MORGANS FOODS INC, 10-K405, 1999-06-01

MORGANS FOODS INC
10-K405, 1999-06-01
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<PAGE> 1

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

Annual Report Pursuant to Section 13 or 15 (d)
of the Securities Exchange Act of 1934

For the fiscal year ended February 28, 1999 Commission file number 0-3833
----------------------- ---------

MORGAN'S FOODS, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)

Ohio 34-0562210
- ------------------------------- ----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)

24200 Chagrin Boulevard, Suite 126, Beachwood, OH 44122
- --------------------------------------------------------------------------------
(Address of principal executive officers) (Zip Code)

Registrant's telephone number, including area code: (216) 360-7500
-----------------------------

Securities registered pursuant of Section 12 (b) of the Act:
Name of each exchange on
Title of each class which registered
------------------- ------------------------

Common Shares, Without Par Value American Stock Exchange

Securities registered pursuant to Section 12 (g) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---

Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

As of May 6, 1999, the aggregate market value of the common stock held
by nonaffiliates of the Registrant was $6,923,407.

As of May 6, 1999, the Registrant had 2,910,839 shares of common stock
outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Part III incorporates by reference certain information from the
definitive Proxy Statement to security holders for the 1999 annual meeting, to
be filed with the Securities and Exchange Commission on or before June 25, 1999.

<PAGE> 2

MORGAN'S FOODS, INC.

PART I

ITEM 1. BUSINESS.

GENERAL. The Registrant operates, through wholly-owned subsidiaries,
Kentucky Fried Chicken ("KFC") restaurants under franchises from KFC
Corporation. The Company also operates East Side Mario's restaurants in the
Cleveland/Akron and Columbus, Ohio areas under franchises from East Side
Mario's, Inc. As of May 27, 1999, the Company operated 48 KFC restaurants, three
of which also offer Taco Bell products, as well as five East Side Mario's
restaurants. The headquarters of the Registrant are located in the Cleveland,
Ohio metropolitan area. Throughout this Report, the Registrant together with its
subsidiaries is referred to as the "Company."

RESTAURANT OPERATIONS. The Company's KFC restaurants prepare and sell
the distinctive "Kentucky Fried Chicken" and Tender Roast(R) chicken along with
related food items. All containers and packages bear KFC trademarks. The
KFC/Taco Bell "2 in 1" restaurants prepare and sell a limited menu of Taco Bell
items using the appropriate Taco Bell containers and packages as well as the
full KFC menu. The East Side Mario's restaurants are full service, mid-priced,
informal family restaurants inspired by New York City's famous "Little Italy"
district of the 1950's. The menu features a variety of All-American grill
favorites and authentic Italian specialties.

Of the 48 KFC restaurants operated by the Company as of May 27, 1999,
14 are located in Ohio, 21 in Pennsylvania, 10 in Missouri, 1 in Illinois, 1 in
West Virginia and 1 in New York. The Company was one of the first KFC
Corporation franchisees and has operated in excess of 20 KFC franchises for more
than 25 years. Operations relating to these KFC units are seasonal to a certain
extent, with higher sales generally occurring in the summer months. Five East
Side Mario's restaurants operated by the Company are located in the
Cleveland/Akron area and one in Columbus, Ohio.

FRANCHISE AGREEMENTS. All of the Company's KFC restaurants are operated
under franchise agreements with KFC Corporation. The Company considers retention
of these agreements to be important to the success of its restaurant business
and believes that its relationship with KFC Corporation is satisfactory. For KFC
products, the Company is required to pay royalties of 4% of gross revenues and
to expend an additional 5% of gross revenues on national and local advertising
pursuant to its franchise agreements. In May 1997, the Company renewed
substantially all of its franchise agreements for twenty years. Subject to
satisfying KFC requirements for restaurant image and other matters, franchise
agreements are renewable at the Company's option for successive ten year
periods. The franchise agreements provide that each KFC unit is to be inspected
by KFC Corporation approximately three or four times per year. These inspections
cover product preparation and quality, customer service, and restaurant
appearance and operation. Taco Bell products are offered in the Company's
KFC/Taco Bell "2 in 1" restaurants under five year license agreements which
require the Company to pay royalties at 10% and advertising fund contributions
at 1/2% of Taco Bell gross revenue. Both KFC Corporation and Taco Bell
Corporation are wholly owned by Tricon Global Restaurants, Inc. The East Side
Mario's restaurants are operated under franchise agreements with East Side
Mario's, Inc., for remaining terms of 15 to 17 years and are renewable by the
Company for one additional term of 10 years. The East Side Mario's franchise
agreements require the Company to pay royalties of 4% on gross revenue and

2
<PAGE> 3

MORGAN'S FOODS, INC.

PART I (CONT'D)

1/2% of gross revenue to an advertising fund. The franchise agreements also
require the Company to expend an additional 2 1/2% of gross revenue for
advertising and promotion. The East Side Mario's franchise agreements also grant
the right to East Side Mario's, Inc. to perform quality and franchise compliance
inspections without prior notice to the Company. The Company is engaged in legal
proceedings against the franchisor of East Side Mario's which are described in
Item 3 below.

COMPETITION. The restaurant business is highly competitive. Each of the
Company's KFC restaurants competes directly or indirectly with a large number of
national and regional restaurant operations, as well as with locally owned
restaurants, drive-ins, diners and numerous other establishments which offer
low- and medium-priced chicken, steak, pizza and other food to the public. The
East Side Mario's restaurants compete with other mid-priced, casual, full
service restaurants.

The Company's KFC restaurants and KFC/Taco Bell "2 in 1" restaurants
rely on innovative marketing techniques and promotions to compete with other
restaurants in the areas in which they are located. The Company's competitive
position is also enhanced by the national advertising program sponsored by KFC
Corporation, Taco Bell Corporation and their franchisees. The East Side Mario's
restaurants rely on a distinctive themed decor and a variety of Italian and
American menu items at moderate prices. Emphasis is placed by the Company on its
control systems and the training of personnel to maintain high food quality and
good service. The Company believes that its KFC restaurants are competitive with
other quick service restaurants on the basis of the important competitive
factors in the restaurant business which include primarily restaurant location,
product price, quality and differentiation; and restaurant and employee
appearance. The Company considers the East Side Mario's restaurants to be less
competitive against other casual mid-priced restaurants due to inadequate menus,
food systems and marketing and operational support provided by the franchisor.

SUPPLIERS. The Company has been able to obtain sufficient supplies to
carry on its business and believes it will be able to do so in the future.

GROWTH. During fiscal 1999, the Company completed construction of a new
KFC restaurant in Boardman, OH and acquired four KFC restaurants in the Erie, PA
market area, two KFC restaurants in the Jamestown, NY area and two KFC
restaurants in the St. Louis market area. Also, the Company entered into a
binding agreement to purchase two KFC restaurants in Erie, PA, which transaction
is expected to close in early June 1999. Also, in May 1999, the Company signed
definitive agreements to purchase 43 KFC restaurant properties and 12 Taco Bell
restaurants from KFC Corporation and Taco Bell Corporation respectively and
expects to close the transactions in middle to late June 1999. During fiscal
1999, the Company also ceased operations at its East Side Mario's restaurant in
Mayfield Heights, OH and liquidated its leasehold interest subsequent to the end
of the fiscal year. During fiscal 1998, the Company completed the construction
of a new KFC restaurant on leased land in Greensburg, PA and completed the
rebuilding of a KFC restaurant in the St. Louis market area.

<PAGE> 4

MORGAN'S FOODS, INC.

PART I (CONT'D)

EMPLOYEES. As of May 27, 1999, the Company employed approximately 1,217
persons, including 31 administrative and 116 managerial employees. The balance
are hourly employees, most of whom are part-time. None of the restaurant
employees are represented by a labor union. The Company considers its employee
relations to be satisfactory.

ITEM 2. PROPERTIES.

The Company leases approximately 5,388 square feet of space for its
headquarters in Cleveland, Ohio. The lease expires in 2001 and the rent under
the current term is $7,097 per month. The lease also contains a renewal option
of five years, which may be exercised by the Company. The Company also leases
space for a regional office in Youngstown, OH, which is used to assist in the
operation of the KFC restaurants.

Of the 48 KFC restaurants, the Company owns the land and building for
23 locations, owns the building and leases the land for 6 locations and leases
the land and building for 19 locations. Twenty of the owned properties are
subject to mortgages. Remaining lease terms (including renewal options) range
from 1 to 27 years and average approximately 15 years. These leases generally
require the Company to pay taxes and utilities, to maintain casualty and
liability insurance, and to keep the property in good repair. The Company pays
annual rental for each leased KFC restaurant in amounts ranging from $10,800 to
$78,750. In addition, 16 of these leases require payment of additional rentals
based on a percentage of gross sales in excess of certain base amounts. Sales
for 7 KFC restaurants exceeded the respective base amounts in fiscal 1999. Of
the five East Side Mario's restaurants, the Company owns the building and leases
the land on one location and leases the land and the building for four
locations. In addition, three of the East Side Mario's restaurant leases require
payment of additional rentals based on a percentage of gross sales in excess of
certain base amounts. Sales for these East Side Mario's restaurants did not
exceed their base amounts for fiscal 1999.

The Company believes that its restaurants are generally efficient, well
equipped and maintained and in good condition.

ITEM 3. LEGAL PROCEEDINGS.

On April 20, 1998 the Company and its wholly owned subsidiary, Morgan's
Creative Restaurant Concepts, Inc., filed a lawsuit against East Side Mario's,
Inc. and other related parties in Federal District Court in Cleveland, Ohio and
on July 8, 1998 the Company filed a second suit against the same parties. The
suits allege fraud, deceptive trade practices and failure to support the East
Side Mario's franchisees among other things and they cover complex business and
trade issues involving many counts. As a result of the lawsuits certain royalty
and advertising fund payments are in dispute. Because of the complex nature of
litigation, the Company is unable to determine the outcome of the matter or to
estimate potential recovery, if any.

