a total
of 4,247,516 of its Common Stock for $210,000 in cash and the cancellation of a
Voting Agreement that facilitated the reverse merger between the Company and
SCAC. For more information on the shares issued for cancellation of the Voting
Agreement, SEE ITEM 7. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
On the basis of records maintained by the Company, the Company believes
that each offering was restricted to accredited investors, and a Form D was
filed with the Securities and Exchange Commission for each offering.
Subscription Agreements maintained by the Company indicate that the shares
offered were restricted.
Except for the private placements described above, there has been no
underwriting undertaken by the Company.
ITEM 5. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Florida Statutes Section 607.0850 provides that a Florida corporation has
the power to indemnify its Directors, Officers, Employees and Agents if he or
she acted in good faith and in an manner he or she reasonably believed to be in,
or not opposed to, the best interests of the corporation. Additionally, in a
criminal action or proceeding, a Florida corporation can indemnify a director,
officer, employee and agent if he had no reasonable cause to believe his conduct
was unlawful. Pursuant to Article X of the Company's Amended and Restated
Articles of Incorporation, the Company is obligated to indemnify its officers
and directors to the fullest extent permitted by law. A copy of the Company's
Amended and Restated Articles of Incorporation and Bylaws are attached as
Exhibits to this registration statement and incorporated herein by reference.
The Company has entered into Indemnification Agreements with each of its
current directors. These agreements provide that the Company will hold harmless
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and indemnify each director against any and all expenses, liabilities, and
losses (including investigation expenses, expert witness and attorneys' fees and
expenses, costs of court, judgments, penalties and fines, and amounts paid or to
be paid in settlement) actually incurred by the director, net of any insurance
proceeds, in connection with any suit or proceeding, whether civil, criminal, or
administrative, to which the director is a party or threatened to be made a
party, based upon, or arising from, or by reason of the fact that the director
is or was a director or officer of the Company, or, at the Company's request,
serves or has served as a director, officer, partner, trustee, employee or agent
of another company or affiliate. The Company is obliged to indemnify each
director to the fullest extent not prohibited by Florida law.
Each indemnified director is granted the right to receive prior to a final,
non-appealable judgment, advances from the Company for all expenses, including
investigative expenses, court costs, expert witness and attorneys' fees, and
other expenses, incurred in connection with an indemnifiable claim or
proceeding. To obtain these advances, the director must execute and deliver to
the Company a schedule setting forth in reasonable detail the dollar amount
expended and must provide the Company with a written undertaking that the
director acted in good faith and in accordance with the standard of conduct
applicable in order for the Company to indemnify the director, and a written
agreement to repay the Company if it is ultimately determined that the director
has not satisfied the applicable standard of conduct. Indemnification is not
available to a director, if he has engaged in certain prohibited acts. These
include any matters for which indemnification is barred by law, and any
violation of a director's duty of loyalty to the Company. The Indemnification
Agreement is not exclusive, and is in addition to any other rights of
indemnification provided by the Company's Amended and Restated Articles of
Incorporation, Bylaws, or by law. A copy of each of these indemnification
agreements is attached as an Exhibit to this registration statement and
incorporated herein by reference.
The Company also maintains, at is sole cost and expense, a director's and
officer's insurance policy (the "Policy") with coverage up to $5,000,000. Mr.
Blackwell, Ms. Blackwell, Mr. Guarino, Mr. Corliss, and Mr. Plato are all named
insureds, in their respective capacities as officers and directors of the
Company under the POLICY.
In the Share Purchase Agreement between the Company and SCAC, dated March
15, 1999, the Company agreed to indemnify the officers, directors, employees,
and shareholders of SCAC, both past and present, and Mr. Blackwell, Mr. Guarino,
and Ms. Blackwell, from and against any and all costs and expenses including,
but not limited to, lease obligations, personal guarantees, the warrants issued
to Weider, entering into the Share Purchase Agreement with SCAC, the avoidance
of or alleged avoidance of any agreement, and the breach of or alleged breach of
any agreement (including those incurred pursuant to a settlement entered into in
good faith). A copy of the Share Purchase Agreement containing this
Indemnification Provision is attached to this registration statement as an
Exhibit and incorporated herein by reference.
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PART III
ITEM 1. INDEX TO EXHIBITS.
Exhibit
Number Description
------ -----------
2.1 Order Confirming First Modified Joint Plan of Reorganization
Proposed by the Debtor and the Official Committee of Unsecured
Creditors, previously filed with the Company's Registration
Statement on Form 10SB filed with the Securities and Exchange
Commission on December 20, 1999, File No. 0-30444.
2.2 First Modified Joint Plan of Reorganization Proposed by the
Debtor and the Official Committee of Unsecured Creditors dated
May 13, 1997, as amended July 22, 1997, previously filed with the
Company's Registration Statement on Form 10SB filed with the
Securities and Exchange Commission on December 20, 1999, File No.
0-30444.
2.3 Amended Disclosure Statement accompanying First Modified Joint
Plan of Reorganization Proposed by the Debtor and the Official
Committee of Unsecured Creditors dated May 13, 1997, as amended
July 22, 1997, previously filed with the Company's Registration
Statement on Form 10SB filed with the Securities and Exchange
Commission on December 20, 1999, File No. 0-30444.
2.4 Share Purchase Agreement between Sports Group International, Inc.
and Surf City Acquisition Corporation II dated March 15, 1999,
previously filed with the Company's Registration Statement on
Form 10SB filed with the Securities and Exchange Commission on
December 20, 1999, File No. 0-30444.
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2.5 Membership Interest Purchase Agreement between Sports Group
International, Inc. and Apache Peak Capital, L.LC., dated March
12, 1999, previously filed with the Company's Registration
Statement on Form 10SB filed with the Securities and Exchange
Commission on December 20, 1999, File No. 0-30444.
2.6 Share Purchase Agreement between Sports Group International,
Inc., Ziad S. Dalal and Selman Systems, Inc. dated May 21, 1999,
previously filed with the Company's Registration Statement on
Form 10SB filed with the Securities and Exchange Commission on
December 20, 1999, File No. 0-30444.
2.7 Stock Purchase Agreement between Selman Systems, Inc., Kenneth L.
Musgrave, Ltd., Tony Condor and Larry Pearce dated May 21, 1999,
previously filed with the Company's Registration Statement on
Form 10SB filed with the Securities and Exchange Commission on
December 20, 1999, File No. 0-30444.
3.1 Amended and Restated Articles of Incorporation of Sports Group
International, Inc., previously filed with the Company's
Registration Statement on Form 10SB filed with the Securities and
Exchange Commission on December 20, 1999, File No. 0-30444.
3.2 Bylaws of Sports Group International, Inc., previously filed with
the Company's Registration Statement on Form 10SB filed with the
Securities and Exchange Commission on December 20, 1999, File No.
0-30444.
4.1 Promissory Note with United Texas Bank, previously filed with the
Company's Registration Statement on Form 10SB filed with the
Securities and Exchange Commission on December 20, 1999, File No.
0-30444.
4.2 Bank One Promissory Note, previously filed with the Company's
Registration Statement on Form 10SB filed with the Securities and
Exchange Commission on December 20, 1999, File No. 0-30444.
4.3 Promissory Note between SCAC and the Petersen Trust, previously
filed with the Company's Registration Statement on Form 10SB
filed with the Securities and Exchange Commission on December 20,
1999, File No. 0-30444.
-46-
<PAGE>
4.4 Consent and Waiver of Terms of Series A Preferred Stock,
previously filed with the Company's Registration Statement on
Form 10SB filed with the Securities and Exchange Commission on
December 20, 1999, File No. 0-30444.
10.1 Sports Group International, Inc.'s 1999 Stock Option Plan,
previously filed with the Company's Registration Statement on
Form 10SB filed with the Securities and Exchange Commission on
December 20, 1999, File No. 0-30444.
10.2 Employment Agreement between Mr. Kevin A. Blackwell and Sports
Group International, Inc. dated October 1, 1999, previously filed
with the Company's Registration Statement on Form 10SB filed with
the Securities and Exchange Commission on December 20, 1999, File
No. 0-30444.
10.3 Employment Agreement between Mr. David A. Guarino and Sports
Group International, Inc. dated October 1, 1999, previously filed
with the Company's Registration Statement on Form 10SB filed with
the Securities and Exchange Commission on December 20, 1999, File
No. 0-30444.
10.4 Series B Preferred Stock and Warrant Purchase Agreement between
Sports Group International, Inc., Robert E. Petersen and Margaret
Petersen dated May 20, 1999, previously filed with the Company's
Registration Statement on Form 10SB filed with the Securities and
Exchange Commission on December 20, 1999, File No. 0-30444.
10.5 Warrant to purchase 1,000,000 shares of the Company's Common
Stock, previously filed with the Company's Registration Statement
on Form 10SB filed with the Securities and Exchange Commission on
December 20, 1999, File No. 0-30444.
10.6 Master Franchise Agreement between Surf City Squeeze Franchise
Corp. and 1238176 Ontario, Inc. dated July 7, 1998, previously
filed with the Company's Registration Statement on Form 10SB
filed with the Securities and Exchange Commission on December 20,
1999, File No. 0-30444.
10.7 Indemnification Agreement for Kathryn Blackwell, previously filed
with the Company's Registration Statement on Form 10SB filed with
the Securities and Exchange Commission on December 20, 1999, File
No. 0-30444.
-47-
<PAGE>
10.8 Indemnification Agreement for Kevin Blackwell, previously filed
with the Company's Registration Statement on Form 10SB filed with
the Securities and Exchange Commission on December 20, 1999, File
No. 0-30444.
10.9 Indemnification Agreement for David Guarino, previously filed
with the Company's Registration Statement on Form 10SB filed with
the Securities and Exchange Commission on December 20, 1999, File
No. 0-30444.
10.10 Indemnification Agreement for Robert Corliss, previously filed
with the Company's Registration Statement on Form 10SB filed with
the Securities and Exchange Commission on December 20, 1999, File
No. 0-30444.
10.11 Indemnification Agreement for Don Plato, previously filed with
the Company's Registration Statement on Form 10SB filed with the
Securities and Exchange Commission on December 20, 1999, File No.
0-30444.
10.12 Compromise Settlement and Non-Modification Agreement between
Sports Group International, Inc., Selman Systems, Inc., and Ziad
S. Dalal, dated February 1, 2000, previously filed with the
Company's Amendment No. 1 to its Form 10-SB/A Registration
Statement filed with the Securities and Exchange Commission on
February 16, 2000.
11 Computation of Per Share Earnings Located in December 31, 1999
Financial Statements, previously field with the Company's
Amendment No. 3 to its Registration Statement on Form 10SB/A
filed with the Securities and Exchange Commission on April 28,
2000 , File No. 0-30444.
21 Subsidiary Information. (See Chart), previously filed with the
Company's Registration Statement on Form 10SB filed with the
Securities and Exchange Commission on December 20, 1999, File No.
0-30444.
27 Financial Data Schedule, previously filed with the Company's
Amendment No. 3 to its Registration Statement on Form 10SB/A
filed with the Securities and Exchange Commission on April 28,
2000, File No. 0-30444.
-48-
<PAGE>
Pursuant to the requirements of Section 12 of the Securities Exchange Act
of 1934, the registrant has duly caused this registration statement to be signed
on its behalf by the undersigned, thereunto duly authorized.
May 9, 2000 SPORTS GROUP INTERNATIONAL, INC.
By: /s/ Kevin A. Blackwell
------------------------------------
Kevin A. Blackwell, President, Chief
Executive Officer and Director
By: /s/ David A. Guarino
------------------------------------
David A. Guarino Vice President -
Principal Financial Officer and
Director
-49-
<PAGE>
PART F/S
SPORTS GROUP INTERNATIONAL, INC.
CONTENTS TO F/S SECTION
A. Sports Group International, Inc. Financial Statements for the Year ending
December 31, 1999
Consolidated Financial Statements as of December 31, 1999 and
Independent Auditors' Report
B. Registrant's Financial Statements for the Year ending December 31, 1998
(Surf City Squeeze Acquisition Corporation II)
Consolidated Financial Statements as of December 31, 1998 and
Independent Auditors' Report
BUSINESSES ACQUIRED:
C. Selman Systems, Inc.
Consolidated Financial Statements as of December 27, 1998 and
Independent Auditors' Report
D. Fru-Cor, Inc.
Financial Statements as of December 31, 1998 and Independent Auditors'
Report
E. Sports Group International, Inc.
Unaudited Pro Forma Financial Condensed Statements for the years ended
December 31, 1999 and 1998
-50-
<PAGE>
SPORTS GROUP INTERNATIONAL, INC.
TABLE OF CONTENTS
- - --------------------------------------------------------------------------------
Page
INDEPENDENT AUDITORS' REPORT A-2
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheet at December 31, 1999 A-3
Consolidated Statements of Operations for the years ended
December 31, 1999 and 1998 A-4
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1999 and 1998 A-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1999 and 1998 A-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A-8
A-1
<PAGE>
INDEPENDENT ACCOUNTANTS' REPORT
To the Stockholders and Board of Directors of
Sports Group International, Inc.:
We have audited the accompanying balance sheet of Sports Group International,
Inc. as of December 31, 1999 and the related statements of operations,
stockholders' equity and cash flows for each of the two years in the period
ended December 31, 1999. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe 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 Sports Group International,
Inc. as of December 31, 1999, and the results of its operations and cash flows
for each of the two years in the period ended December 31, 1999, in conformity
with generally accepted accounting principles.
/s/ KING, WEBER & ASSOCIATES. P.C.
Tempe, Arizona
April 24, 2000
A-2
<PAGE>
SPORTS GROUP INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1999
- - --------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash $ 644,264
Trade and other accounts receivable,
net of allowance of $22,987 316,983
Inventories 118,908
Prepaid expenses and other assets 42,381
Deferred income taxes 91,001
Notes receivable - current portion, net of allowance 89,193
------------
Total current assets 1,302,730
PROPERTY AND EQUIPMENT, net 3,379,231
LEASE DEPOSITS 153,311
NOTES RECEIVABLE - less current portion 747,516
GOODWILL, net of accumulated amortization of $164,772 5,972,985
DEFERRED INCOME TAXES 289,970
------------
TOTAL ASSETS $ 11,845,743
============
LIABILITIES AND STOCKHOLDERS' EQUITY:
CURRENT LIABILITIES:
Accounts payable $ 952,455
Accrued liabilities 1,054,073
Line of credit 199,555
Notes payable - current portion 804,069
Acquisition notes payable 1,283,264
Confirmed bankruptcy liabilities - current portion 585,775
------------
Total current liabilities 4,879,191
NOTES PAYABLE - long-term portion 671,090
ACQUISITION NOTES PAYABLE - long-term portion 216,736
CONFIRMED BANKRUPTCY LIABILITIES - long term portion 841,669
DEPOSITS HELD UNDER CONTRACT 240,000
DEFERRED FRANCHISE FEE INCOME 214,472
------------
Total liabilities 7,063,158
------------
STOCKHOLDERS' EQUITY:
Series A preferred stock, $10.00 par value,
575,000 shares designated, 575,000 issued 5,750,000
Series B preferred stock, $10.00 par value,
650,000 shares designated, 650,000 issued 6,500,000
Common stock, $.001 par value, 100,000,000 shares
authorized, 8,227,418 issued and outstanding 8,227
Paid in capital 4,048,878
Accumulated deficit (11,524,520)
------------
Total stockholders' equity 4,782,585
------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 11,845,743
============
The accompanying notes are an integral part of these
consolidated financial statements.
