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As filed with the Securities and Exchange Commission on August 12, 1997
Registration No. 333-_______
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM S-4
REGISTRATION STATEMENT
under
THE SECURITIES ACT OF 1933
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MERITAGE HOSPITALITY GROUP INC.
(Exact name of Registrant as specified in its charter)
MICHIGAN 38-2730460
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
40 PEARL STREET, N.W., SUITE 900
GRAND RAPIDS, MICHIGAN 49503
(616) 776-2600
(Address, including zip code, and telephone number, including
area code, of Registrant's principal executive offices)
Gary P. Kreider, Esquire
Keating, Muething & Klekamp
1800 Provident Tower
One East Fourth Street
Cincinnati, Ohio 45202
(513) 579-6400
(Name, address, including zip code, and telephone
number, including zip code, of agent for service)
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after the effective date of this Registration Statement.
-------------------------------
If the securities being registered on this Form are being offered in connection
with the formation of a holding company and there is compliance with General
Instruction G, check the following box.
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CALCULATION OF REGISTRATION FEE
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TITLE OF EACH CLASS OF PROPOSED MAXIMUM AGGREGATE AMOUNT OF
SECURITIES TO BE REGISTERED OFFERING PRICE (1) REGISTRATION FEE (2)
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<S> <C> <C>
Common Shares $4,320,000 $1,309
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<FN>
(1) Based on the value of $7,500 in Meritage Common Shares to be issued per
Limited Partnership Unit of Wendy's of West Michigan Limited Partnership.
(2) Computed pursuant to Rule 457(f)(2).
</TABLE>
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE
OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
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Information contained herein is subject to completion or amendment. A
registration statement relating to these securities has been filed with the
Securities and Exchange Commission. These securities may not be sold nor may
offers to buy be accepted prior to the time the registration statement becomes
effective. This prospectus shall not constitute an offer to sell or the
solicitation of an offer to buy nor shall there be any sale of these securities
in any State in which such offer, solicitation or sale would be unlawful prior
to registration or qualification under the securities laws of any such State.
SUBJECT TO COMPLETION, DATED AUGUST 12, 1997
MERITAGE HOSPITALITY GROUP INC.
PROSPECTUS FOR COMMON SHARES
This Prospectus is being furnished to holders of limited partnership
units of the Wendy's of West Michigan Limited Partnership (the "WENDY'S
PARTNERSHIP") in connection with the sale of all of the assets of the Wendy's
Partnership to a limited partnership affiliated with Meritage Hospitality Group
Inc. ("MERITAGE"), and the subsequent dissolution of the Wendy's Partnership.
When the proposal is approved, limited partners of the Wendy's Partnership will
receive Meritage Common Shares. Upon dissolution, the Meritage Common Shares
would be distributed to non-affiliated limited partners on the basis of that
number of Meritage Common Shares that have a value of $7,500 per unit, based on
the average high and low bid price on the OTC Bulletin Board for the 10 trading
days preceding the date of dissolution. A wholly owned subsidiary of Meritage,
MHG Food Service Inc., presently holds approximately 54% of the outstanding
units, and, because affirmative consent of the holders of a majority of the
units is required to approve the proposal, approval is assured.
This Prospectus also constitutes notice of the transaction. In
accordance with Section 12.7 of the Amended and Restated Agreement of Limited
Partnership for the Wendy's Partnership, limited partners will be deemed to have
consented to the transaction unless they indicate to the contrary in writing to
the Wendy's Partnership before _________________, 1997.
Meritage's Common Shares are traded on the Chicago Stock Exchange under
the symbol "MHG" and on the OTC Bulletin Board under the symbol "MHGI." On
August 6, 1997, the average high and low bid price on the OTC Bulletin Board was
$2 7/8 per share. Units of the Wendy's Partnership are not publicly traded.
SEE "RISK FACTORS" ON PAGE 16 FOR A DISCUSSION OF CERTAIN FACTORS THAT
SHOULD BE CONSIDERED BY THE LIMITED PARTNERS.
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITES COMMISSION
NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
The date of this Prospectus is August ___, 1997.
2
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TABLE OF CONTENTS
<TABLE>
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PAGE
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AVAILABLE INFORMATION........................................................................................5
SUMMARY......................................................................................................6
The Parties.........................................................................................6
The Transaction.....................................................................................6
Wendy's Partnership Authorization...................................................................6
Meritage Common Shares Outstanding..................................................................7
Certain Risk Factors................................................................................7
Recommendation of the General Partner...............................................................9
Material Effects to the Limited Partners............................................................9
Background and Reasons for the Transaction..........................................................9
Tax Effects.........................................................................................9
Dissenters' Rights of Partners......................................................................9
Market Quotations..................................................................................10
Meritage Hospitality Group Inc. Summary Consolidated Financial Data................................11
Wendy's of West Michigan Limited Partnership Summary Consolidated Financial Data...................13
COMPARATIVE PER SHARE AND UNIT DATA.........................................................................15
RISK FACTORS AND OTHER CONSIDERATIONS.......................................................................16
Risks Associated with Dissolution of the Wendy's Partnership.......................................16
Risks Associated with Investment in Meritage Common Shares.........................................17
Risks Associated with Meritage's Business..........................................................18
CAPITALIZATION..............................................................................................22
PRICE RANGE OF COMMON SHARES................................................................................22
DISTRIBUTION POLICIES.......................................................................................23
BACKGROUND AND REASONS FOR THE TRANSACTION..................................................................23
Background of the Transaction......................................................................23
Fees and Expenses of the Transaction...............................................................25
Determination of Consideration for Units...........................................................25
Background of the Wendy's Partnership..............................................................25
Other Considerations...............................................................................25
Fairness of Transaction............................................................................25
MERITAGE HOSPITALITY GROUP INC.
SELECTED CONSOLIDATED FINANCIAL DATA...............................................................28
MERITAGE HOSPITALITY GROUP INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION.......................................................29
General............................................................................................29
Results of Operations..............................................................................29
Liquidity and Capital Resources....................................................................37
Inflation and Changing Prices .....................................................................41
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
SELECTED CONSOLIDATED FINANCIAL DATA...............................................................42
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION.......................................................43
Results of Operations..............................................................................43
Liquidity and Capital Resources....................................................................45
Inflation and Changing Prices .....................................................................45
</TABLE>
3
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<TABLE>
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PAGE
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BUSINESS....................................................................................................46
General............................................................................................46
Change in Business Orientation.....................................................................47
Replacement and Restructuring of Management........................................................47
Food Service Group.................................................................................47
Lodging Group......................................................................................48
Competition and Industry Conditions................................................................50
Relationship with Wendy's International............................................................51
Governmental Regulations...........................................................................52
Other Assets.......................................................................................52
Properties.........................................................................................52
Legal Proceedings..................................................................................53
MANAGEMENT..................................................................................................54
Directors and Executive Officers...................................................................54
Executive Compensation.............................................................................55
Certain Relationships and Related Transactions.....................................................56
PRINCIPAL SHAREHOLDERS......................................................................................59
FEDERAL INCOME TAX CONSEQUENCES.............................................................................60
DESCRIPTION OF CAPITAL SHARES...............................................................................61
Common Shares......................................................................................61
Preferred Shares...................................................................................62
Transfer Agent.....................................................................................62
COMPARATIVE RIGHTS..........................................................................................63
Federal Income Taxation............................................................................63
Management.........................................................................................63
Voting Rights......................................................................................63
Amendments to Governing Documents..................................................................64
Dividends and Distributions........................................................................64
Continuity of Existence............................................................................64
Rights Upon Liquidation............................................................................64
Dissenters' Rights.................................................................................65
Liability; Indemnification.........................................................................65
Meetings...........................................................................................65
LEGAL MATTERS...............................................................................................66
EXPERTS.....................................................................................................66
INDEX TO FINANCIAL STATEMENTS...............................................................................67
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES CONSOLIDATED FINANCIAL
STATEMENTS AND REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS........................................M-1
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP FINANCIAL STATEMENTS
AND REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS...................................................W-1
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES UNAUDITED PRO FORMA
CONSOLIDATED FINANCIAL STATEMENTS........................................................................P-1
</TABLE>
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AVAILABLE INFORMATION
Meritage is subject to the informational requirements of the Securities
Exchange Act of 1934 and, in accordance therewith, files reports, proxy
statements and other information with the Securities and Exchange Commission.
Such reports, proxy and information statements and other information filed with
the Commission by Meritage may be inspected and copied at the public reference
facilities maintained by the Commission at 450 Fifth Street, N.W., Washington,
D.C. 20549, and at the Commission's Regional Offices located at the Citicorp
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois, and at Seven
World Trade Center, Suite 1300, New York, New York. Copies of such material can
also be obtained, at prescribed rates, by mail from the Public Reference Section
of the Commission at its Washington, D.C. address set forth above. In addition,
material filed by Meritage can be obtained and inspected at the offices of the
Chicago Stock Exchange, 440 South LaSalle Street, Chicago, Illinois 60605, on
which Meritage's Common Shares are listed. The Commission also maintains a Web
site (located at http://www.sec.gov) that contains Meritage's reports, proxy
statements and other information.
Meritage has filed with the Commission a Registration Statement on Form
S-4 under the Securities Act of 1933 with respect to the securities offered
hereby. This Prospectus does not contain all of the information set forth in the
Registration Statement, certain parts of which were omitted in accordance with
the rules and regulations of the Commission. Such additional information may be
obtained from the public reference room of the Commission, 450 Fifth Street,
N.W., Washington, D.C. 20549. Statements contained in this Prospectus or in any
document incorporated by reference in this Prospectus as to the content of any
contract or other document referred to herein or therein are not necessarily
complete, and in each instance reference is made to the copy of such contract or
other document filed as an exhibit to the Registration Statement or such other
document, each such statement being qualified in all respects by such reference.
THIS MATERIAL CONTAINS "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING
OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES
EXCHANGE ACT OF 1934 THAT INVOLVE SUBSTANTIAL RISKS AND UNCERTAINTIES. WHEN
WORDS SUCH AS "ANTICIPATE," "BELIEVE," "COULD," "ESTIMATE," "INTENDS," "EXPECT,"
"PLAN," "WOULD" AND SIMILAR EXPRESSIONS ARE USED, THEY ARE INTENDED TO IDENTIFY
THE STATEMENTS AS FORWARD-LOOKING. ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS
CAN DIFFER MATERIALLY FROM RESULTS SUGGESTED BY THESE FORWARD-LOOKING STATEMENTS
BECAUSE OF A VARIETY OF FACTORS INCLUDING, WITHOUT LIMITATION, THOSE OFFERED IN
THE TEXT.
NO PERSON IS AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS IN CONNECTION WITH THE OFFERING
MADE HEREBY AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION SHOULD NOT
BE RELIED UPON AS HAVING BEEN AUTHORIZED BY MERITAGE.
THIS PROSPECTUS DOES NOT COVER ANY RESALES OF THE MERITAGE COMMON
SHARES OFFERED HEREBY TO BE RECEIVED BY PARTNERS OF THE WENDY'S PARTNERSHIP WHO
MAY BE DEEMED TO BE AFFILIATES OF MERITAGE UPON THE CONSUMMATION OF THE
TRANSACTION.
NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY DISTRIBUTION OF
SECURITIES MADE HEREUNDER SHALL IMPLY THAT THERE HAS BEEN NO CHANGE IN THE
INFORMATION SET FORTH HEREIN OR IN THE AFFAIRS OF MERITAGE OR THE WENDY'S
PARTNERSHIP SINCE THE DATE HEREOF.
WENDY'S INTERNATIONAL, INC. IS NOT SELLING OR OFFERING FOR SALE ALL OR
ANY PART OF THE COMMON SHARES. WENDY'S INTERNATIONAL DOES NOT ENDORSE OR MAKE
ANY RECOMMENDATIONS WITH RESPECT TO THE TRANSACTION.
NEITHER THE TRANSACTION NOR THE CONTENTS OF THIS PROSPECTUS (AND
SPECIFICALLY, ANY FINANCIAL DATA CONTAINED HEREIN) HAVE BEEN APPROVED OR
ENDORSED BY WENDY'S INTERNATIONAL.
WENDY'S INTERNATIONAL HAS NOT PARTICIPATED IN THE PREPARATION OF THE
PRO FORMA FINANCIAL DATA OF MERITAGE, NOR HAS WENDY'S INTERNATIONAL APPROVED OR
ENDORSED THIS INFORMATION.
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WENDY'S INTERNATIONAL ASSUMES NO OBLIGATION TO ANY INVESTOR IN
CONNECTION WITH THE TRANSACTION OR THE ACCURACY OR ADEQUACY OF ANY PORTION OF
THIS PROSPECTUS. WENDY'S INTERNATIONAL FURTHER DISCLAIMS ANY LIABILITY UNDER
STATE OR FEDERAL SECURITIES LAWS ARISING OUT OF OR IN CONNECTION WITH THE
TRANSACTION, INCLUDING WITHOUT LIMITATION, ANY LIABILITY AS A SELLER, AFFILIATE
OR CONTROLLING PERSON OF A SELLER OR AFFILIATE.
SUMMARY
THE PARTIES
Meritage is engaged in the hospitality business through its operation
of two distinct business segments. The Company's Food Service Group consists of
its majority ownership, through a wholly owned subsidiary, of the Wendy's
Partnership which operates 25 "Wendy's Old Fashioned Hamburgers" restaurants
(under franchise with Wendy's International) throughout Western and Southern
Michigan. Since November 1996, the operations of the Wendy's Partnership have
been consolidated with Meritage. MCC Food Service Inc., an affiliate of
Meritage, is the general partner of the Wendy's Partnership and operates the
Wendy's Partnership.
Meritage's Lodging Group owns and operates three full service hotels in
Michigan. The Company has received inquiries regarding the sale of its hotels.
Because current market conditions make this an opportune time to sell full
service hotels, the Company intends to explore carefully any opportunity which
may arise regarding the sale of one or more of its hotels. The Company has
retained a professional brokerage firm to assist it in this regard.
The principal executive office of both Meritage and the Wendy's
Partnership is 40 Pearl Street, N.W., Suite 900, Grand Rapids, Michigan 49503,
its telephone number is (616) 776-2600, and its facsimile number is (616)
776-2776.
THE TRANSACTION
MHG Food Service, a subsidiary of Meritage, owns approximately 54% of
the outstanding units and has appointed MCC Food Service, an affiliate of
Meritage, as the general partner of the Wendy's Partnership. A newly formed
limited partnership, which will be affiliated with Meritage, intends to purchase
the assets, and assume the liabilities, of the Wendy's Partnership in exchange
for Meritage Common Shares. Following such purchase, the Wendy's Partnership
will be dissolved. Upon dissolution, the Meritage Common Shares will be
distributed to non-affiliated limited partners on the basis of that number of
Meritage Common Shares that have a value of $7,500 per unit, based on the
average high and low bid price on the OTC Bulletin Board for the 10 trading days
preceding the date of dissolution. Units held by Meritage will be canceled. As a
result of the transaction, the newly formed limited partnership will acquire all
assets and assume all the liabilities of the Wendy's Partnership and succeed to
all business operations currently conducted by the Wendy's Partnership. See
"Background and Reasons for the Transaction - Determination of Consideration for
Units" for a description of the measurement of consideration to be paid in the
transaction.
WENDY'S PARTNERSHIP AUTHORIZATION
THIS PROSPECTUS CONSTITUTES NOTICE OF THE TRANSACTION. IN ACCORDANCE
WITH SECTION 12.7 OF THE WENDY'S PARTNERSHIP AGREEMENT, LIMITED PARTNERS WILL BE
DEEMED TO HAVE CONSENTED TO THE TRANSACTION UNLESS THEY INDICATE TO THE CONTRARY
IN WRITING TO THE WENDY'S PARTNERSHIP BEFORE ____ 1997.
WE ARE NOT ASKING YOU FOR A PROXY AND YOU ARE REQUESTED NOT TO SEND US
A PROXY.
MERITAGE COMMON SHARES OUTSTANDING
3,217,094 Common Shares are currently issued and outstanding.
6
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CERTAIN RISK FACTORS
Risks Associated with Dissolution of the Partnership
- CONFLICTS OF INTEREST. MHG Food Service, a subsidiary of
Meritage, owns approximately 54% of the outstanding units of
the Wendy's Partnership and has appointed MCC Food Service, an
affiliate of Meritage, as the general partner of the Wendy's
Partnership. This ownership position results in Meritage
having a conflict of interest in purchasing the assets
because, as a practical matter, Meritage controls the outcome
of the transaction.
- NO INDEPENDENT FAIRNESS DETERMINATION. The general partner has
not obtained an opinion from any third party regarding the
fairness of the consideration to be received as a result of
the transaction.
- CHANGE IN NATURE OF INVESTMENT AND STATUS OF LIMITED PARTNERS.
An investment in Meritage Common Shares constitutes a
fundamental change in the nature of the investment of
non-affiliated limited partners, including the change from an
investment in a partnership of limited duration that is
designed to distribute excess cash, to an investment in a
corporation of perpetual duration that has no present
intention to pay cash dividends.
- NO APPRAISAL RIGHTS. Limited partners do not have appraisal,
dissenters' or similar rights under Michigan law or the
Wendy's Partnership Agreement.
- NO INDEPENDENT REPRESENTATION OF LIMITED PARTNERS. The
non-affiliated limited partners received no independent
representation regarding the determination of the
consideration to be received in the transaction.
Risks Associated with an Investment in Meritage's Common Shares
- LIMITED PUBLIC TRADING MARKET. Although the Common Shares are
traded on the OTC Bulletin Board and are listed on the Chicago
Stock Exchange, they are not actively traded.
- SUBSTANTIAL DEBT. Meritage had $25.3 million of long-term debt
and capitalized lease payments outstanding at July 1, 1997.
The Company has $275,000 of long term borrowings available to
fund a marina development project. Its expansion programs will
likely result in additional debt.
- CONTROL BY INSIDERS. Meritage's directors and executive
officers beneficially own approximately 62% of Meritage's
outstanding Common Shares and, therefore, have the practical
ability to control its operations and policies.
- LEGAL PROCEEDINGS. Meritage received a notice from the
Internal Revenue Service that approximately $2.1 million,
which Meritage deducted as a business expense in connection
with litigation in 1995 and 1996 relating to the replacement
and restructuring of former management, should be treated as a
capital expenditure and, therefore, disallowed as a deduction.
Meritage believes the deduction was proper and is vigorously
contesting the disallowance. If the IRS were to completely
prevail in its position, then Meritage would be required to
make a payment of approximately $340,000 in additional federal
and state income taxes, not including any interest or
penalties. If Meritage is able to carry back its 1996 tax
loss, then any amount that Meritage would be required to pay
would be refunded within 120 days of payment.
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On May 19, 1997, Wendy's West Michigan, Inc. was removed as
general partner of the Wendy's Partnership and replaced with
MCC Food Service, an affiliate of Meritage. On May 21, 1997,
Wendy's West Michigan, Inc. commenced a lawsuit against
Meritage, MHG Food Service, and MCC Food Service (Case No.
97-05360-CB, Kent County (Michigan) Circuit Court, Buth, J.).
Wendy's West Michigan, Inc. has attempted to assert claims on
behalf of the Wendy's Partnership as well. The complaint
seeks, among other things, (i) a declaration that Wendy's West
Michigan, Inc. is the general partner of the Wendy's
Partnership, (ii) injunctive relief in the form of a temporary
restraining order or a preliminary injunction which would
prohibit the defendants from participating in the management
of the Wendy's Partnership, and (iii) damages for various
business torts. Plaintiff's motion for a temporary restraining
order was denied on May 21, 1997. Defendants believe that the
lawsuit is entirely without merit and is seeking its
dismissal. Wendy's International stated that it will not take
a position regarding any legal issues raised by this lawsuit.
The consent of Wendy's International to MCC Food Service
serving as the general partner has already been obtained.
Risks Associated with Meritage's Business
- BROADENED BUSINESS ORIENTATION. Although Meritage was engaged
only in the lodging business prior to acquiring its interest
in the Wendy's Partnership, Meritage has recently reassessed
its long-range objectives and made a strategic decision to
further expand its Food Service Group through the acquisition
of additional chain restaurant businesses. In addition, the
Company has received inquiries regarding the sale of its
hotels. Because current market conditions make this an
opportune time to sell full service hotels, the Company
intends to explore carefully any opportunity which may arise
regarding the sale of one or more of its hotels. The Company
has retained a professional brokerage firm to assist it in
this regard. There is a risk that this expansion of the
business operations might not be successfully implemented for
many reasons, including the timing and prices involved in
sales of the lodging properties, the availability and pricing
of additional restaurant operations, and the ability of
management to successfully manage new restaurant businesses.