<PAGE> 5

MORGAN'S FOODS, INC.

PART I (CONT'D)

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

There were no matters submitted to security holders for a vote during
the last quarter of the Company's fiscal year ended February 28, 1999.

EXECUTIVE OFFICERS OF THE COMPANY

The Executive Officers and other Officers of the Company are as
follows:

POSITION WITH
NAME AGE REGISTRANT OFFICER SINCE
- ------------------- --- -------------------- -------------

<S> <C> <C> <C>
EXECUTIVE OFFICERS:

Leonard Stein-Sapir 60 Chairman of the Board April 1989
and Chief Executive
Officer

James J. Liguori 50 President and Chief June 1979
Operating Officer

Kenneth L. Hignett 52 Senior Vice President- May 1989
Chief Financial Officer
& Secretary

OTHER OFFICERS:

Barton J. Craig 50 Senior Vice President - January 1994
General Counsel

Vincent J. Oddi 56 Vice President- September 1979
Restaurant Development

Ramesh J. Gursahaney 50 Vice President- January 1991
Operations Services

</TABLE>

Mr. Craig serves as a Law Professor at Albertus Magnus College.

Executive officers of the Company serve for a term of one year and
until their successors are elected and qualified, unless otherwise specified by
the Board of Directors. Any officer is subject to removal with or without cause,
at any time, by a vote of a majority of the Board of Directors.

<PAGE> 6

MORGAN'S FOODS, INC.

PART II

ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

The Company's Common Shares are traded on the American Stock Exchange
under the symbol "MR". The following table sets forth, for the periods
indicated, the high and low sales prices of the Common Shares as reported on the
American Stock Exchange. All prices are adjusted for the 1 for 6 reverse stock
split which was effective July 14, 1997.

PRICE RANGE
HIGH LOW
-----------------
<S> <C> <C>
YEAR ENDED FEBRUARY 28, 1999:
1st Quarter ...................... $3 5/8 $2 1/8
2nd Quarter ...................... 2 13/16 2
3rd Quarter ...................... 2 3/8 2
4th Quarter ...................... 2 3/4 2

YEAR ENDED MARCH 1, 1998:
1st Quarter ...................... $3 $2 1/4
2nd Quarter ...................... 3 1 11/16
3rd Quarter ...................... 3 1 15/16
4th Quarter ...................... 2 3/4 1 7/8
</TABLE>

As of May 6, 1999, the Company had approximately 1,086 shareholders of
record. The Company has paid no dividends since fiscal 1975.

<PAGE> 7

MORGAN'S FOODS, INC.

PART II (CONT'D)

ITEM 6. SELECTED FINANCIAL DATA.

The following selected financial information for each of the five
fiscal years in the period ended February 28, 1999, is derived from, and
qualified in its entirety by, the consolidated financial statements of the
Company. The following selected financial information should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the consolidated financial statements and the
notes thereto included elsewhere in this Report.

Dollars in thousands except per share amounts.

YEARS ENDED
------------------------------------------------------------
FEBRUARY 28, MARCH 1, MARCH 2, MARCH 3, FEBRUARY 26,
1999 1998 1997 1996 1995
------------ ---------- ----------- ----------- ------------

<S> <C> <C> <C> <C> <C>
Revenues .......................... $ 40,607 $ 38,868 $ 38,252 $ 42,510 $ 53,295
Cost of sales:
Food, paper and beverage ........ 12,774 12,259 12,141 13,662 17,282
Labor and benefits .............. 10,635 10,456 9,951 11,122 13,807
Restaurant operating expenses ..... 11,348 11,001 11,047 12,256 14,632
Depreciation and amortization ..... 1,948 1,840 1,888 1,988 2,536
Asset impairments ................. -- -- 2,939 -- --
General and administrative
expenses ......................... 3,137 2,799 2,876 2,947 3,759
-------- -------- -------- -------- --------
Operating income (loss) ........... 765 513 (2,590) 535 1,279
Gain (loss) on sale or disposal
of restaurant assets ............. -- (98) (248) 1,681 --
Income (loss) before
extraordinary items .............. (721) (928) (4,055) 1,126 (425)
Extraordinary loss on early
extinguishment of debt (2) ....... (287) -- -- -- --
-------- -------- -------- -------- --------
Net income (loss) ................. (1,008) (928) (4,055) 1,126 (425)
Income (loss) per common share (1):
Income (loss) before
extraordinary item ............ (.25) (.31) (1.37) .38 (.14)
Loss on early extinguishment
of debt ....................... (.10) -- -- -- --
-------- -------- -------- -------- --------
Net income (loss) ............... (.35) (.31) (1.37) .38 (.14)
Working capital (deficiency) ...... (2,182) (2,046) (884) (562) (3,728)
Total assets ...................... 24,011 20,110 19,312 22,034 29,432
Long-term debt .................... 13,094 7,815 6,474 5,448 4,151
Long-term capital lease
obligations ...................... 4,244 5,019 4,847 5,062 3,896

Shareholders' equity .............. 1,248 2,256 3,300 7,378 6,249

</TABLE>

(1) Computed based upon the weighted average number of common and
common equivalent shares outstanding during each year, which were 2,910,839 in
1999, 2,936,877 in 1998, 2,967,574 in 1997, 2,969,355 in 1996 and 2,967,806 in
1995. All share and per share amounts have been restated for the reverse stock
split which was effective July 14, 1997.

(2) Prepayment penalty, write off of deferred financing and early
buy-out of capitalized leases costs related to early extinguishment of debt.

7
<PAGE> 8

MORGAN'S FOODS, INC.

PART II (CONT'D)

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

RESULTS OF OPERATIONS. During fiscal 1997 through 1999 the Company
operated Kentucky Fried Chicken ("KFC") franchised restaurants, of which three
also offer Taco Bell products, in the states of Illinois, Missouri, Ohio,
Pennsylvania, West Virginia and New York and East Side Mario's franchised
restaurants in Ohio. The average number of KFC restaurants in operation during
fiscal 1999 was 44 compared to 39 during fiscal 1998 and 40 during fiscal 1997.
During fiscal 1999, the Company acquired 8 KFC restaurants and opened one new
KFC restaurant. The Company closed one East Side Mario's during fiscal 1999 and
currently operates five of the restaurants.

REVENUES. Revenue was $40,607,000 in fiscal 1999 an increase of
$1,739,000 or 4.5% compared to an increase of $616,000 or 1.6% in fiscal 1998.
KFC revenue was $33,040,000 in fiscal 1999, an increase of $3,127,000 or 10.5%
compared to an increase of 4.8% in fiscal 1998. East Side Mario's revenue was
$7,567,000 in fiscal 1999, a decrease of $1,388,000 or 15.5% compared to a
decrease of 7.9% in fiscal 1998.

The 10.5% increase in KFC revenue during fiscal 1999 was the result of
a 1.0% increase in comparable restaurant revenues and $2,569,000 in revenues
generated by the eight KFC's which were acquired and the one new KFC which was
built during fiscal 1999. The 15.5% revenue decrease in the East Side Mario's
restaurants during fiscal 1999 was caused by a comparable restaurant decrease of
8.5% combined with the closing of one East Side Mario's during the third quarter
of fiscal 1999. The KFC restaurants continue to perform well because of
effective support provided by the franchisor and continuing upgrades and
improvements made by the Company. The East Side Mario's restaurants continue to
perform poorly because of the lack of an effective food system, lack of
advertising support and complete failure of the franchisor to make the concept
competitive in the mid-priced casual restaurant market. The 1.6% increase in
revenue during fiscal 1998 was due to the combination of several factors. First,
sales in the comparable KFC restaurants increased 1.8% or $383,000 primarily due
to the addition of Taco Bell products. The two KFC restaurants which were
acquired just prior to the beginning of fiscal 1998 and the new KFC opened
during the year accounted for an increase of $1,735,000, which was partially
offset by three closed KFC restaurants in the St. Louis market which caused a
decline of $738,000 in sales. Finally, East Side Mario's restaurant sales
declined $764,000 or 7.9% compared to the prior year. Revenues for the
comparable KFC restaurants were flat during fiscal 1998 compared to the prior
year primarily because fiscal 1997 revenues were extremely strong and many of
the Company's KFC restaurants were closed for short periods of time during the
fiscal 1998 year to facilitate remodeling and image enhancements.

Revenues for the 16 weeks ended February 28, 1999 were $11,969,000, an
increase of $745,000 from the 16 weeks ended March 1, 1998. KFC restaurant
revenues increased $1,432,000 to 9,980,000 in the fiscal 1999 quarter compared
to the fiscal 1998 quarter due to a comparable restaurant increase of 2.1% and
the addition of nine new restaurants, three of which were added during the
fiscal fourth quarter. East Side Mario's comparable restaurant revenues declined
by $687,000 to $1,989,000 for the fiscal 1999 fourth quarter caused by a
comparable restaurant revenue decline of 8.5% combined with the closing of one
restaurant late in the third quarter. The reasons for these changes are the same
as mentioned above in the full year comparisons.

<PAGE> 9

MORGAN'S FOODS, INC.