A-3
<PAGE>
SPORTS GROUP INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS DECEMBER 31,
- - --------------------------------------------------------------------------------
REVENUES: 1999 1998
------------ ------------
Net product and store sales $ 7,925,096 $ 1,058,238
Franchise fees 380,038 483,088
Royalties 1,457,273 722,130
Rental income 451,062 404,233
------------ ------------
Total revenues 10,213,469 2,667,689
------------ ------------
EXPENSES:
Cost of product sales 2,575,200 437,525
Store operating costs 433,106 164,303
Personnel expenses 3,191,415 720,670
Rent 1,798,382 655,017
Depreciation and amortization 497,127 9,932
General and administrative expenses 1,722,913 506,410
------------ ------------
Total expenses 10,218,143 2,493,857
------------ ------------
OPERATING (LOSS) INCOME (4,674) 173,832
------------ ------------
OTHER (INCOME) AND EXPENSES
Interest expense 258,336 176,806
Interest income (26,078) (23,045)
Other income -- (108,345)
------------ ------------
Total other expense 232,258 45,416
------------ ------------
INCOME BEFORE INCOME TAXES (236,932) 128,416
INCOME TAX (BENEFIT) PROVISION (86,897) 83,503
------------ ------------
NET (LOSS) INCOME $ (150,035) $ 44,913
============ ============
NET (LOSS) PER SHARE:
Basic $ (0.16) $ (0.27)
============ ============
Diluted $ (0.16) $ (0.27)
============ ============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic 5,357,277 2,000,000
============ ============
Diluted 5,357,277 2,000,000
============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
A-4
<PAGE>
SPORTS GROUP INTERNATIONAL, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY FOR THE
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
- - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
COMMON STOCK PREFERRED A PREFERRED B
---------------------------- --------------------------- ---------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
------------ ------------ ------------ ------------ -------- ----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE JANUARY 1, 1998 2,000,000 $ 2,000 $ 575,000 $ 5,750,000 $ -- $ --
Net Income 44,913 44,913
------------ ------------ ------------ ------------ -------- ----------
BALANCE DECEMBER 31, 1998 2,000,000 2,000 575,000 5,750,000 -- --
Reverse Merger 4,300,000 4,300 205,700 210,000
Exercise of warrants in subsidiary 1,750 1,750
Preferred B issued for cash 650,000 6,500,000 6,500,000
Common stock issued as payment
for legal fees and settlment 225,000 225 48,575 48,800
Common stock for preferred
dividends 1,702,418 1,702 717,751 (719,453)
Net income (150,035) (150,035)
------------ ------------ ------------ ------------ -------- ----------
BALANCE
DECEMBER 31, 1999 8,227,418 $ 8,227 575,000 $ 5,750,000 650,000 $6,500,000
============ ============ ============ ============ ======== ==========
PAID-IN ACCUMULATED
CAPITAL DEFICIT TOTAL
------------ ------------ ------------
BALANCE JANUARY 1, 1998 $ 3,075,102 $(10,699,945) $ (1,872,843)
Net Income
------------ ------------ ------------
BALANCE DECEMBER 31, 1998 3,075,102 (10,655,032) (1,827,930)
Reverse Merger
Exercise of warrants in subsidiary
Preferred B issued for cash
Common stock issued as payment
for legal fees and settlment
Common stock for preferred
dividends
Net income
------------ ------------ ------------
BALANCE
DECEMBER 31, 1999 $ 4,048,879 $(11,524,520) $ 4,782,585
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements
A-5
<PAGE>
SPORTS GROUP INTERNATIONAL, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE
YEARS ENDED DECEMBER 31,
- - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CASH FLOWS FROM OPERATING ACTIVITIES: 1999 1998
----------- -----------
<S> <C> <C>
Net income $ (150,035) $ 44,913
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 497,127 9,932
Non cash income (32,729) (97,718)
Deferred income taxes (86,897) 83,502
Legal fees & settlement paid by issuance of common stock 48,800 --
Changes in assets and liabilities (net of business acquisitions):
Trade and other accounts receivable (63,846) (21,216)
Inventories 25,866 (4,309)
Refundable lease deposits (2,724) 61,537
Prepaids and other current assets 123,552 11,122
Other assets 16,680 2,335
Accounts payable 160,269 (100,645)
Accrued liabilities (1,113) 52,368
Deferred franchise fee income 175,034 (279,432)
----------- -----------
Net cash provided by (used in) operating activities 709,984 (237,611)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (248,696) --
Financing of notes receivable (124,604) --
Collections on notes receivable 111,277 348,688
Proceeds from sale of property and equipment -- 472,000
Purchase of business (6,500,000) --
----------- -----------
Net cash (used in) investing activities (6,762,023) 820,688
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings on line of credit 199,555 --
Proceeds from borrowings on notes payable 1,324,500 129,000
Principal repayments on notes payable (1,114,044) (298,872)
Payments on confirmed bankruptcy liabilities (444,925) (574,231)
Proceeds from the sale of preferred stock 6,500,000 --
Proceeds from sale of common stock 211,750 --
----------- -----------
Net cash provided by (used in) financing activities 6,676,836 (744,103)
----------- -----------
INCREASE (DECREASE) IN CASH 624,797 (161,026)
CASH, BEGINNING OF YEAR 19,467 180,493
----------- -----------
CASH, END OF YEAR $ 644,264 $ 19,467
=========== ===========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
A-6
<PAGE>
SPORTS GROUP INTERNATIONAL, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS, (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31,
- - --------------------------------------------------------------------------------
SUPPLEMENTAL CASH FLOW INFORMATION: 1999 1998
---------- ----------
Interest paid $ 233,940 $ 84,564
========== ==========
Income taxes paid $ 12,200 $ --
========== ==========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING
AND FINANCING ACTIVITIES:
Purchase of business by issuance of notes payable $1,500,000
==========
Common stock for legal fees and settlement $ 48,800
==========
Preferred stock issued for business acquisition $5,750,000
==========
Common stock issued for business acquisition $ 2,000
==========
Common stock issued as preferred stock dividends $1,702,418
==========
Sale of property & equipment under notes receivable $ 462,253 $ 65,000
========== ==========
Debt for legal settlement $ 10,419
==========
Notes receivable for franchise fees $ 122,386
==========
Accrued interest added to bankruptcy liabilities $ 36,224
==========
The accompanying notes are an integral part of these
consolidated financial statements.
A-7
<PAGE>
SPORTS GROUP INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
- - --------------------------------------------------------------------------------
1. ORGANIZATION AND BASIS OF PRESENTATION
Sports Group International, Inc. (the "Company") was formed in 1997 under
its former name, Secretarial Services of Orlando, Inc. The Company merged
with Surf City Acquisition Corporation II ("SCAC") in March 1999 by the
issuance of 2,000,000 shares of common stock and 575,000 shares of Series A
Preferred Stock. Prior to its merger with SCAC, the Company had no
significant operations. SCAC was formed as a holding company to acquire and
recapitalize Surf City Squeeze, Inc., an entity operating in a Chapter 11
bankruptcy, and other affiliated entities. Under the confirmed bankruptcy
plan, SCAC acquired all of the outstanding interests in the following
entities: Surf City Squeeze, Inc. ("Surf City"), Surf City Squeeze
Franchise Corporation ("SCSFC") and Kona Coast Provisions, Inc. ("Kona")
and Malibu Smoothie Franchise Corporation ("Malibu Smoothie"). SCAC,
through its operating subsidiaries, operates and franchises juice bars in
the United States and Canada. The stores are generally located in shopping
malls and health clubs and operate under the name of "Surf City Squeeze".
On May 21, 1999, the Company issued 650,000 shares of its Series B
Convertible Preferred Stock for $6,500,000. The proceeds were used to
acquire all of the issued and outstanding stock of Selman Systems, Inc.
("Selman"), an operator and franchisor of a chain of cafes and bakeries
operating under the name of Frullati Cafe and Bakery ("Frullati").
On July 7, 1999, the Company, through Selman, purchased all of the
outstanding stock of Fru-Cor, Inc., ("Fru-Cor") an owner of eight Frullati
locations. The purchase was effected through the issuance of a promissory
note for $1,200,000.
The accompanying financial statements represent the consolidated financial
position and results of operations of the Company and includes the accounts
and results of operations of the Company and its wholly owned subsidiaries
for the twelve months ended December 31, 1999. The consolidated results of
operations and cash flows for the twelve months ended December 31, 1999
include that of Frullati and Frucor from the respective acquisition dates
through December 31, 1999.
As a result of the merger transaction with SCAC, the former SCAC
stockholders held approximately 69% of the Company's voting stock. For
financial accounting purposes, the acquisition was a reverse acquisition of
the Company by SCAC, under the purchase method of accounting, and was
treated as a recapitalization with SCAC as the acquirer. Accordingly, the
historical financial statements have been restated after giving effect to
the March 15, 1999, acquisition of the Company. The financial statements
have been prepared to give retroactive effect to January 1, 1998, of the
reverse acquisition completed on March 15, 1999, and represent the
operations of SCAC. Consistent with reverse acquisition accounting: (i) all
of SCAC's assets, liabilities, and accumulated deficit, are reflected at
their combined historical cost (as the accounting acquirer) and (ii) the
preexisting outstanding shares of the Company (the accounting acquiree) are
reflected at their net asset value as if issued on March 15, 1999.
A-8
<PAGE>
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH includes all short-term highly liquid investments that are readily
convertible to known amounts of cash and have original maturities of three
months or less. At times cash deposits may exceed government insured
limits. At December 31, 1999, cash deposits exceeded those insured limits
by $ 406,488.
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include
the accounts of the Company and its wholly owned subsidiaries, SCAC, Surf
City, SCSFC, Kona, Malibu Smoothie, Selman and its two operating
subsidiaries, Frullati Enterprises, Inc. and Frullati Franchise Systems,
Inc. and Frucor. All significant intercompany accounts and transactions are
eliminated.
INVENTORIES consist primarily of food products, drink mixes, supplements
and supplies. Inventories are recorded at the lower of cost or market on a
first-in, first-out basis.
PROPERTY AND EQUIPMENT is stated at cost less accumulated depreciation.
Depreciation is recorded on a straight-line basis over a period of the
shorter of the applicable lease term or the estimated useful lives of the
assets ranging from 3 to 10 years. Depreciation expense for the years ended
December 31, 1999 and 1998 was $332,355 and $9,932, respectively.
REVENUE RECOGNITION - Initial franchise fees are deferred until
substantially all services and conditions relating to the sale of the
franchise have been performed or satisfied. The Company will occasionally
finance the initial franchise fee by taking a note receivable from the
franchisee. The notes receivable are typically payable by the franchisee
over five years. Due to uncertainties relative to the success of these
stores and franchisees, revenue on the financed initial franchise fees is
recognized on an installment basis until 30% of the principal balance of
the note is collected. At that time, the remaining deferred balance is
recognized as revenue.
Fees from Area Development Agreements ("ADA") are recognized as revenue on
a pro rata basis based on the number of stores opened to-date to total
stores to be developed as stipulated in the ADA. If the total number of
stores stipulated in the ADA are not opened at the expiration of the ADA,
the balance of such fees is recognized.
Kona sells mixes and supplements to franchisees. Revenue on such sales is
recognized when the product is shipped. Sales from the Company owned stores
are recognized at the point of sale.
The Company also receives sublease rental income. The Company is the
primary lessee on certain franchised stores. Rental income is recognized
ratably over the term of the subleases.
INCOME TAXES - The Company provides for income taxes based on the
provisions of Statement of Financial Accounting Standards No. 109,
ACCOUNTING FOR INCOME TAXES, which, among other things, requires that
recognition of deferred income taxes be measured by the provisions of
enacted tax laws in effect at the date of financial statements.
A-9
<PAGE>
FINANCIAL INSTRUMENTS - Financial instruments consist primarily of cash,
accounts receivable, notes receivable, and obligations under accounts
payable, accrued expenses, notes payable and confirmed bankruptcy
obligations. The carrying amounts of cash, accounts receivable, accounts
payable and accrued expenses approximate fair value because of the short
maturity of those instruments. The carrying value of the Company's notes
receivable approximate fair value because they contain market interest
rates and allowances are provided for any estimated uncollectible amounts.
The carrying value of notes payable and confirmed bankruptcy obligations
approximate fair value because they contain market value interest rates and
have specified repayment terms. The Company has applied certain assumptions
in estimating these fair values. The use of different assumptions or
methodologies may have a material effect on the estimates of fair values.
USE OF ESTIMATES - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
ADVERTISING EXPENSES are expensed as incurred. Advertising expense was for
the year ended December 31, 1999 and 1998 were $54,000 and $4,500,
respectively.
GOODWILL is recorded for the difference between the purchase price of the
acquired business and the fair value of the identifiable net assets.
Goodwill is amortized on a straight-line basis over 20 years. The 20-year
period is based on the initial and renewable franchise periods in most
franchise agreements.
STOCK-BASED COMPENSATION - Statements of Financial Accounting Standards No.
123, ACCOUNTING FOR STOCK-BASED COMPENSATION, ("SFAS 123") established
accounting and disclosure requirements using a fair-value based method of
accounting for stock-based employee compensation. In accordance with SFAS
123, the Company has elected to continue accounting for stock based
compensation using the intrinsic value method prescribed by Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees." The proforma effect of the fair value method is discussed in
Note 15.
IMPAIRMENT OF LONG-LIVED ASSETS are assessed by the Company for impairment
whenever there is an indication that the carrying amount of the asset may
not be recoverable. Recoverability of these assets is determined by
comparing the forecasted undiscounted cash flows generated by those assets
to the assets' net carrying value. The amount of impairment loss, if any,
is measured as the difference between the net book value of the assets and
the estimated fair value of the related assets. Assets held for sale are
recorded at fair value less selling costs.