- RISKS OF THE LODGING INDUSTRY. Meritage is subject to all of
the risks inherent to the lodging industry. These risks
include, among other factors, varying levels of demand for
rooms and related services, adverse effects of the general and
local economic and market conditions, changes in travel
patterns, changes in governmental regulations that influence
wages, prices or construction costs, changes in interest
rates, availability of credit and changes in real estate
taxes, availability of labor in a labor-intensive industry and
operating expenses, and the recurring need for renovations,
refurbishment and improvement of hotel properties. Values of
hotel properties are sensitive to changes in local market and
economic conditions and to the fluctuations in the economy as
a whole. Due to the high level of fixed costs required to
operate hotels, significant expenditures necessary to the
hotel operations cannot be reduced substantially when
circumstances cause a reduction of revenue.
- RISKS AFFECTING RESTAURANT OPERATIONS. Meritage's operations
in its Food Service Group are pursuant to franchise agreements
with Wendy's International. Restrictions that accompany this
relationship may have the effect of limiting Meritage's
ability to pursue its business plans. In addition, Meritage's
restaurant operations could be materially and adversely
affected by any adverse developments regarding the reputation
of Wendy's International on a national level.
- GEOGRAPHIC CONCENTRATION. All of Meritage's restaurant and
lodging operations are located in smaller urban areas in
Michigan. A marked decline in the Michigan economy could
adversely affect its revenues.
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RECOMMENDATION OF THE GENERAL PARTNER
The General Partner, MCC Food Service, believes that the transaction is
fair and is in the best interests of the Wendy's Partnership and the Limited
Partners, excluding Meritage. The General Partner, however, has not obtained any
independent opinion regarding the transaction and has a conflict of interest
because it is affiliated with Meritage. However, the General Partner does
believe that the transaction will result in benefits to the holders of the units
as described in "Background and Reasons for the Transaction."
MATERIAL EFFECTS TO THE LIMITED PARTNERS
After the transaction closes, the limited partners of the Wendy's
Partnership will change from being partners in an entity with limited duration
that is engaged solely in the food service business, to shareholders of a
corporation of perpetual duration which is also engaged in the lodging business.
The limited partners have limited voting rights in the Wendy's Partnership,
primarily relating to removal of the General Partner, the sale of all assets and
the dissolution of the Partnership. Shareholders of Meritage have more voting
rights, including the right to vote on the election of directors annually, on
compensation plans submitted for shareholder approval, on amendments to the
Articles of Incorporation, and on major transactions such as mergers. The
Wendy's Partnership Agreement is also designed to provide for distributions of
cash to the limited partners, with past distributions ranging from $250 per unit
in 1996 to $450 per unit in 1995. By contrast, Meritage currently pays no
dividends on its Common Shares. There is no established market for the Wendy's
Partnership units. Although Meritage's Common Shares are thinly traded, they are
listed on the Chicago Stock Exchange and are quoted on the OTC Bulletin Board.
BACKGROUND AND REASONS FOR THE TRANSACTION
Meritage Capital Corp. ("MCC"), an affiliate of Meritage, first
expressed an interest in acquiring the Wendy's Partnership in March 1995.
Meritage purchased units in 1996 and now owns, through its wholly owned
subsidiary, over half of the outstanding units. In addition, a party affiliated
with Meritage is the general partner of the Wendy's Partnership. Meritage's
ability to control the Wendy's Partnership effectively foreclosed the ability of
the general partner to consider other alternatives to the transaction.
Therefore, alternatives such as sale of the Wendy's Partnership to a third party
or the liquidation of the Wendy's Partnership have not been considered.
Meritage initiated the transaction without the participation of the
former general partner. Meritage wants to complete the transaction so that it
may obtain total ownership of the limited partnership that owns the 25 Wendy's
restaurants. Meritage has not obtained any opinion of an outside advisor as to
the price it will pay in the transaction. It based the price to be paid in the
transaction upon the prices paid by it in 1996 for its acquisition of a majority
of the units.
TAX EFFECTS
Unit holders receiving Meritage shares will recognize a capital gain or
loss for federal income tax purposes. Such holders may also recognize ordinary
income to the extent the consideration received is attributable to that holder's
portion of the unrealized receivables of the Wendy's Partnership, and is subject
to recapture as ordinary income through depreciation recapture or otherwise. See
"Federal Income Tax Consequences."
DISSENTERS' RIGHTS OF PARTNERS
None. Limited partners have the right to obtain a list of other limited
partners pursuant to Section 12.1(b) of the Wendy's Partnership Agreement.
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MARKET QUOTATIONS
On September 18, 1996, the date Meritage first announced its intention
to make a tender offer for the units of the Limited Partnership, Meritage's
Common Shares were quoted at $ 4.25 bid and $ 4.75 asked. There is no trading
market for the Wendy's Partnership units. Meritage acquired 14 units for $5,000
cash per unit in June 1996, 143.25 units in July 1996 for 171,900 Meritage
Common Shares which Meritage valued at $6,000 per unit because of the
unregistered status of the Meritage shares, 482.55 units in October 1996 in the
tender offer for $7,000 cash per unit, and 41 units in November 1996 for 29,520
shares of Meritage Series A Convertible Preferred Stock which Meritage value at
$7,200 per unit. See "Price Range of Common Shares."
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MERITAGE HOSPITALITY GROUP INC.
SUMMARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AND RATIO DATA)
<TABLE>
<CAPTION>
Six Months ended
Years Ended November 30, May 31,
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1996 1995 1994 1993 1992 1997 1996
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STATEMENT OF EARNINGS DATA
Net Revenue
Rooms $ 6,282 $ 5,999 $ 6,048 $ 5,681 $ 5,820 $ 2,503 $ 2,571
Food, beverage and other 10,603 8,442 9,312 8,564 8,525 16,495 4,121
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Total Revenue 16,885 14,441 15,360 14,245 14,345 18,998 6,692
Cost and expenses
Cost of food and beverages 3,334 2,864 3,042 2,852 2,800 4,871 1,339
Operating expenses 9,492 7,215 7,180 7,024 6,690 11,771 3,523
General and administrative expenses 3,951 4,980 2,597 2,131 2,013 1,934 1,576
Depreciation and Amortization 1,082 1,426 1,232 1,175 1,143 1,078 449
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Total costs and expenses 17,859 16,485 14,051 13,182 12,646 19,654 6,887
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Earnings (loss) from operations (974) (2,044) 1,309 1,063 1,699 (656) (195)
Other income (expense)
Interest (net) (985) (968) (1,119) (1,063) (1,374) (1,148) (367)
Other 13 242 12 395 199 (36) --
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Total other expense (972) (726) (1,107) (668) (1,175) (1,184) (367)
-------------------------------------------------------------------------------
Earnings (loss) before federal income
tax and cumulative effect of change in
accounting principle (1,946) (2,770) 202 395 524 (1,840) (562)
Federal income tax expense (benefit) (20) (721) 112 165 225 -- (191)
-------------------------------------------------------------------------------
Earnings (loss) before cumulative effect of
change in accounting principle (1,926) (2,049) 90 230 299 (1,840) (371)
Cumulative effect of prior years of changing
to a different method of accounting for
income taxes -- -- (117) -- -- -- --
-------------------------------------------------------------------------------
Net earnings (loss) (1,926) (2,049) (27) 230 299 (1,840) (371)
Preferred Stock Dividends -- -- -- -- -- 39 --
-------------------------------------------------------------------------------
Net earnings (loss) on Common Shares $ (1,926) $ (2,049) $ (27) $ 230 $ 299 $ (1,879) $ (371)
===============================================================================
Earnings (loss) per share
Before cumulative effect of change in
accounting principle $ (0.62) $ (1.13) $ 0.06 $ 0.15 $ 0.20 $ (0.59) $ (0.12)
Cumulative effect of change in accounting
principle -- -- (0.08) -- -- -- --
-------------------------------------------------------------------------------
After cumulative effect of change in
accounting principle $ (0.62) $ (1.13) $ (0.02) $ 0.15 $ 0.20 $ (0.59) $ (0.12)
===============================================================================
Weighted average shares outstanding 3,082 1,816 1,520 1,520 1,520 3,212 3,020
===============================================================================
Ratio of earnings to fixed charges $ (0.16) $ (0.08) $ 0.98 $ 1.34 $ 1.31 $ (0.20) $ 0.24
Coverage deficiency (1) 1,947 2,049 27 -- -- 1,804 563
<FN>
(1) Earnings are inadequate to cover fixed charges in years ended 1996,
1995 and 1994 as well as the six months ended May 31, 1997 and May 31,
1996.
</TABLE>
CONTINUED ON NEXT PAGE
11
<PAGE> 12
MERITAGE HOSPITALITY GROUP INC.
SUMMARY CONSOLIDATED FINANCIAL DATA (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AND RATIO DATA)
<TABLE>
<CAPTION>
(1)
Six Months ended
------------------------------------------
Years Ended November 30, May 31,1997
-------------------------------------------------- ----------------
1996 1995 1994 1993 1992 Actual Pro Forma May 31, 1996
---- ---- ---- ---- ---- ------ --------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA
Cash and cash equivalents $ 2,265 $ 1,337 $ 622 $ 451 $ 577 $ 1,122 $ 1,061 $ 2,107
Working capital 103 44 406 (450) (4,429) (1,786) (1,847) 1,935
Property and equipment, net 21,757 13,218 13,645 14,069 14,867 21,498 22,538 13,538
Total assets 31,929 17,984 19,688 20,004 20,145 30,810 33,688 19,030
Long-term debt, including
current maturities 24,293 11,443 12,647 12,905 13,209 24,850 24,850 14,931
Shareholders' equity 2,021 3,055 5,225 5,252 5,022 225 4,545 1,624
STATEMENT OF CASH FLOWS DATA
Net increase (decrease) in cash
and cash equivalents $ 929 $ 715 $ 171 $ (127) $ 322 $ (1,143) $ (1,205) $ 770
Net cash provided by (used in)
operating activities (1,496) 425 990 1,056 1,687 (935) (935) (903)
Dividends - common stock 1,510 -- -- -- -- -- -- 1,510
Dividends - preferred stock -- -- -- -- -- 39 39 --
<FN>
(1) The transaction is reflected under the purchase method of accounting, and
the Pro Forma data is derived in accordance with such method. The Pro Forma
data prior to the effective time of the transaction may not be indicative
of the results that actually would have occurred if the transaction had
been in effect during the periods presented or which may be attained in the
future. Please refer to pages P-1 through P-7 for further Pro Forma
information.
</TABLE>
12
<PAGE> 13
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
SUMMARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER LIMITED PARTNER UNIT DATA,
PARTNERSHIP UNITS OUTSTANDING AND RATIO DATA)
<TABLE>
<CAPTION>
Six Months ended
(1) Years ended December 31, May 31,
Eleven Months ended ------------------------- -------
November 30, 1996 1995 1994 1993 1992 1997 1996
----------------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF EARNINGS DATA
Net Revenue
Rooms $ -- $ -- $ -- $ -- $ -- $ -- $ --
Food, beverage and other 24,687 25,601 24,910 23,685 22,743 13,042 12,314
--------------------------------------------------------------------------------
Total Revenue 24,687 25,601 24,910 23,685 22,743 13,042 12,314
Cost and expenses
Cost of food and beverages 7,223 7,391 7,295 7,187 6,850 3,734 3,555
Operating expenses 14,662 15,099 13,987 13,264 12,819 7,896 7,441
General and administrative
expenses 1,046 1,250 1,279 1,203 1,098 655 616
Depreciation and Amortization 769 853 857 971 950 458 417
--------------------------------------------------------------------------------
Total costs and expenses 23,700 24,593 23,418 22,625 21,717 12,743 12,029
Earnings from operations 987 1,008 1,492 1,060 1,026 299 285
Other income (expense)
Interest (net) (403) (512) (557) (622) (661) (221) (223)
Other (25) 31 6 -- (17) -- --
--------------------------------------------------------------------------------
Total other income (expense) (428) (481) (551) (622) (678) (221) (223)
Earnings before extra-
ordinary item 559 527 941 438 348 78 62
Extraordinary item -- (21) -- (87) -- -- --
--------------------------------------------------------------------------------
Net earnings $ 559 $ 506 $ 941 $ 351 $ 348 $ 78 $ 62
================================================================================
Net earnings attributable to:
Limited Partners $ 553 $ 501 $ 931 $ 348 $ 345 $ 77 $ 61
General Partner 6 5 10 3 3 1 1
--------------------------------------------------------------------------------
$ 559 $ 506 $ 941 $ 351 $ 348 $ 78 $ 62
================================================================================
Earnings per unit of limited
partnership unit
Before extraordinary item $ 440.22 $ 415.14 $ 740.96 $ 345.06 $ 274.42 $ 61.56 $ 48.64
Extraordinary item - loss on
extinguishment of debt -- (16.18) -- (68.53) -- -- --
--------------------------------------------------------------------------------
After extraordinary item $ 440.22 $ 398.96 $ 740.96 $ 276.53 $ 274.42 $ 61.56 $ 48.64
================================================================================
Number of limited partnership
units outstanding 1256.8 1256.8 1256.8 1256.8 1256.8 1256.8 1256.8
================================================================================
Ratio of earnings to fixed charges 2.36 1.94 2.65 1.49 1.52 1.34 1.27
================================================================================
<FN>
(1) In fiscal 1996, the Wendy's Partnership changed its fiscal year from
December 31 to November 30, due to the consolidation of the Wendy's
Partnership's financial statements with Meritage. Meritage acquired a
majority interest in the Wendy's Partnership on October 31, 1996.
</TABLE>
CONTINUED ON NEXT PAGE
13
<PAGE> 14
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
SUMMARY CONSOLIDATED FINANCIAL DATA (CONTINUED)
(IN THOUSANDS, EXCEPT PER LIMITED PARTNER UNIT DATA,
LIMITED PARTNERSHIP UNITS OUTSTANDING AND RATIO DATA)
<TABLE>
<CAPTION>
(1) (2)
Six Months ended
-----------------------------------
Years Ended November 30, May 31,1997
Eleven months ended ------------------------ -----------
November 30, 1996 1995 1994 1993 1992 Actual Pro Forma May 31, 1996
------------------ ---- ---- ---- ---- ------ --------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA
Cash and cash equivalents $ 394 $ 411 $ 776 $ 409 $ 422 $ 619 $ 619 $ 409
Working capital (850) (912) (824) (1,089) (2,733) (1,085) (1,085) (851)
Property and equipment, net 5,897 5,671 5,933 5,763 5,611 5,936 6,976 5,759
Total assets 9,076 8,832 9,698 9,341 9,478 9,079 9,079 8,826
Long-term debt, including
current maturities 4,379 4,469 5,127 5,494 4,176 4,170 4,170 4,538
Partners' equity
General Partner (29) (31) (31) (36) (40) (28) (28) (31)
Limited Partner 3,131 2,892 2,956 2,402 2,054 3,208 3,208 2,880
STATEMENT OF CASH FLOWS DATA
Net increase (decrease) in cash
and cash equivalents $ (17) $ (365) $ 367 $ (12) $ 194 $ 224 $ 224 $ 125
Net cash provided by
operating activities 1,201 1,366 1,808 627 1,207 857 857 590
Distributions 317 571 381 -- -- -- -- 127
<FN>
(1) In fiscal 1996, the Wendy's Partnership changed its fiscal year from
December 31 to November 30, due to the consolidation of the Wendy's
Partnership's financial statements with Meritage. Meritage acquired a
majority interest in the Wendy's Partnership on October 31, 1996.
(2) The transaction is reflected under the purchase method of accounting, and
the Pro Forma data is derived in accordance with such method. The Pro Forma
data prior to the effective time of the transaction may not be indicative
of the results that actually would have occurred if the transaction had
been in effect during the periods presented or which may be attained in the
future. Please refer to pages P-1 through P-7 for further Pro Forma
information.
</TABLE>
14
<PAGE> 15
COMPARATIVE PER SHARE AND UNIT DATA
The following table sets forth certain per share and unit information for
both Meritage and the Wendy's Partnership on an historical basis and selected
unaudited, pro forma, combined, comparative per share data for Meritage and the
Wendy's Partnership combined. The transaction is reflected under the purchase
method of accounting, and pro forma data are derived in accordance with such
method. The Wendy's Partnership pro forma equivalent amounts are presented with
respect to each set of pro forma information. Such amounts are computed by
multiplying the pro forma amounts by the assumed exchange ratio of 2,142.85
shares of Meritage Common Shares for each unit held by non-affiliated limited
partners. The pro forma data prior to the effective time of the transaction may
not be indicative of the results that actually would have occurred if the
transaction had been in effect during the periods presented or which may be
attained in the future.
<TABLE>
<CAPTION>
MERITAGE THE PARTNERSHIP PRO FORMA
(PER SHARE) (PER UNIT) (PER SHARE)
----------------------------------------------------
<S> <C> <C> <C>
EARNINGS (LOSS) PER SHARE OR UNIT:
Fiscal 1996 $ (0.62) $ 440.22 $ (0.52)
Fiscal 1995 (1.13) 398.96
Fiscal 1994 (0.02) 740.96
Fiscal 1993 0.15 276.53
Fiscal 1992 0.20 274.42
Six months ended May 31, 1997 (0.59) 61.56 (0.43)
Six months ended May 31, 1996 (0.12) 48.64
COMMON STOCK DIVIDENDS DECLARED/DISTRIBUTIONS
PER SHARE OR UNIT:
Fiscal 1996 0.50 250.00 0.42
Fiscal 1995 --- 450.00
Fiscal 1994 --- 300.00
Fiscal 1993 --- ---
Fiscal 1992 --- ---
Six months ended May 31, 1997 --- --- ---
Six months ended May 31, 1996 0.50 100.00
BOOK VALUE PER SHARE OR UNIT:
Fiscal 1996 0.63 2,491.07
Fiscal 1995 1.01 2,300.85
Fiscal 1994 3.44 2,351.90
Fiscal 1993 3.46 1,910.94
Fiscal 1992 3.30 1,634.41
Six months ended May 31, 1997 0.07 2,552.62 1.02
Six months ended May 31, 1996 0.54 2,349.49
</TABLE>
15
<PAGE> 16
RISK FACTORS AND OTHER CONSIDERATIONS
Each Limited Partner should carefully consider the factors set forth
below, as well as other information included elsewhere herein.
RISKS ASSOCIATED WITH DISSOLUTION OF THE WENDY'S PARTNERSHIP
Conflicts of Interest
Meritage has an inherent conflict of interest in that MHG Food Service,
a subsidiary of Meritage, owns approximately 54% of the outstanding units of the
Wendy's Partnership and has appointed MCC Food Service, an affiliate of
Meritage, as the general partner of the Wendy's Partnership. Meritage is in a
position to cause the sale of assets to it and the dissolution of the Wendy's
Partnership without the vote of the non-affiliated limited partners, and
obviously would desire to pay less for the Wendy's Partnership units than the
limited partners would want to receive. As general partner, MCC Food Service is
accountable to the limited partners as a fiduciary and must, therefore, exercise
good faith and integrity in the resolution of any conflict of interest and in
its dealings with the Wendy's Partnership.
Meritage desires to obtain the remaining units of the Wendy's
Partnership at the best price available to it. Therefore, neither Meritage, MHG
Food Service nor MCC Food Service is making any recommendation with respect to
the transaction. Meritage, MHG Food Service and MCC Food Service, nevertheless,
believe that the transaction is fair, from a financial point of view, to the
non-affiliated limited partners. See "Background and Reasons for the
Transaction."
No Independent Fairness Determination
Meritage established the exchange ratio of the shares for units to be
higher than the highest prices it paid in 1996 to non-affiliated limited
partners. See "Background and Reasons for the Transaction - Determination of
Consideration for Units." However, neither Meritage nor the general partner
engaged any outside party to render an opinion as to this value or to represent
the interests of the non-affiliated limited partners. Meritage's management
decided not to obtain a fairness opinion because of their belief that the
transaction was fair and because of the costs associated with obtaining a
fairness opinion. Meritage believes that the value of the Wendy's Partnership
units has not appreciated significantly since the series of purchases made by
Meritage in 1996 at prices valued from $5,000 to $7,200 per unit, and that the
value of the exchange for each unit, $7,500 based on a market price for each of
the Meritage Common Shares being exchanged for a unit, is fair because it
exceeds the highest purchase prices paid for units in 1996. The risk exists that
a higher value than that being paid by Meritage for each unit could be obtained
through a sale of the Wendy's Partnership's assets and business to a third party
and that the opinion of a qualified outside appraiser could be that the value is
higher than that being offered by Meritage.
Change in Nature of Investment and Status of Limited Partners
Upon completion of the transaction, the economic interest of the
Wendy's Partnership limited partners will change from interests in ownership of
a limited partnership with a limited duration that is designed to distribute
income, to that of a shareholder of a larger organization with perpetual
duration which presently does not intend to pay dividends. Collectively, the
Meritage Common Shares issued in the transaction will represent approximately
___% of Meritage's outstanding Common Shares as determined after the
transaction. The economic interests of the limited partners will change from
only restaurant operations, to a broader corporate operation which, unlike the
Wendy's Partnership, may include businesses other than restaurant operations.
See "Distribution Policies."