PART II (CONT'D)

COST OF SALES - FOOD, PAPER AND BEVERAGE. Food, paper and beverage
costs were $12,774,000 or 31.5% of sales in fiscal 1999 compared to $12,259,000
or 31.5% of sales in fiscal 1998. Food, paper and beverage costs declined by
0.2% of sales in the KFC's due to efficiencies from higher average restaurant
volumes and the continuation of low chicken prices. Food, paper and beverage
costs rose 0.2% of sales in the East Side Mario's due to declining revenues and
the absence of menu price increases to offset higher food procurement costs.
Food, paper and beverage costs were $12,259,000 or 31.5% of sales in fiscal 1998
compared to $12,141,000 or 31.7% of sales in fiscal 1997. Food, paper and
beverage costs declined by 0.4% of sales in the KFC's due to efficiencies from
higher volumes and the absence of high food cost promotions. Food, paper and
beverage costs remained constant as a percentage of sales in the East Side
Mario's due to more effective operational controls offset by decreased
efficiency due to lower volumes.

For the fourth quarter, food, paper and beverage costs in fiscal 1999
increased as a percentage of sales to 31.7% from 31.2% in fiscal 1998. KFC food,
paper and beverage cost increased 0.5% of sales due to lower food cost
efficiency in the restaurants acquired late in fiscal 1999. The East Side
Mario's food, paper and beverage costs increased 0.2% of sales during the fiscal
1999 fourth quarter due to lower restaurant volumes.

COST OF SALES - LABOR AND BENEFITS. Labor and benefits decreased to
26.2% of sales or $10,635,000 in fiscal 1999 from 26.9% of sales or $10,456,000
in fiscal 1998. Labor and benefit costs in the KFC's decreased 0.5% in fiscal
1999 compared to the prior year primarily due to reduced workers compensation
costs. Labor and benefit costs in the East Side Mario's increased 0.2% of sales
in fiscal 1999 because of reduced efficiency caused by lower volume levels.
Labor and benefit costs in fiscal 1998 increased to 26.9% of sales or
$10,456,000 compared to 26.0% of sales or $9,951,000 in fiscal 1997. Labor costs
in the KFC's increased by approximately 1.6% of sales primarily due to the
increase in the minimum wage and the inefficiencies created by many short term
restaurant closings during fiscal 1998 to facilitate image enhancements and
remodeling. The labor costs in the East Side Mario's remained relatively
consistent as a percentage of sales despite lower volumes due to continuing
strong management controls.

Labor and benefit costs for the fourth quarter decreased to 26.7% of
sales or $3,201,000 compared to 27.9% of sales or $3,127,000 in fiscal 1998.
Labor costs as a percentage of sales in the KFC's decreased 0.7% in the fiscal
1999 fourth quarter compared to the fiscal 1998 fourth quarter while labor costs
in the East Side Mario's increased 1.4% percent of sales for the same periods.
The changes were primarily caused by lower workers' compensation rates which
were offset, in the East Side Mario's, by decreased efficiency due to lower
volumes.

RESTAURANT OPERATING EXPENSES. Restaurant operating expenses in fiscal
1999 decreased to 27.9% of sales or $11,348,000 compared to 28.3% of sales or
$11,001,000 in the prior year. KFC restaurant operating expenses decreased to
25.7% of sales in fiscal 1999 compared to 26.1% of sales in fiscal 1998 due to
increased average sales volumes. Restaurant operating expenses in the East Side
Mario's restaurants increased as percentage of sales to 37.8% from 35.8% in the
prior year due to lower average volumes and the closing of one restaurant in the
third quarter of fiscal 1999. Restaurant operating expenses in fiscal 1998
declined slightly to $11,001,000 or 28.3% of revenue from $11,047,000 or 28.9%
of revenue in fiscal 1997.

<PAGE> 10

MORGAN'S FOODS, INC.

PART II (CONT'D)

KFC operating expenses declined by 0.7% of sales primarily due to lower rent and
advertising expenditures and the East Side Mario's increased 1.0% of sales due
to lower sales volumes combined with increases in land and building rent.

Restaurant operating expenses for the fourth quarter of fiscal 1999
decreased to 29.2% of sales or $3,492,000 from 30.8% of sales or $3,460,000 in
the year earlier quarter. KFC restaurant operating expenses decreased to 27.0%
of sales in the fiscal 1999 period from 28.3% of sales in the comparable prior
year period primarily due to higher restaurant volumes. Restaurant operating
expenses for the East Side Mario's restaurants in the fourth quarter of fiscal
1999 rose to 40.2% of sales compared to 38.9% of sales in the year earlier
period due to lower restaurant volumes and the closing of one restaurant in the
third quarter of fiscal 1999.

DEPRECIATION AND AMORTIZATION. Depreciation and amortization in fiscal
1999 increased to $1,948,000 from $1,840,000 in fiscal 1998. Depreciation for
the KFC restaurants increased $46,000 from the prior year to $1,198,000 due to
the building of one restaurant and the acquisition of eight others during fiscal
1999. Depreciation for the East Side Mario's remained essentially the same at
$559,000. Amortization for fiscal 1999 increased to $191,000 from $130,000 in
the prior year due to increased balances for franchise fees and deferred
financing costs. Depreciation and amortization in fiscal 1998 decreased slightly
to $1,840,000 from $1,888,000 in fiscal 1997. Depreciation for the KFC
restaurants increased to $1,152,000 in fiscal 1998 from $1,068,000 in fiscal
1997 due to increased asset balances related to acquisition and image
enhancement of several restaurants. Depreciation in the East Side Mario's
restaurants decreased to $558,000 in fiscal 1998 from $661,000 in fiscal 1997
due to the asset impairment write-down taken in the fourth quarter of fiscal
1997. Amortization decreased to $130,000 in fiscal 1998 from $159,000 in fiscal
1997 primarily due to the write off of goodwill in the fourth quarter of fiscal
1997.

ASSET IMPAIRMENTS. The Company recorded asset impairments of $2,939,000
in the fourth quarter of fiscal 1997. These impairments included $1,700,000 to
write-down the carrying value of certain East Side Mario's restaurants and
$1,239,000 to write-off goodwill remaining from a previous KFC acquisition. The
write-down of these assets resulted from management's evaluation of
recoverability of their carrying values from estimated future cash flows from
their operation and/or liquidation, as explained in Note 4 to the Consolidated
Financial Statements.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative
expenses increased to $3,137,000 in fiscal 1999 from $2,799,000 in fiscal 1998.
The increase of $338,000 was the result of adding a KFC market manager to keep
pace with the KFC expansion, higher training costs due to KFC acquisitions and
$118,000 of legal expenses in the East Side Mario's litigation which is
described in Item 3 of this report. General and administrative expenses
decreased to $2,799,000 in fiscal 1998 from $2,876,000 in fiscal 1997. The
decrease was primarily due to lack of the workers' compensation litigation
accrual recorded in fiscal 1997 and reduction of field administration expenses
in the East Side Mario's restaurants, partially offset by increased expenses
related to the reverse stock split and upgrading of computer systems.

<PAGE> 11

MORGAN'S FOODS, INC.

PART II (CONT'D)

OPERATING INCOME. Operating income in fiscal 1999 increased $252,000 to
$765,000 from $513,000 in fiscal 1998. This increase was the result of expansion
of the KFC restaurant segment, partially offset by larger losses in the East
Side Mario's restaurants. Operating income in fiscal 1998 was $513,000 compared
to an operating loss of $2,590,000 in fiscal 1997. The operating loss in fiscal
1997 would have been operating income of $349,000 without the asset impairment
write-down of $2,939,000, which was taken in fiscal 1997. The improvement in
fiscal 1998 is primarily the result of additional KFC restaurants, the addition
of Taco Bell products to three existing KFC restaurants, improvement in food
costs and reduction in general and administrative expenses as discussed above.

INTEREST EXPENSE AND OTHER INCOME. Interest expense from bank debt and
notes payable increased to $992,000 in fiscal 1999 from $836,000 in fiscal 1998
due to increased borrowings to fund the acquisition and expansion of KFC
restaurants. The company acquired eight existing KFC restaurants from other
franchisees and built one new KFC restaurant during fiscal 1999. Interest
expense from capitalized lease debt remained relatively constant at $546,000 in
fiscal 1999. Interest expense from bank debt and notes payable increased to
$836,000 in fiscal 1998 compared to $635,000 in fiscal 1997. This increase is
the result of additional debt incurred for the purchase of two KFC restaurants
late in fiscal 1997, the building of one new KFC, the image enhancement of 12
KFC's, the addition of Taco Bell facilities to three KFC restaurants, and the
early renewal of substantially all of the Company's KFC franchise agreements.
Interest on capitalized lease debt, at $554,000 in fiscal 1998, was
substantially unchanged from $564,000 in fiscal 1997.

GAIN (LOSS) ON SALE OF RESTAURANT ASSETS. In fiscal 1999, the Company
recorded losses of $11,000 for the disposal of equipment related to several KFC
restaurant image enhancements. In fiscal 1998 the Company recorded losses of
$98,000 related to the closing of one KFC restaurant and the disposal of
equipment during several image enhancements.

EXTRAORDINARY LOSS ON EARLY EXTINGUISHMENT OF DEBT. During fiscal 1999,
the Company paid $4,899,000 of 15 year maturity, fixed rate debt, carrying an
interest rate of approximately 10.0%, which was incurred in the third quarter of
fiscal 1996, in advance of its scheduled maturity. This prepayment was funded by
borrowing $6,762,000 of 20 year maturity, fixed rate debt carrying an interest
rate of approximately 8.7%. The Company paid prepayment penalties of $98,000,
wrote off $140,000 of deferred financing costs related to this transaction and
incurred a loss of $49,000 on the early buy out of capitalized leases covering
equipment at three of the locations. This transaction is more fully described in
Note 3 to the consolidated financial statements.

LIQUIDITY AND CAPITAL RESOURCES. The Company, like others in the
restaurant industry, operates on minimal working capital and relies on cash flow
from operations, debt borrowings and lease financing for the construction and
refurbishment of restaurant properties and repayment of debt. Cash flow activity
for fiscal 1999, 1998 and 1997 is presented in the Consolidated Statements of
Cash Flows.