3. BANKRUPTCY PETITION AND REORGANIZATION
On January 13, 1997, Surf City filed a voluntary petition for relief (under
Chapter 11 of the United States Bankruptcy Code) in the United States
Bankruptcy Court for the District of Arizona. The bankruptcy plan was
confirmed by the Court on November 18, 1997 to become effective within 45
days of confirmation (the "Plan").
A-10
<PAGE>
Surf City's largest single creditor was also a significant shareholder of
Surf City at the time of the bankruptcy. Immediately prior to filing the
bankruptcy petition, Surf City reached an agreement with the creditor for
discharge and settlement of $3,500,000 in debt. As part of that agreement,
the creditor also agreed to provide $800,000 in cash to the Company as
settlement of various claims made against the creditor by the Company. The
Company used the funds as its investment in Surf City and the related
operating subsidiaries. The controlling ownership of Surf City and the
other operating subsidiaries did not change as a result of this
transaction. Due to the controlling ownership of operating companies
effectively remaining with the same shareholders after the acquisition, the
purchase is recorded at the existing bases of the net assets of the
operating companies. There are no adjustments to reflect the differences
between the fair values and book values of the net assets at the time of
the transaction.
Debts that were subject to compromise under the Plan include priority
claims for sales taxes, secured claims from equipment vendors, contractors,
landlords and franchisees, and certain administrative and unsecured claims.
The majority of unsecured claims in the Plan are those commitments of Surf
City for future rents due under real property operating leases. Surf City
rejected certain material operating leases under the Plan. All allowed
claims under the Plan are recorded at the present value of those debts
based on the confirmed repayment terms and discount rates of 8% to 10%.
The allowed General Unsecured Claims under the Plan includes a contingency
for payments based on future cash flow of Surf City and its subsidiaries.
The terms of the repayment of the General Unsecured Claims require minimum
quarterly payments of $43,750 over a seven year period to an Unsecured
Creditors Pool, resulting in a minimum of $1,225,000 payable over that
seven year period. In addition, amounts determined as 25% of the first
$50,000 of quarterly Net Cash Flow, as defined in the Plan, and 40% of the
quarterly Net Cash Flow in excess of $50,000, are required to be paid to
the Unsecured Creditors Pool on a quarterly basis. The Company has recorded
the General Unsecured Claims liability at the present value of the 28
quarterly payments of $43,750. The Plan lists the total General Unsecured
Claims to be $5,000,000 to $6,000,000, but states that much of that
estimate arises from the rejection of unexpired operating leases. The
Company believed that it could not reasonably estimate the amount of those
claims at the time of the Plan confirmation because the damages arising
from rejected leases are likely to be reduced as the locations under those
leases are re-leased to new tenants. The Company also believes that it
cannot reasonably estimate the amount of contingency payments because of
uncertainties in Surf City's likelihood to generate net cash flow and the
inability to estimate the timing of any such Net Cash Flow if it does
occur. Surf City has not yet made any contingent payments to the Unsecured
Creditors Pool.
4. NOTES RECEIVABLE
Notes receivable principally result from the financing of the initial
franchise fees required from franchisees and the sale of corporate owned
stores and certain related expenses paid for on behalf of the franchisees.
The notes are generally guaranteed by the franchisee or purchaser and are
collateralized by the related juice bar business, and associated equipment
and leasehold improvements. The notes are generally due in monthly
installments of principal and interest with interest at 10% per annum.
A-11
<PAGE>
The Company periodically reviews the collectibility of its notes
receivable. Due to matters related to the Surf City bankruptcy, certain
notes were written off or allowances for credit losses were established.
The Company recognizes interest income on notes it has determined to be
impaired only when payments are received.
At December 31, 1999, the Company has determined that one note receivable
is impaired. The allowance for credit losses on notes receivable was $8,605
at December 31, 1999. The allowance for credit losses decreased by $46,921
for the year ended December 31, 1999. At December 31, 1999, the investment
in impaired notes receivable was $14,751. The average balance of impaired
notes receivable was $68,650 and $149,771 for the years ended December 31,
1999 and 1998 respectively. Interest income earned on impaired notes
receivable was $1,748 and $3,375 for the years ended December 31, 1999 and
1998 respectively.
5. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 31, 1999:
Leasehold improvements $ 2,534,027
Store fixtures, equipment and furnishings 1,086,012
Office furnishings and equipment 59,210
Construction-in-progress 31,181
-----------
Total 3,710,430
Less accumulated depreciation (331,199)
-----------
Property and equipment, net $ 3,379,231
===========
The Company's operating plan includes the sale of all or a majority of the
Corporate owned stores. All stores will continue normal operations as the
Company seeks buyers and negotiates the sales of the stores. The Company
does not believe that there is a net impairment on the assets held for
sale.
6. NOTES PAYABLE
Notes payable at December 31, 1999 are comprised of the following:
$200,000 Revolving line of credit, interest at
Federal Funds rate plus 0.42% which was computed
to be 5.17% at December 31, 1999. The credit
facility expires on January 10, 2001. Personally
guaranteed by three stockholders. $199,555
Term loan from bank. Repayment terms require
monthly installments of principal and interest
at Federal Funds rate plus 0.42%, 5.17% at December
31, 1999 of $25,000 commencing on February 1, 2000
through 2003. Personally guaranteed by three
stockholders. 800,000
A-12
<PAGE>
Note payable to stockholder, original balance of
$332,500, interest at 10% per annum, principal
and interest installments of $14,882 due monthly
through 2001. Personally guaranteed by other
stockholders. 194,140
Notes payable to franchisees in settlement of
legal claims. Repayment terms require monthly
installments of principal and interest at 10% per
annum of $7,500 through 2002. Collateralized by
royalties and franchise fees of designated store
locations. Original principal balance of notes
was $335,000. 151,422
Note payable to equipment vendor. Payment terms
require monthly installments $7,000 through
July 2000. The stated balance of promissory note
is $215,129. A balloon payment of $71,129 is due
July 15, 2000. The promissory note has no stated
interest. The present value of the note was
determined using a discount rate of 10%.
Collateralized by certain royalties and shares of
the Company's common held by the Company's
president. Personally guaranteed by the Company's
president. 108,934
Two note payables arising out of settlements for
operating matters. No stated interest due to
short-term nature of nature, both of which are
due in September 2000. 220,663
Acquisition note payable related to the acquisition
of Selman. Repayment terms require monthly
installments of principal and interest at 9% per
annum of $9,540 starting on February 1, 2000 for
three years. Collateralized by royalties of
designated store locations. 300,000
Acquisition note payable related to the acquisition
of Fru-Cor. Interest at 9%, monthly interest only
payments, note is due and payable in full, plus
accrued interest, on May 21, 2000. Collateralized
by the stock of Selman. 1,200,000
----------
Totals 3,174,714
Less current portion (2,286,888)
----------
Long-term portion $ 887,826
==========
A-13
<PAGE>
Principal payments due as follows:
Year ended December 31: 2000 $ 2,286,888
2001 487,018
2002 400,808
-----------
Total $ 3,174,714
===========
Significant royalty income generated by the Company is pledged as
collateral on certain of the above notes.
The Company had, at December 31, 1999 unused lines of credit in the amount
of $100,455.
The acquisition note payable for $1,200,000 is due in full on May 21, 2000.
The Company is in negotiations with the note holder to restructure the
note. The Company anticipates the renegotiated terms to include
installments through the year 2000. However, there can be no assurances
that the Company will be successful in securing those new terms on this
note.
7. BUSINESS COMBINATIONS
On March 15, 1999, the Company exchanged 575,000 shares of Series A
Convertible Preferred Stock ("Series A Preferred") and 2,000,000 shares of
common stock for all of the common stock of Surf City Acquisition
Corporation II ("SCAC") and its wholly owned subsidiaries. The preferred
stock has voting rights and is convertible to common stock at a ratio of 13
1/3 per share, resulting in the shareholders of SCAC obtaining control of
the voting interest in the Company at the time of the transaction.
Additionally, SCAC's management and board of directors became the new
management of the Company. The Company had no material assets or operations
at the time of the transaction. For financial accounting purposes, the
acquisition was a reverse merger and was treated as a recapitalization with
SCAC as the acquirer.
On May 21, 1999, the Company issued 650,000 shares of its Series B
Convertible Preferred Stock for $6,500,000. The proceeds were used to
acquire all of the issued and outstanding stock of Selman Systems, Inc.
("Selman"), an operator and franchisor of a chain of cafes and bakeries
under the name of Frullati Cafe and Bakery ("Frullati"). The acquisition
was recorded under the purchase method of accounting. The aggregate
purchase price has been allocated to the assets acquired and liabilities
assumed based on their respective fair values at the date of acquisition.
The excess consideration paid over the fair market value of the net assets
acquired of $4,940,343 is recorded as goodwill. The operating results of
Selman are included in the accompanying consolidated financial statements
for the period May 21, 1999 through December 31, 1999.
On July 7, 1999, the Company, through Selman, purchased all of the
outstanding stock of Fru-Cor, Inc., an owner of eight Frullati locations.
The purchase was effected through the issuance of a promissory note for
$1,200,000 plus assumption of other debt. The note is due on May 21, 2000.
The acquisition was recorded under the purchase method of accounting. The
aggregate purchase price has been allocated to the assets acquired and
liabilities assumed based on their respective fair values at the date of
acquisition. The excess consideration paid over the fair market value of
the net assets acquired of $1,197,414 is recorded as goodwill.
A-14
<PAGE>
The operating results of Fru-Cor are included in the accompanying
consolidated financial statements for the period July 7, 1999 through
December 31, 1999.
The following summarizes unaudited pro forma consolidated financial
information for the years ended December 31, 1999 and 1998 assuming that
the acquisitions of Selman and Fru-Cor occurred on January 1, 1999:
1999 1998
----------- -----------
Net sales $16,099,672 16,805,172
Net income/(loss) $ (309,408) (298,998)
Basic loss per share $ (0.19) (0.29)
The pro forma financial information is presented for informational purposes
only and may not necessarily reflect the results had Selman and Fru-Cor
actually been acquired on January 1, 1999, nor is this information
indicative of the future consolidated results.
8. INCOME TAXES
The Company recognizes deferred income taxes for the differences between
financial accounting and tax bases of assets and liabilities. Income taxes
for the years ended December 31, 1999 and 1998 consisted of the following:
1999 1998
--------- ---------
Current tax (benefit) provision $(107,559) $(102,453)
Deferred tax (benefit) provision 20,662 185,956
--------- ---------
Total income tax provision $ (86,897) $ 83,503
========= =========
Net deferred tax assets of $3,392,758 less a valuation allowance of
$3,011,787, relate primarily to net operating loss carryforwards and
differences in book and tax bases of property and equipment, deferred
revenue and notes receivable. The net deferred income tax asset at December
31, 1999 is comprised of:
Allowance for losses on notes and accounts receivable $ 18,241
Differences in liabilities related to deferred
revenue and rent 72,760
Net operating loss carryforwards 3,537,717
-----------
Deferred income tax asset 3,628,718
Less: valuation allowance (3,011,787)
-----------
Total deferred income tax asset 616,931
Deferred income tax liability related to book/tax
differences in bases of property and equipment
and goodwill (235,950)
-----------
Net deferred income tax asset $ 380,981
===========
A-15
<PAGE>
Federal net operating loss carryforwards of $8,588,000 expire from 2010
through 2018. State net operating loss carryforwards of $8,588,000 expire
from 2000 through 2003. Due to the change in control of the Company
discussed in Note 7, future utilization of the net operating losses may be
restricted.
The differences between the statutory and effective tax rates is as follows
for the years ended December 31:
1999 1998
--------------- ---------------
Federal statutory rates $(74,634) (32)% 33,333 26%
State income taxes (18,955) (8)% 10,723 8%
Valuation allowance for
operating loss carryforwards 31,094 24%
Other 6,691 3% 8,353 7%
-------- ---- -------- ----
Effective rate $(86,898) (37)% 83,503 65%
======== ==== ======== ====
Income taxes for the year ended December 31, 1998 reflect a reversal of
certain temporary differences that reduced the net deferred income tax
asset as well as an increase in the valuation allowance for uncertainties
relative to the future utilization of net operating loss carryforwards.
9. LEASES
Surf City, SCSFC and Selman are the primary lessees on most of their
franchised stores under long-term operating leases. The leases generally
have initial terms of five to seven years and usually provide for renewal
options ranging from five to seven additional years. These operating leases
expire at various dates through 2007. Most of the leases contain escalation
clauses and common area maintenance charges. The franchised locations are
subleased to the franchisees. There were approximately 117 leases under
these terms at December 31, 1999. The Company records rent expense and
sublease rental income only on locations at a certain health club chain
because the Company is directly responsible for payment to the landlord and
collection from the franchisee. On other store locations, the franchisees
have direct responsibility for payment to the lessor. Rent expense under
the leases in which the Company is directly responsible, including
corporate owned stores, was $1,798,382 for the year ended December 31,
1999. Sublease rental income under these leases was $451,062 for the year
ended December 31, 1999.
The Company also leases its offices and warehouses under long-term
operating leases expiring through 2001. Rent expense under these leases was
$159,496 for the year ended December 31, 1999.
A-16
<PAGE>
Future minimum annual lease payments and sublease rentals under operating
lease agreements for years ended December 31 are:
Sublease Warehouse
Store Leases Rental and Office
----------- ----------- -----------
2000 $ 5,918,865 $ 5,339,459 $ 70,334
2001 5,934,255 5,353,320 38,711
2002 6,108,427 5,541,969 --
2003 4,992,232 4,451,200 --
2004 4,081,612 3,639,827 --
Thereafter 7,318,868 6,254,061 --
----------- ----------- -----------
$34,354,259 $30,579,836 $ 109,045
=========== =========== ===========
10. STOCKHOLDERS' EQUITY
The Company issued 575,000 shares of its Series A Convertible Preferred
Stock in connection the SCAC merger. The Series A Preferred Stock has a $10
par and liquidation value. The Series A Preferred also has a 10% per annum
cumulative dividend payable quarterly. The dividend can be paid in cash or
common stock of the Company at the option of the holder. Series A Preferred
stock is convertible to the Company's common stock at the option of the
holder at a rate of 13 1/3 shares of common for each share of Series A
Preferred.
The holders of Series A Preferred stock are entitled to vote in the same
matters as the common shareholders at a ratio of 13 1/3 votes per share of
Series A Preferred held.