In addition, this change also results in significant modifications to
the rights of the limited partners with respect to voting, meetings of holders,
dissolution and liquidation, and access to investor lists and other books and
records. Also, there will be changes with respect to the management, taxation of
the entity, its investors, and marketability and transferability of the equity
interests. If the transaction is consummated, holders of the units
16
<PAGE> 17
would become shareholders of Meritage, a Michigan corporation, and would
therefore experience a change in the rights from those of limited partners of a
Michigan limited partnership to those of shareholders of a Michigan corporation.
See "Description of Capital Shares" and "Comparative Rights."
No Appraisal Rights
Under Michigan law and the terms of the Wendy's Partnership Agreement,
a limited partner will have no appraisal, dissenters' or similar rights (i.e.,
rights, instead of receiving Meritage Common Shares, to seek a judicial
determination of the "fair value" of the units and to compel the Wendy's
Partnership to purchase units for cash in that amount). Such rights will not
voluntarily be accorded to limited partners by Meritage or the Wendy's
Partnership. Should any litigation ensue with respect to the transaction,
Meritage would assert any consents returned to it as a defense.
No Independent Representation of Limited Partners
The consideration to be received by non-affiliated limited partners in
the transaction was determined by Meritage. See "Background and Reasons for the
Transaction - Determination of Consideration for Units." No independent
representative or counsel has acted on behalf of the non-affiliated limited
partners, nor did the management of Meritage negotiate the terms of the
transaction with any non-affiliated limited partner. There is a possibility
that, if such representatives or non-affiliated limited partners have taken part
in such determination and negotiation, the terms of the transaction might have
been different, and perhaps, more favorable to non-affiliated limited partners.
RISKS ASSOCIATED WITH INVESTMENT IN MERITAGE COMMON SHARES
Limited Trading Market
Although the Common Shares have been continuously traded on the OTC
Bulletin Board since September 1995 and listed on the Chicago Stock Exchange
since October 22, 1996, they are not actively traded. Presently, four broker
dealer firms provide bid and asked quotations for the Common Shares. Meritage
cannot estimate the effect on the trading market that will result from the
issuance of Common Shares in the transaction. Those shares will be freely
transferable in the hands of the former limited partners who are not affiliates
of Meritage, and sales of a substantial amount of the shares could depress the
market price for the Common Shares.
Substantial Debt
Meritage had $25.3 million of long-term debt outstanding at July 1,
1997, which included current portions of long-term debt and the debt of the
Wendy's Partnership. Included in the debt is an $875,000 loan for the
development of a marina. As of July 1, 1997, $600,000 had been borrowed on the
marina development loan leaving $275,000 available. The Company's expansion
programs will likely result in additional debt. Furthermore, additional sales of
Meritage preferred stock could increase preferred dividend service requirements.
Increases in general interest rate levels and general credit tightening
situations could adversely affect Meritage's financial condition in the future.
Common Share Ownership and Control by Insiders
Meritage's officers, directors, principal shareholders and their
affiliates beneficially own approximately 62% of Meritage's outstanding Common
Shares (all of which are eligible for sale under Securities and Exchange
Commission Rule 144 promulgated under the Securities Act of 1933). As a result,
these shareholders and, in particular, Meritage's officers and directors, when
acting in concert, have the ability to influence significantly most matters
requiring approval by shareholders of Meritage, including the election of a
majority of the directors. In addition, the Board of Directors has the authority
to issue up to approximately 26,780,000 Common Shares and 4,860,000 shares of
undesignated preferred stock and to determine the rights, preferences privileges
and restrictions,
17
<PAGE> 18
including voting rights, of such preferred shares, without any future vote or
action by the shareholders. The voting power of these principal shareholders,
officers and directors, or the issuance of Common Shares or preferred stock
under certain circumstances, could have the effect of delaying, deferring or
preventing a change in control of Meritage. Although the ownership of this group
will decline from approximately 62% to ___% upon completion of the transaction,
their degree of control will remain.
Legal Proceedings
In December 1996, Meritage received a notice from the Internal Revenue
Service that approximately $2.1 million, which Meritage deducted as a business
expense in connection with litigation in 1995 and 1996 relating to the
replacement and restructuring of former management, should be treated as a
capital expenditure and, therefore, disallowed as a deduction. Meritage is
vigorously contesting the disallowance. If the IRS were to completely prevail in
its position, then Meritage would be required to make a payment of approximately
$340,000 for additional federal and state income taxes, not including any
interest or penalties. If Meritage is able to carry back its 1996 tax loss, then
any amount that Meritage would be required to pay would be refunded within 120
days of payment.
On May 19, 1997, Wendy's West Michigan, Inc. was removed as general
partner of the Wendy's Partnership and replaced with MCC Food Service, an
affiliate of Meritage. On May 21, 1997, Wendy's West Michigan, Inc. commenced a
lawsuit against Meritage, MHG Food Service, and MCC Food Service (Case No.
97-05360-CB, Kent County (Michigan) Circuit Court, Buth, J.). Wendy's West
Michigan, Inc. has attempted to assert claims on behalf of the Wendy's
Partnership as well. The complaint seeks, among other things, (i) a declaration
that Wendy's West Michigan, Inc. is the general partner of the Wendy's
Partnership, (ii) injunctive relief in the form of a temporary restraining order
or a preliminary injunction which would prohibit the defendants from
participating in the management of the Wendy's Partnership, and (iii) damages
for various business torts. Plaintiff's motion for a temporary restraining order
was denied on May 21, 1997. Defendants believe that the lawsuit is entirely
without merit and is seeking its dismissal. Wendy's International stated that it
will not take a position regarding any legal issues raised by this lawsuit. The
consent of Wendy's International to MCC Food Service serving as the general
partner has already been obtained.
RISKS ASSOCIATED WITH MERITAGE'S BUSINESS
Broadened Business Orientation
Although Meritage was engaged only in the lodging business before its
acquisition of a controlling interest in the Wendy's Partnership, Meritage has
recently reassessed its long-range objectives and made a strategic decision to
expand further its Food Service Group through the acquisition of additional
chain restaurant businesses. In addition, the Company has received inquiries
regarding the sale of its hotels. Because current market conditions make this an
opportune time to sell full service hotels, the Company intends to explore
carefully any opportunity which may arise regarding the sale of one or more of
its hotels. The Company has retained a professional brokerage firm to assist it
in this regard. Proceeds of any sale would be used to reduce the Company's debt.
Management cannot, of course, determine whether it will sell any of its
hotels or, if it decides to sell, how long it will take to sell these assets at
prices that are acceptable to Meritage. Furthermore, there is a risk that this
expansion of the business operations might not be successfully implemented for
many reasons, including the timing and prices involved in any sales of the
lodging properties, the availability and pricing of additional restaurant
operations, and the ability of management to successfully manage new restaurant
businesses. Utilization of the proceeds from the sale of any of the hotels and
other assets to acquire additional food service properties will involve all of
the risks normally attendant to acquisitions, including whether the selection,
timing and pricing of acquisitions will enable Meritage to operate these
businesses at a profit. The acquisition, consolidation and integration of
management systems and procedures of acquired businesses into Meritage's
existing management structure will present a significant challenge, and
expansion of the Food Service Group may require additional operating staff. Any
substantial difficulties experienced in this program could have a material
adverse effect on Meritage's
18
<PAGE> 19
operations and financial condition. Also, although Meritage may require
additional debt or equity financing to accomplish its aims, such financing may
not be available or, if available, not on terms acceptable to Meritage
The hotel properties which have been owned since 1986, have been
substantially depreciated and are carried on the books at approximately $14
million. As a result, if a sale occurs, the sales are expected to result in
substantial gains that will trigger the payment of approximately 32% of the tax
profit in income taxes prior to the application of any available NOL
carryforwards and any current year operating losses. Thus, the net taxes paid
would reduce the proceeds available to pay down the Company's debt.
Risks of the Lodging Industry
Meritage is subject to all of the risks inherent to the lodging
industry. These risks include, among other factors, varying levels of demand for
rooms and related services, adverse effects of the general and local economic
and market conditions, changes in travel patterns, changes in governmental
regulations that influence wages, prices or construction costs, changes in
interest rates, availability of credit and changes in real estate taxes,
availability of labor in a labor-intensive industry and operating expenses, and
the recurring need for renovations, refurbishment and improvement of hotel
properties. Values of hotel properties are sensitive to changes in local market
and economic conditions and to the fluctuations in the economy as a whole. Due
to the high level of fixed costs required to operate hotels, significant
expenditures necessary to the hotel operations cannot be reduced substantially
when circumstances cause a reduction of revenue. Investments in limited purpose
facilities, such as a hotel, typically involve greater risks than do investments
in multi-purpose properties, some of which risks are as follows:
Over-building
New hotel construction is increasing from levels experienced in the
early 1990's as a result of increasing occupancy rates. Room starts declined
from an annual rate of approximately 160,000 in 1984, to less than 40,000 in the
mid-1990's and are projected to be at approximately 110,000 for 1997. These
factors could lead to an overbuilding situation, such as occurred in the 1980's,
when an oversupply of rooms adversely affected occupancy levels and room rates.
If this situation develops it could adversely affect the prices at which
Meritage values its hotel properties.
Competition for Market Share
The lodging industry is highly competitive. There is no single
competitor or small number of competitors of Meritage that are dominant in the
industry. Meritage's hotels operate in areas that contain numerous competitors,
many of which have substantially greater resources than Meritage. Competition in
the lodging industry is based generally on convenience of location, room rates,
and range and quality of services and guest amenities offered. Meritage
considers the location of its hotels and the services and guest amenities
provided by it to be among the most important factors it its business.
Demographic, geographic or other changes in one or more of Meritage's markets
could impact the convenience or desirability of the sites of certain hotels,
which would in turn affect the operations of those hotels. In addition, new or
existing competitors could significantly lower rates or offer greater
conveniences, services or amenities or significantly expand, improve or
introduce new facilities in markets in which Meritage's hotels compete, thereby
adversely affecting Meritage's operations. See "Business - Competition and
Industry Conditions."
Requirements for Capital and Labor
Hotel operations are capital, management and labor intensive. In order
to remain competitive, hotel facilities must be continually maintained,
modernized and refurbished. This increases the need for capital funds from
reserves, current cash flow or debt financing and thereby increases the
sensitivity of the investment to the cost and availability of such funds. In
addition, hotels are especially susceptible to the impact of economic and other
conditions outside the control of the hotel owner.
19
<PAGE> 20
Seasonality
The lodging industry is seasonal in nature. Generally, hotel revenues
are greater in Meritage's third fiscal quarter than in its other fiscal
quarters. This seasonality can be expected to cause fluctuations in the revenues
of Meritage. Quarterly earnings may also be adversely affected by events beyond
Meritage's control, such as extreme weather conditions, economic factors and
other considerations affecting travel.
Risks Affecting Restaurant Operations
The restaurant industry in the United States is generally viewed as
being over-expanded in relation to customer demand. This factor puts a premium
upon an operator's ability to provide products that differentiate it from its
competitors and to operate its business in an efficient manner. Although the
Company's operations are now confined to smaller urban areas in Michigan, as it
expands, Meritage will have to take into account and adjust for changing
competitive conditions in each particular food service business that it enters
into with respect to its markets. Meritage's expansion plans in the food service
industry are not limited to Wendy's Restaurants and may include any one of a
variety of existing restaurant businesses. The restaurant industry typically
involves risks such as the following:
Competition
The quick-service restaurant industry is intensely competitive with
respect to price, service, location and food quality. The industry is mature,
and competition can be expected to increase. Other major quick-service
restaurant chains (with greater financial and other resources than those
possessed by Meritage) have similar or competing operational concepts to those
of Meritage. A significant change in pricing or other business strategies by one
or more of Meritage's competitors, including an increase in the number of
restaurants in Meritage's territories, could have an adverse impact on
Meritage's sales, earnings and growth.
Meritage and the quick-service restaurant industry are significantly
affected by factors such as changes in local, regional or national economic
conditions, changes in consumer tastes, and consumer concerns about the
nutritional quality of quick-service food. In addition, factors such as
increases in food, labor and energy costs, the availability and cost of suitable
restaurant sites, fluctuating insurance rates, state and local regulations, and
the availability of an adequate number of hourly-paid employees can also
adversely affect the quick-service restaurant industry. See "Business -
Competition and Industry Conditions."
Restrictions Imposed by Wendy's International
As the general partner of the Wendy's Partnership, MCC Food Service, an
affiliate of Meritage, now directs the operations of the 25 Wendy's restaurants
operated by the Wendy's Partnership. MCC Food Service's control is being
challenged in a lawsuit commenced by the former general partner of the Wendy's
Partnership. See "Risks Associated with Investment in Meritage Common Shares -
Legal Proceedings." Operations of the Wendy's Partnership are conducted pursuant
to franchise agreements with Wendy's International. In addition to the
contractual restrictions imposed by the franchise agreements, Meritage and its
affiliates which are involved in the Wendy's business, are subject to certain
restrictions imposed by policies and procedures established by Wendy's
International as in effect from time to time. These restrictions may have the
effect of limiting Meritage's ability to pursue some of its business plans.
The consent of Wendy's International may be required for certain
transactions by Meritage. If consent is required and not obtained, Meritage will
not be able to proceed with those plans which, in turn, could affect Meritage's
growth strategy and could have a material adverse effect on Meritage's financial
condition and results of operations. If Meritage proceeds without Wendy's
International's consent, Wendy's International could terminate its franchise
agreements. Termination of the franchise agreements would have a material
adverse effect on Meritage's financial condition and results of operations.
20
<PAGE> 21
Part of Meritage's business strategy is to expand its operations
through the acquisition and development of Wendy's restaurants. The approval of
Wendy's International is required for the acquisition of Wendy's restaurants by
Meritage from other Wendy's franchisees and the development of new Wendy's
restaurants by Meritage. Approval is also required for the renewal of existing
franchise agreements. Wendy's consent to such renewals, acquisitions or
development may be withheld in Wendy's sole discretion. Pursuant to its
agreement with Wendy's International, Meritage is also limited in both the
acquisition or development of other chain restaurant businesses. Wendy's
International has restricted Meritage's involvement with any quick-service
restaurant in Meritage's market area, and any quick-service restaurant outside
of Meritage's market area that sells chicken sandwiches, hamburgers or products
similar to Wendy's International which is located within a three mile radius of
another Wendy's restaurant operated by a Wendy's franchisee.
Wendy's International must approve the opening by Meritage of any new
restaurant, including restaurants opened within Meritage's existing franchise
territories. Wendy's International also maintains discretion over the menu items
that may be offered in Meritage's restaurants. By virtue of franchise and other
agreements, Meritage is required to pay to Wendy's International technical
assistance fees upon the opening of new restaurants and monthly royalty and
national advertising fees. These agreements also provide for the termination of
Meritage as a franchisee upon the failure of Meritage to comply with certain
restrictions and obligations imposed on Meritage.
Dependence Upon Wendy's International
Meritage's restaurant operations are largely dependent on the Wendy's
restaurant chain, which in turn is dependent upon the management and financial
condition of Wendy's International and the reputation developed by Wendy's
restaurants operated by other Wendy's franchisees. Should Wendy's International
be unable to compete effectively with similar restaurant chains in the future,
Meritage would be materially and adversely affected. Furthermore, many of the
attributes which lead to the success of Wendy's operations are factors over
which Meritage has no control, such as marketing efforts, introduction of new
products, quality assurance and other operational systems. Adverse publicity
involving other Wendy's franchisees could have an adverse effect on all
franchisees including Meritage.
Geographic Concentration of Operations
All of Meritage's restaurant operations and hotels are now concentrated
in smaller urban areas of Michigan. A marked decline in the Michigan economy
could adversely affect Meritage's operations.
21
<PAGE> 22
CAPITALIZATION
The following table sets forth the capitalization of Meritage at May
31, 1997 and as adjusted to give effect to the issuance of Common Shares in the
transaction whereby Meritage will acquire all remaining units of the Wendy's
Partnership not owned by Meritage. The table should be read in conjunction with
Meritage's Consolidated Financial Statements and related Notes thereto appearing
elsewhere in this Prospectus.
<TABLE>
<CAPTION>
May 31, 1997
-------------------------------
Actual Pro Forma
------------- --------------
<S> <C> <C>
Long-term debt, including current maturities $ 24,850,370 $ 24,850,370
Shareholders' equity:
Preferred Stock, 5,000,000 shares authorized,
138,387 issued and outstanding 1,384 1,384
Common Shares, 30,000,000, 3,216,379 (actual) and
4,448,748 (as adjusted) issued and outstanding 32,164 44,507
Additional paid-in capital 12,975,142 17,282,799
Note receivable from sale of shares (5,412,183) (5,412,183)
Accumulated deficit (7,371,788) (7,371,788)
------------- --------------
Total Shareholders' equity $ 224,719 $ 4,544,719
------------- --------------
Total capitalization $ 25,075,089 $ 29,395,089
============= =============
</TABLE>
PRICE RANGE OF COMMON SHARES
Meritage's Common Shares are currently traded on the OTC Bulletin Board
under the symbol "MHGI" and on the Chicago Stock Exchange under the symbol
"MHG." No recent quotations were published until the beginning of Meritage's
fourth quarter of fiscal 1995. The following are published high and low bid
prices (beginning on October 18, 1995) for the Company's Common Shares as
reported on the OTC Bulletin Board.
<TABLE>
<CAPTION>
======================================================================
HIGH LOW
----------------------------------------------------------------------
<S> <C> <C>
FISCAL YEAR ENDED NOVEMBER 30, 1995
----------------------------------------------------------------------
October 18, 1995 - November 30, 1995 $ 7 1/2 $ 5 7/8
----------------------------------------------------------------------
FISCAL YEAR ENDED NOVEMBER 30, 1996
----------------------------------------------------------------------
First Quarter $ 7 1/8 $ 5 1/2
----------------------------------------------------------------------
Second Quarter $ 6 3/8 $ 5 5/8
----------------------------------------------------------------------
Third Quarter $ 6 3/8 $ 4 1/4
----------------------------------------------------------------------
Fourth Quarter $ 6 1/4 $ 4 1/4
======================================================================
</TABLE>
22
<PAGE> 23
<TABLE>
<CAPTION>
======================================================================
HIGH LOW
----------------------------------------------------------------------
<S> <C> <C>
FISCAL YEAR 1997
----------------------------------------------------------------------
First Quarter $ 6 1/4 $ 5 3/8
----------------------------------------------------------------------
Second Quarter $ 5 1/4 $ 4
----------------------------------------------------------------------
Third Quarter (through August 6) $ 4 $ 2 5/8
======================================================================
</TABLE>
As of July 31, 1997, there were approximately 600 record holders of the
Common Shares which Meritage believes represents approximately 1,400 beneficial
holders.
DISTRIBUTION POLICIES
Other than a special dividend in the amount of $.50 per share of
Meritage's outstanding Common Shares paid on April 26, 1996, Meritage has not
paid cash dividends on its Common Shares. It intends to continue its current
policy of retaining funds for operations. Moreover, payment of dividends on the
Common Shares is prohibited by the terms of Meritage's loan agreement with its
primary long-term lender. See "Capitalization," "Meritage Hospitality Group Inc.
- - Management's Discussion and Analysis of Financial Condition and Results of
Operation - Liquidity and Capital Resources" and "Description of Capital
Shares."
Previously, the general partner reviewed the Wendy's Partnership's
results of operations and cash requirements on a semi-annual basis and
determined the cash flow from operations available for distribution to the
limited partners. The loan agreement for the Wendy's Partnership limited the
cash available for distribution. See "Wendy's of West Michigan Limited
Partnership - Management's Discussion and Analysis of Financial Condition and
Results of Operation - Liquidity and Capital Resources." In January 1995, July
1995, January 1996 and July 1996, the Wendy's Partnership distributed $250,
$200, $100 and $150, respectively, per unit.
BACKGROUND AND REASONS FOR THE TRANSACTION
BACKGROUND OF THE TRANSACTION
The Prospectus relates to Meritage's plans to cause the Wendy's
Partnership to sell all of its assets, subject to liabilities, to a new limited
partnership being formed under the direction of Meritage. The partnership will
receive Meritage Common Shares. After the purchase, the Wendy's Partnership will
be dissolved and the Common Shares will be distributed to all limited partners
other than Meritage. The number of shares to be distributed will be that number
that has a value of $7,500 for each limited partnership unit, based on the
average high and low bid price on the OTC Bulletin Board for the 10 trading days
preceding the date of dissolution. The partnership units held by Meritage will
be canceled.
The transaction will be accomplished in accordance with Section 12.7 of
the Wendy's Partnership Agreement. Under Section 12.7, the limited partners are
deemed to have consented to the transaction unless they indicated to the
contrary in writing to the Wendy's Partnership before ___________, 1997. The
transaction requires approval by the general partner and over half of the
outstanding limited partnership units. Since Meritage is affiliated with the
general partner, and owns over half of the outstanding limited partnership
units, the transaction will be approved regardless of the vote or objections of
non-affiliated limited partners.