<PAGE> 12

MORGAN'S FOODS, INC.

PART II (CONT'D)

Capital expenditures for fiscal 1999 were $5,379,000, substantially all
of which related to KFC restaurants. In fiscal 1999 the Company received
$10,769,000 in mortgage financing for the construction of one new KFC
restaurant, the acquisition of eight existing KFC restaurants and the prepayment
of $4,899,000 of debt. The Company made principal payments on long-term debt of
$577,000 in fiscal 1999.

The Company has installed the newest version of its accounting software
package and a recent version of the network operating system used at the Home
Office, both of which are year 2000 compliant. Management has identified several
minor machines and non-critical systems which are not year 2000 compliant and is
in the process of replacing them. Management believes that this will be
completed well before the end of 1999 and that it has no significant year 2000
operating exposure in its critical core systems. The Company has two major
suppliers upon which it relies for food and related restaurant supplies and
which are using computerized ordering systems. Both of these suppliers have
represented that they will be year 2000 compliant before the end of the year.
The Company is requesting certification of year 2000 readiness from these
suppliers and is evaluating possible backup solutions since failure of these
suppliers to continue operations in the year 2000 could cause material
disruptions to the operation of the Company's restaurants. Items disclosed
herein constitute "Y2000 Readiness Disclosures" under the Year 2000 Information
and Readiness Disclosure Act.

The KFC operations of the Company have historically provided sufficient
cash flow to service the Company's debt, refurbish and upgrade KFC restaurant
properties and cover administrative overhead. Management believes that operating
cash flow will provide sufficient capital to continue to operate and maintain
the KFC and East Side Mario's restaurants, service the Company's debt and
support required corporate expenses. In addition to the Company's operating cash
flow, management believes that additional financing, including long-term leases
of build-to-suit restaurants, development lines of credit and sale/leaseback
arrangements can be obtained to refurbish and acquire KFC restaurants.
Subsequent to the end of fiscal 1999 the Company entered into definitive
agreements to purchase forty-three existing KFC restaurants from KFC Corp. and
twelve Taco Bell restaurants from Taco Bell Corp. which will be financed under a
new mortgage financing commitment.

The Company is currently not in full compliance with the American Stock
Exchange financial condition guidelines for continued listing. Specifically, the
guidelines indicate that any company with shareholders' equity less than
$4,000,000 and losses in 3 of its last 4 fiscal years may be considered for
delisting. This condition has been reviewed with representatives of the American
Stock Exchange who indicated that the Company's performance would continue to be
monitored by the Exchange.

The Company has been financing the expansion and image enhancement
of its restaurants primarily through the use of fixed rate long-term debt on
which the rate is fixed at the time of funding. At February 28, 1999 there was
$13,671,000 of such debt outstanding at rates ranging from 8.3% to 10.6%.
Management has evaluated the potential effect of a 1.0% increase in these rates
on future capital spending plans and believes that there would be no material
effect.

<PAGE> 13

MORGAN'S FOODS, INC.

PART II (CONT'D)

The Company will commit approximately $3,600,000 to image enhancements
and expansions of existing KFC restaurants during fiscal 2000, for which
financing is not yet committed, as well as approximately $1,600,000 to upgrade
point of sale devices and add equipment for the roll out, in the third quarter
of fiscal 2000, of the KFC sandwich program for which financing requests are in
process. There are no plans to add additional East Side Mario's restaurants for
the next fiscal year.

SEASONALITY. The operations of the Company are affected by seasonal
fluctuations. Historically, the Company's revenues and income have been highest
during the summer months with the fourth fiscal quarter representing the slowest
period. This seasonality is primarily attributable to weather conditions in the
Company's marketplace which consists of portions of Ohio, Pennsylvania,
Missouri, Illinois, West Virginia and New York.

NEW ACCOUNTING STANDARD. The Financial Accounting Standards Board has
issued Statement of Financial Accounting Standards (SFAS) No. 133, Accounting
for Derivative Instruments and Hedging Activities. The Company has not yet
completed its analysis of SFAS No. 133 and accordingly has not yet determined
what effect, if any, it may have on future financial statements.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

The Consolidated Financial Statements of the Company are set forth in
Item 14 of this Report.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

None.

<PAGE> 14

MORGAN'S FOODS, INC.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

Information on Directors of the Company is incorporated herein by
reference to the definitive Proxy Statement to security holders for the 1999
annual meeting to be filed with the Securities and Exchange Commission on or
before June 25, 1999.

Information regarding the Executive Officers of the Company is reported
in a separate section captioned "Executive Officers of the Company" included in
Part I hereof.

ITEM 11. EXECUTIVE COMPENSATION.

Information on executive compensation is incorporated herein by
reference to the definitive Proxy Statement to security holders for the 1999
annual meeting to be filed with the Securities and Exchange Commission on or
before June 25, 1999.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

Information on security ownership of certain beneficial owners,
officers and directors is incorporated herein by reference to the definitive
Proxy Statement to security holders for the 1999 annual meeting to be filed with
the Securities and Exchange Commission on or before June 25, 1999.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

Information on certain relationships and related transactions is
incorporated herein by reference to the definitive Proxy Statement to security
holders for the 1999 annual meeting to be filed with the Securities and Exchange
Commission on or before June 25, 1999.

<PAGE> 15

MORGAN'S FOODS, INC.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

(a) 1 and 2. Financial Statements and Financial Statement
Schedules.

The Financial Statements and Financial Statement Schedules
listed on the accompanying Index to Financial Statements and
Financial Statement Schedules are filed as part of this Annual
Report on Form 10-K.

(a) 3. Exhibits.

The Exhibits listed on the accompanying Index to Exhibits are
filed as part of this Annual Report on Form 10-K.

<PAGE> 16

MORGAN'S FOODS, INC.
INDEX TO FINANCIAL STATEMENTS AND
FINANCIAL STATEMENT SCHEDULES
ITEM 14 (a) 1 AND 2

PAGE
ITEM 14 (a) 1 REFERENCE
- ------------- ---------

<S> <C>
Independent Auditors' Report.................................................. 17

Consolidated Balance Sheets
at February 28, 1999 and March 1, 1998...................................... 18

Consolidated Statements of Operations
for the years ended February 28, 1999, March 1, 1998 and March 2, 1997...... 19

Consolidated Statements of Shareholders' Equity
for the years ended February 28, 1999, March 1, 1998 and March 2, 1997...... 20

Consolidated Statements of Cash Flows
for the years ended February 28, 1999, March 1, 1998 and March 2, 1997...... 21

Notes to Consolidated Financial Statements.................................... 22

</TABLE>

ITEM 14 (a) 2
- -------------

All schedules normally required by Form 10-K are not required under the
related instructions or are inapplicable, and therefore are not presented.

<PAGE> 17

INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Shareholders
Morgan's Foods, Inc.
Cleveland, Ohio

We have audited the accompanying consolidated balance sheets of Morgan's
Foods, Inc. and subsidiaries as of February 28, 1999 and March 1, 1998 and
the related consolidated statements of operations, shareholders' equity, and
cash flows for each of the three years in the period ended February 28,
1999. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on the financial
statements based on our audits.

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

In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Morgan's Foods, Inc. and
subsidiaries at February 28, 1999 and March 1, 1998 and the results of their
operations and their cash flows for each of the three years in the period
ended February 28, 1999 in conformity with generally accepted accounting
principles.

/s/Deloitte & Touche LLP
Cleveland, Ohio
May 26, 1999

<PAGE> 18

MORGAN'S FOODS, INC.
CONSOLIDATED BALANCE SHEETS
FEBRUARY 28, 1999 AND MARCH 1, 1998

ASSETS
1999 1998
------------ ------------
<S> <C> <C>
Current assets:
Cash and equivalents .................................... $ 2,655,000 $ 2,316,000
Marketable securities ................................... - 102,000
Receivables ............................................. 38,000 74,000
Inventories ............................................. 332,000 325,000
Prepaid expenses ........................................ 218,000 157,000
------------ ------------
3,243,000 2,974,000

Property and equipment (Notes 7 and 8):

Land .................................................... 3,379,000 1,949,000
Buildings and improvements .............................. 9,433,000 7,160,000
Property under capital leases ........................... 5,089,000 5,621,000
Leasehold improvements .................................. 3,578,000 3,280,000
Equipment, furniture and fixtures ....................... 9,915,000 8,995,000
Construction in progress ................................ 344,000 28,000
------------ ------------
31,738,000 27,033,000
Less accumulated depreciation and amortization ........... 13,346,000 11,934,000
------------ ------------
18,392,000 15,099,000
Other assets ............................................. 1,776,000 1,437,000
Deferred taxes (Note 10) ................................. 600,000 600,000
------------ ------------
$ 24,011,000 $ 20,110,000
============ ============

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
Current maturities of long-term debt (Note 7) ........... $ 577,000 $ 563,000
Current maturities of capital lease obligations (Note 8) 453,000 503,000
Accounts payable ........................................ 2,066,000 1,969,000
Accrued liabilities (Note 6) ............................ 2,329,000 1,985,000
------------ ------------
5,425,000 5,020,000

Long-term debt (Notes 3 and 7) ........................... 13,094,000 7,815,000
Long-term capital lease obligations (Note 8) ............. 4,244,000 5,019,000

Commitments and contingencies (Notes 5, 7 and 8)

SHAREHOLDERS' EQUITY

Preferred shares, 1,000,000 shares authorized,
no shares outstanding
Common Stock:
Authorized shares - 25,000,000
Issued shares - 2,969,405 .............................. 30,000 30,000
Treasury Shares - 58,566 ............................... (139,000) (139,000)
Capital in excess of stated value ........................ 28,875,000 28,875,000
Accumulated deficit ...................................... (27,518,000) (26,510,000)
------------ ------------
Total shareholders' equity ............................... 1,248,000 2,256,000
------------ ------------
$ 24,011,000 $ 20,110,000
============ ============

</TABLE>

See notes to consolidated financial statements.