The Company issued 650,000 shares of its Series B Convertible Preferred
Stock for $6,500,000. The Series B Preferred Stock has a $10 par and
liquidation value. The Series B Preferred also has a 10% per annum
cumulative dividend payable quarterly. The dividend can be paid in cash or
common stock of the Company at the option of the holder. For purposes of
liquidation and dividends, Series B ranks on parity with Series A. Series B
Preferred stock is convertible to the Company's common stock at the option
of the holder at a rate of 10 shares of common for each share of Series B
Preferred. The holders of Series B Preferred stock are entitled to vote in
the same matters as the common shareholders at a ratio of 10 votes per
share of Series B Preferred held.
During the year ended December 31, 1999, the Company issued 1,702,418
shares of its common stock as payment of preferred dividends through
December 1, 1999. The number of common shares issued was based on the
trading value of the common stock, less a 50% discount for the restricted
nature of the shares issued, and the amount of the dividend determined on
the stated rate of 10%.
The Company issued 225,000 shares of its common stock in settlement of
amounts due under a legal settlement and related attorneys fees. The value
of the shares was determined based on the trading value of the Company's
common stock less a 10% discount for the restricted nature of the shares
issued.
A-17
<PAGE>
Prior to the merger with SCAC, the Company's board of directors approved a
reverse stock split of one common share for every two common shares issued
and outstanding.
Also prior to the merger with SCAC, the Company issued 4,247,516 shares of
its common stock in a private offering for $210,000.
11. COMMITMENTS AND CONTINGENCIES
As discussed in Note 6, certain of the Company's notes payable are
collateralized by revenue generated from royalties.
As discussed in Note 3, there are contingent amounts payable to an
Unsecured Creditors Pool subject to quarterly cash flows through 2004.
The Company had filed a lawsuit during 1999 seeking declaratory relief that
a merger agreement with a third party was never consummated, but rather it
expired under its own terms and conditions. The third party responded with
a cross-complaint against the Company seeking both monetary damages and
declaratory relief for breach of the merger agreement.
On April 14, 2000, the San Diego Superior Court ruled in the Company's
favor on its declaratory relief action against the third party. The Court
found that the Company and the third party did not merge in 1999, and that
the Company was justified in rejecting the proposed merger with the third
party. The Court's decision establishes that the Company and the third
party are separate and independent entities. The Court also ruled in the
Company's favor on the third party's cross complaint for breach of contact.
There are certain claims by creditors of the third party against the
Company for certain obligations of the third party based solely on the
theory that the two companies merged. Given the Court's April 14, 2000
ruling, the Company believes that all of these claims will be resolved
without a material adverse effect on the Company's financial condition.
A-18
<PAGE>
12. NET INCOME PER SHARE
Net loss per share is calculated using the weighted average number of
shares of common stock outstanding during the year. Preferred stock
dividends are subtracted from the net income to determine the amount
available to common shareholders. Preferred stock convertible to 14,166,667
and 7,666,667 common shares were not considered in the calculation for
diluted earnings per share for the years ended December 31, 1999 and 1998,
respectively, because the effect of their inclusion would be antidilutive.
<TABLE>
<CAPTION>
1999 1998
------------------------------- -------------------------------
INCOME PER INCOME PER
(LOSS) SHARES SHARE (LOSS) SHARES SHARE
--------- --------- ----- --------- --------- -----
<S> <C> <C> <C> <C> <C> <C>
Net (Loss) Income $(150,035) $ 44,913
Preferred stock
dividends (719,453) (575,000)
BASIC EARNINGS
PER SHARE
Loss available to
common stockholders $(869,488) 5,357,277 $(0.16) $(530,087) 2,000,000 $(0.27)
Effect of dilutive
securities N/A N/A
DILUTED EARNINGS
PER SHARE N/A N/A
</TABLE>
13. RELATED PARTY TRANSACTIONS
The Company's officers and stockholders have personally guaranteed certain
of the Company's operating leases. The Company's president is named as the
lessee on the lease of one of the Company's warehouse leases.
As discussed in Note 5, the Company has debt due to related parties and
certain debt includes a personal guarantee and pledge of common stock owned
by the Company's president.
In February 1999, the holder of the Series B Preferred Stock loaned SCAC
$332,500 under a promissory note. The Company paid interest on this note of
$20,457 during the year ended December 31, 1999. The same shareholder, and
two of the Company's officers, have guaranteed $1,000,000 in bank debt. The
company received a favorable interest rate because of the shareholders'
guarantee. The shareholder was compensated by the reduction of the exercise
price of common stock warrants held by this shareholder from $2.00 per
share to $0.40 per share.
A-19
<PAGE>
From time to time, the Company borrows funds from certain of its officers.
No interest was incurred on these loans.
14. CONCENTRATION OF CREDIT RISK
The Company maintains cash balances at banks in Arizona, Texas and
Louisiana. Accounts are insured by the Federal Deposit Insurance
Corporation up to $100,000. At December 31, 1999, the Company had no
uninsured bank balances.
Financial instruments that potentially subject the Company to
concentrations of credit risk are primarily notes receivable and trade
accounts receivable. The trade accounts receivable are due primarily from
franchisees in numerous geographical locations in the United States. The
Company has not historically experienced material losses due to
uncollectible trade accounts receivable.
The Company's notes receivable are generally due from franchisees and are
guaranteed by the franchisee and collateralized by leasehold improvements
and rights under the franchise agreement. The Company has experienced
credit losses under notes receivable and has generally foreclosed on the
related stores and attempted to re-franchise those locations. The notes
receivable balance at December 31, 1999 is comprised of numerous debtors.
However, one creditor represents approximately 32%, another 21%, and two
others 11% each of the total balance at December 31, 1999. Therefore, 75%
of the notes receivable balance at December 31, 1999 are concentrated with
four debtors. No other single note or debtor comprises greater than 10% of
the total balance at December 31, 1999.
15. STOCK BASED COMPENSATION
The Company issues stock options from time to time to executives, key
employees and members of the Board of Directors. The Company has adopted
the disclosure-only provisions of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation," and continues
to account for stock based compensation using the intrinsic value method
prescribed by Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees". Accordingly, no compensation cost has been
recognized for the stock options granted to employees. Had compensation
cost for the Company's stock options been determined based on the fair
value at the grant date for awards in 1999, consistent with the provisions
of SFAS No. 123, the Company's net loss and loss per share would have been
increased to the pro forma amounts indicated below:
1999
---------
Net Loss - as reported $(150,035)
Net Loss - pro forma $(213,581)
Loss per share - as reported $ (0.16)
Loss per share - pro forma $ (0.17)
There were no stock options granted or outstanding in the year ended
December 31, 1998. Under the provisions of SFAS No. 123, there were no
fully vested options and 85,556 proportionately vested options for the year
ended December 31, 1999 used to determine net earnings and earnings per
share under a pro forma basis.
A-20
<PAGE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions for
years ended December 31:
1999
----
Dividend yield None
Volatility 3.196
Risk free interest rate 6.00%
Expected asset life 5 years
Under the Employee Incentive Stock Option Plan approved by the stockholders
in 1999, the total number of shares of common stock that may be granted is
2,000,000. The plan provides that shares granted come from the
Corporation's authorized but unissued common stock. The price of the
options granted pursuant to these plans will not be less than 100 percent
of the fair market value of the shares on the date of grant. The options
expire ten years from date of grant.
During the year ended December 31, 1999, the Company granted 1,240,000
options to certain key employees. These options all vest over three years.
Of these options, 600,000 and 640,000 were granted at an exercise price of
$1.00 and $0.50 per share respectively, the fair market value of the
underlying shares on the date of grant. The options expire ten years from
date of grant. The summary of activity for the Company's stock options is
presented below:
Weighted
Average
Exercise
1999 Price
---- -----
Options outstanding at beginning of year 0
Granted 1,240,000 $ 0.74
Exercised 0
Terminated/Expired 0
Options outstanding at end of year 1,240,000 $ 0.74
Options exercisable at end of year 0
Options available for grant at end of year 760,000
Price per share of options outstanding $0.06 - $0.42
Weighted average remaining contractual lives 9.8 years
Weighted Average fair value of options granted
during the year $0.53
A-21
<PAGE>
In conjunction with the issuance of the Series B Preferred Stock, the
Company granted 1,000,000 warrants to purchase the Company's common. Those
warrants were repriced $0.40 per share in December 1999 as consideration to
the shareholder for that shareholder's personal guarantee on bank debt.
There was no expense recognized in either the original grant or the
repricing. The exercise price of the warrants exceeded the trading value of
the Company's common stock at the time of issuance and repricing.
16. EMPLOYEE BENEFIT PLAN
Selman maintains a 401(k) savings plan for its employees. Employees are
eligible to participate in the plan upon reaching age 21 and completion of
six months of service. Selman matches 25% of the first 6% of the employee's
salary contributed to the plan. Selman made matching contributions to the
plan of $2,882 for the year ended December 31, 1999.
* * * * * *
<PAGE>
SURF CITY ACQUISITION CORPORATION II
TABLE OF CONTENTS
PAGE
----
INDEPENDENT AUDITORS' REPORT B-1
CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 1998:
Consolidated Balance Sheet B-2
Consolidated Statements of Operations B-3
Consolidated Statements of Stockholders' (Deficit) B-4
Consolidated Statements of Cash Flows B-5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS B-7
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
Surf City Acquisition Corporation II:
Scottsdale, Arizona
We have audited the accompanying consolidated balance sheet of Surf City
Acquisition Corporation II (the "Company"), as of December 31, 1998, and the
related statements of operations, stockholders' (deficit) and cash flows for
each of the two years in the period ended December 31, 1998. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated 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 our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Surf
City Acquisition Corporation II at December 31, 1998, and the consolidated
results of its operations and its cash flows for each of the two years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles.
KING, WEBER & ASSOCIATES, P.C.
Tempe, Arizona
November 18, 1999
<PAGE>
SURF CITY ACQUISITION CORPORATION II
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1998
ASSETS
CURRENT ASSETS
Cash $ 19,467
Trade accounts receivable 137,889
Other receivables 15,217
Inventories 59,138
Prepaid expenses and other assets 5,157
Notes receivabl, net - current portion 115,473
------------
Total current assets 352,341
PROPERTY AND EQUIPMENT, net 12,556
LEASE DEPOSITS 150,587
NOTES RECEIVABLE, net - less current portion 134,922
DEFERRED INCOME TAXES 492,665
OTHER ASSETS 12,134
------------
TOTAL ASSETS $ 1,155,205
============
LIABILITIES AND STOCKHOLDERS' EQUITY:
CURRENT LIABILITIES:
Accounts payable $ 231,396
Accrued liabilities 143,531
Notes payable - current portion 332,877
Confirmed bankruptcy liabilities - current portion 843,572
------------
Total current liabilities 1,551,376
NOTE PAYABLE - long-term portion 260,358
LEASE SECURITY DEPOSITS HELD 11,666
CONFIRMED BANKRUPTCY LIABILITIES - long term portion 1,055,997
DEFERRED FRANCHISE FEE INCOME 103,738
------------
Total liabilities 2,983,135
------------
STOCKHOLDERS' (DEFICIT):
Serial preferred stock, $10.00 par value,
1,000,000 shares authorized, none issued
Common stock, $.01 par value, 10,000,000
shares authorized, 825,000 issued and outstanding 8,250
Paid in capital 8,818,852
Accumulated deficit (10,655,032)
------------
Total stockholders' (deficit) (1,827,930)
------------
TOTAL LIABILITIES AND STOCKHOLDERS' (DEFICIT) $ 1,155,205
============
The accompanying notes are an integral part of these
consolidated financial statements.
B-2
<PAGE>
SURF CITY ACQUISITION CORPORATION II
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
1998 1997
----------- -----------
Debtor-in-
Possession
REVENUES:
Net product sales $ 1,049,997 $ 1,706,117
Franchise fees 483,088 321,165
Royalties 722,130 656,174
Rental income 404,233 591,963
Other 8,241 40,278
----------- -----------
Total revenues 2,667,689 3,315,697
----------- -----------
EXPENSES:
Cost of product sales 437,525 511,542
Store operating costs 164,303 372,832
Personnel expenses 720,670 1,199,023
Rent 655,017 928,596
Franchising expense 21,429 59,675
General and administrative expenses 494,913 662,008
----------- -----------
Total expenses 2,493,857 3,733,676
----------- -----------
OPERATING INCOME (LOSS) 173,832 (417,979)
----------- -----------
OTHER (INCOME) AND EXPENSES
Interest expense 176,806 75,851
Interest income (23,045) --
Other income (108,345) (20,520)
----------- -----------
Total other expense 45,416 55,331
----------- -----------
INCOME (LOSS) BEFORE REORGANIZATION ITEMS
AND INCOME TAXES 128,416 (473,310)
REORGANIZATION ITEMS -- 1,180,585
----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES 128,416 (1,653,895)
INCOME TAX PROVISION/(BENEFIT) 83,503 (27,691)
----------- -----------
NET INCOME (LOSS) $ 44,913 $(1,626,204)
=========== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
B-3
<PAGE>
SURF CITY ACQUISITION CORPORATION II
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
---------------------- PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
------ ------ ------- ------- -----
<S> <C> <C> <C> <C> <C>
BALANCE
JANUARY 1, 1997 3,972,200 $ 39,722 $7,987,380 $ (9,073,741) $(1,046,639)
Bankruptcy reorganization (3,972,200) (39,722) 39,722 0
Recapitalization 8,250,000 8,250 791,750 800,000
Net loss (1,626,204) (1,626,204)
---------- --------- ---------- ------------ -----------
BALANCE
DECEMBER 31, 1997 8,250,000 8,250 8,818,852 (10,699,945) (1,872,843)
Net income 44,913 44,913
---------- --------- ---------- ------------ -----------
BALANCE
DECEMBER 31, 1998 8,250,000 $ 8,250 $8,818,852 $(10,655,032) $(1,827,930)
========== ========= ========== ============ ===========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
B-4
<PAGE>
SURF CITY ACQUISITION CORPORATION II
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
1998 1997
--------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 44,913 $(1,626,204)
Adjustments to reconcile net income
(loss) to net cash provided by
operating activities:
Depreciation 9,932 53,952
(Gain) loss on disposal of property
and equipment (97,718) --
Deferred income taxes 83,502 (27,691)
Impairment expense on property and
equipment -- 297,685
Net settlement expense paid by issuance
of note payable 10,419 --
Allowance for doubtful collection on
notes receivable (8,084) 34,989
Changes in assets and liabilities:
Trade and other accounts receivable (21,216) 64,910
Inventories (4,309) 131,574
Refundable lease deposits 64,785 39,562
Prepaids and other current assets 11,122 (21,709)
Accounts payable (100,645) 1,493,910
Accrued liabilities 52,368 879
Deferred franchise fee income (279,432) (169,379)
Deposits (3,248) 11,666
--------- -----------
Net cash (used in) provided by
operating activities (237,611) 284,144
--------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment -- (387,569)
Collections on notes receivable 348,688 327,207
Proceeds from sale of property
and equipment 472,000 40,000
--------- -----------
Net cash provided by (used in)
investing activities 820,688 (20,362)
--------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings on notes payable 129,000 --
Principal repayments on notes payable (298,872) (116,720)
Payments on confirmed bankruptcy liabilities (574,231) (993,001)
Proceeds from sale of common stock -- 800,000
--------- -----------
Net cash (used in) financing activities (744,103) (309,721)
--------- -----------
DECREASE IN CASH (161,026) (45,939)
CASH, BEGINNING OF YEAR 180,493 226,432
--------- -----------
CASH, END OF YEAR $ 19,467 $ 180,493
========= ===========
The accompanying notes are an integral part of these
consolidated financial statements.