In March 1995, MCC (Meritage's principal shareholder) made an inquiry
to a representative of Wendy's West Michigan, Inc., the former general partner
of the Wendy's Partnership, regarding the possible acquisition of the Wendy's
Partnership. In August 1995, MCC made a formal offer to a representative of the
former general partner to purchase the Wendy's Partnership in a transaction
whereby each limited partner would receive approximately $6,000 per unit. The
offer was not presented to the limited partners for its approval.
23
<PAGE> 24
Meritage then commenced privately negotiated purchase of units. On June
11, 1996, Meritage purchased 14 units for $5,000 cash per unit. On July 10,
1996, Meritage purchased an additional 143.25 units in exchange for 171,900
Meritage Common Shares which Meritage valued at $6,000 per unit based on the
unregistered nature of such shares and the then two-year holding period. One of
those sellers, Robert E. Schermer, Sr., is Chairman of Meritage's Board of
Directors. On October 31, 1996, Meritage acquired 482.55 units in a tender offer
for $7,000 cash per unit. Meritage also stated in the tender offer that its
ultimate objective was to acquire all of the units of the Wendy's Partnership.
In November 1996, Meritage acquired 41 units for 29,520 shares of Meritage
Series A Convertible Preferred Stock, which Meritage valued at $7,200 per unit.
Meritage decided the purchase prices for such units based on its determination
of the value of the Wendy's Partnership.
Meritage obtained a report dated June 26, 1996, valuing the Wendy's
Partnership units based on the Wendy's Partnership's 1995 results. The report
stated values at $6,359 per unit on a present value discounted cash flow basis
and $6,304 as a market comparison average. The report did not render any values
based on net book value, disaggregation value or acquisition value. The report
did not address the fairness of these values to the Wendy's Partnership or the
limited partners. It did conclude that the fair market value of the units was
$6,332 per unit and noted that interim results available indicated that the
Wendy's Partnership was below budget for 1996 and warned that if results did not
meet budget, the conclusions would have to be discounted. Meritage did not
utilize this report to establish prices but instead determined to purchase units
at the best prices it could negotiate with third parties.
The report was prepared by Roney & Co. to assist Meritage in assessing
the financial value of the Wendy's Partnership. Roney is an investment banker
and a member of the New York Stock Exchange which has been in operation since
1925. Meritage paid Roney $30,000 for this service and chose Roney based on
personal familiarity with certain of its principals. This discussion is being
presented solely because it is required by regulations of the Securities and
Exchange Commission. Meritage does not hold it out as having any bearing on the
fairness of the market value of its Common Shares which will be issued for each
unit in the closing of the transaction. Meritage will furnish to any limited
partner, upon written request and without charge, a copy of the report. Requests
should be directed to James R. Saalfeld, Vice President and General Counsel,
Meritage Hospitality Group Inc., 40 Pearl Street, N.W., Suite 900, Grand Rapids,
Michigan 49503.
As a result of these transactions, Meritage owns (through its
subsidiary MHG Food Service) approximately 54% of the units. The Wendy's
Partnership Agreement provides that the replacement of the general partner of
the Wendy's Partnership, the sale of all of the assets of the Wendy's
Partnership and its dissolution can be authorized by the affirmative vote of a
majority of all limited partnership units. On May 19, 1997, Meritage appointed
MCC Food Service, an affiliate of Meritage, as substitute general partner of the
Wendy's Partnership. Meritage's ownership position is sufficient to allow it,
without the consent of any of the other limited partners, to effectuate the sale
of assets to Meritage in exchange for Meritage Common Shares and to dissolve the
Wendy's Partnership. In the dissolution, each non-affiliated limited partner
will receive Meritage Common Shares valued at $7,500 per unit. Meritage proposed
the transaction in order to obtain all assets of the Wendy's Partnership. No
alternatives were considered as part of Meritage's goal to dissolve the Wendy's
Partnership.
The Meritage Common Shares to be issued in the dissolution have been
registered under the Securities Act of 1933. Although this transaction is not
governed by the proxy statement rules of the Securities Exchange Act of 1934, it
is subject to regulations of the Securities and Exchange Commission. These
regulations require, among other things, that this prospectus be delivered to
unit holders at least 60 days prior to the date of the sale of assets and
dissolution of the Wendy's Partnership.
24
<PAGE> 25
FEES AND EXPENSES OF THE TRANSACTION
Meritage will pay the following fees associated with the transaction:
<TABLE>
<S> <C>
Securities and Exchange Commission registration fee .............. $ 1,500
Legal fees and expenses .......................................... 25,000
Accounting fees and expenses ..................................... 7,000
Printing fees .................................................... 10,000
State securities laws fees and expenses .......................... 10,000
Miscellaneous .................................................... 8,000
-------
$61,500
=======
</TABLE>
DETERMINATION OF CONSIDERATION FOR UNITS
In arriving at the consideration of $7,500 of Meritage Common Shares
per unit in the transaction, Meritage is offering an amount per unit which
exceeds, or is at least equal to, the most that Meritage has paid for any of the
units it acquired. In November 1996, Meritage purchased 41 units for Meritage
Series A Convertible Preferred Stock value at $7,200 per unit. All other
purchases by Meritage were for less than $7,200 per unit. Although Meritage
booked a purchase price of $7,500 per unit for the purchase of a substantial
number of units for Meritage Common Shares in July 1996, Meritage believes that
the fair market value of the consideration for such units was less. This
transaction involved a purchase by Meritage of 143.25 units at a price of 1,200
Meritage Common Shares per unit. The Meritage shares were not registered under
the Securities Act of 1933 and consequently are subject to a two year holding
period before the shares can be sold publicly. For that reason, and the
significant block of Meritage Common Stock involved, Meritage estimates that the
value of the stock per unit was $6,000 per unit which is 80% of the asked quote
on the date of sale.
BACKGROUND OF THE WENDY'S PARTNERSHIP
The Wendy's Partnership began operations on December 12, 1986, with the
admission into the Partnership as investor limited partners of 499 persons who
subscribed for 1,256.8 limited partnership units and contributed $6,284,000 to
the capital of the Wendy's Partnership.
On December 13, 1986, the Wendy's Partnership consummated the purchase
of all of the issued and outstanding stock of Wendy's of Michigan, Inc., a
Michigan corporation, that owned and operated 20 "Wendy's Old Fashioned
Hamburgers" restaurants in the Western and Southern Michigan counties of
Allegan, Calhoun, Kalamazoo, Kent, Muskegon, Ottawa and VanBuren. Immediately
upon completing the stock purchase, the Wendy's Partnership conveyed all of the
assets and liabilities of Wendy's of Michigan, Inc. to the Wendy's Partnership
in exchange for the stock, in complete liquidation of Wendy's of Michigan, Inc.
Since the acquisition, five additional restaurants have been added to
the Wendy's Partnership which now operates a total of 25 restaurants.
OTHER CONSIDERATIONS
The general partner did not consider alternatives to the transaction.
Meritage intends to acquire all assets of the Wendy's Partnership. If the
transaction is not consummated, limited partners would continue to hold a
minority interest in the Wendy's Partnership. Limited partners would also only
have an interest in the food service operations of the Wendy's Partnership as
opposed to the combined operations of Meritage and the Wendy's Partnership.
The general partner is entitled to a maximum management/administration
fee of 2% of gross operating revenues. This arrangement would have called for
payment to the prior general partner of $334,032 for fiscal 1994 and $347,291
for fiscal 1995. However, this amount was voluntarily reduced by the former
general partner to $160,000 for each of those two years and the former general
partner received a fee on an annual basis of $160,000
25
<PAGE> 26
until replaced by MCC Food Service on May 19, 1997. MCC Food Service, the
present general partner, has also voluntarily agreed to reduce the management
fee to an annual basis of $160,000 for fiscal 1997.
The general partner, due to its inherent conflict of interest, has
determined not to make any recommendation with respect to the transaction. See
"Conflicts of Interest."
FAIRNESS OF TRANSACTION
The general partner, an affiliate of Meritage, believes that the
transaction is fair, from a financial point of view, to the non-affiliated
limited partners. In arriving at this conclusion, the general partner
considered:
- That, although the Meritage Common Shares are thinly traded,
in the transaction non-affiliated limited partners would be
receiving fully registered securities which are currently
traded on the OTC Bulletin Board and the Chicago Stock
Exchange. No active market exists for the limited partnership
units.
- That Meritage would be acquiring a minority interest in the
transaction but is offering no less than the equivalent of the
highest amount of consideration paid by Meritage for any
previously acquired units.
- That Meritage believes all sales of units prior to Meritage's
interest in the Partnership were for $5,000 or less; and
- That the net book value per unit is $2,552.62 as of May 31,
1997.
The general partner did not secure a fairness opinion as the
consideration being paid in the transaction. A report was prepared for Meritage
by an independent party in June 1996, which valued each unit at approximately
$6,300. The report was based primarily on publicly available information. The
report was not utilized by Meritage to establish purchase prices.
In 1996, the former general partner investigated the possibility of
acquiring the Wendy's Partnership units in a leveraged buyout transaction. That
proposed transaction was not consummated for unknown reasons. Also in 1996, U.S.
Restaurants investigated a proposed acquisition of the Wendy's Partnership.
However, that transaction did not proceed to the point where U.S. Restaurants
made a formal offer. The former general partner would not provide specific
details to Meritage regarding these proposed transactions.
26
<PAGE> 27
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated statements of operations and balance sheet
data as of, and for, the years ended November 30, 1996, 1995, 1994, 1993 and
1992 are derived from, and are qualified by reference to, the consolidated
financial statements of the Company audited by Grant Thornton LLP, independent
certified public accountants, appearing elsewhere in this Prospectus. The
consolidated statement of operations and balance sheet data as of, and for, the
six month periods ended May 31, 1997 and 1996 are unaudited but have been
derived from the Company's internal consolidated financial statements, which in
the opinion of management of the Company, have been prepared on the same basis
as the audited financial statements and reflect all adjustments, consisting of
normal recurring adjustments, necessary for a fair presentation of the financial
position and results of operations of the Company. The selected consolidated
financial and operating data presented below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and with the Consolidated Financial Statements and the Notes thereto
and other financial information appearing elsewhere in this Prospectus. The
results of operations for the period ended May 31, 1997 are not necessarily
indicative of results for the full fiscal year.
27
<PAGE> 28
MERITAGE HOSPITALITY GROUP INC.
SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Six Months
Years Ended November 30, ended May 31,
------------------------------------------------------- ---------------------
1996 1995 1994 1993 1992 1997 1996
---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF EARNINGS DATA
Total revenue $ 16,885 $ 14,441 $ 15,360 $ 14,245 $ 14,345 $ 18,998 $ 6,692
Operating costs and expenses 17,859 16,485 14,051 13,182 12,646 19,654 6,887
Earnings (loss) from operations (974) (2,044) 1,309 1,063 1,699 (656) (195)
Earnings (loss) before cumulative effect of
change in accounting principle (1,926) (2,049) 90 230 299 (1,840) (371)
Net earnings (loss) (1,926) (2,049) (27) 230 299 (1,840) (371)
Earnings (loss) per share:
Before cumulative effect of change in
accounting principle (0.62) (1.13) 0.06 0.15 0.20 (0.59) (0.12)
After cumulative effect of change in
accounting principle (0.62) (1.13) (0.02) 0.15 0.20 (0.59) (0.12)
Cash dividends declared per common share 0.50 -- -- -- -- -- --
BALANCE SHEET DATA
Cash and cash equivalents 2,265 1,337 622 451 577 1,122 2,107
Working capital 103 44 406 (450) (4,429) (1,786) 1,935
Property and equipment, net 21,757 13,218 13,645 14,069 14,867 21,498 13,538
Total assets 31,929 17,984 19,688 20,004 20,145 30,810 19,030
Long-term debt, including current maturities 24,293 11,443 12,647 12,905 13,209 24,850 14,931
Shareholders' equity 2,021 3,055 5,225 5,252 5,022 225 1,624
STATEMENT OF CASH FLOWS DATA
Net increase (decrease) in cash and cash
equivalents 929 715 171 (127) 322 (1,143) 770
Net cash provided by (used in) operating
activities (1,496) 425 990 1,056 1,687 (935) (903)
Dividends - common stock 1,510 -- -- -- -- -- 1,510
Dividends - preferred stock -- -- -- -- -- 39 --
</TABLE>
28
<PAGE> 29
MERITAGE HOSPITALITY GROUP INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION
GENERAL
On October 31, 1996, Meritage acquired 482.55 units of the Wendy's
Partnership at $7,000 per unit pursuant to a tender offer. This acquisition,
coupled with an additional 198.25 Units acquired by Meritage in private
transactions, has resulted in Meritage owning (through its subsidiary MHG Food
Service) approximately 54% of the outstanding units. Meritage spent
approximately $3.4 million in the tender offer, of which $3 million was financed
through Meritage's long-term lender. On May 19, 1997, Meritage appointed MCC
Food Service, an affiliate of Meritage, as the substitute general partner of the
Wendy's Partnership. Control of the Wendy's Partnership requires control of the
general partner.
In October, 1996, Meritage commenced a private offering of a newly
designated series of Series A Convertible Preferred Shares. As of May 10, 1997,
Meritage had sold $1,383,870 of such shares, consisting of $1,088,670 issued for
cash ($243,670 of which certain executive officers and management elected to
take in lieu of all or a portion of their year end cash bonuses), and $295,200
issued in exchange for units in the Wendy's Partnership.
RESULTS OF OPERATIONS
The following summarizes the Company's results of operations for the
Lodging Group for the six months ended May 31, 1997 and 1996.
<TABLE>
<CAPTION>
STATEMENTS OF OPERATIONS
---------------------------------------
SIX MONTH PERIODS ENDED MAY 31,
---------------------------------------
1997 1996 1997 1996
------------------ -----------------
(as a percentage
(in thousands) of revenues)
------------------ -----------------
<S> <C> <C> <C> <C>
Net revenue
Room revenue $ 2,503 $ 2,571 42.0% 38.4%
Food and beverage revenue 3,149 3,862 52.9 57.7
Telephone and sundry revenue 306 259 5.1 3.9
------- ------- ------ ------
Total revenue 5,957 6,692 100.0 100.0
Costs and expenses
Cost of food and beverages 1,137 1,339 19.1 20.0
Operating expenses 3,875 3,523 65.0 52.6
General and administrative
expenses 1,280 1,576 21.5 23.6
Depreciation and amortization 541 449 9.1 6.7
------- ------- ------ ------
Total costs and expenses 6,833 6,888 114.7 102.9
Loss from operations (876) (196) (14.7) (2.9)
Other income (expense)
Interest expense (1,204) (725) (20.2) (10.8)
Interest income 277 358 4.6 5.3
------- ------- ------ ------
(927) (367) (15.6) (5.5)
------- ------- ------ ------
Loss before
federal income tax (1,803) (563) (30.3) (8.4)
Federal income tax benefit -- 191 -- 2.9
------- ------- ------ ------
Net loss $(1,803) $ (371) (30.3)% (5.5)%
======= ======= ====== ======
</TABLE>
29
<PAGE> 30
The following summarizes the Company's results of operations for the
Lodging Group for the years ended November 30, 1996, 1995 and 1994.
<TABLE>
<CAPTION>
STATEMENTS OF OPERATIONS
----------------------------------------------------------------
1996 1995 1994 1996 1995 1994
-------------------------------- -----------------------------
(in thousands) (as a percentage of revenues)
-------------------------------- -----------------------------
<S> <C> <C> <C> <C> <C> <C>
REVENUE
Room Revenue $ 6,282 $ 5,999 $ 6,048 42.6% 41.5% 39.4%
Food and beverage revenue 7,786 8,246 9,100 52.7 57.1 59.2
Telephone and sundry revenue 695 196 212 4.7 1.4 1.4
-------------------------------- -----------------------------
Total revenue 14,763 14,441 15,360 100.0 100.0 100.0
COSTS AND EXPENSES
Cost of food and beverages 2,700 2,864 3,041 18.3 19.8 19.8
Operating expenses 8,166 7,215 7,180 55.3 50.0 46.7
General and administrative 3,854 4,980 2,597 26.2 34.5 16.9
Depreciation and amortization 1,010 1,427 1,232 6.8 9.9 8.0
-------------------------------- -----------------------------
Total costs and expenses 15,730 16,485 14,051 106.6 114.2 91.5
-------------------------------- -----------------------------
Earnings (loss) from operations (967) (2,044) 1,309 (6.6) (14.2) 8.5
Other income (expense)
Interest expense (1,605) (1,355) (1,206) (10.9) (9.4) (7.9)
Interest income 658 387 87 4.5 2.7 0.6
Gain (loss) on sale of assets (7) 242 12 (0.0) 1.7 0.1
-------------------------------- -----------------------------
Total other expense (954) (726) (1,107) (6.4) (5.0) (7.2)
-------------------------------- -----------------------------
Earnings (loss) before federal income
tax and cumulative effect of change
in accounting principle (1,921) (2,770) 202 (13.0) (19.2) 1.3
Federal income tax expense (benefit) (20) (721) 112 (0.1) (5.0) 0.7
-------------------------------- -----------------------------
Earnings (loss) before cumulative
effect of change in accounting
principle (1,901) (2,049) 90 (12.9) (14.2) 0.6
Cumulative effect of change in
accounting principle -- -- (117) -- -- (0.8)
-------------------------------- -----------------------------
Net loss $ (1,901) $ (2,049) $ (27) (12.9%) (14.2)% (0.2)%
================================ =============================
</TABLE>
Comparison of Six Month Periods Ended May 31, 1997 and May 31, 1996
- -------------------------------------------------------------------
LODGING GROUP
REVENUE
Total revenue for the Lodging Group was $5,956,765 for the six month
period ended May 31, 1997 compared to $6,692,224 for the same period of 1996, a
decrease of 11.0%. The following table outlines revenues (excluding sundry and
telephone) by category:
30
<PAGE> 31
<TABLE>
<CAPTION>
1997 1996 (Decrease) % Decrease
-----------------------------------------------------------------------
<S> <C> <C> <C> <C>
Room revenue $ 2,502,555 $ 2,571,115 $ (68,560) (2.7)%
Food and beverage revenue 3,148,703 3,861,790 (713,087) (18.5)%
-----------------------------------------------------------------------
Total $ 5,651,258 $ 6,432,905 $ (781,647) (12.2)%
=======================================================================
</TABLE>
The decrease in room revenue was attributable to a decrease in hotel
occupancy from 53.6% to 51.4% for the six month periods ended May 31, 1996 and
1997, respectively. The decrease in occupancy was partially offset by an
increase in the overall average daily rate of $5.68 (8.0%) from $71.19 for the
six month period ended May 31, 1996 to $76.87 for the same period of 1997.
The declines in room revenue are primarily attributable to increased
competition. Specifically, the hotels are experiencing the impact of new limited
service hotels which are targeting the price sensitive guest with their lower
rates. In addition to the increased competition, the Grand Haven Holiday Inn has
been under renovation during the past year causing a negative impact on room
revenue.
The decrease in food and beverage revenue for the six month periods
ended May 31, 1997 and 1996 was also primarily attributable to increased
competition in the area. Catering sales have declined at the Thomas Edison Inn
and St. Clair Inn due to the opening of two new banquet facilities in their
market area. Additionally, a new restaurant was established a short distance
from the St. Clair Inn. While increased competition is the primary reason for
the decline in food and beverage revenue, certain changes instituted by new
management were not well received by the local clientele and compounded the
impact of increased competition.
The Company is aggressively working towards offsetting the effect of
the increased competition by new marketing programs, hiring locally experienced
sales personnel and by continually reviewing and updating the menu offerings.
Telephone and sundry revenue increased $46,188 (17.8%) for the six
month period ended May 31, 1997 compared to the same period of 1996. The
installation of new telephone systems at the Thomas Edison Inn and the St. Clair
Inn improved accounting for telephone charges and contributed to the generation
of additional telephone income. Public room rental income and commissions from
rental of audio/visual equipment have contributed to the increase in sundry
revenue.
COST OF FOOD AND BEVERAGES
Cost of food and beverages as a percentage of food and beverage revenue
for the six month period ended May 31, 1997 was 36.1% compared to 34.7% for the
same period of 1996. The increase is attributable to the decline in catering
functions at the hotels, which have a relatively lower cost.
OPERATING EXPENSES
Operating expenses for the six month periods ended May 31, 1997 and
1996 were $3,874,811 and $3,522,786, respectively, an increase of $352,025
(10.0%). As a percentage of total revenue, operating expenses increased 12.4
percentage points, from 52.6% for the six month period ended May 31, 1996 to
65.0% for the same period of 1997. One-half of the increase (approximately
$171,000) is due to the recording of a one-time accounting correction which
decreased the operating expenses for the six month period ended May 31, 1996.
Approximately $65,000 of the increase is attributable to new marketing programs
which were instituted to increase revenue. The remaining increase is
attributable to a reclassification in payroll and certain other expenses.