<PAGE> 19

MORGAN'S FOODS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED FEBRUARY 28, 1999, MARCH 1, 1998 AND MARCH 2, 1997

1999 1998 1997
------------ ------------ ------------

<S> <C> <C> <C>
Revenues ............................. $ 40,607,000 $ 38,868,000 $ 38,252,000

Cost of sales:
Food, paper and beverage ........... 12,774,000 12,259,000 12,141,000
Labor and benefits ................. 10,635,000 10,456,000 9,951,000
Restaurant operating expenses ........ 11,348,000 11,001,000 11,047,000
Depreciation and amortization ........ 1,948,000 1,840,000 1,888,000
Asset impairments (Note 4) ........... - - 2,939,000
General and administrative expenses .. 3,137,000 2,799,000 2,876,000
------------ ------------ ------------
Operating income (loss) .............. 765,000 513,000 (2,590,000)
Interest Expense:
Bank debt and notes payable ........ (992,000) (836,000) (635,000)
Capital leases ..................... (546,000) (554,000) (564,000)
Loss on sale or disposal
of restaurant assets (Note 5) ....... (11,000) (98,000) (248,000)
Other income and expense, net ........ 83,000 61,000 7,000
------------ ------------ ------------
Loss before extraordinary item
and income taxes .................. (701,000) (914,000) (4,030,000)
Provision for income taxes (Note 10) . 20,000 14,000 25,000
------------ ------------ ------------
Loss before extraordinary item ....... (721,000) (928,000) (4,055,000)
Extraordinary loss on early
extinguishment of debt (Note 3) ..... (287,000) - -
------------ ------------ ------------
Net loss ............................. $ (1,008,000) $ (928,000) $ (4,055,000)
============ ============ ============
Income (loss) per common share:
Loss before extraordinary item ..... $ (.25) $ (.31) $ (1.37)
Loss on early extinguishment of debt (.10) - -
------------ ------------ ------------
Net loss per share ................. $ (.35) $ (.31) $ (1.37)
============ ============ ============

</TABLE>

See notes to consolidated financial statements.

<PAGE> 20

MORGAN'S FOODS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED FEBRUARY 28, 1999, MARCH 1, 1998 AND MARCH 2, 1997

COMMON SHARES TREASURY SHARES
---------------------------- ----------------------------
SHARES AMOUNT SHARES AMOUNT
------------ ------------ ------------ ------------

<S> <C> <C> <C> <C>
Balance, March 3, 1996 ......... 2,969,405 2,969,000 - -
Change in stated value (Note 9) (2,939,000)
Net loss .......................
Purchase of treasury shares .... (8,333) (23,000)
------------ ------------ ------------ ------------
Balance, March 2, 1997 ......... 2,969,405 30,000 (8,333) (23,000)
Net loss .......................
Purchase of treasury shares .... (50,233) (116,000)
------------ ------------ ------------ ------------
Balance, March 1, 1998 ......... 2,969,405 $ 30,000 (58,566) $ (139,000)
Net loss .......................
------------ ------------ ------------ ------------
Balance, February 28, 1999 ..... 2,969,405 $ 30,000 (58,566) $ (139,000)
============ ============ ============ ============

</TABLE>

CAPITAL IN TOTAL
EXCESS OF ACCUMULATED SHAREHOLDERS'
STATED VALUE DEFICIT EQUITY
------------ ------------ ------------

<S> <C> <C> <C>
Balance, March 3, 1996 ......... 25,936,000 (21,527,000) 7,378,000
Change in stated value (Note 9) 2,939,000
Net loss ....................... (4,055,000) (4,055,000)
Purchase of treasury shares .... (23,000)
------------ ------------ ------------
Balance, March 2, 1997 ......... 28,875,000 (25,582,000) 3,300,000
Net loss ....................... (928,000) (928,000)
Purchase of treasury shares .... (116,000)
------------ ------------ ------------
Balance, March 1, 1998 ......... $ 28,875,000 $(26,510,000) $ 2,256,000
Net loss ....................... (1,008,000) (1,008,000)
------------ ------------ ------------
Balance, February 28, 1999 ..... $ 28,875,000 $(27,518,000) $ 1,248,000
============ ============ ============

</TABLE>

See notes to consolidated financial statements.

<PAGE> 21

MORGAN'S FOODS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED FEBRUARY 28, 1999, MARCH 1, 1998 AND MARCH 2, 1997

1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss .................................. $ (1,008,000) $ (928,000) $ (4,055,000)
Adjustments to reconcile to net cash
provided by operating activities:
Depreciation and amortization ........... 1,948,000 1,840,000 1,888,000
Asset impairments ....................... -- -- 2,939,000
Loss on sale or disposal
of restaurant assets ................... 11,000 98,000 248,000
Changes in assets and liabilities:
Decrease in receivables ................ 36,000 38,000 30,000
Decrease (Increase) in inventories ..... (7,000) (32,000) 54,000
Decrease (Increase) in prepaid expenses (69,000) 34,000 17,000
(Increase) in other assets ............. (203,000) (91,000) (12,000)
Increase in accounts payable ........... 96,000 55,000 30,000
Increase (Decrease) in accrued
liabilities ........................... 344,000 (60,000) 382,000
------------ ------------ ------------
Net cash provided by operating activities . 1,148,000 954,000 1,521,000
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sale of restaurants ....................... - 15,000 21,000
Capital expenditures ...................... (5,379,000) (3,074,000) (2,203,000)
Proceeds from sale and maturity
of marketable securities ................. 102,000 96,000 87,000
------------ ------------ ------------
Net cash provided by (used in)
investing activities ..................... (5,277,000) (2,963,000) (2,095,000)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt,
net of financing costs ................... 10,769,000 1,651,000 1,355,000
Principal payments on long-term debt ...... (577,000) (490,000) (268,000)
Principal payments on capital
lease obligations ........................ (825,000) (431,000) (373,000)
Bank debt repayment in advance of
scheduled maturities ..................... (4,899,000) - -
Proceeds from sale/leaseback transactions . 698,000 230,000
Purchase of treasury shares ............... - (116,000) (23,000)
------------ ------------ ------------
Net cash provided by (used in)
financing activities ..................... 4,468,000 1,312,000 921,000
------------ ------------ ------------
Net change in cash and equivalents ........ 339,000 (697,000) 347,000
Cash and equivalents, beginning balance ... 2,316,000 3,013,000 2,666,000
------------ ------------ ------------
Cash and equivalents, ending balance ...... $ 2,655,000 $ 2,316,000 $ 3,013,000
============ ============ ============
Noncash investing and financing activities-
franchise fees and capital leases ........ $ - $ 418,000 $ -
============ ============ ============

</TABLE>

See notes to consolidated financial statements.

<PAGE> 22

MORGAN'S FOODS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 1999, MARCH 1, 1998 AND MARCH 2, 1997

NOTE 1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.

DESCRIPTION OF BUSINESS. Morgan's Foods, Inc. ("The Company") operates
48 Kentucky Fried Chicken ("KFC") restaurants, of which three also offer Taco
Bell products, in the states of Illinois, Missouri, Ohio, Pennsylvania, West
Virginia and New York which comprised 81% of total revenues for fiscal 1999. The
Company also operates, as franchisee, 5 East Side Mario's ("ESM") restaurants as
well as an additional ESM which was operated through the first 33 weeks of
fiscal 1999, in the Cleveland/Akron and Columbus, Ohio areas which comprised 19%
of total revenues for fiscal 1999. The Company's fiscal year is a 52-53 week
year ending on the Sunday nearest the last day of February.

USE OF ESTIMATES. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions pending completion of related events. These estimates
and assumptions affect the amounts reported at the date of the financial
statements for assets, liabilities, revenues and expenses and the disclosure of
contingencies. Actual results could differ from those estimates.

PRINCIPLES OF CONSOLIDATION. The consolidated financial statements
include the accounts of the Company and its subsidiaries. All significant
intercompany transactions and balances have been eliminated.

CASH AND EQUIVALENTS. The Company considers all highly liquid debt
instruments purchased with an initial maturity of three months or less to be
cash equivalents.

MARKETABLE SECURITIES. Marketable securities consist of U.S. Treasury
Notes and Bills, including those pledged as collateral for long-term debt. These
securities are classified as held to maturity and accordingly, are carried at
amortized cost unless there is a permanent impairment of their value.

INVENTORIES. Inventories, principally food, beverages and paper
products, are stated at the lower of aggregate cost (first-in, first-out basis)
or market.

PROPERTY AND EQUIPMENT. Property and equipment are stated at cost.
Depreciation is computed using the straight-line method over the estimated
useful lives of the related assets as follows: buildings and improvements - 3 to
20 years; equipment, furniture and fixtures - 10 years. Leasehold improvements
are amortized over 3 to 15 years, which is the shorter of the life of the asset
or life of the lease. The asset values of the capitalized leases are amortized
using the straight-line method over the lives of the respective leases which
range from 15 to 20 years. Depreciation and amortization expense for fiscal
1999, 1998 and 1997 was $1,863,000, $1,772,000 and $1,770,000, respectively.

Management evaluates the net carrying value of property and equipment
periodically in light of both the estimated future cash flows resulting from the
use of the assets as well as the estimated liquidation value of such assets.
Management believes the carrying value of property and equipment at February 28,
1999 will be recovered from future cash flows.