B-5
<PAGE>
SURF CITY ACQUISITION CORPORATION II
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
1998 1997
---------- ----------
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid $ 84,564 $ 69,716
========== ==========
Income taxes paid $ -0- $ -0-
========== ==========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING
AND FINANCING ACTIVITIES:
Sale of property and equipment under
notes receivable $ 65,000
==========
Debt for legal settlement $ 10,419
==========
Notes receivable for franchise fees $ 122,386 $ 230,163
========== ==========
Accrued interest added to bankruptcy liabilities $ 36,224
==========
Bankruptcy administrative fees added to long-term
bankruptcy liabilities $1,336,646
==========
The accompanying notes are an integral part of these
consolidated financial statements.
B-6
<PAGE>
SURF CITY ACQUISITION CORPORATION II
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998 AND 1997
1. ORGANIZATION AND BASIS OF PRESENTATION
Surf City Acquisition Corporation II (the "Company") was formed in 1997 as
a holding company to acquire and recapitalize Surf City Squeeze, Inc., an
entity operating in a Chapter 11 bankruptcy, and other affiliated entities.
Under the confirmed bankruptcy plan, the Company acquired all of the
outstanding interests in: Surf City Squeeze, Inc. ("Surf City"), Surf City
Franchise Corporation ("SCSFC") and Kona Coast Provisions, Inc. ("Kona").
The Company later formed another wholly owned subsidiary in 1998, Malibu
Smoothie Franchising Corporation ("Malibu Smoothie"). The Company, through
its operating subsidiaries, operates and franchises juice bars in the
United States and Canada. The stores are generally located in shopping
malls and health clubs and operate under the name of "Surf City Squeeze".
The accompanying financial statements represent the consolidated financial
position and results of operations of the Company and includes the accounts
and results of operations of the Company and its wholly owned subsidiaries
for the years ended December 31, 1998 and 1997.
The statements of operations and cash flows for the year ended December 31,
1997 reflect the operations of the "debtor-in-possession". Because the
parent company, Surf City Acquisition Corporation II, was formed to acquire
the bankrupt entity, and because the controlling ownership of the operating
companies did not change as a result of the reorganization, the financial
statements are presented as if the parent company had owned and managed the
operating companies for the full year ended 1997. Due to the controlling
ownership of those operating companies effectively remaining with the same
shareholders after the acquisition, the purchase is recorded at the
existing bases of the net assets of the operating companies. There are no
adjustments to reflect the differences between the fair values and book
values of the net assets at the time of the transaction.
Surf City filed its voluntary Chapter 11 bankruptcy petition on January 13,
1997. The bankruptcy plan of reoganization was confirmed on November 18,
1997 to be effective within 45 days after the confirmation date. The only
significant debt discharged was $3,500,000 due to a significant
shareholder. The discharge of that debt had been agreed upon by the
creditor and Surf City prior to the bankruptcy filing. The effect of the
debt forgiveness was therefore recorded prior to 1997. Due to the short
period of time after the 1996 year end to the filing of the bankruptcy
petition, all prepetition liabilities were recorded at the expected amount
of the allowed claims effective December 31, 1996. All allowed claims have
been recorded at the present value of such debts under the payment plans as
outlined by the confirmed bankruptcy plan.
B-7
<PAGE>
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH includes all short-term highly liquid investments that are readily
convertible to known amounts of cash and have original maturities of three
months or less.
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include
the accounts of the Company and its wholly owned subsidiaries, Surf City,
SCSFC, Kona and Malibu Smoothie. All significant intercompany accounts and
transactions are eliminated.
INVENTORIES consist primarily of food products, drink mixes, supplements
and supplies. Inventories are recorded at the lower of cost or market on a
first-in, first-out basis.
PROPERTY AND EQUIPMENT is stated at cost less accumulated depreciation.
Depreciation is recorded on a straight-line basis over a period of the
shorter of the applicable lease term or the estimated useful lives of the
assets ranging from 3 to 10 years.
REVENUE RECOGNITION - Initial franchise fees are deferred until
substantially all services and conditions relating to the sale of the
franchise have been performed or satisfied. The Company will finance the
initial franchise fee by taking a note receivable from the franchisee. The
notes receivable are typically payable by the franchisee over five
years.Due to uncertainties relative to the success of these stores and
franchisees, revenue on the financed initial franchise fees is recognized
on an installment basis until 30% of the principal balance of the note is
collected. At that time, the remaining deferred balance is recognized as
revenue.
Fees from Area Development Agreements ("ADA") are recognized as revenue on
a pro rata basis based on the number of stores opened to-date to total
stores to be developed as stipulated in the ADA. If the total number of
stores stipulated in the ADA are not opened at the expiration of the ADA,
the balance of such fees is recognized.
Kona sells mixes and supplements to franchisees. Revenue on such sales is
recognized when the product is shipped. Sales from the Company owned stores
are recognized at the point of sale.
The Company also receives sublease rental income. The Company is the
primary lessee on certain franchised stores. Rental income is recognized
ratably over the term of the subleases.
INCOME TAXES - The Company provides for income taxes based on the
provisions of Statement of Financial Accounting Standards No. 109,
ACCOUNTING FOR INCOME TAXES, which, among other things, requires that
recognition of deferred income taxes be measured by the provisions of
enacted tax laws in effect at the date of financial statements.
FINANCIAL INSTRUMENTS - Financial instruments consist primarily of cash,
accounts receivable, notes receivable, and obligations under accounts
payable, accrued expenses, notes payable and confirmed bankruptcy
obligations. The carrying amounts of cash, accounts receivable, accounts
payable and accrued expenses approximate fair value because of the short
maturity of those instruments. The carrying value of the Company's notes
receivable approximate fair value because they contain market interest
rates and allowances are provided for any estimated uncollectible amounts.
B-8
<PAGE>
The carrying value of notes payable and confirmed bankruptcy obligations
approximate fair value because they contain market value interest rates and
have specified repayment terms. The Company has applied certain assumptions
in estimating these fair values. The use of different assumptions or
methodologies may have a material effect on the estimates of fair values.
USE OF ESTIMATES - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
Advertising expenses are expensed as incurred. Advertising expense was not
significant for the years ended December 31, 1998 and 1997 respectively.
3. BANKRUPTCY PETITION AND REORGANIZATION
On January 13, 1997, Surf City filed a voluntary petition for relief (under
Chapter 11 of the United States Bankruptcy Code in the United States
Bankruptcy Court for the District of Arizona. The bankruptcy plan was
confirmed by the Court on November 18, 1997 to become effective within 45
days of confirmation (the "Plan").
Surf City's largest single creditor was also a significant shareholder of
Surf City at the time of the bankruptcy. Immediately prior to filing the
bankruptcy petition, Surf City reached an agreement with the creditor for
discharge and settlement of $3,500,000 in debt. As part of that agreement,
the creditor also agreed to provide $800,000 in cash to the Company as
settlement of various claims made against the creditor by the Company. The
Company used the funds as its investment in Surf City and the related
operating subsidiaries. The controlling ownership of Surf City and the
other operating subsidiaries did not change as a result of this
transaction.
Debts that were subject to compromise under the Plan include priority
claims for sales taxes, secured claims from equipment vendors, contractors,
landlords and franchisees, and certain administrative and unsecured claims.
The majority of unsecured claims in the Plan are those commitments of Surf
City for future rents due under real property operating leases. Surf City
rejected certain material operating leases under the Plan. All allowed
claims under the Plan are recorded at the present value of those debts
based on the confirmed repayment terms and discount rates of 8% to 10%.
The allowed General Unsecured Claims under the Plan includes a contingency
for payments based on future cash flow of Surf City and its subsidiaries.
The terms of the repayment of the General Unsecured Claims require minimum
quarterly payments of $43,750 over a seven year period to an Unsecured
Creditors Pool resulting in a minimum of $1,225,000 payable over that seven
year period. In addition, amounts determined as 25% of the first $50,000 of
quarterly Net Cash Flow, as defined in the Plan, and 40% of the quarterly
Net Cash Flow in excess of $50,000 are required to be paid to the Unsecured
Creditors Pool on a quarterly basis. The Company has recorded the General
Unsecured Claims liability at the present value of the 28 quarterly
payments of $43,750. The Plan lists the total General Unsecured Claims to
be $5,000,000 to $6,000,000, but states that much of that estimate includes
B-9
<PAGE>
commitments for future rents on unexpired operating leases which were
rejected by Surf City. The Company believed that it could not reasonably
estimate the amount of those claims at the time of the Plan confirmation
because the damages arising from rejected leases are likely to be reduced
as the locations under those leases are re-leased to new tenants. The
Company also believes that it cannot reasonably estimate the amount of
contingency payments because of uncertainties in Surf City's likelihood to
generate net cash flow and the inability to estimate the timing of any such
Net Cash Flow if it does occur. Surf City has not yet made any contingent
payments to the Unsecured Creditors Pool.
The scheduled repayments of remaining bankruptcy liabilities at December
31, 1998 is as follows:
1999 $ 843,572
2000 216,570
2001 199,548
2002 218,337
2003 224,422
2004 197,120
----------
$1,899,569
==========
The effect of transactions and adjustments related to reorganization related
activities in the statement of operations for the year ended December 31,
1997 are:
Provision for closed locations and impairment
losses on locations held for sale $ 297,685
Professional fees and other expenses 933,669
Interest income (50,769)
----------
Total reorganization items $1,180,585
==========
Certain store locations were selected for sale. The net book value of the
assets of those locations were written down to a fair value estimated based
on the expected selling price of the stores. As of November 30, 1999, all
stores that were selected for sale under the Plan of Reorganization had been
sold and the corresponding assets removed from the Company's balance sheet.
4. NOTES RECEIVABLE
Notes receivable principally result from the financing of the initial
franchise fees required from franchisees and the sale of corporate owned
stores. The notes are generally guaranteed by the franchisee or purchaser
and are collateralized by the related juice bar business, and related
equipment and leasehold improvements. The notes are generally due in monthly
installments of principal and interest with interest at 10% per annum.
The Company periodically reviews the collectibility of its notes receivable.
Due to matters related to the Surf City bankruptcy, certain notes were
written off or allowances for credit losses were established. The Company
recognizes interest income on notes it has determined to be impaired only
when payments are received.
B-10
<PAGE>
At December 31, 1998, the investment in impaired notes receivable was
$122,550 and the related allowance on that investment was $93,991. The
allowance for credit losses on these impaired notes decreased by $8,084 to
$104,036 and increased by $34,989 to $112,120 for the years ended and at
December 31, 1998 and 1997 respectively. The average balance of impaired
notes receivable was $149,771 and $82,315 for the years ended December 31,
1998 and 1997 respectively. Interest income earned on impaired notes
receivable was $3,375 and $3,263 for the years ended December 31, 1998 and
1997 respectively.
5. NOTES PAYABLE
Notes payable at December 31, 1998 are comprised of the following:
Notes payable to officer and affiliate, no specified
repayment terms, unsecured, no stated rate of interest. $ 159,166
Notes payable to franchisees in settlement of legal
claims. Repayment terms require $7,500 monthly
installments of principal and interest at 10% per annum
through 2002. Collateralized by royalties and franchise
fees of designated store locations. Original principal
balance of notes was $335,000. 222,379
Note payable to equipment vendor. Payment terms require
monthly installments $7,000 through July 2000. The
stated balance of promissory note is $215,129. A
balloon payment of $71,129 is due July 15, 2000. The
promissory note has no stated interest. The present
value of the note was determined using a discount rate
of 10%. Collateralized by certain royalties and 412,500
shares of the Company's common stock held by the
Company's president. Personally guaranteed by the
Company's president. 169,331
Other miscellaneous notes payable arising from various
settlements. Payment terms vary requiring minimum
monthly installments of principal and interest at 10%
per annum of $10,812 plus royalties earned from two
store locations through 1999. 42,359
---------
Totals 593,235
Less current portion (332,877)
---------
Long-term portion $ 260,358
=========
One note payable, with a principal balance of $13,282 at December 31, 1998
was settled for a single payment $10,000 in 1999.
B-11
<PAGE>
Principal payments due in years ended December 31:
1999 $ 332,877
2000 187,321
2001 66,243
2002 6,794
---------
Total $ 593,235
=========
The fair value of the related party notes payable could not be estimated
due to the related nature of the notes and the unspecified repayment terms.
There were no interest payments on the related party notes in the years
ended December 31, 1998 and 1997. Significant royalty income generated by
the Company is pledged as collateral on certain of the above notes.
6. INCOME TAXES
The Company recognizes deferred income taxes for the differences between
financial accounting and tax bases of assets and liabilities. Income taxes
for the years ended December 31, consisted of the following:
1998 1997
--------- ---------
Current tax (benefit) provision $(102,453) $(737,364)
Deferred tax (benefit) provision 185,956 709,673
--------- ---------
Total income tax (benefit) provision $ 83,503 $ (27,691)
========= =========
Deferred tax assets of $3,439,913 less a valuation allowance of $2,947,248,
relate to net operating loss carryforwards and differences in book and tax
bases of property and equipment and notes receivable. The valuation
allowance was increased by $31,094 and $666,633 for the years ended
December 31, 1998 and 1997 respectively. The net deferred income tax asset
at December 31, 1998 is comprised of:
Allowance for losses on notes receivable $ 35,375
Write-down of property and equipment on closed locations 38,948
Net operating loss carryforwards 3,365,590
------------
Total deferred income tax asset 3,439,913
Less: valuation allowance (2,947,248)
------------
Net deferred income tax asset $ 492,665
============
Federal net operating loss carryforwards of $8,323,000 expire from 2010
through 2018. State net operating loss carryforwards of $8,323,000 expire
from 2000 through 2003.