31
<PAGE> 32
GENERAL AND ADMINISTRATIVE
General and administrative expenses decreased $296,670 (18.8%), from
$1,576,310 for the six month period ended May 31, 1996 to $1,279,640 for the
same period of 1997. The decrease in general and administrative expenses is
primarily due to approximately $375,000 of non-recurring expenses incurred in
1996 in connection with the replacement and restructuring of management of the
Company. The Company incurred $58,000 of management fees in 1996 that were
eliminated in 1997, thus further reducing general and administrative expenses in
1997. Other reductions in expenses for the six months ended May 31, 1997
compared to the same period of 1996 include a reclassification in payroll and
other certain expenses. These reductions in expenses were offset by a one-time
accounting correction of approximately $243,000 which decreased general and
administrative expenses for the six month period ended May 31, 1996.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense increased $91,391, from $449,377
for the six month period ended May 31, 1996 to $540,768 for the same period of
1997. The increase in depreciation and amortization for the six month period was
attributable to significant property, plant and equipment additions in the
second half of 1996 and to depreciation and amortization associated with the
acquisition of a majority interest in the Wendy's Partnership which was
accounted for under the purchase method of accounting.
INTEREST EXPENSE
Interest expense for the six month periods ended May 31, 1997 and 1996
was $1,204,607 and $724,744, respectively. The increase of $479,863 for the six
month period ended May 31, 1997 was due to additional borrowings in fiscal 1996.
See "Liquidity and Capital Resources" of this item for details of the Company's
long-term debt.
INTEREST INCOME
Interest income decreased from $357,652 for the six month period ended
May 31, 1996 to $276,884 for the same period of 1997. The decrease in interest
income was due to a decrease in cash and cash equivalents during the six month
period. The decrease is also attributable to the reduction in note receivable
interest income from the sale of stock due to the reduction in the note
receivable as a result of a $750,000 principal payment received in May 1996.
32
<PAGE> 33
FOOD SERVICE GROUP
On October 31, 1996, the Company acquired a majority interest in the
Wendy's Partnership. At May 31, 1997, the Company owned approximately 54% of the
Wendy's Partnership, all of which was acquired in fiscal 1996. Because of this
acquisition, the results of operations of the Wendy's Partnership have been
included in the Company's Consolidated Statements of Operations for the entire
six month period ended May 31, 1997. Below is a summary of the results of the
Food Service Group (the Wendy's Partnership) for the six month period ended May
31, 1997. Because the Wendy's Partnership is not a wholly owned subsidiary and
because its daily operations are managed separately, the Wendy's Partnership has
its own administrative expenses related solely to its operations. Therefore, all
executive level general and administrative expenses of the Company are included
in the Lodging Group operations.
<TABLE>
<CAPTION>
1997 % of Revenue
---------------------------------
<S> <C> <C>
Net revenue
Food and beverage revenue $ 12,949,739 99.3%
Sundry revenue 91,711 0.7
---------------------------------
Total revenue 13,041,450 100.0
Costs and expenses
Cost of food and beverages 3,733,590 28.6
Operating expenses 7,896,199 60.5
General and administrative expenses 654,938 5.0
Depreciation and amortization 457,948 3.5
---------------------------------
Total costs and expenses 12,742,675 97.7
Earnings from operations 298,775 2.3
Other income (expense)
Interest expense (227,179) (1.7)
Interest income 6,548 --
---------------------------------
(220,631) (1.7)
---------------------------------
Earnings before federal
income tax 78,144 0.6
Federal income tax -- --
---------------------------------
Net earnings $ 78,144 0.6%
=================================
</TABLE>
Comparison of Fiscal Years Ended November 30, 1996 and November 30, 1995
- ------------------------------------------------------------------------
LODGING GROUP
Revenue
Total revenue for the Lodging Group was $14,762,822 for fiscal 1996
compared to $14,441,020 for fiscal 1995, an increase of 2.2%. The following
table outlines revenues (excluding sundry and telephone) by category:
<TABLE>
<CAPTION>
Increase % Increase
1996 1995 (Decrease) (Decrease)
--------------------------------------------------------------------
<S> <C> <C> <C> <C>
Room revenue $ 6,281,711 $ 5,999,024 $ 282,687 4.7%
Food and beverage revenue 7,786,154 8,245,880 (459,726) (5.6)%
-------------------------------------------------------------------
Total $ 14,067,865 $ 14,244,904 $ (177,039) (1.2%)
===================================================================
</TABLE>
33
<PAGE> 34
The increase in room revenue was attributable to an increase in the
overall average daily rate of $2.94 (4.0%), from $74.46 in fiscal 1995 to $77.40
in fiscal 1996. Also contributing to the increase in room revenue was a slight
increase in hotel occupancy from 60.3% in fiscal 1995 to 60.6% in fiscal 1996.
The decrease in food and beverage revenue from fiscal 1995 to fiscal 1996 was
primarily attributable to a decrease in social function bookings at the
Company's hotels during the second half of fiscal 1996. This decrease at the
Thomas Edison Inn and the St. Clair Inn is the result of increased competition
from two new banquet facilities in the market area. The Company is aggressively
working toward offsetting the effect of the increased competition by
implementing new marketing programs, hiring locally experienced sales personnel,
and continually reviewing and updating the menu offerings.
Telephone and sundry revenue increased $498,841, from $196,116 in
fiscal 1995 to $694,957 in fiscal 1996. A large portion of the increase was
attributable to the recognition of approximately $217,000 of expired gift
certificates as income in fiscal 1996. Also contributing to the increase was the
recovery of approximately $68,000 from the collection of amounts due from
parties related to the Company prior to the change in control of the Company,
which had been written off to bad debt expense in fiscal 1995. In addition, new
telephone systems were installed at the Thomas Edison Inn and the St. Clair Inn.
Rate schedules used to calculate telephone charges were updated generating
additional telephone income.
Cost of Food and Beverages
Due to the change in revenue mix between room revenue and food and
beverage revenue displayed above, cost of food and beverages (as a percentage of
total revenue) was 18.3% in fiscal 1996 and 19.8% in fiscal 1995. As a
percentage of food and beverage revenue, cost of food and beverages was 34.7% in
both fiscal 1996 and 1995 despite the decline in food and beverage revenue.
Operating Expenses
Operating expenses for fiscal 1996 and fiscal 1995 were $8,166,380 and
$7,215,061, respectively, an increase of $951,319 (13.2%). As a percentage of
total revenue, operating expenses increased 5.3 percentage points from 50.0% of
total revenue in fiscal 1995 to 55.3% of total revenue in fiscal 1996. The
increase in operating expenses in fiscal 1996 compared to fiscal 1995 was
primarily the result of a 4.0 percentage point increase in payroll costs due to
increased staffing, and salary and wage increases aimed at improving service to
increase revenue. Increases in sales and marketing expenses, entertainment
expenses and repairs and maintenance also contributed to the increase in
operating expenses.
General and Administrative
General and administrative expenses decreased $1,126,084 in fiscal 1996
compared to fiscal 1995. General and administrative expenses were abnormally
high in fiscal 1995 as a result of $2,154,163 of expenses related to various
lawsuits in fiscal 1995. See "Business - Replacement and Restructuring of
Management." Excluding this $2,154,163 of expenses, general and administrative
expenses increased $1,028,079 in fiscal 1996 compared to fiscal 1995. In fiscal
1996, the Company decided to manage the Company's hotels directly as compared to
fiscal 1995 when the hotels were managed by a management company (owned by Mr.
Reynolds, the former majority shareholder of the Company). This decision
eliminated the fees and expenses assessed by the management company, but
increased payroll costs attributable to the corporate management staff. This
additional staffing was also required to implement the Company's strategy to
expand the Company through the acquisition of new businesses (including the
Partnership).
34
<PAGE> 35
Depreciation and Amortization
Depreciation and amortization expense decreased $416,871, from
$1,426,642 in fiscal 1995 to $1,009,771 in fiscal 1996. Amortization expense was
abnormally high in fiscal 1995 due to the write-off of deferred loan costs of
approximately $350,000 because of the refinancing of the Company's long-term
debt in February 1996. Also, depreciation expense for fiscal 1996 was lower
compared to fiscal 1995 because of certain property and equipment that became
fully depreciated during fiscal 1995.
Interest Expense
Interest expense for fiscal 1996 and 1995 was $1,605,047 and
$1,335,389, respectively. The increase of $249,658 from fiscal 1995 to fiscal
1996 was due to additional borrowings in fiscal 1996.
Interest Income
Interest income increased from $387,099 in fiscal 1995 to $658,007 in
fiscal 1996. The increase was due to an increase in cash and cash equivalents in
fiscal 1996 compared to fiscal 1995, and an increase in interest income from a
note receivable from the sale of stock (see Note J of the Meritage Consolidated
Financial Statements for fiscal 1996).
Fourth Quarter Operations
The Company's loss before federal income tax increased from $19,677 for
the nine months ended August 31, 1996 to $1,945,570 for the year ended November
30, 1996. The significant loss in the fourth quarter of fiscal 1996 was
attributable to several factors. Hotel revenues decreased approximately 9% in
the fourth quarter of fiscal 1996 as compared to fiscal 1995. This decrease was
the result of a decline in food and beverage revenue caused by a decline in
social function bookings and a decrease in food and beverage business from local
clientele resulting from increased competition. Hotel operating expenses,
including fixed payroll costs, entertainment expense and sales and marketing
expenses, all increased in an effort to reverse the downward sales trend.
General and administrative expenses were also unusually high for the fourth
quarter of fiscal 1996 due to increased professional fees, year-end bonuses to
employees which were allocated at the discretion of the Company's Compensation
Committee, and significant costs related to public company matters including
fees and expenses associated with creating a market for the Company's Common
Stock.
FOOD SERVICE GROUP
The Company acquired a majority interest in the Wendy's Partnership on
October 31, 1996, resulting in the consolidation of the Wendy's Partnership's
operations for the month of November 1996. Revenue from the Wendy's Partnership
was $2,122,040. The Wendy's Partnership's operating loss for the month of
November was $8,136 and the loss before federal income tax was $24,745.
Comparison of Fiscal Years Ended November 30, 1995 and November 30, 1994
- ------------------------------------------------------------------------
LODGING GROUP
Revenue
Total revenue of the Lodging Group decreased 6.0%, from $15,360,028 in
fiscal 1994 to $14,441,020 in fiscal 1995. The decrease in total revenue was
primarily attributable to decreased food and beverage revenue. Room revenue
decreased only $48,486 (0.8%). Food and beverage revenue, however, decreased
$854,278 (9.4%). The following table outlines revenues (excluding sundry and
telephone) by category and hotel:
35
<PAGE> 36
<TABLE>
<CAPTION>
Increase % Increase
1995 1994 (Decrease) (Decrease)
--------------------------------------------------------------------
<S> <C> <C> <C> <C>
Room revenue $ 5,999,024 $ 6,047,510 $ (48,486) (0.8%)
Food and beverage revenue 8,245,880 9,100,158 (854,278) (9.4%)
-------------------------------------------------------------------
Total $ 14,244,904 $ 15,147,668 $ (902,764) (6.0%)
===================================================================
</TABLE>
The decrease in room revenue was the result of a decrease in overall
occupancy for the hotels in fiscal 1995 compared to fiscal 1994. Hotel occupancy
decreased 1.5%, from 61.2% in fiscal 1994 to 60.3% in fiscal 1995. The decrease
in hotel occupancy was largely offset by an increase in the overall average
daily rate of $0.55 (0.7%), from $73.91 in fiscal 1994 to $74.46 in fiscal 1995.
The decrease in food and beverage revenue from fiscal 1994 to fiscal 1995 was
primarily attributable to the decrease in meeting/conference business at the
Thomas Edison Inn due to the loss of a contract with a major customer.
Cost of Food and Beverages
As a percentage of total revenue, cost of food and beverages was 19.8%
in fiscal 1995 and fiscal 1994. As a percentage of food and beverage revenue,
cost of food and beverages increased from 33.4% in fiscal 1994 to 34.7% in
fiscal 1995. The increase in cost of food and beverages was due to a change in
product mix resulting primarily from the loss of banquet (e.g.
meetings/conferences, weddings, etc.) business at the Thomas Edison Inn
described in the previous paragraph. Food and beverage costs for banquet
business are relatively lower than food and beverage costs for restaurant and
lounge business.
Operating Expenses
Operating expenses increased 0.5%, from $7,179,572 in fiscal 1994 to
$7,215,061 in fiscal 1995. As a percentage of total revenue, operating expenses
increased 3.3 percentage points to 50.0% in fiscal 1995 compared to 46.7% in
fiscal 1994. The increase in operating expenses was primarily the result of an
increase of approximately 2 percentage points in salaries and wages. This
increase was the result of increased hourly wages (due to the tight labor market
in Michigan) and the negative impact on fixed labor of reduced revenues in
fiscal 1995 compared to fiscal 1994. Increased property taxes and an increase in
repairs and maintenance also contributed to the increase in operating expenses
(as a percentage of sales).
General and Administrative
General and administrative expenses increased $2,384,070 in fiscal 1995
compared to fiscal 1994, of which $2,154,163 related to various lawsuits in
fiscal 1995 described under "Business - Replacement and Restructuring of
Management." General and administrative expenses in fiscal 1995 also included
bad debt expenses of $260,000 relating to the former majority shareholder's
indebtedness to the Company. Excluding these unusual expenses of $2,414,163,
general and administrative expenses were $2,565,458 in fiscal 1995 compared to
$2,597,278 in fiscal 1994.
Depreciation and Amortization
Depreciation and amortization expense increased $194,455, from
$1,232,187 in fiscal 1994 to $1,426,642 in fiscal 1995. The increase was the
result of increased amortization due to the write-off of deferred loan costs of
approximately $350,000 because of the refinancing of the Company's long-term
debt in February 1996. Depreciation expense decreased because certain property
and equipment acquired in 1986 became fully depreciated during fiscal 1995.
36
<PAGE> 37
Interest Expense
Interest expense for fiscal 1995 and 1994 was $ 1,355,389 and
$1,206,151, respectively. The increase of $149,238 from fiscal 1994 to fiscal
1995 was due to increases in the prime rate. All of the Company's debt had been
based on variable interest rates that were based on the prime rate.
Interest Income
Interest income increased from $87,028 in fiscal 1994 to $387,099 in
fiscal 1995. The increase was due to an increase in cash and cash equivalents in
fiscal 1995 compared to fiscal 1994 and an increase in interest on the payment
of outstanding loans from then related parties. Also contributing to the
increase was interest income from a note receivable from the sale of stock in
September 1995 (see Note J of the Meritage Consolidated Financial Statements for
fiscal 1996).
Gain on Sale of Assets
The gain on sale of assets of $241,646 in fiscal 1995 was primarily the
result of the sale of a portion of the land adjacent to the Thomas Edison Inn.
LIQUIDITY AND CAPITAL RESOURCES
On October 31, 1996, the Company acquired a majority interest in the
Wendy's Partnership. At November 30, 1996, the Company owned approximately 54%
of the Wendy's Partnership, all of which was acquired in fiscal 1996. As a
result of this acquisition, the financial statements of the Wendy's Partnership
have been included in the Company's consolidated operating results beginning
November 1, 1996 and the Company's consolidated balance sheet at November 30,
1996. The value of the assets of the Wendy's Partnership as of November 30,
1996, which have been included in the consolidated financial statements, was
approximately $10,500,000. This accounts for the majority of the increase in
total assets of the Company from $17,983,503 at November 30, 1995 to $31,928,864
as of November 30, 1996. The acquisition was funded by payment of approximately
$3,500,000 in cash and the issuance of approximately $1,370,000 of Company
stock. Of the cash payment $3,000,000 was provided by proceeds from borrowings.
Cash Flows - Six months ended May 31,1997
Cash and cash equivalents ("cash") decreased $1,143,315 from $2,265,497
as of November 30, 1996 to $1,122,182 as of May 31, 1997. The decrease in cash
was the result of the following:
<TABLE>
<S> <C>
Net cash used in operating activities $ (935,254)
Net cash used in investing activities (580,946)
Net cash provided by financing activities 372,885
----------------
Net decrease in cash $ (1,143,315)
================
</TABLE>
Net cash used in operating activities of $935,254 was primarily due to
the net loss before depreciation and amortization of $762,083. Other non-cash
effects on net income and net cash used in operating activities totaled
$181,687. The net change in non-cash assets and liabilities of $8,516 accounted
for the remaining net cash used in operating activities. Included in this amount
was an increase in marina development costs of $191,141.
Net cash used in investing activities of $580,946 was primarily the
result of purchases of property, plant and equipment of $471,925. Increases in
other assets accounted for the remaining $109,021.
Net cash provided by financing activities of $372,885 was primarily the
result of proceeds from long-term borrowings of $750,000 and proceeds from the
issuance of preferred shares of $300,000. These two items were offset by
principal payments of long-term debt of $526,895 and payments on obligations
under capital leases of $110,780. For the six months ended May 31, 1997, the
Company also paid dividends on preferred stock of $39,440.
37
<PAGE> 38
Cash Flows - Year ended November 30, 1996
Cash and cash equivalents ("cash") increased $928,606 from $1,336,891
as of November 30, 1995 to $2,265,497 as of November 30, 1996. The increase in
cash was the result of the following:
<TABLE>
<CAPTION>
<S> <C>
Net cash used in operating activities $ (1,496,419)
Net cash used in investing activities (5,601,790)
Net cash provided by financing activities 8,026,815
----------------
Net increase in cash $ 928,606
================
</TABLE>
Net cash used in operating activities of $1,496,419 was primarily due
to the net loss before depreciation and amortization of $843,866. Other non-cash
effects on net income and net cash used in operating activities totaled
$243,620. The net change in non-cash current assets and current liabilities of
$408,933 accounted for the remaining net cash used in operating activities.
Net cash used in investing activities of $5,601,790 was primarily the
result of purchases of property, plant and equipment of $2,211,392 and the
acquisition of the majority interest in the Wendy's Partnership for $3,184,460
(net of cash acquired upon consolidation of the Wendy's Partnership).
Net cash provided by financing activities of $8,026,815 was primarily
the result of net proceeds from long-term borrowings of $8,271,698 (proceeds of
$37,717,705 less retirement of debt $29,446,007) resulting from the Company's
long-term debt refinancing discussed below under "Financing and Encumbrances."
Other significant items which effected net cash provided by financing activities
included $750,000 in principal payments received on the note receivable from
sale of shares and proceeds from the issuance of preferred and common shares of
$545,000. These two items were offset by the payment of a one time special
dividend of $0.50 per Common Share on April 26, 1996. The total dividend paid
was $1,501,075. Of this amount $435,124 was withheld from the Company's former
majority shareholder (Mr. Reynolds) and applied against amounts due to the
Company from Mr. Reynolds and companies related to Mr. Reynolds at that date. An
additional $775,000 of the dividend was paid to MCC which then paid $750,000 to
the Company as an early prepayment on the Company's note receivable from the
sale of shares to MCC.
Financial Condition
At May 31, 1997, the Company's current liabilities exceeded its current
assets by $1,785,689 compared to November 30, 1996 when current assets exceeded
current liabilities by $103,112. At these dates, the ratios of current assets to
current liabilities were 0.62:1 and 1.03:1 respectively. The discussion above of
cash flows for the six months ended May 31, 1997 explains the decrease in cash
as well as the most significant reasons for the decrease in working capital. The
other reason for the decrease in working capital was the $527,816 increase in
current portion of long-term debt from November 30, 1996 to May 31, 1997.
The Company's long-term debt consists primarily of the following:
1) $13,891,775 first mortgage loan requiring monthly payments of
$137,897, including interest at 10.3%, through December 31, 2003
when the remaining unpaid principal will be due.
2) $5,250,000 second mortgage loan requiring monthly payments of
interest only at 8% over the prime rate through November 1, 1997.
Beginning December 1, 1997, monthly principal payments of $50,000,
plus interest at 8% over the prime rate, will be required through
March 1, 1998. Beginning April 1, 1998, monthly principal payments
of $100,000, plus interest at 8% over the prime rate, will be
required until the loan is retired in June 2002.
38
<PAGE> 39
3) $875,000 (marina) third mortgage loan requiring monthly payments
of interest at 1% over the prime rate. Principal payments of
$35,000 are required at the time of the sale of any of the boat
slips. As of June 30, 1997 the loan balance outstanding was
$600,000 and the Company had $275,000 of available borrowings
under the loan.
4) $1,886,536 revolving term loan of the Wendy's Partnership
requiring monthly payments of $43,313, including interest at 1%
over the prime rate, through February 2005 when any remaining
unpaid will be due. Under the revolving loan agreement, the
required monthly payments may be offset by additional borrowings
up to the unused available borrowings. The total available
borrowings under the loan agreement were $2,856,018 at May 31,
1997. The loan is guaranteed by Meritage and secured by
substantially all of the assets of the Wendy's Partnership.
5) $518,665 note payable requiring monthly payments of $14,693,
including interest at 8.8%, through October 2000.
6) $750,000 note payable to Meritage's Chairman of the Board of
Directors (and a shareholder of Meritage). The loan requires
Meritage to make monthly payments of interest only at prime plus
8% provided Meritage is not in default under its first and second
mortgage long-term debt with its primary lender. Unpaid principal
and accrued interest must be paid by the later of December 31,
1997 or 91 days after the first, second and third mortgage
long-term debt is paid off.