<PAGE> 23

MORGAN'S FOODS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 1999, MARCH 1, 1998 AND MARCH 2, 1997

FRANCHISE AGREEMENTS. Franchise agreements are recorded at cost.
Amortization is computed on the straight-line method over the term of the
franchise agreement. The Company's franchise agreements are predominantly 20
years in length. Annual amortization expense was $43,000, $29,000 and $12,000
for fiscal years 1999, 1998 and 1997. Franchise fees and accumulated
amortization were $872,000 and $104,000 for fiscal 1999 and $659,000 and $61,000
for fiscal 1998, respectively.

DEFERRED FINANCING COSTS. Costs related to the acquisition of long-term
debt are capitalized and expensed over the term of the related debt. Annual
amortization expense was $34,000, $29,000 and $56,000 for fiscal years 1999,
1998 and 1997. The balance of deferred financing costs was $500,000 for fiscal
1999 and $367,000 for fiscal 1998.

GOODWILL. Goodwill was amortized over forty years on a straight-line
basis. Annual amortization expense was $40,000 for fiscal 1997. Management
evaluated the carrying amount of goodwill periodically based upon past and
projected cash flows from operations and the estimated fair value of related
assets and as a result, wrote off the remaining balance of goodwill in fiscal
1997 (see Note 4).

INCOME TAXES. The provision for income taxes is based upon income or
loss before tax for financial reporting purposes. Deferred tax assets or
liabilities are recognized for the expected future tax consequences of temporary
differences between the tax basis of assets and liabilities and their carrying
values for financial reporting purposes. A deferred tax asset is recorded for
the benefits of future deductible temporary differences and operating loss and
tax credit carryforwards. A valuation allowance is recorded to reduce deferred
tax assets to the amount more likely than not to be realized in the future,
based on an evaluation of historical and projected profitability.

STOCK-BASED COMPENSATION. The Company's outstanding stock options are
accounted for using the intrinsic value method, under which compensation cost is
measured as the excess, if any, of the quoted market price of the stock at the
grant date over the amount an employee must pay to acquire the stock.

NOTE 2. SEGMENT REPORTING

For the fiscal year ended February 28, 1999, the Company adopted
Statement of Financial Accounting Standards ("SFAS") 131 requiring the
disclosure of certain information regarding the business segments of an
enterprise. Management has determined that the operations of the Company consist
of two reportable segments. The first segment includes the Company's KFC and
KFC/Taco Bell "2 in 1" restaurants while the second segment contains the ESM
restaurants. Management and the Board of Directors use financial information
separately from each of the KFC and ESM segments to analyze restaurant
operations from revenue through restaurant contribution. Home Office and
supervisory overhead and financing costs are not allocated to the business
segments. The following is the operating segment information and reportable
segment asset information for fiscal years ending in 1999, 1998 and 1997:

<PAGE> 24

MORGAN'S FOODS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 1999, MARCH 1, 1998 AND MARCH 2, 1997
<TABLE>
<CAPTION>

1999 (IN THOUSANDS) KFC ESM TOTAL 1998 (IN THOUSANDS) KFC ESM TOTAL
- ------------------- --- --- ----- ------------------- --- --- -----
<S> <C> <C> <C> <S> <C> <C> <C>
Revenues $ 33,040 $ 7,567 $ 40,607 Revenues $ 29,913 $ 8,955 $ 38,868
Cost of Sales 18,404 5,005 23,409 Cost of Sales 16,885 5,830 22,715
Operating Expenses 8,486 2,862 11,348 Operating Expenses 7,800 3,201 11,001
Depreciation 1,198 559 1,757 Depreciation 1,152 558 1,710
-------- ------- -------- -------- ------- --------
Restaurant Contribution $ 4,952 $ (859) 4,093 Restaurant Contribution $ 4,076 $ (634) 3,442
======== ======= ======== =======
General & Administrative 3,137 General & Administrative 2,799
Interest Expense 1,538 Interest Expense 1,390
Amortization 191 Amortization 130
Other (72) Other 37
-------- --------
Loss before extraordinary Loss before
item & income taxes $ (701) income taxes $ (914)
======= ========
</TABLE>

1997 (IN THOUSANDS) KFC ESM TOTAL
- ------------------- --- --- -----
<S> <C> <C> <C>
Revenues $ 28,533 $ 9,719 $ 38,252
Cost of Sales 15,762 6,330 22,092
Operating Expenses 7,663 3,384 11,047
Depreciation 1,068 661 1,729
-------- ------- --------
Restaurant Contribution $ 4,040 $ (656) 3,384
======== =======
General & Administrative 2,876
Interest Expense 1,199
Amortization 159
Asset Impairment 2,939
Other 241
--------
Loss before
Income taxes $ (4,030)
========
</TABLE>

(IN THOUSANDS) KFC ESM PARENT TOTAL
- -------------- --- --- ------ -----
<S> <C> <C> <C> <C>
1999 Total Assets $ 15,939 $ 4,476 $ 3,596 $ 24,011
Capital Expenditures 5,330 0 49 5,379
1998 Total Assets 11,663 5,110 3,337 20,110
Capital Expenditures 3,001 6 67 3,074

</TABLE>

<PAGE> 25

MORGAN'S FOODS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 1999, MARCH 1, 1998 AND MARCH 2, 1997

NOTE 3. EARLY EXTINGUISHMENT OF DEBT.

In the fourth quarter of fiscal 1999, the Company paid, in advance of
scheduled maturity, seven mortgage loans with a combined balance of $4,899,000.
The seven loans were originated in September 1995 with an original balance of
$5,509,000, 15 year terms, fixed interest rates of approximately 10.0% and were
secured by mortgages on seven of the Company's KFC restaurants. The loans were
replaced by new mortgage loans having 20 year terms, 8.7% fixed interest rates,
secured by the same seven KFC properties and having an initial, combined balance
of $6,762,000. In consummating this transaction, the Company incurred prepayment
penalties of $98,000 and expensed $140,000 of deferred financing costs related
to the loans, which were paid early. As part of the refinancing transaction, the
Company also incurred a loss of $49,000 to buy out capitalized leases covering
equipment at three of the locations. In addition, the Company received
$1,205,000 in cash net of loan costs and replaced annual debt service of
$785,000 with new annual debt service of $716,000.

NOTE 4. ASSET IMPAIRMENTS.

The Company recorded asset impairments of $2,939,000 in the fourth
quarter of fiscal 1997. These impairments included $1,700,000 to write-down the
carrying value of certain East Side Mario's restaurants and $1,239,000 to
write-off goodwill remaining from a previous KFC acquisition. The write-down of
these assets resulted from management's evaluation of recoverability of their
carrying values from estimated future cash flows from their operation and/or
liquidation, as explained below:

Comparable restaurant revenues, operating income and cash
flows of East Side Mario's restaurants had decreased in fiscal 1996.
The franchisor and the Company instituted a number of changes in fiscal
1997 which were expected to improve the financial performance of the
East Side Mario's restaurants. However, in spite of those changes, the
financial performance of these restaurants further declined
significantly in fiscal 1997. Also, in February 1997, East Side
Mario's, Inc., the franchisor of these restaurants, was sold by Pizza
Hut, Inc., a subsidiary of PepsiCo, Inc., to another franchisor. Based
upon the poor financial performance of the East Side Mario's
restaurants, which management expects to continue unless changes are
made to this restaurant concept, and the uncertainty of when or if such
improvements may be made by the new franchisor, management determined
that the carrying value of property and equipment of certain East Side
Mario's restaurants was impaired. Accordingly, the Company recorded
asset impairments of $1,700,000 to write-down property and equipment of
certain East Side Mario's restaurants, based upon the present value of
estimated future cash flows of the restaurants.

<PAGE> 26

MORGAN'S FOODS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 1999, MARCH 1, 1998 AND MARCH 2, 1997

The Company also wrote off remaining goodwill of $1,239,000
related to the 1987 purchase of KFC restaurants in the St. Louis,
Missouri market. This impairment resulted from new requirements for
expenditures to upgrade facilities due to the August 1996 settlement of
the long-standing lawsuit between the Association of KFC Franchisees
and KFC Corporation. This settlement included a requirement that
franchisees upgrade their restaurants to current KFC standards in order
to obtain new 20 year franchise agreements under favorable terms. The
specific facility upgrade requirements were communicated to the Company
and all other KFC franchisees in January 1997 after facility
inspections by representatives of KFC Corporation. Including these
expenditures, management estimated that future cash flows from
operation or liquidation of these restaurants would not recover the
carrying value of goodwill.

These asset impairments resulted from management's estimates of future
cash flows from operation and/or liquidation of the assets. It is reasonably
possible that actual cash flows in the future from these assets could be
greater, or less, than management's current estimates, and such differences
could be material. Differences between management's current estimates of future
cash flows and revised estimates, or actual cash flows, in the future could
result in additional gains or losses in future periods from operation or
liquidation of these assets.

NOTE 5. DISPOSITION OF ASSETS.

During fiscal 1999, 1998 and 1997, the Company recognized losses
totaling $11,000, $98,000 and $248,000, respectively from the sale or disposal
of restaurant assets and the closing of unprofitable restaurants. These
restaurants did not have a material effect upon the Company's consolidated
results of operations or financial position. As of February 28, 1999, the
Company remains as the guarantor on two leases from the sale of 24 KFC
restaurants in May 1995.

<PAGE> 27

MORGAN'S FOODS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 1999, MARCH 1, 1998 AND MARCH 2, 1997

NOTE 6. ACCRUED LIABILITIES.