The differences between the statutory and effective tax rates is as
follows:
1998 1997
-------------- ----------------
Federal statutory rates $33,333 26% $(562,324) (34)%
State income taxes 10,723 8% (132,312) (8)%
Valuation allowance for
operating loss carryforwards 31,094 24% 666,633 40%
Other 8,353 7% 312 --%
------- ---- --------- ----
Effective rate $83,503 65% $ (27,691) (2)%
======= ==== ========= ====
B-12
<PAGE>
Income taxes for the year ended December 31, 1998 reflect a reversal of
certain temporary differences that reduced the net deferred income tax
asset as well as an increase in the valuation allowance for uncertainties
relative to the future utilization of net operating loss carryforwards.
7. LEASES
The Company is the primary lessee on most of its franchised stores under
long-term operating leases. The leases generally have initial terms of five
to seven years and usually provide for renewal options ranging from five to
seven additional years. These operating leases expire at various dates
through 2006. Most of the leases contain escalation clauses and common area
maintenance charges. The Company sublease the store locations to
franchisees. There were approximately 70 leases under these terms at
December 31, 1998. The Company records rent expense and sublease rental
income only on locations at a certain health club chain because the Company
is directly responsible for payment to the landlord and collection from the
franchisee. On other store locations, the franchisees have direct
responsibility for payment to the lessor. Rent expense under the leases in
which the Company is directly responsible, including corporate owned
stores, was $557,008 and $863,076 for the years ended December 31, 1998 and
1997 respectively. Sublease rental income under these leases was $404,233
and $591,963 for the years ended December 31, 1998 and 1997 respectively.
The Company also leases its offices and warehouses under long-term
operating leases expiring through 2001. Rent expense under these leases was
$98,008 and $65,518 for the years ended December 31, 1998 and 1997
respectively.
B-13
<PAGE>
Future minimum annual lease payments and sublease rentals under operating
lease agreements for years ended December 31 are:
Sublease Warehouse
Store Leases Rental and Office
------------ ------------ ----------
1999 $ 2,482,031 $ 2,523,144 $ 113,640
2000 2,557,935 2,579,895 72,542
2001 2,579,834 2,587,724 29,604
2002 2,809,675 2,813,175 --
2003 1,749,432 1,749,432 --
Thereafter 2,451,884 2,451,884 --
------------ ------------ ---------
$ 14,630,791 $ 14,705,254 $ 215,786
============ ============ =========
8. STOCKHOLDERS' DEFICIT
The Company issued 825,000 shares of its common stock for $800,000 in the
year ended December 31, 1997.
As part of a settlement with a former creditor, the Company issued warrants
to purchase 175,000 shares of its common stock in the year ended December
31, 1997. The exercise price of the warrants is $0.01 per share. Subsequent
to December 31, 1998, the warrants were exercised.
9. SUBSEQUENT EVENTS
On March 15, 1999, the Company exchanged all of its common stock for
575,000 shares of Series A Convertible Preferred Stock ("Series A
Preferred") of Sports Group International, Inc. ("SPGK") resulting in the
Company and its subsidiaries becoming wholly owned subsidiaries of SPGK.
The Series A Preferred has voting rights and is convertible at a ratio that
effectively results in the controlling interest of SPGK belonging to the
shareholders of the Company at the time of the transaction. Additionally,
the Company's management and board of directors became the new management
of SPGK. SPGK had no material assets or operations at the time of the
transaction.
On February 22, 1999, SPGK borrowed $332,500 under a promissory note from a
significant shareholder. The promissory note is personally guaranteed by
the shareholders and officers of the Company.
On May 21, 1999, SPGK issued 650,000 shares of its Series B Convertible
Preferred Stock for $6,500,000. The proceeds were used to acquire all of
the issued and outstanding stock of Selman Systems, Inc. ("Selman"), an
operator and franchisor of a chain of cafes and bakeries under the name of
Frullati Cafe and Bakery ("Frullati").
B-14
<PAGE>
On July 7, 1999, SPGK, through Selman, purchased all of the outstanding
stock of Fru-Cor, Inc., an owner of eight Frullati locations. The purchase
was effected through the issuance of a promissory note for $1,200,000. The
note is due on May 20, 2000.
10. COMMITMENTS AND CONTINGENCIES
As discussed in Note 5, certain of the Company's notes payable are
collateralized by revenue generated from franchise fees and royalties.
As discussed in Note 3, there are contingent amounts payable to an
Unsecured Creditors Pool subject to quarterly cash flows through 2004.
Surf City is involved in litigation with three landlords. The landlords
sought claims of $76,000 plus expenses. In September, 1999, the Bankruptcy
Court ruled that the landlords were bound by the Plan. However, the
landlords amended their claim to $41,000 and the Company believes that it
may owe approximately $37,000. The $37,000 was accrued by the Company at
December 31, 1998 but payment of such is pending final decision from the
Court.
A party has filed a complaint against SCSFC alleging that SCSFC is liable
for certain debts of Surf City discharged in bankruptcy. The Company
believes that all amounts billed by this party were paid. In 1997, an
arbitrator ruled that SURF CITY owed the party approximately $126,000,
including attorneys' fees. The award was considered an unsecured claim in
the bankruptcy. The party has attempted to include SCSFC as a creditor
under the claim but the attempts have been denied by the arbitrator and a
motion for summary judgement filed by the party in Orange County Superior
Court to enforce the award has also been denied. The matter is set for
trial in early 2000. The Company intends to defend its position. However,
management and the Company's counsel believe it is not yet possible to
determine the likelihood or extent of any unfavorable outcome.
The Company may be subject to other claims as a result of its merger with
SPGK and Frullati (see Note 9).
SPGK has been named in a lawsuit by a third party alleging that SPGK
breached its merger agreement with the third party. SPGK has responded that
the third party failed to meet certain conditions required under the merger
agreement and that it had notified the third party that the merger was
properly terminated. The third party seeks unspecified damages. SPGK
believes that it has adequate defenses but that the case has not proceeded
to a point where the outcome can be estimated. There are claims made
against this third party by others that, based on the outcome of this case,
may have an effect on SPGK.
A franchisee of Frullati has sued for breach of contract and related causes
of action is seeking approximately $400,000 in damages. The claim stems
from alleged cost overruns in the construction of two Frullati stores that
the franchisee believes payment for such are the responsibility of Selman
or its subsidiaries. Frullati has filed a counter claim against the
franchisee. Management and the Company's counsel believe it is not yet
possible to determine the likelihood or extent of any unfavorable outcome.
B-15
<PAGE>
11. RELATED PARTY TRANSACTIONS
The Company's officers and stockholders have personally guaranteed certain
of the Company's operating leases. The Company's president is named as the
lessee on the lease of one of the Company's warehouse leases.
As discussed in Note 5, the Company has debt due to related parties and
certain debt includes a personal guarantee and pledge of common stock owned
by the Company's president.
12. CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to
concentrations of credit risk are primarily notes receivable and trade
accounts receivable. The trade accounts receivable are due primarily from
franchisees in numerous geographical locations in the United States. The
Company has not historically experienced material losses due to
uncollectible trade accounts receivable.
The Company's notes receivable are generally due from franchisees and are
guaranteed by the franchisee and collateralized by leasehold improvements
and rights under the franchise agreement. The Company has experienced
credit losses under notes receivable and has generally foreclosed on the
related stores and attempted to re-franchise those locations. The notes
receivable balance at December 31, 1998 is comprised of numerous debtors.
One of which represents approximately 15% of the total balance at December
31,1998. No other single note or debtor comprises greater than 10% of the
total balance at December 31, 1998.
* * * * * *
B-16
<PAGE>
SELMAN SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 27, 1998
C-1
<PAGE>
SELMAN SYSTEMS, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
- - --------------------------------------------------------------------------------
PAGE
----
Report of Independent Accountants C-3
Consolidated Financial Statements
Consolidated Balance Sheet C-4
Consolidated Statement of Income and Retained Earnings C-5
Consolidated Statement of Cash Flows C-6
Notes to Consolidated Financial Statements C-7
C-2
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholder of
Selman Systems, Inc. and Subsidiaries
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income and retained earnings and of cash flows
present fairly, in all material respects, the financial position of Selman
Systems, Inc. and its subsidiaries at December 27, 1998, and the results of
their operations and their cash flows for the year then ended, in conformity
with generally accepted accounting principles. 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 of these statements in accordance with generally accepted auditing
standards which 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
Dallas, Texas
June 11, 1999
C-3
<PAGE>
SELMAN SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
DECEMBER 27, 1998
- - --------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 179,635
Certificate of deposit 64,492
Accounts and notes receivable
(net of allowance of $46,635) 210,322
Income tax refund receivable 23,390
Inventories 125,603
Prepaid expenses and other current assets 85,094
Deferred income tax asset 51,771
----------
Total current assets 740,307
Property and equipment, net 3,084,220
Long-term receivables 23,011
Other assets 15,745
----------
Total assets $3,863,283
----------
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Accounts payable $ 790,650
Accrued liabilities 303,198
Deferred revenue 93,400
Current portion of long-term debt 147,565
Due to related parties 132,606
----------
Total current liabilities 1,467,419
Deferred rent 34,333
Long-term debt 457,234
Deferred income tax payable 250,361
----------
Total liabilities 2,209,347
Commitments and contingencies (Note 4)
Stockholder's equity:
Common stock, at $1.00 par value, 1,000 shares
authorized; 1,000 shares issued and outstanding 1,000
Additional paid-in capital 100,000
Retained earnings 1,552,936
----------
Total stockholder's equity 1,653,936
----------
Total liabilities and stockholder's equity $3,863,283
==========
The accompanying notes are an integral part of these
consolidated financial statements.
C-4
<PAGE>
SELMAN SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME AND RETAINED EARNINGS
YEAR ENDED DECEMBER 27, 1998
- - --------------------------------------------------------------------------------
Revenues:
Store sales $ 12,148,375
Franchise royalties 952,779
Initial franchise and development fees 320,537
Other income 95,506
------------
Total revenues 13,517,197
Operating expenses:
Compensation 4,032,835
Cost of sales 3,664,796
Selling, general and administration 2,878,973
Occupancy 2,425,680
Depreciation and amortization 558,725
------------
Total operating expenses 13,561,009
------------
Operating loss (43,812)
Other income:
Gain on sale of property and other assets 213,314
Interest and other income 26,511
Interest expense (75,187)
------------
Total other income 164,638
------------
Income before income taxes 120,826
Provision for income taxes 98,067
------------
Net income 22,759
Retained earnings at beginning of year 1,530,177
------------
Retained earnings at end of year $ 1,552,936
============
The accompanying notes are an integral part of these
consolidated financial statements.
C-5
<PAGE>
SELMAN SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 27, 1998
- - --------------------------------------------------------------------------------
Operating activities:
Net income $ 22,759
Noncash items in net income:
Depreciation and amortization 558,725
Gain on sale of property and other assets (213,314)
Change in deferred rent 10,423
Deferred income taxes (12,617)
Cash from (used for) changes in operating working capital:
Accounts and notes receivable 238,246
Inventories 3,657
Prepaid expenses and other assets (91,846)
Accounts payable and accrued liabilities (120,397)
Deferred revenue 73,400
---------
Net cash provided by operating activities 469,036
---------
Investing activities:
Purchases of property and equipment (904,636)
Proceeds from sales of property and equipment 547,022
---------
Net cash used in investing activities (357,614)
---------
Financing activities:
Net repayments of bank line of credit (85,210)
Proceeds from notes payable to bank 61,794
Repayments of notes payable to bank (26,929)
Proceeds from notes payable to related parties 20,000
Repayments of notes payable to related parties (168,545)
---------
Net cash used in financing activities (198,890)
---------
Net decrease in cash (87,468)
Cash and cash equivalents, beginning of year 267,103
---------
Cash and cash equivalents, end of year $ 179,635
=========
Supplemental cash flow disclosures:
Cash paid for income taxes $ 131,847
=========
Cash paid for interest $ 74,418
=========
Noncash transactions:
Receipt of note for equipment $ 45,000
=========
The accompanying notes are an integral part of these
consolidated financial statements.
C-6
<PAGE>
SELMAN SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BACKGROUND AND PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Selman
Systems, Inc. and its wholly-owned subsidiaries, Frullati Enterprises,
Inc., Frullati Franchise Systems, Inc., Frullati, Inc., and Frullati
Systems, Inc. (collectively, the "Company"). All material intercompany
balances and transactions have been eliminated.
The Company operates restaurants under the name of "Frullati Cafe," which
serve fruit smoothie drinks, along with sandwich and salad items. The
Company currently operates 30 stores in 11 states (Arkansas, Florida,
Indiana, Kentucky, Louisiana, Minnesota, Missouri, North Carolina, Ohio,
Texas and Virginia). Additionally, the Company franchises its operations,
with 55 franchise locations in operation at year-end.
FISCAL PERIOD
The fiscal period of the Company is based on a 52- and 53-week calendar,
which ends on the Sunday closest to December 31.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect reported amounts of assets and liabilities and
disclosure of contingencies at the date of the financial statement and the
reported amounts of revenues and expenses for the period. Actual results
could subsequently differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers all cash on hand and in banks, and highly liquid
investments with original maturities of three months or less, to be cash
and cash equivalents.
CERTIFICATE OF DEPOSIT
The certificate of deposit is a time deposit at a bank which is due on June
12, 1999, and bears interest at 4.3% per annum.
REVENUE RECOGNITION
Franchise royalties are recognized as earned.
Initial franchise and development fees are recognized upon fulfillment of
all significant obligations to the franchisee.
Revenues from store sales are recognized at the point of sale.
C-7
<PAGE>
SELMAN SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
INVENTORIES
Inventory consists primarily of food and service items and is stated at the
lower of cost or market. Inventory costs are determined using the average
cost method, the use of which approximates the first-in, first-out basis.
PROPERTY AND EQUIPMENT
Property and equipment is recorded at cost and is depreciated on a
straight-line basis, over the estimated useful life of the respective
asset. Leasehold improvements are depreciated over the estimated useful
life or the term of the related lease, whichever is shorter. Major
additions and betterments are capitalized and depreciated over the
remaining estimated useful life of the related asset. Maintenance, repairs,
and minor improvements are charged to expense as incurred.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company assesses long-lived assets (primarily property and equipment)
for impairment whenever there is an indication that the carrying amount of
the asset may not be recoverable. Recoverability of these assets is
determined by comparing the forecasted undiscounted cash flows generated by
those assets to the assets' net carrying value. The amount of impairment
loss, if any, is measured as the difference between the net book value of
the assets and the estimated fair value of the related assets. Assets held
for sale are recorded at fair value less selling costs.
During the year ended December 27, 1998, the Company determined that it
would dispose of four of its company-owned stores. The Company expects to
sell these stores during 1999. The assets were written down to fair value
less selling costs based on the estimated selling prices of the individual
stores. An impairment loss of $145,031 has been recorded to the
accompanying income statement and is included in depreciation expense.