The loan agreement with Meritage's primary lender contains numerous
covenants regarding the maintenance of a prescribed amount of net worth, certain
financial ratios, and restrictions on certain Common Stock purchases, dividends,
additional indebtedness and executive compensation. At May 31,1997, the Company
failed to meet certain of these covenants. However, a waiver of these covenants
has been obtained through December 30, 1997.
Since October 1996, the Company issued $1,383,870 (138,387 shares) of
Series A Convertible Preferred Stock. The shares have an annual dividend rate of
$0.90 per share and payment of dividends is cumulative. Based on the present
shares outstanding, quarterly dividend payments of $31,137 are due on January 1,
April 1, July 1 and October 1 of each year. All dividends declared have been
paid through July 1, 1997.
The Company estimates capital expenditures for the next twelve months
ended to be approximately $1,200,000 for building improvements, and furniture,
fixtures and equipment purchases, at its existing hotels and at the existing
Wendy's Partnership restaurants. Of the $1,200,000, approximately $700,000 is
estimated for capital expenditures at existing Wendy's restaurants. The Company
has received various proposals to finance (through debt or lease) both the real
estate and furniture, fixtures and equipment of any new Wendy's restaurants. Of
the $1,200,000, the Company estimates capital expenditures at its full service
hotels to be approximately $500,000. This does not include completing the
improvements to the marina condominium project being developed by the Company's
subsidiary, Grand Harbor Yacht Club. This is a reduction from previous capital
expenditures budgets for the Company's full service hotels as the Company is
reassessing how to best utilize its capital resources between the Lodging Group
and the Food Service Group.
The Company plans to meet its current obligations for the next twelve
months by:
- Completing the acquisition of the remaining units of the Wendy's
partnership through the issuance of the Company's Common Stock. In
fiscal 1996, net cash from operating activities of the Wendy's
Partnership was approximately $1,201,000. The Wendy's Partnership
also had available borrowings under its long-term revolving loan
of approximately $969,000.
- The sale of non-core assets valued at approximately $1,000,000 to
$1,500,000.
- Reducing the negative cash flow from the lodging group through
improving operations.
- Continuing to explore the sale of one or more of the hotels.
39
<PAGE> 40
Financing and Encumbrances
On February 26, 1996, the Company entered into an agreement with Great
American Life Insurance Company ("GALIC"), an affiliate of American Financial
Group, Inc., to refinance all of its mortgage debt. The Company executed two
promissory notes in favor of GALIC in the principal amount of $12,000,000 ("Loan
A") and $3,000,000 ("Loan B"), respectively. The interest rate on Loan A was the
Prime Rate of The Provident Bank (Cincinnati, Ohio) plus 1%, fully floating. The
interest rate on Loan B was the Prime Rate of The Provident Bank plus 8%, fully
floating. Loan A had a maturity date of March 1, 2012, with monthly payments of
interest only during the first year and 180 equal monthly payments of principal
plus accrued interest thereafter. Loan B had a maturity date of March 1, 2002,
with monthly payments of interest only during the first year and 60 equal
monthly payments of principal and accrued interest thereafter. Loan A could be
prepaid in whole or in part at any time without penalty upon payment of all
accrued interest and principal. Loan B could be prepaid in whole or in
increments of $100,000 upon payment of all accrued interest plus a prepayment
premium of 10% of the principal balance so prepaid, except that no prepayment
premium would be payable if GALIC required such prepayment from the proceeds
resulting from the disposition of certain collateral securing Loan B. Loan A was
secured by, among other things, a first priority mortgage lien on the Company's
hotels. Loan B was secured by a second priority mortgage lien on the Company's
Hotels; by a first priority mortgage lien on the undeveloped land adjacent to
the Thomas Edison Inn, the commercial property adjacent to the St. Clair Inn,
and the Grand Harbor Yacht Club; by a collateral assignment of all life
insurance policies owned by the Company on the life of Mr. Reynolds; and by an
assignment of a Secured Promissory Note in the principal amount of $10,500,000
payable by MCC to the Company. Both Loan A and Loan B contained cross-default
provisions.
On October 31, 1996, the Company entered into Amendment No. 1 to the
loan agreement with GALIC to obtain an additional $3,000,000 mortgage loan
("Loan C"). The proceeds from Loan C were used to pay the costs associated with
commencing and closing the tender offer for the limited partnership units of the
Wendy's Partnership. The terms of Loan C were nearly identical to Loan B
described above, although Loan C's security included all of the outstanding
limited partnership units of the Wendy's Partnership owned by the Company.
On November 26, 1996, the Company entered into a new loan agreement
with GALIC to replace the existing loan agreement and restructure the Company's
total indebtedness. Loan A was refinanced and an additional $2,000,000 was
borrowed ("Loan I"). Loan I is with the subsidiaries of the Company and is
secured by a first mortgage lien on the Company's hotels, a first priority
security interest in the hotel personal property and an assignment of the hotel
franchise agreement. Loan I is guaranteed by the Company and bears a fixed
interest rate of 10.3%. Loan I requires equal monthly payments of principal and
interest of $137,897 (based upon a 20 year amortization) through December 1,
2003, at which time the loan matures and any remaining unpaid principal and
interest will be due. Loan I may not be prepaid, in whole or in part, within 48
months, except in the event of the sale of one of the hotels, in which case the
prepayment amount is an amount equal to a predetermined release price for the
property being sold plus a prepayment premium. The prepayment premium is 4% of
the amount prepaid if the sale is within 12 months after closing; 3% if the sale
is after 12 months and prior to 24 months after closing; 2% if the sale is after
24 months and prior to 36 months after closing; and 1% if the sale is after 36
months and prior to 48 months after closing. Beginning after the fourth
anniversary of the closing, and continuing until the sixth anniversary of the
closing, Loan I may be prepaid, with a "make whole premium" as defined in the
loan agreement.
At the same time, Loan B and Loan C (together totaling $5,250,000) were
combined into one loan ("Loan II"). Loan II is with the Company and certain of
its subsidiaries, and bears an interest rate of prime (based on The Provident
Bank - Cincinnati, Ohio) plus 8%, fully floating. Loan II has a maturity date of
June 1, 2002, with monthly payments of interest only during the first year;
principal payments of $50,000 plus accrued interest from December 1, 1997
through March 1, 1998; and principal payments of $100,000 plus accrued interest
thereafter. Loan II may be prepaid in whole or in increments of $100,000 upon
payment of all accrued interest plus a prepayment premium of 10% of the
principal balance so prepaid, except that no prepayment premium shall be payable
if GALIC requires such prepayment from the proceeds resulting from the
disposition of certain collateral securing Loan II. Loan II is secured by a
second priority mortgage lien on the hotels; by a first priority security
interest on undeveloped land adjacent to the Thomas Edison Inn, commercial
property adjacent to the St. Clair Inn, and the Grand Harbor Yacht Club; by a
collateral assignment of all life insurance policies owned by the Company
40
<PAGE> 41
on the life of Mr. Reynolds; by an assignment of the Secured Promissory Note in
the principal amount of $9,750,000 payable by MCC to the Company; by the
Company's pledge of the common stock of each of its subsidiaries; and by the
Company's pledge of its partnership interests in the Wendy's Partnership. Both
Loan I and II contain cross-default provisions.
On May 23, 1997, the Company entered into Amendment No. 1 to the loan
agreement with GALIC to obtain an additional $875,000 mortgage loan ("Loan
III"). The proceeds from Loan III are being utilized to complete the
improvements to the marina condominium project being developed by the Company's
subsidiary, Grand Harbor Yacht Club Inc., which is adjacent to the Grand Haven
Holiday Inn. The loan bears an interest rate of prime plus 1%, fully floating.
Monthly payments of interest are required. Principal payments of $35,000 are
required at the time of the sale of any of the marina condominium units. Loan
III is secured by the following: a mortgage on the real property and marina
facility owned by the Grand Harbor Yacht Club; mortgages on the real property
owned by the St. Clair Inn, Grand Harbor Resort and the Thomas Edison Inn; a
security agreement in all personal property owned by the Grand Harbor Yacht
Club; a guaranty executed by Meritage, Thomas Edison Inn, MHG Food Service, St.
Clair Inn and Grand Harbor Resort; and an assignment of certain construction
agreements, management agreements, permits and contracts. Loan III also contains
cross-default provisions.
The loan agreement contains a covenant that requires that (i)
Christopher B. Hewett, or another person acceptable to GALIC, serve as the
Company's President and Chief Executive Officer, (ii) Mr. Hewett own not less
than 50% of MCC, and (iii) MCC own and control at least 25% of the Company's
issued and outstanding Common Shares, or in the event of an issuance of Common
Shares by the Company, that MCC own more Common Shares than any other person or
group acting in concert and have sufficient control to cause the election of
persons nominated by MCC as a majority of the Company's directors.
The Wendy's Partnership has a note payable with First of America
Bank-Michigan, N.A. in the principal amount of $1,886,536. The loan requires
monthly payments of $43,313 based on a ten year amortization including interest
at 1% over prime. The revolving loan agreement allows the Wendy's Partnership to
apply its excess cash against the loan balance to reduce the interest charged on
the loan. As of May 31, 1997, the loan was paid down to a balance of $1,886,536
while the permitted (amortized) balance was $2,856,018. The loan is guaranteed
by Meritage and secured by substantially all the assets of the Wendy's
Partnership.
INFLATION AND CHANGING PRICES
The rate of inflation as measured by changes in the average consumer
price index has not had a material effect on the Company's financial condition
or results of operations for the periods presented.
41
<PAGE> 42
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER UNIT DATA)
<TABLE>
<CAPTION>
Six Months
(1) Years Ended December 31, ended May 31,
Eleven Months ended ------------------------ -------------
November 30, 1996 1995 1994 1993 1992 1997 1996
----------------- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA
Total Revenue $ 24,687 $ 25,601 $ 24,910 $ 23,685 $ 22,743 $ 13,042 $ 12,314
Operating costs and expenses 23,700 24,593 23,418 22,625 21,717 12,743 12,029
Earnings from operations 987 1,008 1,492 1,060 1,026 299 285
Earnings before extraordinary item 559 527 941 438 348 78 62
Net earnings 559 506 941 351 348 78 62
Net earnings attributable to:
Limited Partners $ 553 $ 501 $ 931 $ 348 $ 345 $ 77 $ 61
General Partner 6 5 10 3 3 1 1
--------------------------------------------------------------------------------
$ 559 $ 506 $ 941 $ 351 $ 348 $ 78 $ 62
================================================================================
Earnings before extraordinary item per
limited partnership unit $ 440.22 $ 415.14 $ 740.96 $ 345.06 $ 274.42 $ 61.56 $ 48.64
Net earnings per limited partnership
unit 440.22 398.96 740.96 276.53 274.42 61.56 48.64
Cash distributions per limited
partnership unit 250.00 450.00 300.00 -- -- -- 100.00
BALANCE SHEET DATA
Cash and cash equivalents 394 411 776 409 422 619 409
Working capital (850) (912) (824) (1,089) (2,733) (1,085) (851)
Property and equipment, net 5,897 5,671 5,933 5,763 5,611 5,936 5,759
Total assets 9,076 8,832 9,698 9,341 9,478 9,079 8,826
Long-term debt, including current
maturities 4,379 4,469 5,127 5,494 4,176 4,170 4,538
Total liabilities 5,793 5,972 6,773 6,976 7,464 5,899 5,976
Partners' equity:
General Partner (29) (31) (31) (36) (40) (28) (31)
Limited Partners 3,131 2,892 2,956 2,402 2,054 3,208 2880
Partners' equity per limited partnership
unit 2,491.07 2,300.85 2,351.90 1,910.94 1,634.41 2,552.62 2,349.49
STATEMENT OF CASH FLOWS DATA
Net increase (decrease) in cash and
cash equivalents (17) (365) 367 (12) 194 224 125
Net cash provided by
operating activities 1,201 1,366 1,808 627 1,207 857 590
Distributions 317 571 381 -- -- -- 127
<FN>
(1) In fiscal 1996, the Wendy's Partnership changed its fiscal year from
December 31 to November 30, due to the consolidation of the Wendy's
Partnership's financial statements with Meritage. Meritage acquired a
majority interest in the Wendy's Partnership on October 31, 1996.
</TABLE>
42
<PAGE> 43
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION
RESULTS OF OPERATIONS
The following table summarizes the results of operations for years
ended December 31, 1995 and 1994.
<TABLE>
<CAPTION>
STATEMENTS OF OPERATIONS
-------------------------------------------------------------------
1995 1994 1995 1994
----------------------- ------------------------------
(in thousands) (as a percentage of net sales)
----------------------- ------------------------------
<S> <C> <C> <C> <C>
Net Sales $ 25,601 $ 24,910 100.0% 100.0%
Cost of Sales 7,391 7,295 28.9 29.3
-------------------------------------------------------------------
Gross Profit 18,210 17,615 71.1 70.7
Expense (Income):
Restaurant Operating
Expenses 15,099 13,987 59.0 56.2
General and
Administrative 1,250 1,279 4.9 5.1
Depreciation and
Amortization 853 857 3.4 3.4
Interest Expense 512 557 2.0 2.2
Loss (Gain) on
Disposal of Assets 1 (6) 0.0 0.0
Insurance in Excess
of Net Book Value of
Fire Damaged Assets (32) -0- (0.1) 0.0
Loss from Extinguishment
of Debt 21 -0- (0.1) 0.0
-------------------------------------------------------------------
17,704 16,674 69.1 66.9
-------------------------------------------------------------------
Net Income $ 506 $ 941 2.0% 3.8%
===================================================================
</TABLE>
43
<PAGE> 44
Sales
Net sales increased 2.6% from $24,702,000 in 1994 to $25,365,000 in
1995. The sales increase for 1995 was due to the Partnership having additional
restaurants in operation during 1995 compared to 1994. The Partnership opened
its twenty-fourth restaurant in August 1994 and its twenty-fifth restaurant in
April 1995. Sales on a per restaurant basis for the Partnership's twenty-three
restaurants in operation during the entire twelve months of both 1995 and 1994
are set forth in the table below for the three months ended March 31, June 30,
September 30 and December 31, 1995 and 1994. Sales for 1995 have been adjusted
so that comparable figures are produced to account for one of the Partnership'
restaurants being closed for seven weeks during the second quarter of 1995 due
to fire damage.
<TABLE>
<CAPTION>
Average Net Sales Per Restaurant Unit
-------------------------------------
Increase % Increase
1995 1994 (Decrease) (Decrease)
---- ---- ---------- -----------
<S> <C> <C> <C> <C>
Three months ended March 31 $ 255,107 $ 229,358 $ 25,749 11.2%
Three months ended June 30 273,240 272,810 430 0.1%
Three months ended September 30 279,643 286,830 (7,187) (2.5)%
Three months ended December 31 254,357 275,842 (21,485) (7.7)%
----------- ----------- ------------ ----------
$ 1,062,347 $ 1,064,840 $ (2,493) (0.2)%
=========== =========== ============ ==========
</TABLE>
Net sales increased 11.2% during the first quarter of 1995 compared to
the same period of 1994 due to unusually mild winter weather during the first
quarter of 1995 compared to the same period of 1994. During the second quarter
of 1995 sales flattened. Sales decreased 2.5% and 7.7% for the third and fourth
quarters, respectively, compared to the same periods of 1995. Although sales
were flat for the year, the Partnership's sales still compared favorably with
Wendy's International, Inc. corporate owned restaurants which had average sales
of $1,014,000 per restaurant unit in 1995 and Wendy's franchise markets which
had average sales of $974,000 per restaurant unit in 1995. Due to intense
competition as described in the following paragraphs, selling price increases in
1995 were less than 1%.
Sales in the second and third quarter of 1995 were adversely impacted
by heavy marketing and price discounting by the Partnership's competition. Also
contributing to the declining sales trend was a reduction in sales of
approximately $270,000 in 1995 compared to 1994 at one of the Partnership's
restaurants due to extensive and prolonged road construction at this location.
Sales at this restaurant were down 16% in 1995 compared to 1994.
The heavy discounting and competitive intrusion continued into the
fourth quarter of 1995. This intense competition combined with unseasonable cold
and snowy weather conditions beginning in early November 1995, compared to
relatively mild weather during the fourth quarter of 1994, contributed to the
7.7% decrease in sales during the fourth quarter of 1994.
Gross Profit
Gross profit increased $567,000 in 1995 compared to 1994. This increase
was the result of increased sales combined with a .4 percentage point increase
in the Partnership's gross profit percentage (from 70.5% of sales in 1994 to
70.9% of sales in 1995). The increase in the Partnership's gross profit
percentage was primarily the result of a decline in meat prices in 1995 combined
with continued effective cost controls at the store operation level.
Restaurant Operating Expenses
As a percentage of sales, restaurant operating expenses increased 2.9
percentage points during 1995 compared to 1994. This increase was primarily due
to a 1.6 percentage point increase in hourly payroll costs (as a percentage of
sales). The increase in hourly payroll cost was the result of increased hourly
wage rates as average wage rates rose throughout 1995 due to intense competition
for labor in the Partnership's market where the unemployment level fell as low
as 3.5% during 1995. Average hourly wage rates were approximately 9% higher in
44
<PAGE> 45
1995 than in 1994. Also contributing to the increase in restaurant operating
expenses were slight increases in utilities, repairs and maintenance, property
taxes and coupon discounts.
On a per restaurant basis, restaurant operating expenses increased from
an average of $598,000 per restaurant in 1994 to an average of $610,000 per
restaurant in 1995, an increase of 1.9% compared to the 0.2% decrease in per
restaurant sales for 1995. The 1.9% increase in restaurant operating expenses
for 1995 compares favorably with the 3.7% increase in restaurant operating
expenses in 1994 over 1993.
General and Administrative
General and administrative expenses decreased $29,000 in 1995 compared
to 1994 (from $1,279,000 to $1,250,000). As a percentage of sales, general and
administrative expenses decreased from 5.2% of sales in 1994 to 4.9% of sales in
1995. Decreases in administrative salaries, Michigan single business tax and
professional fees offset slight increases in profit sharing expenses and
increased recruiting costs (due to the labor shortage discussed earlier) to
account for the decrease in general and administrative expenses.
Interest Expense
Interest expense decreased $45,000 in 1995 compared to 1994 (from
$577,000 to $512,000). In March 1995 the Partnership refinanced its long-term
debt reducing the interest rate on the Partnership's debt from 2% over prime to
1% over prime. The new loan agreement also allows the Partnership to apply its
excess cash against the loan balance which combined with the reduction in the
interest rate caused the decrease in interest expense.
LIQUIDITY AND CAPITAL RESOURCES
On October 31, 1996, Meritage acquired 482.55 units of the Wendy's
Partnership pursuant to a tender offer. This acquisition, coupled with an
additional 198.25 units acquired by Meritage in private transactions, has
resulted in Meritage owning (through its subsidiary MHG Food Service)
approximately 54% of the outstanding units. Effective at the time of the tender
offer Meritage's financial results included its share of the Wendy's operations.
As such, the relevant discussion regarding liquidity and capital resources will
be found under the Meritage "Liquidity and Capital Resources" section discussed
earlier in this filing.
INFLATION AND CHANGING PRICES
As discussed under item "Restaurant Operating Expenses" of this report,
rising hourly wage rates had a negative impact on the Partnership's operating
results for 1995. This increase in labor costs along with periodic increases in
food and other operating expenses are normally passed on to customers in the
form of price increases. However, highly competitive market conditions have
severely minimized the Partnership's ability to offset cost increases through
increased prices to its customers.
45
<PAGE> 46
BUSINESS
GENERAL
Meritage Hospitality Group is engaged in the hospitality business
through its operation of two distinct business segments. The Company's Food
Service Group consists of its majority ownership of a limited partnership which
operates 25 "Wendy's Old Fashioned Hamburgers" restaurants throughout Western
and Southern Michigan. The Company's Lodging Group owns and operates three full
service hotels in Michigan.
FOOD SERVICE GROUP
In the Food Service Group, the Company owns, through a wholly owned
subsidiary, 680.8 limited partnership units of the Wendy's Partnership,
representing approximately 54% of the total outstanding limited partnership
units. The Wendy's Partnership operates 25 "Wendy's Old Fashioned Hamburgers"
restaurants throughout Western and Southern Michigan which are operated pursuant
to franchise agreements with Wendy's International. The Partnership employs
approximately 900 people and reported sales of approximately $26.5 million in
fiscal 1996. The restaurants offer a diverse menu featuring hamburgers, chicken
breast sandwiches, baked and french fried potatoes, pita sandwiches, freshly
prepared salads, soft drinks and "Frosty" desserts.
The Wendy's restaurants are operated pursuant to license agreements
with Wendy's International. These agreements impose requirements regarding the
preparation and quality of food products, the level of service, and general
operating procedures. The Wendy's Partnership makes a monthly royalty payment to
Wendy's International (the greater of 4% of monthly gross sales or $250 per
restaurant) and commits a certain percentage of monthly gross sales to
advertising. The Wendy's Partnership is also permitted to utilize Wendy's
International's trademarks, service marks, designs and other propriety rights in
connection with the operation of the restaurants.