Accrued liabilities consist of the following at February 28, 1999 and
March 1, 1998:

1999 1998
---------- ----------
<S> <C> <C>
Accrued compensation ................ $ 738,000 $ 631,000
Accrued taxes other than income taxes 411,000 291,000
Accrued liabilities related
to sold restaurants ................ 172,000 266,000
Accrued royalties and advertising ... 430,000 104,000
Other accrued expenses .............. 578,000 693,000
---------- ----------
$2,329,000 $1,985,000
========== ==========

</TABLE>

NOTE 7. LONG-TERM DEBT.

Long-term debt consists of the following at February 28, 1999 and March
1, 1998:

<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Mortgage debt, monthly payments of $91,000 including
interest at 8.3% to 10.6%, through 2012,
collateralized by twenty restaurants having a
net book value at February 28, 1999 of $7,830,000 .......... $13,144,000 $ 7,610,000

Equipment loans, monthly payments of $7,000 including
interest at 10.1% through February 2004 collateralized
by equipment at four KFC restaurants ....................... 314,000 362,000

Notes payable, monthly payments of $12,000 including interest
at 7.0% through June 2000 for early renewal franchise fees . 190,000 321,000

Note payable at 9.0%, monthly payments of $9,100 including
interest through October 1998 and thereafter $500 through
October 2003 ............................................... 23,000 85,000
----------- -----------
13,671,000 8,378,000
Less current maturities ..................................... 577,000 563,000
----------- -----------
$13,094,000 $ 7,815,000
=========== ===========

</TABLE>

Certain of the Company's debt arrangements require the maintenance of a
consolidated fixed charge coverage ratio of 1.2 to 1.0.

The Company paid interest relating to long-term debt of approximately
$1,100,000, $800,000 and $590,000 in fiscal 1999, 1998 and 1997, respectively.

<PAGE> 28

MORGAN'S FOODS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 1999, MARCH 1, 1998 AND MARCH 2, 1997

NOTE 8. LEASE OBLIGATIONS AND OTHER COMMITMENTS.

Property under capital leases at February 28, 1999 and March 1, 1998
are as follows:

1999 1998
---------- ----------

<S> <C> <C>
Leased property:
Buildings ....................... $3,720,000 $3,895,000
Equipment, furniture
and fixtures ................... 1,369,000 1,726,000
---------- ----------
Total ........................... 5,089,000 5,621,000
Less accumulated amortization........ 1,946,000 1,723,000
---------- ----------
$3,143,000 $3,898,000
========== ==========
</TABLE>

Amortization of leased property under capital leases was $545,000,
$482,000 and $495,000 in fiscal 1999, 1998 and 1997, respectively.

Related obligations under capital leases at February 28, 1999 and
March 1, 1998 are as follows:

1999 1998
---------- ----------

<S> <C> <C>
Capital lease obligations ........... $4,697,000 $5,522,000
Less current maturities ............. 453,000 503,000
---------- ----------
Long-term capital lease obligations . $4,244,000 $5,019,000
========== ==========
</TABLE>

The Company paid interest of approximately $546,000, $554,000 and
$564,000 relating to capital lease obligations in fiscal 1999, 1998 and 1997,
respectively.

Future minimum rental payments to be made under capital leases at
February 28, 1999, are as follows:

<S> <C>
2000 ................... $ 907,000
2001 ................... 723,000
2002 ................... 650,000
2003 ................... 600,000
2004 ................... 592,000
Later years ............ 5,226,000
----------
8,698,000
Less amount representing
interest ............... 4,001,000
----------
Total obligations under
capital leases ......... $4,697,000
==========

</TABLE>

The Company's leases for restaurant land and buildings are noncancellable and
expire on various dates through 2014. The leases have renewal options ranging
from 1 to 26 years. Certain restaurant land and building leases require the
payment of additional rent equal to an amount by which a percentage of annual

<PAGE> 29

MORGAN'S FOODS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 1999, MARCH 1, 1998 AND MARCH 2, 1997

sales exceeds annual minimum rentals. The interest rates on the leases range
predominantly from 9.5% to 13.0%. Total contingent rentals were $75,000, $72,000
and $63,000 in fiscal 1999, 1998 and 1997, respectively. Future noncancellable
minimum rental payments under operating leases at February 28, 1999, are as
follows: 2000 - $1,379,000; 2001 - $1,327,000; 2002 - $1,160,000; 2003 -
$982,000; 2004 - $981,000; and an aggregate $7,535,000 for the years thereafter.
Rental expense for all operating leases was $1,867,000, $1,620,000, and
$1,915,000 for fiscal 1999, 1998 and 1997, respectively.

For KFC products, the Company is required to pay royalties of 4% of
gross revenues and to expend an additional 5% of gross revenues on national and
local advertising pursuant to its franchise agreements. In addition, for Taco
Bell products, the Company pays royalties of 10% and advertising fees of 0.5% of
gross revenues under the five year license agreements for the KFC/Taco Bell "2
in 1" locations.

The East Side Mario's franchise agreement requires the Company to pay
royalties of 4% on gross revenues and 1/2% of gross revenues to an advertising
fund. The franchise agreement also requires the Company to expend an additional
2 1/2% of gross revenues for advertising and promotion. On April 20, 1998 the
Company and its wholly owned subsidiary, Morgan's Creative Restaurant Concepts,
Inc., filed a lawsuit against East Side Mario's, Inc. and other related parties
in Federal District Court in Cleveland, Ohio. The suit alleges fraud, deceptive
trade practices and failure to support the East Side Mario's franchisees among
other things and sets forth a demand for $20 million in damages. The Company
filed a second suit against the same parties on July 8, 1998, which brought the
total claim for damages to $60 million. Royalty and advertising fund payments
have been accrued but have not been made since prior to the filing of the first
lawsuit (see Note 6).

NOTE 9. NET INCOME (LOSS) PER COMMON SHARE.

All net income (loss) per common share amounts have been computed based
on the weighted average number of common shares outstanding during each year
which totaled 2,910,839, 2,936,877 and 2,967,574 for fiscal 1999, 1998 and 1997,
respectively. A one for six reverse stock split was effective on July 14, 1997.
All share and per share data have been restated to reflect the one for six
reverse stock split.

NOTE 10. INCOME TAXES.

The current provision for income taxes, which approximates tax
payments, consists of state and local taxes of $20,000, $14,000 and $25,000 for
fiscal 1999, 1998 and 1997, respectively. There was no deferred provision for
income taxes during each of the fiscal years 1999, 1998 and 1997.

<PAGE> 30

MORGAN'S FOODS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 1999, MARCH 1, 1998 AND MARCH 2, 1997

A reconciliation between the provision for income taxes and income
taxes calculated at the statutory tax rate of 35% is as follows:

1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Tax provision (benefit) at
statutory rate ................. $ (336,000) $ (320,000) $(1,411,000)
Goodwill amortization/write-off . - - 448,000
State and local taxes,
net of federal benefit ......... 13,000 9,000 16,000
Losses (income) and temporary
differences with no
tax benefit (expense) .......... 338,000 321,000 970,000
Other ........................... 5,000 4,000 2,000
----------- ----------- -----------
$ 20,000 $ 14,000 $ 25,000
=========== =========== ===========

</TABLE>

The components of deferred tax assets (liabilities) at February 28,
1999 and March 1, 1998 are as follows:
<TABLE>
<CAPTION>

1999 1998
----------- -----------

<S> <C> <C>
Operating loss carryforwards ............ $ 5,942,000 $ 8,835,000
Tax credit carryforwards ................ 93,000 214,000
Property and equipment .................. 1,134,000 1,013,000
Accrued expenses not currently deductible 355,000 191,000
Inventory valuation ..................... 4,000 4,000
Deferred tax asset valuation adjustment . (6,928,000) (9,657,000)
----------- -----------
Net deferred tax asset .................. $ 600,000 $ 600,000
=========== ===========

</TABLE>

The valuation allowance increased $296,000 and $827,000 during
fiscal 1998 and 1997, respectively and decreased $2,729,000 during fiscal 1999.

At February 28, 1999, the Company has net operating loss
carryforwards which, if not utilized, will expire as follows:

<S> <C>
2000 ................... $ 4,513,000
2001 ................... 4,055,000
2004 ................... 737,000
2005 ................... 2,786,000
2009 ................... 1,077,000
2012 ................... 744,000
2013 ................... 728,000
2014 ................... 215,000
-----------
Total .................. $14,855,000
===========

</TABLE>
The Company also has alternative minimum tax net operating loss
carryforwards of $12,866,000 which will expire, if not utilized, in varying
amounts through fiscal 2014. These carryforwards are available to offset up to
90% of any alternative minimum taxable income which would otherwise be taxable.

<PAGE> 31

MORGAN'S FOODS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 1999, MARCH 1, 1998 AND MARCH 2, 1997

As of February 28, 1999, the Company has an alternative minimum tax
credit carryforward of $56,000. In addition, the Company has approximately
$37,000 of investment tax credits (after reduction pursuant to the Tax Reform
Act of 1986) available to offset future federal income tax liabilities through
fiscal 2000.

NOTE 11. STOCK OPTIONS AND SHAREHOLDERS' EQUITY.

As of June 28, 1996, the Board of Directors of the Company changed the
stated value of the Company's common shares to $0.01 per share from $1.00 per
share.

The Company previously had an Incentive Stock Option Plan ("Incentive
Plan") and a Non-Qualified Stock Option Plan ("Stock Option Plan") which
provided options exercisable at the market value of the underlying common shares
on the date of the grant. Both plans expired during fiscal 1995. Options granted
under the Incentive Plan remain outstanding with option exercise prices of
$10.50 to $16.125 until they individually expire through January 2004
according to the terms of the plan.