Additionally, the net loss resulting from the operations of these stores in
the amount of $136,220 is included in the accompanying income statement.
DEFERRED RENT
Deferred rent represents the difference between rent paid on a cash basis
and rent amortized equally over the lease period for financial statement
purposes.
INCOME TAXES
Income taxes are recorded based on the liability method of accounting.
Deferred income taxes are recorded to reflect the tax benefit and
consequences of future years' differences between the tax bases of assets
and liabilities and their financial reporting basis. The Company records a
valuation allowance to reduce deferred tax assets if it is more likely than
not that some portion or all of the deferred tax assets will not be
realized.
C-8
<PAGE>
SELMAN SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
FAIR VALUE OF FINANCIAL INSTRUMENTS
At December 27, 1998, the Company's carrying value of financial instruments
approximates fair value due to the short maturities of these instruments or
variable or market rates of interest. During 1998, no financial instruments
were held or issued for trading purposes.
ADVERTISING EXPENSES
Advertising costs are expensed as incurred. Advertising expense for 1998
was $282,993.
START-UP COSTS
In April 1998, the AICPA issued Statement of Position 98-5, REPORTING ON
THE COSTS OF START-UP ACTIVITIES ("SOP 98-5"). SOP 98-5 becomes effective
for all fiscal years beginning after December 15, 1998. The Company's
current policy falls within the guidelines of SOP 98-5.
2. FRANCHISE OPERATIONS
The Company charges a nonrefundable initial franchise fee of $20,000 for
the right to establish a single cafe. An existing franchisee may purchase
the right to establish additional cafes for a reduced fee of $17,500 which
includes a $5,000 nonrefundable deposit per location. The Company provides
one on-site evaluation of the proposed site and initial training to the
cafe's operating principal or general manager at no additional charge. As
of December 27, 1998, the Company had substantially performed all of the
significant commitments and obligations related to all new franchises, with
the exception of five. As a result, the accompanying balance sheet reflects
deferred revenue of $93,400 at December 27, 1998. The Company fulfilled its
commitments and recognized this revenue in the first quarter of 1999.
Under the terms of the franchise agreements, the Company has no obligation
to refund any part of either the initial franchise fee or any development
fee if the franchise agreement is terminated at any time by either the
Company or the franchisee.
The Company experienced the following changes in the ownership of
franchises for the year ended December 27, 1998:
Number of franchised cafes in operation at December 28, 1997 49
Number of new franchises sold during year 7
Number of franchises closed during year (1)
------
Number of franchised cafes in operation at December 27, 1998 55
======
C-9
<PAGE>
SELMAN SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
Useful December 31,
Life 1998
------ -----------
Leasehold improvements 10 $ 2,164,413
Store fixtures, equipment and furniture 10 1,727,277
Assets held for sale 213,039
Truck and autos 5 17,412
Construction-in-progress 84,735
-----------
Total 4,206,876
Less accumulated depreciation (1,122,656)
-----------
Property and equipment, net $ 3,084,220
===========
Depreciation expense for the year ended December 27, 1998 was $557,650.
4. LEASE COMMITMENTS
The Company leases certain of its store facilities pursuant to
noncancelable operating leases that expire at various times through 2007.
The Company also leases store facilities which are operated by and
subleased to franchisees. Future minimum lease payments under the operating
leases are as follows:
FISCAL YEARS ENDING DECEMBER:
1999 $ 3,241,140
2000 3,205,814
2001 3,194,803
2002 3,136,728
2003 3,077,776
Thereafter 8,077,938
-----------
Total $23,934,199
===========
The total future minimum lease payments exclude expense reimbursements to
lessors, as well as contingent rentals which are based upon sales volume.
Lease agreements frequently require the Company to pay utilities, taxes,
insurance and maintenance related to the property. Rent expense in 1998
(net of sublease payments by franchisees) was approximately $2,418,739, of
which approximately $400,796 was contingent rent.
Deferred rent of $34,333 has been recorded to account for rent expenses on
a straight-line basis over the lease term, where lease payments are not
made on such basis.
C-10
<PAGE>
SELMAN SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
Future minimum lease payments receivable under subleases to franchisees are
as follows (which are included in the minimum lease obligations listed
above):
FISCAL YEARS ENDING DECEMBER:
1999 $ 2,184,339
2000 2,208,852
2001 2,212,167
2002 2,157,199
2003 2,149,095
Thereafter 5,463,828
-----------
$16,375,480
===========
5. DEBT
December 27,
DESCRIPTION OF DEBT 1998
----------
Note payable to bank; interest at 10.5%; due
in monthly installments through September 2003;
collateralized by equipment, common stock,
intangibles and other $ 553,573
Note payable to creditor, interest at 6.99%;
due August 1999. 51,226
Revolving line of credit, variable interest rates
(10.5% at December 27, 1998); due February 1999,
collateralized by certificate of deposit. --
----------
604,799
Less: current portion 147,565
----------
$ 457,234
==========
Total long-term maturities in 2000, 2001, 2002 and 2003 are $106,427,
$117,572, $129,883 and $103,352, respectively.
C-11
<PAGE>
SELMAN SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
6. INCOME TAXES
December 27,
1998
----------
Deferred tax assets:
Current:
Deferred revenue $ 34,530
Reserves for bad debt 17,241
----------
Total current deferred tax assets 51,771
Noncurrent:
Deferred rent 12,693
Net operating loss carryforwards (state) 64,538
----------
Total deferred tax assets 129,002
Less: valuation allowance (64,538)
----------
Net deferred tax assets 64,464
----------
Deferred tax liabilities:
Noncurrent:
Book-tax basis differences in fixed assets (18,086)
Deferred gain on sale of assets (244,968)
----------
Total deferred tax liabilities (263,054)
----------
Net deferred tax liabilities $ (198,590)
==========
Net operating loss carryforwards in the amount of $64,538 are attributable
to Frullati Enterprises, Inc. and Frullati Systems, Inc., both of which
have recorded cumulative taxable losses through December 27, 1998. For
state tax purposes, the net operating losses generated by various legal
entities cannot offset taxable income from income generating entities for
the current year. Certain states do not allow consolidated or combined
filings for state income tax purposes. A valuation allowance has been
provided related to these state net operating loss carryforwards as the
Company believes that it is more likely than not that these tax benefits
will not be realized.
The components of income tax expense for the year ended December 27, 1998
are as follows:
Current:
Federal $ 37,577
State 73,107
---------
110,684
---------
Deferred (12,617)
---------
$ 98,067
=========
C-12
<PAGE>
SELMAN SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
The Company's income tax expense for the year ended December 27, 1998
differed from the statutory federal rate of 34% as follows:
Statutory rate applied to earnings before income taxes $ 41,081
Increase in income taxes resulting from:
State income taxes 46,334
Non-deductible meal and entertainment expense 8,792
Other 1,860
---------
Income tax expense $ 98,067
---------
7. RETIREMENT PLAN
During 1998, the Company began offering its employees the option of
participating in a 401(k) savings plan (the "Plan"). Employees are eligible
to participate in the Plan upon reaching the age of 21 and upon completion
of six months of service. The Company currently matches 25% of the first 6%
of an employee's contribution to the Plan. During the year ended December
27, 1998, matching contributions to the Plan were $5,254. Also during the
year ended December 27, 1998, the Company paid $3,307 of expenses on behalf
of the Plan.
8. RELATED PARTY TRANSACTIONS
Included in due to related parties is an amount owed to an affiliated
entity, Continental Realty, Inc. ("CRI"), as compensation for management
services provided to the Company through June 15, 1998, the termination
date of the agreement. CRI is owned by the Company's stockholder. The
remaining unpaid balance at December 27, 1998 is $131,186.
9. SUBSEQUENT EVENTS
On April 9, 1999, the Company and its parent and affiliates were acquired
by Fru-Cor, Inc. In connection with this acquisition, amounts due to
related parties were paid in full.
Subsequently on May 20, 1999, the Company and its parent and affiliates
were acquired by Sports Group International, Inc.
C-13
<PAGE>
FRU-COR, INC.
FINANCIAL STATEMENTS AS OF
DECEMBER 31, 1998
AND INDEPENDENT AUDITORS' REPORT
D-1
<PAGE>
FRU-COR, INC.
TABLE OF CONTENTS
- - --------------------------------------------------------------------------------
PAGE
----
INDEPENDENT AUDITORS' REPORT D-3
FINANCIAL STATEMENTS AS OF DECEMBER 27, 1998:
Balance Sheet D-4
Statement of Operations D-5
Statement of Stockholders' Equity D-6
Statement of Cash Flows D-7
NOTES TO FINANCIAL STATEMENTS D-8
D-2
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
Fru-Cor, Inc.:
Scottsdale, Arizona
We have audited the accompanying consolidated balance sheet of Fru-Cor, Inc.
(the "Company"), as of December 27, 1998, and the related consolidated
statements of operations, stockholders' equity and cash flows for the period
July 1, 1998, date of inception, through December 27, 1998. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated 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 our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Fru-Cor, Inc. at December 27, 1998, and the consolidated results of its
operations and its cash flows for the period July 1, 1998, date of inception,
through December 27, 1998, in conformity with generally accepted accounting
principles.
/s/ KING, WEBER & ASSOCIATES, P.C.
Tempe, Arizona
December 6, 1999
D-3
<PAGE>
FRU-COR, INC.
CONSOLIDATED BALANCE SHEET
DECEMBER 27, 1998
- - --------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash $ 248,406
Inventories 25,301
Prepaid expenses and other assets 3,923
-----------
Total current assets 277,630
PROPERTY AND EQUIPMENT, net 688,743
DEFERRED INCOME TAXES 14,698
DEFERRED DEVELOPMENT AND FRANCHISE FEES 164,120
GOODWILL 52,834
-----------
TOTAL ASSETS $ 1,198,025
===========
LIABILITIES AND STOCKHOLDERS' EQUITY:
CURRENT LIABILITIES:
Accounts payable $ 93,480
Accrued liabilities 63,524
Payable to franchisor 21,240
-----------
Total current liabilities 178,244
-----------
DEFERRED RENT 20,590
-----------
Total liabilities 198,834
-----------
STOCKHOLDERS' EQUITY:
Common stock, no par value, 1,200,000 shares
authorized, 1,200,000 issued and outstanding 1,200,000
Accumulated deficit (200,809)
-----------
Total stockholders' equity 999,191
-----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,198,025
===========
The accompanying notes are an integral part of these
consolidated financial statements.
D-4
<PAGE>
FRU-COR, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE PERIOD JULY 1, 1998, (DATE OF INCEPTION) THROUGH
DECEMBER 27, 1998
- - --------------------------------------------------------------------------------
REVENUES:
Net product sales $ 761,976
---------
EXPENSES:
Cost of product sales 231,697
Store operating costs 61,466
Personnel expenses 327,373
Rent 191,470
Depreciation 35,628
Royalties and franchising expense 60,288
General and administrative expenses 71,553
---------
Total expenses 979,475
---------
OPERATING LOSS (217,499)
---------
OTHER (INCOME) AND EXPENSES
Interest expense 209
Interest income (426)
Other income (1,775)
---------
Total other expense (1,992)
---------
LOSS BEFORE INCOME TAXES (215,507)
INCOME TAX BENEFIT 14,698
---------
NET (LOSS) $(200,809)
=========
The accompanying notes are an integral part of these
consolidated financial statements.
D-5
<PAGE>
FRU-COR, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE PERIOD JULY 1, 1998, (DATE OF INCEPTION) THROUGH
DECEMBER 27, 1998
- - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Common Stock
-------------------------- Accumulated
Shares Amount Deficit Total
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
BALANCE
JULY 1, 1998 -- $ -- $ -- $ --
Common stock issued for cash 1,200,000 1,200,000 1,200,000
Net loss (200,809) (200,809)
----------- ----------- ----------- -----------
BALANCE
DECEMBER 27, 1998 1,200,000 $ 1,200,000 $ (200,809) $ 999,191
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
D-6
<PAGE>
FRU-COR, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE PERIOD JULY 1, 1998, (DATE OF INCEPTION) THROUGH DECEMBER 27, 1998
- - --------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) $ (200,809)
Adjustments to reconcile net (loss) to net cash
provided by operating activities:
Depreciation and amortization 36,752
Deferred income taxes (14,698)
Changes in assets and liabilities:
Inventories (25,301)
Prepaids and other current assets (3,923)
Deferred development fees (164,120)
Accounts payable 93,480
Accrued liabilities 63,524
Payable to franchisor 21,240
Deferred rent 20,590
-----------
Net cash (used in) operating activities (173,265)
-----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (585,204)
Proceeds from sale of property and equipment (193,125)
-----------
Net cash (used in) investing activities (778,329)
-----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock 1,200,000
-----------
Net cash provided by financing activities 1,200,000
-----------
DECREASE IN CASH 248,406
CASH, BEGINNING OF PERIOD --
-----------
CASH, END OF PERIOD $ 248,406
===========
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid $ 209
===========
Income taxes paid $ -0-
===========
The accompanying notes are an integral part of these
consolidated financial statements.
D-7
<PAGE>
FRU-COR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE PERIOD JULY 1, 1998, (DATE OF INCEPTION) THROUGH DECEMBER 27, 1998
- - --------------------------------------------------------------------------------
1. ORGANIZATION AND BASIS OF PRESENTATION
Fru-Cor, Inc. (the "Company") was formed in 1998 to acquire and operate, as a
franchisee, cafes and bakeries under the name of Frullati Cafe and Bakery
("Frullati"). At December 27, 1998, the Company owned and operated seven
Frullati stores in Texas, Lousiana and Mississippi. The stores are generally
located in shopping malls. In the period ended December 27, 1998, the Company
acquired all of the outstanding voting stock of Texas Class, Inc. ("TCI"), the
owner and operator of a single Frullati location an Abilene, Texas. The
accompanying financial statements represent the consolidated financial position
and results of operations of the Company and includes the accounts and results
of operations of the Company for the period July 1, 1998 (date of inception)
through December 27, 1998 and its wholly owned subsidiary, TCI for the period
August 4, 1998 (date of acquisition) through December 27, 1998.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH includes all short-term highly liquid investments that are readily
convertible to known amounts of cash and have original maturities of three
months or less.
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include
the accounts of the Company and its wholly owned subsidiary, TSI. All
significant intercompany accounts and transactions are eliminated.
INVENTORIES consist primarily of food products, drink mixes, supplements
and supplies. Inventories are recorded at the lower of cost or market on a
first-in, first-out basis.
PROPERTY AND EQUIPMENT is stated at cost less accumulated depreciation.
Depreciation is recorded on a straight-line basis over a period of the
shorter of the applicable lease term or the estimated useful lives of the
assets ranging from 3 to 10 years. Maintenance, repairs and minor
improvements are expensed as incurred.