The franchise agreements provide, among other things, that a change in
the operational control of the Wendy's Partnership or general partner cannot
occur without prior consent of Wendy's International. The franchise agreements
also provide that any proposed sale of the Wendy's Partnership's business,
interests or franchise rights is subject to the consent and right of first
refusal of Wendy's International.
The franchise agreements currently in place with the Wendy's
Partnership generally expire 20 years after the date the restaurant at issue was
opened or under construction. Subject to certain conditions, the franchise
agreements generally are renewable for a term equal to the term set forth in the
standard form of franchise agreement that is executed by other Wendy's
International franchise owners renewing their franchises at or about the same
time.
The Wendy's Partnership cannot conduct its present business without its
affiliation with Wendy's International which gives the Wendy's Partnership the
right to use certain registered trademarks and service marks such as "Wendy's"
and "Wendy's Old Fashioned Hamburgers." A default by the Wendy's Partnership
under a franchise agreement could result in adverse consequences, including
their termination of the franchise agreement.
LODGING GROUP
In the Lodging Group, the Company owns and operates three full service
hotels: the 149-room Thomas Edison Inn located on the St. Clair River in Port
Huron, Michigan; the 78-room St. Clair Inn located on the St. Clair River in St.
Clair, Michigan; and the 121-room Grand Haven Holiday Inn located on the Grand
River in Spring Lake, Michigan. Each hotel has a picturesque waterfront setting
and seeks business and leisure travelers who desire full service accommodations,
such as guest rooms and suites, a restaurant and cocktail lounge, and
meeting/conference rooms.
Meritage is a Michigan corporation incorporated in 1986. On May 21,
1996, shareholders amended the Articles of Incorporation to change the Company's
name from "Thomas Edison Inns., Inc." to "Meritage Hospitality Group Inc." The
Company's principal executive office is located at 40 Pearl Street, N.W., Suite
900, Grand Rapids, Michigan 49503, its telephone number is (616) 776-2600 and
its facsimile number is (616) 776-2776.
46
<PAGE> 47
BROADENED BUSINESS ORIENTATION
Although Meritage was engaged only in the lodging business since its
inception, Meritage has recently reassessed its long-range objectives and made a
strategic decision to further expand its Food Service Group through the
acquisition of additional chain restaurant businesses. In addition, the Company
has received inquiries regarding the sale of its hotels. Because current market
conditions make this an opportune time to sell full service hotels, the Company
intends to explore carefully any opportunity which may arise regarding the sale
of one or more of its hotels. The Company has retained a professional brokerage
firm to assist it in this regard. Proceeds of any sale would be used to reduce
the Company's debt . Management cannot, of course, determine whether it will
sell any of its hotels or, if it decides to sell, determine how long it will
take to sell these assets and whether the prices offered will be acceptable to
Meritage.
REPLACEMENT AND RESTRUCTURING OF MANAGEMENT
From the Company's inception in 1986 until January 1996, Donald W.
Reynolds served as Chairman of the Board, President, Chief Executive Officer,
Treasurer and Secretary of the Company, and the Company engaged Innkeepers
Management Company, a Michigan corporation wholly-owned by Mr. Reynolds, to
manage the Company's business pursuant to a Management Agreement.
Mr. Reynolds was removed as an officer and director of the Company by
the St. Clair County (Michigan) Circuit Court on January 8, 1996 (Case NO.
95-00-33-88-CZ, Deegan, J.). While the Court's written order did not state why
Mr. Reynolds was removed, the Court questioned the manner in which Mr. Reynolds
conducted his affairs and articulated the Court's objective of protecting the
interests of the Company's minority shareholders. The Court appointed Frank O.
Staiger as acting President and director. On January 25, 1996, MCC, the
Company's majority shareholder, amended the Company's Bylaws to, among other
things, expand the Board of Directors to 10 directors and appointed 5 new
directors. On January 25, 1996, the Company's newly expanded Board of Directors
appointed Christopher B. Hewett as the Company's new President and Chief
Executive Officer. The Board also terminated the Management Agreement with
Innkeepers and removed David C. Distad, Mr. Reynolds's son-in-law, as Vice
President and Chief Financial Officer of the Company. Instead of employing a
third party management company, the Company now operates its business directly
in an effort to more effectively utilize its resources and employees.
FOOD SERVICE GROUP
General
The food service industry serves as the nation's largest retail
employer, providing jobs for over 9 million people at over 730,000 locations in
the United States. The growth rate of the quick-service segment has consistently
exceeded that of the food service industry as a whole for more than 20 years.
The historic change in domestic lifestyles which favor greater convenience has
significantly impacted this trend. Because of this growth rate, competition in
the quick-service restaurant segment is intense and can be expected to increase.
Most of the Partnership's restaurants are in close proximity to other
quick-service restaurants (e.g. McDonald's, Burger King and Taco Bell) which
compete on the basis of price, service, quality and variety. Recently, the major
competitors have attempted to draw customer traffic by a price discounting
strategy. However, neither Wendy's International nor the Company believes this
is a profitable long-term strategy. The Company intends to achieve growth both
by developing new Wendy's restaurants and by increasing the sales at existing
restaurants.
Menu
Each Wendy's restaurant offers a diverse menu containing a variety of
food items, featuring hamburgers, chicken sandwiches and pita sandwiches which
are prepared to order with the customer's choice of condiments. The Wendy's menu
also typically includes, among other things, baked and french fried potatoes,
freshly prepared salads, soft drinks and "Frosty" desserts.
47
<PAGE> 48
Marketing and Promotion
As required by its franchise agreements, the Wendy's Partnership
contributes at least 4% of its restaurant sales to an advertising and marketing
fund. Two and one half percent of restaurant sales is used to benefit all
restaurants owned and franchised by Wendy's International. The Wendy's National
Advertising Program, Inc. uses this fund to develop advertising and sales
promotion materials and concepts to be implemented nationally. The Wendy's
Partnership is required to spend the remainder of the 4% of its restaurant sales
on local advertising. The Wendy's Partnership typically spends local advertising
dollars in support of national television advertising, local television and
radio advertising, print media, local promotions and community goodwill
projects.
Restaurants Layout and Operations
The Wendy's Partnership's 25 restaurants typically range from 2,700 to
3,200 square feet with a seating capacity between 90 and 130 people, and are
typically open from 10:30 a.m. to 10:00 p.m., with many restaurants open for
extended evening hours. Generally, the dining areas are carpeted and informal in
design, with tables for two to four people. With one exception, all of the
Wendy's Partnership's restaurants also feature drive-through windows. Average
drive-through guests generally exceed in-restaurants guests. In fiscal 1996,
drive-through sales constituted approximately 50% of the Wendy's Partnership's
sales.
The Wendy's Partnership's reporting system provides restaurant sales
and operating data, including product sales mix, food usage and labor cost
information with respect to each restaurant operated by the Wendy's Partnership.
Physical inventories of all food items are taken weekly, and inventories of
critical food items are taken twice a day.
Raw Materials
As a Wendy's franchisee, the Wendy's Partnership complies with uniform
recipe and ingredient specifications provided by Wendy's International, and
purchase all food and beverage inventories and restaurant supplies from
independent vendors approved by Wendy's International. Except for the New Bakery
Co. of Ohio, Inc., a wholly-owned subsidiary of Wendy's International, Wendy's
International does not sell food or supplies to its franchisees. The Wendy's
Partnership purchases its sandwich buns from local bakeries for its restaurants.
The Wendy's Partnership purchases soft drink products from the Coca-Cola Company
and its affiliates. Most other food items and supplies purchased by the Wendy's
Partnership are warehoused and distributed by independent distributors. The
Wendy's Partnership and, in some instances Wendy's International, negotiate
prices directly with the vendors.
The Wendy's Partnership has not experienced any significant shortages
of food, equipment, fixtures or other products which are necessary to restaurant
operations. The Wendy's Partnership anticipates no such shortages and believes
that alternate suppliers are available in the event such shortages occur.
LODGING GROUP
The Company's hotels are full service properties that attract business
and leisure travelers. Each hotel provides fully appointed guest rooms and
numerous amenities and services including a restaurant and cocktail lounge,
meeting/conference rooms, and a swimming pool and fitness facility.
Approximately 150 full time, and 325 part time employees are involved in the
operation of the three hotels, none of whom are members of a labor union or part
of a collective bargaining unit.
Thomas Edison Inn
The Thomas Edison Inn, which opened in 1987, is located on
approximately 4 acres bordering the St. Clair River in Port Huron, Michigan. The
hotel has 149 guest rooms, a 250 seat restaurant that overlooks the St. Clair
River and Lake Huron, a 150 seat cocktail lounge, and a variety of
meeting/conference rooms accommodating up to 500 people. Other facilities
include an indoor swimming pool, a pool side whirlpool, and a health club and
retail shops leased to third party vendors. The hotel's room revenue is derived
from business and leisure travelers. The
48
<PAGE> 49
hotel's food and beverage facilities are heavily patronized by local clientele
which results in food and beverage revenues significantly higher than industry
norms for similar size hotels. In 1996, the hotel underwent a $650,000
renovation which included building improvements and the installation of
point-of-sale, property management and telephone systems.
St. Clair Inn
The St. Clair Inn, which opened in 1926, is a state historic site
located on approximately 2.5 acres bordering the St. Clair River in St. Clair,
Michigan. The hotel has 78 rooms, a 240 seat restaurant that overlooks the St.
Clair River, a 60 seat cocktail lounge, and a variety of meeting/conference
rooms accommodating up to 250 people. Other facilities include an indoor
swimming pool and approximately 1,000 feet of frontage along the St. Clair River
with a boardwalk running most of that distance. The hotel's market mix is
similar to that of the Thomas Edison Inn, and the hotel also derives substantial
food and beverage revenue from local clientele. In order to facilitate the sale
of certain assets, three buildings adjacent to the hotel are slated to be
demolished in 1997, resulting in eighteen rooms having been removed from service
in late 1996. See "Other Assets." The hotel underwent a $500,000 renovation in
1996 which included building improvements and the installation of point-of-sale,
property management and telephone systems.
Grand Haven Holiday Inn
The Grand Haven Holiday Inn, which opened in 1969, is located on
approximately 4 acres bordering the Grand River in Spring Lake, Michigan. The
hotel has 121 rooms, a 185 seat restaurant that overlooks the Grand River, a 125
seat cocktail lounge, and a variety of meeting/conference rooms accommodating up
to 300 people. Other facilities include an outdoor and indoor swimming pool. The
Grand Harbor Yacht Club, a newly renovated 55-slip marina condominium project
owned by the Company, borders the property. The hotel's market mix is similar to
that of the Thomas Edison Inn and the St. Clair Inn, and the hotel also derives
substantial food and beverage revenue from local clientele. In 1996, the hotel
underwent a $700,000 renovation whereby the exterior of the hotel was redesigned
and renovated to compliment and accentuate its nautical surroundings.
The hotel is operated under a license agreement between Holiday Inns
Franchising, Inc. and the Company's subsidiary, Grand Harbor Resort Inc. Under
this agreement, the hotel is entitled to use the service marks "Holiday Inn" and
certain other service and trademarks, and a computerized reservation network
operating under the name "Holidex." The hotel is required to pay a variety of
fees and assessments to Holiday Inns Franchising which, in fiscal 1996, totaled
$148,811, or 8.3% of the hotel's gross room revenues. The license agreement
expires in August 2009. Holiday Inns Franchising may terminate the license if
the hotel fails to meet its obligations under the license agreement to the
satisfaction of Holiday Inns Franchising.
The Company believes that its subsidiary is in compliance with the
Holiday Inn license agreement. However, on April 4, 1997, the Company's
subsidiary received a 60-day notice of default in which it was given until June
23, 1997 to complete work mandated by the terms of a property improvement plan
which would require an extensive renovation of the Grand Haven Holiday Inn. The
deadline for completing the work mandated by the terms of the property
improvement plan was extended on a number of occasions while the Company and
Holiday Inn explored the possibility of a resolution. On July 21, 1997, a
resolution was reached, and an agreement was entered into, whereby Holiday Inn
agreed that the Grand Haven Holiday Inn would not be required to complete the
work pursuant to the property improvement plan and would not be liable for
liquidated damages in the approximate amount of $450,000 for a default under the
franchise agreement. In exchange, the Company's subsidiary released Holiday Inn
from all claims under the franchise agreement and agreed to remove the hotel
from the Holiday Inn system no later than October 15, 1997. The Company does not
believe that ending its franchise affiliation with Holiday Inn will have a
material effect on its operations, and, in fact, believes that this event will
allow the Company to identify and market the hotel in a manner that will better
compliment and accentuate its nautical surroundings.
49
<PAGE> 50
COMPETITION AND INDUSTRY CONDITIONS
The quick-service restaurant industry is intensely competitive with
respect to price, service, location and food quality. The industry is mature and
competition can be expected to increase. There are several well-established
competitors with substantially greater financial and other resources than the
Company, some of which have been in existence substantially longer than Meritage
and may have substantially more units in the market where the Wendy's
Partnership's restaurants are or may be located. McDonald's, Burger King and
Taco Bell restaurants are the principal competitors in the Wendy's Partnership's
markets. The Company's major competitors are engaged in an attempt to draw
customer traffic by a deep discounting strategy, however, neither Wendy's
International nor Meritage believe this is a profitable long-term strategy.
The Company and the quick-service restaurant industry generally are
significantly affected by factors such as changes in local, regional or national
economic conditions, changes in consumer tastes, severe weather and consumer
concerns about the nutritional quality of quick-service food. In addition,
factors such as increases in food, labor and energy costs, the availability and
cost of suitable restaurant sites, fluctuating insurance rates, state and local
regulations and the availability of an adequate number of hourly-paid employees
can also adversely affect the quick-service restaurant industry.
The lodging industry is highly competitive. Since 1993, the industry
has been steadily recovering from the recession of the early 1990's and the
over-building of the late 1980's. Occupancy and average daily rates have
consistently increased since 1993. Also, new hotel construction has resumed.
Industry sources forecast modest increases in average daily rates, stable
occupancy rates and modest income for 1997.
The following table illustrates the average daily room rates for the
Company's hotels during 1995 and 1996 as compared to the national average:
<TABLE>
<CAPTION>
=====================================================================================================================
FISCAL YEAR THOMAS EDISON INN ST. CLAIR INN GRAND HAVEN HOLIDAY INN NATIONAL AVE.*
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1995 $ 80.68 $ 71.39 $ 68.11 $ 67.34
- ---------------------------------------------------------------------------------------------------------------------
1996 $ 80.48 $ 83.26 $ 71.02 $ 69.50
=====================================================================================================================
<FN>
* Source: Smith Travel, Coopers & Lybrand and CLS Estimates
</TABLE>
The following table illustrates the average daily room rates per
available room for the Company's hotels during 1995 and 1996 as compared to the
national average:
<TABLE>
<CAPTION>
=====================================================================================================================
FISCAL YEAR THOMAS EDISON INN ST. CLAIR INN GRAND HAVEN HOLIDAY INN NATIONAL AVE.*
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1995 $ 47.98 $ 42.77 $ 42.01 $ 44.11
- ---------------------------------------------------------------------------------------------------------------------
1996 $ 52.75 $ 47.12 $ 40.94 $ 46.22
=====================================================================================================================
<FN>
* Source: Smith Travel, Coopers & Lybrand and CLS Estimates
</TABLE>
The following table illustrates the percentages of occupancy for 1995
and 1996 as compared to the national occupancy rate:
<TABLE>
<CAPTION>
=====================================================================================================================
FISCAL YEAR THOMAS EDISON INN ST. CLAIR INN GRAND HAVEN HOLIDAY INN NATIONAL AVE.*
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1995 59.5% 59.9% 61.7% 65.5%
- ---------------------------------------------------------------------------------------------------------------------
1996 65.5% 56.6% 57.7% 66.5%
=====================================================================================================================
<FN>
* Source: Smith Travel, Coopers & Lybrand and CLS Estimates
</TABLE>
50
<PAGE> 51
The Company's hotels compete with a wide range of lodging facilities
offering various types of hospitality related services to the public. The
competition includes several national and regional hotel chains offering a
variety of accommodations, amenities and levels of service, as well as
independent hotels in each market segment. Business at the hotel varies
seasonally. Historically, demand has been greatest during the summer, resulting
in higher revenues during the Company's third fiscal quarter.
The Company operates the dominant full service hotels in its respective
markets. To maintain its market share, the Company has expanded its sales and
marketing programs and made significant capital improvements. In recent years,
most newly constructed hotels in the Company's markets have been limited service
hotel properties which offer mid-priced or economy level room rates. The Company
anticipates increased competition in its markets as a result of these new
properties.
RELATIONSHIP WITH WENDY'S INTERNATIONAL
Meritage's food service operations are presently conducted through the
Wendy's Partnership which is a franchisee of Wendy's International. The
restaurants are operated under franchise agreements between the Wendy's
Partnership and Wendy's International which generally have a 20-year term. These
agreements require the approval of Wendy's International to the assumption of
control of the franchised businesses by other entity.
As the general partner of the Wendy's Partnership, MCC Food Service, an
affiliate of Meritage, now directs the operations of the 25 Wendy's restaurants
operated by the Wendy's Partnership. MCC Food Service's control is being
challenged in a lawsuit commenced by the former general partner of the Wendy's
Partnership. See "Risks Associated with Investment in Meritage Common Shares -
Legal Proceedings." These operations are conducted pursuant to franchise
agreements with Wendy's International. These franchise agreements grant Wendy's
International wide discretion over advertising and other aspects of restaurant
operations. In addition to the contractual restrictions imposed by the franchise
agreements, Meritage and its affiliates which are involved in the Wendy's
business, are subject to certain restrictions imposed by policies and procedures
established by Wendy's International as in effect from time to time. These
restrictions may have the effect of limiting Meritage's ability to pursue some
of its business plans.
Wendy's International's consent may be required for certain
transactions by Meritage. If Wendy's International's consent is required and not
obtained, Meritage will not be able to proceed with those plans which, in turn,
could affect Meritage's growth strategy and could have a material adverse effect
on Meritage's financial condition and results of operations. If Meritage
proceeds without Wendy's International's consent, Wendy's International could
terminate its franchise agreements. Termination of the franchise agreements
would have a material adverse effect on Meritage's financial condition and
results of operations.
Part of Meritage's business strategy is to expand its operations
through the acquisition and development of Wendy's restaurants. Wendy's
International's approval is required for the acquisition of Wendy's restaurants
by Meritage from other Wendy's franchisees and the development of new Wendy's
restaurants by Meritage. Wendy's International's approval is also required for
the renewal of existing franchise agreements. Wendy's consent to such renewals,
acquisitions or development may be withheld in Wendy's sole discretion. Pursuant
to its agreement with Wendy's International, Meritage is also limited in both
the acquisition or development of other chain restaurant businesses. Wendy's
International has restricted Meritage's involvement with any quick-service
restaurant in Meritage's market area, and any quick-service restaurant outside
of Meritage's market area that sells chicken sandwiches, hamburgers or products
similar to Wendy's International which is located within a three mile radius of
another Wendy's restaurant operated by a Wendy's franchisee.
Wendy's International must approve the opening by Meritage of any new
restaurant, including restaurants opened within Meritage's existing franchise
territories. Wendy's International also maintains discretion over the menu items
that may be offered in Meritage's restaurants. By virtue of franchise and other
agreements, Meritage is required to pay to Wendy's International technical
assistance fees upon the opening of new restaurants and monthly royalty and
national advertising fees. These agreements also provide for the termination of
Meritage as a franchisee upon the failure of Meritage to comply with certain
restrictions and obligations imposed on Meritage.
51
<PAGE> 52
Meritage's restaurant operations are largely dependent on the Wendy's
restaurant chain, which in turn is dependent upon the management and financial
condition of Wendy's International's and the reputation developed by Wendy's
restaurants operated by other Wendy's franchisees. Should Wendy's International
be unable to compete effectively with similar restaurant chains in the future,
Meritage would be materially and adversely affected. Furthermore, many of the
attributes which lead to the success of Wendy's operations are factors over
which Meritage has no control, such as marketing efforts, introduction of new
products, quality assurance and other operational systems. Adverse publicity
involving other Wendy's franchisees could have an adverse effect on all
franchisees including Meritage.
GOVERNMENTAL REGULATIONS
The hotel, restaurant and lounge operations within the Company's
Lodging Group are subject to governmental regulation and licensing requirements,
including, but not limited to, zoning ordinances, public health certification
and liquor licenses. The Company believes its operations would be adversely
affected if these licenses or permits were terminated. The Company does not
anticipate that its licenses or permits will be terminated.