Information with respect to these option plans follows:

1999 1998 1997
------- ------- -------

<S> <C> <C> <C>
Outstanding, beginning of year 57,500 60,167 65,167
Expired during year .......... (33,334) (2,667) (5,000)
------- ------- -------
Outstanding, end of year ..... 24,166 57,500 60,167
======= ======= =======
Exercisable, end of year ..... 24,166 57,500 60,167
======= ======= =======
</TABLE>

On April 2, 1999, the Company adopted the Non-qualified Stock Option
Plan for Executives and Managers. The plan allows for the granting of options to
purchase 145,500 shares of the Company's common stock. All of the available
options were granted on April 2, 1999 at an exercise price of $4 1/8 per share.
The options are exercisable after six months and expire after ten years.

There will be submitted at the Annual Meeting of Shareholders for
action by the holders of Common Shares a proposal to adopt the Key Employees
Nonqualified Stock Option Plan (the "Plan"). The Plan was approved by the board
of directors on April 2, 1999. No awards relating to the Plan have been made. If
the Plan is approved by the holders of Common Shares, the Plan Committee (the
"Committee") will from time to time consider awards for key employees of the
Company under the Plan. Subject to certain provisions in the Plan, an aggregate
of 291,000 Common Shares of the Company may be issued pursuant to the Plan.

<PAGE> 32

MORGAN'S FOODS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 1999, MARCH 1, 1998 AND MARCH 2, 1997

On April 8, 1999, the Company adopted a Shareholder Rights Plan in
which the Board declared a distribution of one Right for each of the Company's
outstanding Common Shares. Each Right entitles the holder to purchase from the
Company one one-thousandth of a Series A Preferred Share (a "Preferred Share")
at a purchase price of $30.00 per right, subject to adjustment. One
one-thousandth of a Preferred Share is intended to be approximately the economic
equivalent of one Common Share. The Rights will expire on April 7, 2009, unless
redeemed by the Company as described below.

The Rights are neither exercisable nor traded separately from the
Common Shares. The Rights will become exercisable and begin to trade separately
from the Common Shares if a person or group becomes the beneficial owner of 21%
or more of the then-outstanding Common Shares or announces an offer to acquire
21% or more of the then-outstanding Common Shares.

If a person or group acquires 21% or more of the outstanding Common
Shares, then each Right not owned by the acquiring person or its affiliates will
entitle its holder to purchase, at the Right's then-current exercise price,
fractional Preferred Shares that are approximately the economic equivalent of
Common Shares (or, in certain circumstances, Common Shares, cash, property or
other securities of the Company) having a market value equal to twice the
then-current exercise price. In addition, if, after the Rights become
exercisable, the Company is acquired in a merger or other business combination
transaction with an acquiring person or its affiliates or sells 50% or more of
its assets or earnings power to an acquiring person or its affiliates, each
Right will entitle its holder to purchase, at the Right's then-current exercise
price, a number of shares of the acquiring person's common stock having a market
value of twice the Right's exercise price. The Board of Directors may redeem the
Rights in whole, but not in part, at a price of $.01 per Right, subject to
certain limitations.

The dividend distribution was made on May 12, 1999, payable to
shareholders of record on that date. The initial distribution of Rights is not
taxable to shareholders.

NOTE 12. 401-K RETIREMENT PLAN.

The Company has a 401-K Retirement Plan in which employees age 21 or
older who have completed one year of service with the Company, working at least
1,000 hours, are eligible to participate. The Company matches, in Company stock,
a percentage of employee contributions. During fiscal 1999, 1998 and 1997,
respectively, the Company incurred $19,000, $20,000 and $25,000, respectively,
in expenses for matching contributions to the plan.

<PAGE> 33

MORGAN'S FOODS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 1999, MARCH 1, 1998 AND MARCH 2, 1997

NOTE 13. FAIR VALUE OF FINANCIAL INSTRUMENTS

Management believes that the fair value of the Company's debt at
February 28, 1999 approximates carrying value, based upon interest rates
obtained in recent financing transactions.

NOTE 14. NEW ACCOUNTING STANDARD

The Financial Accounting Standards Board has issued Statement of
Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative
Instruments and Hedging Activities. The Company has not yet completed its
analysis of SFAS No. 133 and accordingly has not yet determined what effect, if
any, it may have on future financial statements.

NOTE 15. SUBSEQUENT EVENTS

In May 1999, the Company signed definitive agreements to purchase 43
KFC restaurant properties and 12 Taco Bell restaurants from KFC Corporation and
Taco Bell Corporation respectively and expects to close the transactions in
middle to late June 1999. The Company expects to finance these purchases under a
new mortgage financing commitment. During fiscal 1999, the Company also ceased
operations at its East Side Mario's restaurant in Mayfield Heights, OH and
liquidated its leasehold interest subsequent to the end of the fiscal year.

<PAGE> 34

MORGAN'S FOODS, INC.
INDEX TO EXHIBITS
ITEM 14 (a) (3)

Exhibit
Number Exhibit Description
------ -------------------

3.1 Amended Articles of Incorporation, as amended (1)

3.2 Amended Code of Regulations (1)

4.1 Specimen Certificate for Common Shares (2)

10.1 Specimen KFC Franchise Agreements (3)

10.2 Amended and Restated Incentive Stock Option Plan (4)

10.5 Form of East Side Mario's Area Development Agreement and
Franchise Agreement (4)

10.6 Form of Mortgage Loan Agreement with Captec Financial Group,
Inc. (5)

19 Form of Indemnification Contract between Registrant and its
Officers and Directors (4)

21 Subsidiaries

23 Independent Auditors' Consent

27 Financial Data Schedule

(1) Filed as an exhibit to Registrant's Form 10-K for the 1992 fiscal year
and incorporated herein by reference.

(2) Filed as an exhibit to the Registrant's Registration Statement (No.
33-35772) on Form S-2 and incorporated herein by reference.

(3) Filed as an exhibit to the Registrant's Registration Statement (No.
2-78035) on Form S-1 and incorporated herein by reference.

(4) Filed as an exhibit to the Registrant's Form 10-K for the 1993 fiscal
year and incorporated herein by reference.

(5) Filed as an exhibit to the Registrant's Form 10-K for the 1996 fiscal
year and incorporated herein by reference.

<PAGE> 35

SIGNATURES

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

Morgan's Foods, Inc.

<S> <C>
Dated: May 28, 1999 /s/ Leonard Stein-Sapir
-------------------------------- ----------------------------------------
By: Leonard Stein-Sapir
Chairman of the Board,
Chief Executive Officer & Director

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

/s/ Leonard Stein-Sapir /s/ Lawrence S. Dolin
--------------------------------------- ----------------------------------------
By: Leonard Stein-Sapir By: Lawrence S. Dolin
Chairman of the Board, Director
Chief Executive Officer & Director Dated: May 28, 1999
Dated: May 28, 1999

/s/ James J. Liguori /s/ Steven S. Kaufman
--------------------------------------- ----------------------------------------
By: James J. Liguori By: Steven S. Kaufman
Director, President & Director
Chief Operating Officer Dated: May 28, 1999
Dated: May 28, 1999

/s/ Kenneth L. Hignett /s/ Richard A. Arons
--------------------------------------- ----------------------------------------
By: Kenneth L. Hignett By: Richard A. Arons
Director, Senior Vice President, Director
Chief Financial Officer & Secretary Dated: May 28, 1999
Dated: May 28, 1999

/s/ Bernard Lerner
----------------------------------------
By: Bernard Lerner
Director
Dated: May 28, 1999

</TABLE>

<PAGE> 1

EXHIBIT 21 - SUBSIDIARIES OF THE REGISTRANT
-------------------------------------------

SUBSIDIARY STATE OF INCORPORATION
---------- ----------------------

Morgan's Creative Restaurant Concepts, Inc. Ohio
Morgan's Restaurants of Ohio, Inc. Ohio
Morgan's Restaurants of Pennsylvania, Inc. Pennsylvania
Morgan's Restaurants of West Virginia, Inc. West Virginia
(aka Morgan's Weirton Foods, Inc.)
Morgan's Restaurants of New Jersey, Inc. New Jersey
Morgan's Foods of Missouri, Inc. Missouri
Morgan's Restaurants of New York, Inc. New York

<PAGE> 1

EXHIBIT 23 - INDEPENDENT AUDITORS' CONSENT
------------------------------------------

We consent to the incorporation by reference in Registration Statements No.
33-29402 and No. 33-70724 of Morgan's Foods, Inc. on Form S-8 of our report
dated May 26, 1999, appearing in this Annual Report on Form 10-K of Morgan's
Foods, Inc. for the year ended February 28, 1999.

/s/ Deloitte & Touche LLP
Cleveland, Ohio

May 26, 1999

<ARTICLE> 5
<CIK> 0000068145
<NAME> MORGAN'S FOODS, INC.

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> FEB-28-1999
<PERIOD-START> MAR-01-1998
<PERIOD-END> FEB-28-1999
<CASH> 2,655,000
<SECURITIES> 0
<RECEIVABLES> 38,000
<ALLOWANCES> 0
<INVENTORY> 332,000
<CURRENT-ASSETS> 3,243,000
<PP&E> 31,738,000
<DEPRECIATION> 13,346,000
<TOTAL-ASSETS> 24,011,000
<CURRENT-LIABILITIES> 5,425,000
<BONDS> 17,338,000
0
0
<COMMON> 30,000
<OTHER-SE> 1,218,000
<TOTAL-LIABILITY-AND-EQUITY> 1,248,000
<SALES> 40,607,000
<TOTAL-REVENUES> 40,607,000
<CGS> 23,409,000
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,538,000
<INCOME-PRETAX> (701,000)
<INCOME-TAX> 20,000
<INCOME-CONTINUING> (721,000)
<DISCONTINUED> 0
<EXTRAORDINARY> (287,000)
<CHANGES> 0
<NET-INCOME> (1,008,000)
<EPS-BASIC> (.35)
<EPS-DILUTED> (.35)

</TABLE>