REVENUE RECOGNITION - Sales from the Company owned stores are recognized at
the point of sale.
INCOME TAXES - The Company provides for income taxes based on the
provisions of Statement of Financial Accounting Standards No. 109,
ACCOUNTING FOR INCOME TAXES, which, among other things, requires that
recognition of deferred income taxes be measured by the provisions of
enacted tax laws in effect at the date of financial statements.
ADVERTISING EXPENSES are expensed as incurred. Advertising expense was
$3,447 for the period ended December 27, 1998.
D-8
<PAGE>
USE OF ESTIMATES - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
FINANCIAL INSTRUMENTS - At December 27, 1998, the Company's carrying value
of financial instruments approximates fair value due to the short term
maturities of those instruments. The Company held no financial instruments
for trading purposes at December 27, 1997.
DEFERRED DEVELOPMENT AND FRANCHISE FEES are payments made to the franchisor
which are amortized over the initial term of the related agreements of
typically ten years.
GOODWILL is recorded for the difference between the purchase price of the
acquired business and the fair value of the identifiable net assets.
Goodwill is amortized on a straight-line basis over 20 years.
3. STOCKHOLDERS' EQUITY
The Company issued 1,200,000 shares of its common stock for $1,200,000 as
its initial capitalization.
4. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 27, 1998:
Leasehold improvements $ 199,663
Store fixtures, equipment and furnishings 519,120
Construction-in-progress 5,588
-----------
Total 724,371
Less accumulated depreciation (35,628)
-----------
Property and equipment, net $ 688,743
===========
5. BUSINESS COMBINATION
On August 4, 1998, the Company acquired all of the outstanding common stock
of Texas Class, Inc. ("TSI"). TSI is the franchisee, owner and operator of
one Frullati store in Abilene, Texas. The Company paid cash of $193,125 to
the shareholders of TSI. The acquisition was recorded under the purchase
method of accounting. The aggregate purchase price has been allocated to
the assets acquired and liabilities assumed based on their respective fair
values at the date of acquisition. The excess consideration paid over the
fair market value of the net assets acquired is recorded as goodwill. The
operating results of TSI are included in the accompanying consolidated
financial statements for the period August 4, 1998 through December 27,
1998. Due the short intervening period between the date of commencement of
the Company's operations and the acquisition of TSI the consolidated
operation results of the Company would not have been materially different
had the acquisition of TSI occurred on July 1, 1998.
D-9
<PAGE>
6. INCOME TAXES
The Company recognizes deferred income taxes for the differences between
financial accounting and tax bases of assets and liabilities. Income taxes
for the period July 1, 1998 (date of inception) through December 28, 1998
consisted of the following:
Current tax (benefit) provision $ (50,763)
Deferred tax (benefit) provision 36,065
---------
Total income tax (benefit) $ (14,698)
=========
Deferred tax assets of $65,862 less a valuation allowance of $50,763,
relate primarily to net operating loss carryforwards and differences in
book and tax bases of property and equipment and deferred rent. The net
deferred income tax asset at December 31, 1998 is comprised of:
Difference in tax and book bases of property and equipment $ 8,098
Difference in tax and book bases of goodwill (401)
Deferred rent 7,001
Net operating loss carryforwards 50,763
----------
Total deferred income tax asset 65,461
Less: valuation allowance (50,763)
----------
Net deferred income tax asset $ 14,698
==========
Federal net operating loss carryforwards of $173,000 expire through 2018.
Due to the change in control of the Company discussed in Note 8, future
utilization of the net operating losses may be restricted.
The differences between the statutory and effective tax rates is as
follows:
Federal statutory rates $(64,652) (30)%
Valuation allowance for operating loss carryforwards 50,763 23%
Other (809) --%
-------- -----
Effective rate $(14,698) (7)%
======== =====
7. LEASES
The Company leases its stores under long-term operating leases. The leases
generally have initial terms of five to seven years and usually provide for
renewal options ranging from five to seven additional years. These
operating leases expire at various dates through January 31, 2009. Most of
the leases contain escalation clauses and common area maintenance charges.
The Company records rent expense on a straight-line basis over the original
term of the lease. Rent expense under these operating leases was $191,470.
for the period July 1, 1998 (date of inception) through December 28, 1998.
D-10
<PAGE>
Future minimum annual lease payments and sublease rentals under operating
lease agreements for years ended December 31 are:
1999 $ 332,230
2000 339,480
2001 340,480
2002 350,313
2003 352,480
Thereafter 1,134,622
----------
$2,852,605
==========
8. SUBSEQUENT EVENTS
Subsequent to December 27, 1998, the Company enter into and agreement to
acquire all of the issued and outstanding stock of Selman Systems, Inc.
("Selman"), an operator and franchisor of a chain of cafes and bakeries
under the name of Frullati Cafe and Bakery ("Frullati"). That transaction
was later rescinded when Selman agreed to be acquired by Sports Group
International, Inc. ("SPGK"). On July 7, 1999, all of the outstanding
common stock of the Company was acquired by Selman through the issuance by
Selman of $1,200,000 note payable. The Company became a wholly owned
subsidiary of Selman, which is a wholly owned subsidiary of SPGK.
9. CONCENTRATION OF CREDIT RISK
The Company maintains cash balances at banks in Texas and Louisiana.
Accounts are insured by the Federal Deposit Insurance Corporation up to
$100,000. At December 27, 1998, the Company's uninsured bank balances total
$14,287.
* * * * * *
D-11
<PAGE>
PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Sports Group International, Inc. (the "Company") was formed in 1997 under its
former name, Secretarial Services of Orlando, Inc. The Company merged with Surf
City Acquisition Corporation II ("SCAC") in March 1999. Prior to its merger with
SCAC, the Company had no significant operations. As a result of the merger
transaction with SCAC, the former SCAC stockholders held approximately 69% of
the Company's voting stock. For financial accounting purposes, the acquisition
was a reverse merger and was treated as a recapitalization with SCAC as the
acquirer.
On May 21, 1999, the Company issued 650,000 shares of its Series B Convertible
Preferred Stock for $6,500,000. The proceeds were used to acquire all of the
issued and outstanding stock of Selman Systems, Inc. ("Selman"), an operator and
franchisor of a chain of cafes and bakeries under the name of Frullati Cafe and
Bakery ("Frullati").
On July 7, 1999, the Company, through Selman, purchased all of the outstanding
stock of Fru-Cor, Inc., an owner of eight Frullati locations. The purchase was
effected through the issuance of a promissory note for $1,200,000.
The accompanying Pro Forma Condensed Consolidated Financial Statements of
Operations for the year ended December 31, 1998 and the twelve months ended
December 31, 1999 assume that the acquisition of Selman and Fru-Cor took place
on January 1, 1998. The accompanying pro forma information is presented for
illustrative purposes and is not necessarily indicative of the financial
position or results of operations, which would actually have been reports, had
the acquisition been in effect during the periods presented, or which may be
reports in the future.
The accompanying Pro Form Condensed Consolidated Financial Statements should be
read in conjunction with the historical financial statements and related notes
thereto for the Company, SCAC, Selman, and Fru-Cor.
E-1
<PAGE>
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
For the Twelve Months Ended December 31, 1999
(Unaudited)
<TABLE>
<CAPTION>
Historical
----------------------------------------------
Company Frulatti Fru-cor
Twelve Months Results from Results from
Ended Dec. 28, 1998 Dec. 28, 1998 Pro Forma Pro Forma
Dec 31, 1999 to May 16, 1999 to July 10, 1999 Adjustments Combined
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
REVENUES:
Net product sales 7,925,096 4,301,546 1,076,014 -- 13,302,657
Franchise fees 380,038 128,602 -- -- 508,640
Royalties 1,457,273 408,950 -- (28,909)(1) 1,837,314
Rental income 451,062 -- -- -- 451,062
------------ ------------ ------------ ------------ ------------
Total revenues 10,213,469 4,839,098 1,076,014 (28,909) 16,099,672
------------ ------------ ------------ ------------ ------------
EXPENSES:
Cost of product sales 2,575,200 1,267,782 379,620 -- 4,222,602
Store operating costs 433,106 552,705 83,748 (28,909)(1) 1,040,650
Personnel expenses 3,191,415 1,549,962 417,142 -- 5,158,519
Rent 1,798,382 794,962 223,281 -- 2,816,625
Depreciation 497,127 157,966 56,967 85,959 (2) 798,019
General and administrative expenses 1,722,913 347,900 75,327 -- 2,146,140
------------ ------------ ------------ ------------ ------------
Total expenses 10,218,143 4,671,276 1,236,085 57,050 16,182,554
------------ ------------ ------------ ------------ ------------
OPERATING INCOME (LOSS) (4,674) 167,822 (160,071) (85,959) (82,882)
------------ ------------ ------------ ------------ ------------
OTHER (INCOME) AND EXPENSES
Interest expense 258,336 27,384 26,035 63,000 (3) 374,755
Interest income (26,078) -- -- -- (26,078)
Other income -- 19,378 -- -- 19,378
------------ ------------ ------------ ------------ ------------
Total other expense 232,258 46,762 26,035 63,000 368,055
------------ ------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE
INCOME TAXES (236,932) 121,060 (186,106) (148,959) (450,937)
TAX PROVISION/(BENEFIT) (86,897) -- -- (54,632) (141,529)
------------ ------------ ------------ ------------ ------------
NET INCOME (LOSS) $ (150,035) $ 121,060 $ (186,106) $ (94,327) $ (309,408)
============ ============ ============ ============ ============
</TABLE>
NOTES TO PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(1) Eliminate the royalty income and royalty expense of Selman and Fru-Cor,
respectively for the stores owned by Fru-Cor and which Fru-Cor was a
franchisee of Selman.
(2) Amortization of acquired intangibles and goodwill and a reduction of
depreciation expense due to purchase accounting adjustments made to certain
assets of Selman and Fru-Cor.
(3) Interest expense on the $1.5 million acquisition note related to Selman and
Fru-Cor.
E-2
<PAGE>
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
For the Year Ended December 31, 1998
(Unaudited)
<TABLE>
<CAPTION>
Historical Pro Forma Pro Forma
Surf City Frullati Fru-cor Adjustments Combined
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
REVENUES:
Net product sales $ 1,049,997 12,148,375 761,976 -- 13,960,348
Franchise fees 483,088 320,537 -- (95,000)(1) 708,625
Royalties 722,130 952,779 -- (46,690)(2) 1,628,219
Rental income 404,233 -- -- -- 404,233
Other 8,241 95,506 -- -- 103,747
------------ ------------ ------------ ------------ ------------
Total revenues 2,667,689 13,517,197 761,976 (141,690) 16,805,172
------------ ------------ ------------ ------------ ------------
EXPENSES:
Cost of product sales 437,525 3,664,796 231,697 -- 4,334,018
Store operating costs 164,303 61,466 -- 225,769
Personnel expenses 720,670 4,032,835 327,373 -- 5,080,878
Rent 655,017 2,425,680 170,880 -- 3,251,577
Depreciation -- 558,725 35,628 208,795 (3) 803,148
Franchising expense 21,429 60,288 (46,690)(2) 35,027
General and administrative 494,913 2,878,973 71,553 -- 3,445,439
------------ ------------ ------------ ------------ ------------
Total expenses 2,493,857 13,561,009 958,885 162,105 17,175,856
------------ ------------ ------------ ------------ ------------
OPERATING INCOME (LOSS) 173,832 (43,812) (196,909) (303,795) (370,684)
------------ ------------ ------------ ------------ ------------
OTHER (INCOME) AND EXPENSES
Interest expense 176,806 75,187 209 135,000 (4) 387,202
Interest income (23,045) (26,511) (426) -- (49,982)
Other income (108,345) (213,314) (1,775) 222,135 (1) (101,299)
------------ ------------ ------------ ------------ ------------
Total other expense 45,416 (164,638) (1,992) 357,135 235,921
------------ ------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES 128,416 120,826 (194,917) (660,930) (606,605)
INCOME TAX PROVISION/(BENEFIT) 83,503 98,067 (7,697) (481,480) (307,607)
------------ ------------ ------------ ------------ ------------
NET INCOME (LOSS) $ 44,913 22,759 $ (187,220) $ (179,450) $ (298,998)
============ ============ ============ ============ ============
</TABLE>
NOTES TO PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(1) Eliminate the gain on sale of certain stores from Selman to Fru-Cor and
related franchise fee income.
(2) Eliminate the royalty income and royalty expense of Selman and Fru-Cor,
respectively for the stores. owned by Fru-Cor and which Fru-Cor was a
franchisee of Selman.
(3) Amortization of acquired intangibles and goodwill and a reduction of
depreciation expense due to purchase accounting adjustments made to certain
assets of Selman and Fru-Cor.
(4) Interest expense on the $1.5 million acquisition note related to Selman and
Fru-Cor.
E-3
<PAGE>
FOOTNOTE TO PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The schedule below shows the allocation of the purchase price for the
acquisition of Selman ($6,500,00) and of Fru-Cor ($1,200,000) to the assets,
liabilities of each acquisition and the resulting goodwill for each acquisition
in 1999.
SELMAN
-----------------------------------------
MAY 16 '99 ALLOCATION NEW BASIS
---------- ---------- ----------
Receivables 146,361 (54,935) 91,426
Inventories 126,116 (29,219) 96,897
Property, Plant &
Equipment 3,211,803 213,197 3,425,000
Goodwill -- 4,940,343 4,940,343
Other 130,085 4,633 134,718
---------- ---------- ----------
3,614,364 5,074,020 8,688,384
========== ========== ==========
Accounts Payable 491,293 -- 491,293
Accrued Expenses 711,681 -- 711,681
Deferred Revenue 175,700 -- 175,700
Deferred Taxes 198,590 -- 198,590
Other Liabilities 611,120 -- 611,120
Equity 1,425,980 5,074,020 6,500,000
---------- ---------- ----------
3,614,364 5,074,020 8,688,384
========== ========== ==========
FRU-COR
-----------------------------------------
JUL 11 '99 ALLOCATION NEW BASIS
---------- ---------- ----------
Inventories 30,924 (6,184) 24,740
Property, Plant &
Equipment 830,397 (430,397) 400,000
Goodwill 173,050 1,024,364 1,197,414
Other Assets 29,030 (2,972) 26,058
---------- ---------- ----------
1,063,401 584,811 1,648,212
========== ========== ==========
Accounts Payable 69,498 -- 69,498
Accrued Expenses 78,714 -- 78,714
Other Liabilities 50,000 250,000 300,000
Equity 865,189 334,811 1,200,000
---------- ---------- ----------
1,063,401 584,811 1,648,212
========== ========== ==========
E-4