The Wendy's Partnership is also subject to extensive federal, state and
local government regulations relating to the zoning, development and operation
of the restaurants and the preparation and sale of food. The Wendy's Partnership
is also sensitive to laws governing relationships with its employees such as
minimum and overtime wage laws, health insurance coverage requirements, and
working conditions. During fiscal 1996, Congress passed the Minimum Wage Bill
which revised the minimum wage to $4.75 per hour as of October 1, 1996 and will
again increase on September 1, 1997 to $5.15 per hour. Substantial changes in
the minimum wage or mandatory health care coverage could have an adverse effect
on the Wendy's Partnership and on the Company's hotels.
OTHER ASSETS
The Company has a number of assets which do not directly relate to its
hospitality business. These assets include (i) approximately 5.5 acres of
undeveloped land adjacent to the Thomas Edison Inn, (ii) approximately one acre
of commercial property adjacent to the St. Clair Inn, (iii) the Grand Harbor
Yacht Club, a 55-slip marina condominium development which borders the Grand
River adjacent to the Grand Haven Holiday Inn, (iv) $5.1 million in life
insurance policies on the life of the former President and Chief Executive
Officer, and (v) a note receivable from the sale of shares in the outstanding
principal amount of $9,750,000. Except for the note receivable, the Company
intends to sell all of these assets to raise additional funds which, may be used
to pay down the Company's long-term indebtedness or fund acquisitions, capital
expenditures or other corporate purposes. There can be no assurances that the
Company will be able to sell these assets in the near future or as to the prices
it may receive for them.
PROPERTIES
For a description of the properties that are owned and operated by the
Company and its subsidiaries, see "Business - Lodging Group" above.
The Company leases approximately 4,600 square feet of office space
located at 40 Pearl Street, N.W., Suite 900, Grand Rapids, Michigan 49503 as its
corporate headquarters and as the registered office of the Company.
The Wendy's Partnership operates 25 restaurants in the Michigan
counties of Allegan, Calhoun, Kalamazoo, Kent, Muskegon, Ottawa and Van Buren.
The Wendy's Partnership (i) owns the land and buildings comprising five
restaurants, (ii) leases the land and buildings comprising 19 restaurants, and
(iii) owns the building and leases the land comprising one restaurant. The term
of the leases (including options to renew) range from one to 25 years. All of
the equipment used in the operation of the restaurants is owned by the
Partnership. Each restaurant conforms with the size, shape, design and layout
that is required by Wendy's International. The ages of the restaurants range
from one to twenty-three years.
52
<PAGE> 53
The Partnership also leases approximately 4,000 square feet of office
space located at 4613 West Main, Kalamazoo, Michigan 49006 as its operating
headquarters. The principal office of the general partner is located at 40 Pearl
Street, N.W., Suite 900, Grand Rapids, Michigan 49503.
The Company believes that its properties, and the properties held by
the Partnership, are adequately covered by insurance.
LEGAL PROCEEDINGS
The Company is involved in certain routine legal proceedings which are
incidental to its business. Except as described below, all of these proceedings
arose in the ordinary course of the Company's business and, in the opinion of
the Company, any potential liability of the company with respect to these legal
actions will not, in the aggregate, be material to the Company's financial
condition or operations. The Company maintains various types of insurance
standard to the industry which would cover most actions brought against the
Company.
On December 5, 1996, the Company received a notice from the Internal
Revenue Service that approximately $2.1 million, which Meritage deducted as a
business expense in connection with litigation in 1995 and 1996 relating to the
replacement and restructuring of former management, should be treated as a
capital expenditure and, therefore, disallowed as a deduction. Meritage believes
the deduction was proper and is vigorously contesting the disallowance. If the
IRS were to completely prevail in its position, then Meritage would be required
to expend approximately $340,000 for the payment of additional federal and state
income taxes plus any interest. If Meritage is able to carry back its 1996 tax
loss, then any amount that Meritage would be required to pay would be refunded
within 120 days of payment.
On May 19, 1997, Wendy's West Michigan, Inc. was removed as general
partner of the Wendy's Partnership and replaced with MCC Food Service, an
affiliate of Meritage. On May 21, 1997, Wendy's West Michigan, Inc. commenced a
lawsuit against Meritage, MHG Food Service, and MCC Food Service (Case No.
97-05360-CB, Kent County (Michigan) Circuit Court, Buth, J.). Wendy's West
Michigan, Inc. has attempted to assert claims on behalf of the Wendy's
Partnership as well. The complaint seeks, among other things, (i) a declaration
that Wendy's West Michigan, Inc. is the general partner of the Wendy's
Partnership, (ii) injunctive relief in the form of a temporary restraining order
or a preliminary injunction which would prohibit the defendants from
participating in the management of the Wendy's Partnership, and (iii) damages
for various business torts. Plaintiff's motion for a temporary restraining order
was denied on May 21, 1997. Defendants believe that the lawsuit is entirely
without merit and is seeking its dismissal. Wendy's International stated that it
will not take a position regarding any legal issues raised by this lawsuit. The
consent of Wendy's International to MCC Food Service serving as the general
partner has already been obtained.
53
<PAGE> 54
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The following is information concerning each director and executive
officer of Meritage as of July 31, 1997:
<TABLE>
<CAPTION>
==================================================================================================================
NAME AGE POSITION
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Robert E. Schermer, Sr. (1)(2)(3) 62 Chairman of the Board
- ------------------------------------------------------------------------------------------------------------------
Christopher B. Hewett (1)(3) 38 President, Chief Executive Officer and Director
- ------------------------------------------------------------------------------------------------------------------
Robert E. Schermer, Jr. (1) 38 Executive Vice President and Director
- ------------------------------------------------------------------------------------------------------------------
Pauline M. Krywanski 37 Vice President, Treasurer and Chief Financial Officer
- ------------------------------------------------------------------------------------------------------------------
James R. Saalfeld 30 Vice President, General Counsel and Secretary
- ------------------------------------------------------------------------------------------------------------------
Gary R. Garrabrant (2)(4) 40 Director
- ------------------------------------------------------------------------------------------------------------------
David S. Lundeen (4) 35 Director
- ------------------------------------------------------------------------------------------------------------------
Joseph L. Maggini (2) 57 Director
- ------------------------------------------------------------------------------------------------------------------
Jerry L. Ruyan (3)(4) 51 Director
==================================================================================================================
<FN>
(1) Executive Committee Member
(2) Compensation Committee Member
(3) Nominating Committee Member
(4) Audit Committee Member
</TABLE>
Robert E. Schermer, Sr. has been a director of the Company since
January 25, 1996. He is currently Senior Vice President and Managing Director of
Robert W. Baird & Co. Incorporated, an investment banking and securities
brokerage firm headquartered in Milwaukee, Wisconsin. Mr. Schermer has held this
position for more than five years. He is the father of Robert E. Schermer, Jr.
Christopher B. Hewett has been President, Chief Executive Officer and a
director of the Company since January 25, 1996. He has served as President of
MCC since its inception in 1993. Mr. Hewett was Executive Vice President (1990
to 1991) and President (1991 to 1997) of Ocean Reef Club, Inc., which was the
owner, developer and operator of the Ocean Reef Club, a 5,000 acre mixed-use
residential resort community in Key Largo, Florida. In 1993, Ocean Reef Club,
Inc. sold the Ocean Reef Club.
Robert E. Schermer, Jr. has been Executive Vice President and a
director of the Company since January 25, 1996. From January 25, 1996 until
September 16, 1996, Mr. Schermer also served as Treasurer of the Company. Mr.
Schermer has served as Executive Vice President of MCC since 1993. From 1989
until 1993, he was Executive Vice President of Landquest Ltd, a private
investment partnership which financed and developed residential real estate and
hotel investments. He is the son of Robert E. Schermer, Sr.
Pauline M. Krywanski has been Vice President, Treasurer and Chief
Financial Officer of the Company since May 20, 1997. From 1988 to 1997, Ms.
Krywanski was with Med Trans, a nationwide provider of healthcare
transportation. Her most recent position with Med Trans was Director of
Financial Operations for the Midwest Region. Ms. Krywanski is a Certified Public
Accountant.
54
<PAGE> 55
James R. Saalfeld has been Vice President, General Counsel and
Secretary of the Company since March 20, 1996. From 1992 until 1996, Mr.
Saalfeld was an attorney with Dykema Gossett PLLC, a Grand Rapids, Michigan law
firm.
Gary R. Garrabrant has been a director of the Company since October 24,
1996. Mr. Garrabrant is Executive Vice President of Equity Group Investments,
Inc., a private investment company headquartered in Chicago, with significant
real estate and corporate holdings. He joined Equity Group as a Senior Vice
President in January 1996. Previously, Mr. Garrabrant was Director of Sentinel
Securities Corporation and co-founded Genesis Realty Capital Management, both of
which were based in New York, and specialized in real estate securities
investment management. Form 1989 to 1994, he was associated with The Bankers
Trust Company in New York. Mr. Garrabrant has been a director of Capital Trust,
a real estate finance company based in San Francisco, since January 1997.
David S. Lundeen has been a director of the Company since January 25,
1996. Since 1995, he has served as Executive Vice President and Chief Financial
Officer of BSG Corporation, Austin, Texas, an information technology consulting
company. From 1992 to 1995, Mr. Lundeen was President of Blockbuster Technology,
a division of Blockbuster Entertainment. From 1990 to 1992, he worked for
Blockbuster Entertainment as Director of Mergers & Acquisitions and Corporate
Finance. Prior to 1990, Mr. Lundeen was an investment banker at Drexel Burnham
Lambert in New York City.
Joseph L. Maggini has been a director of the Company since January 25,
1996. Since founding it in 1974, he has served as President and Chairman of the
Board of the Magic Steel Corporation, Grand Rapids, Michigan, a steel service
center.
Jerry L. Ruyan has been a director of the Company since October 24,
1996. Since 1995, Mr. Ruyan has been a partner in Redwood Ventures, LLC, an
investment/venture capital company located in Cincinnati, Ohio. Mr. Ruyan is
also a founder of Cincinnati-based Meridian Diagnostics, Inc., which is engaged
in the production of medical diagnostic products, and has been a member of its
Board of Directors since 1977. Mr. Ruyan's other positions with Meridian
Diagnostics, Inc. included Chief Executive Officer (1992 to 1995), and President
and Chief Operating Officer (1986 to 1992). Since October 1996, Mr. Ruyan has
been a member of the Board of Directors of Frisch's Restaurants, Inc., which
operates more than 100 Big Boy restaurants.
EXECUTIVE COMPENSATION
Compensation paid by Meritage for the last three fiscal years to its
former Chief Executive Officer, its current Chief Executive Officer and all
executive officers earning in excess of $100,000 is as follows:
<TABLE>
<CAPTION>
===================================================================================================================
SUMMARY COMPENSATION TABLE
- -------------------------------------------------------------------------------------------------------------------
ANNUAL COMPENSATION LONG-TERM COMPENSATION
SECURITIES UNDER-LYING OPTIONS
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Christopher B. Hewett (1) 1996 $127,735 $ 110,000(2) 50,000
President and Chief Executive
Officer
- -------------------------------------------------------------------------------------------------------------------
Robert E. Schermer, Jr. (1) 1996 $114,961 $ 100,000(2) 45,000
Executive Vice President
===================================================================================================================
<FN>
(1) Messrs. Hewett and Schermer, Jr. assumed their positions as officers on
January 25, 1996.
(2) Represents Series A Convertible Preferred Stock which Messrs. Hewett
and Schermer, Jr. elected to receive in lieu of a year-end cash bonus.
</TABLE>
55
<PAGE> 56
In fiscal 1994, the Company adopted a profit sharing plan established
under Section 401(k) of the Internal Revenue Code that covers employees of the
Company and its subsidiaries who have met certain eligibility requirements.
Effective March 1, 1997, the plan was amended to give the Plan participants
different investment options. The change required the execution of a new (i)
Qualified Retirement Plan and Trust Agreement and (ii) Adoption Agreement. The
amendment did not make any other substantive changes. Company contributions to
the Plan are voluntary and at the discretion of the Board of Directors. The
Company made no contributions to the Plan during fiscal 1996 or during the first
half of fiscal 1997.
Stock Options
The following tables contain information concerning the grant of stock
options to the executives identified in the Summary Compensation Table and the
appreciation of such options:
<TABLE>
<CAPTION>
===================================================================================================================
OPTION GRANTS IN FISCAL 1996
- -------------------------------------------------------------------------------------------------------------------
POTENTIAL REALIZABLE
VALUE AT ASSUMED ANNUAL
RATES OF STOCK PRICE
APPRECIATION FOR OPTION
TERM
% OF TOTAL
NUMBER OF OPTIONS
SECURITIES GRANTED TO EXERCISE
UNDERLYING EMPLOYEES IN PRICE ($ EXPIRATION
NAME OPTIONS GRANTED FISCAL 1996 PER SHARE) DATE 5% 10%
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Christopher B. Hewett 50,000 26.3 % $ 7.00 5/21/2006 $118,500 $395,500
- -------------------------------------------------------------------------------------------------------------------
Robert E. Schermer, Jr. 45,000 23.7 % $ 7.00 5/21/2006 $106,650 $355,950
===================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
===================================================================================================================
FISCAL 1996 OPTION EXERCISES AND FISCAL YEAR-END OPTION VALUES
- -------------------------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT
OPTIONS AT FISCAL YEAR FISCAL YEAR END
END
SHARES
NAME ACQUIRED ON VALUE REALIZED EXERCISABLE/UNEXERSIABLE EXERCISABLE/UNEXERSIABLE
EXERCISE
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Christopher B. Hewett --- --- 0/50,000 $0/$0 (1)
- -------------------------------------------------------------------------------------------------------------------
Robert E. Schermer, Jr. --- --- 0/45,000 $0/$0 (1)
===================================================================================================================
<FN>
(1) The Compensation Committee established the exercise price at $7.00 per
share. Because the stock is currently trading for less than $7.00 per
share, the unexercisable options have no value.
</TABLE>
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Mr. Reynolds, former Chairman of the Board, President, Chief Executive
Officer, Treasurer and Secretary of the Company, was removed from these
positions by the St. Clair County (Michigan) Circuit Court on January 8, 1996.
While the Court's written order did not state why Mr. Reynolds was removed, the
Court questioned the manner in which Mr. Reynolds conducted his affairs and
articulated the Court's objective of protecting the interests of the Company's
minority shareholders. Accordingly, Mr. Reynolds served as an officer and
director of the Company for 39 days in fiscal 1996. Mr. Reynolds's daughter,
Rebecca L. Awtrey, served as a director until May 1996. Management was installed
on January 25, 1996 and does not have specific knowledge of the following
transaction. Therefore, management is unable to determine whether transactions
with Mr. Reynolds and his affiliates were on terms no less favorable to the
Company than those that could be obtained from unaffiliated parties.
From the Company's inception in 1986 until January 1996, the Company
engaged Innkeepers Management Company, a company wholly-owned by Mr. Reynolds,
to manage the Company's hotels pursuant to a Management
56
<PAGE> 57
Agreement. For services in fiscal 1996, prior to termination of the Management
Agreement on January 25, 1996, Innkeepers received $57,650. At December 1, 1995,
Mr. Reynolds, and companies affiliated with Mr. Reynolds and former Board member
William F. Ehinger, owed the Company $695,430. In 1996, Mr. Reynolds incurred an
additional $76,364 of indebtedness and made payments of $580,053 toward this
total indebtedness. This left a balance due of $191,741 for which a $260,000
allowance for doubtful accounts had been established on November 30, 1995,
resulting in a bad debt recovery by the Company of $68,259.
Mr. Reynolds guaranteed the Company's obligations to the Company's
former long-term lender, First Federal Savings and Loan Association, in the
amount of $2,924,975 at December 1, 1995. Reynolds also guaranteed the Company's
obligations to First Federal under a letter of credit in the amount of
$3,929,506. Reynolds also pledged personally owned life insurance policies with
a face value of $3,000,000 as additional collateral for the Company's
obligations pursuant to a loan from another of the Company's former long-term
lenders, Michigan National Bank, in the amount of $4,273,702 at December 1,
1995. The Company's obligations to First Federal and Michigan National were paid
in full with proceeds from the refinancing with GALIC, and the guarantees were
extinguished, in February 1996.
In fiscal 1996, the Company expended approximately $280,000 for
litigation expenses on behalf of, among others, Ms. Awtrey, Mr. Reynolds, Mr.
Ehinger, Mr. Joseph P. Michael and Mr. Raymond A. Weigel, III (all former
members of the Board of Directors). These expenses related to litigation brought
by TEI Acquisitions, Inc. in its attempt to gain control of the Company through
its alleged purchase of the former majority shareholder's Common Shares. This
lawsuit was ultimately dismissed in fiscal 1996.
Management believes that all of the following transactions were on
terms no less favorable to the Company than those could be obtained from
unaffiliated parties.
At November 30, 1996, MCC, owned by Messrs. Hewett and Schermer, Jr.,
owed the Company $9,750,000 pursuant to a secured, non-interest bearing note in
the original amount of $10,500,000 issued to the company in payment for
1,500,000 Common Shares. On May 21, 1996, the company's Board of Directors
approved an early prepayment of $750,000 and released 107,142 shares of the
pledged stock. The note was thereafter amended to provide for repayment in six
annual installments of $1,625,000 beginning on the fifth anniversary of the
promissory note.
At December 1, 1995, Mr. Schermer, Jr. was indebted to Grand Harbor
Resort Inc. in the amount of $70,544. This indebtedness arose from a 7%
promissory note dated December 27, 1987 that Mr. Schermer, Jr. entered into with
a third party. This note was, unbeknownst to Mr. Schermer, Jr., assigned to one
of the Company's subsidiaries. Upon learning of this assignment, Mr. Schermer,
Jr. paid the note in full on March 27, 1996.
In fiscal 1996, the Company remitted approximately $170,000 in
litigation expenses on behalf of its then parent company, MCC, in connection
with litigation brought by TEI Acquisitions, Inc. in its attempt to gain control
of the Company through its alleged purchase of Mr. Reynolds' Common Shares. This
lawsuit was ultimately dismissed in fiscal 1996. These litigation expenses were
accrued by the Company in fiscal 1995. The officers of MCC are members of the
Company's current management and have specific knowledge of the transactions
described in this paragraph. Current management believes this transaction was on
terms no less favorable to the Company than those that could be obtained from
unaffiliated parties.
On April 16, 1996, the Company's Board of Directors approved
reimbursement of $300,188 for expenditures incurred by MCC in connection with
the change in management described under "Business - Replacement and
Restructuring of Management." These expenditures included, among other things,
office furniture, equipment, staff and other associated expenses, and were
reimbursed in accordance with the Stock Purchase and Sale Agreement dated
September 19, 1995 between MCC and the Company. On April 10, 1996, the Company's
Compensation Committee conducted an item-by-item examination of the reimbursable
expenses and recommended that the Board approve the request for reimbursement.
57
<PAGE> 58
On July 10, 1996, the Company entered into an agreement with Mr.
Schermer, Sr. to acquire 103.25 units of the Wendy's Partnership. The purchase
price was 123,900 newly-issued Company Common Shares. The Meritage shares were
not registered under the Securities Act of 1933 and consequently are subject to
a two year holding period before the shares can be sold publicly. For that
reason, and the significant block of Meritage Common Stock involved, Meritage
estimates that the value of the stock per unit was $6,000 per unit which is 80%
of the asked quote on the date of sale ($6.25 per share).
In fiscal 1996, the Company successfully completed a tender offer for a
majority interest in the Wendy's Partnership. Former board member Weigel was a
shareholder of the former General Partner of the Wendy's Partnership. Mr. Weigel
excused himself from any discussions, and abstained from any actions, regarding
this transaction.
On November 19, 1996, the Company purchased 40 units of the Wendy's
Partnership from Raymond A. Weigel, Sr. and his wife, Wavelet M. Weigel. The
company assigned a value of $7,200 to each unit. Mr. and Mrs. Weigel, Sr. are
the parents of former board member Weigel. The purchase price was 28,800 share
of Series A Convertible Preferred Stock.
The Company's Board of Directors authorized the issuance of up to
200,000 shares of Series A Convertible Preferred Stock in a private offering of
such preferred stock. Certain officers and members of the board of Directors
purchased Convertible Preferred Stock pursuant to the private offering. Mr.
Maggini purchased 10,000 shares, Mr. Lundeen 12,500 shares, Mr. Schermer, Sr.
20,000 shares, Mr. Hewett 31,000 shares, Mr. Schermer, Jr. 20,000 shares, and
Mr. Saalfeld 1,067 shares.
On January 24, 1997, the Board of Directors approved an expense sharing
arrangement whereby MCC and its principals (Messrs. Hewett and Schermer, Jr. )
will pay the Company $2,500 per year (commencing as of January 25, 1997) for
shared office space and occasional use of equipment and employee services. The
Compensation Committee of the Board of Directors will review the arrangement on
an annual basis.
On January 24 and May 20, 1997, the Board of Directors authorized
agreements whereby MCC, its principals and its subsidiary, will be indemnified
by the Company for any losses or expenses that they may incur as guarantors of
the Company's obligations to its primary financing institutions (GALIC and
Michigan National Bank) and the Company's and its subsidiaries' obligations to
their franchisors (Holiday Inn and Wendy's International). The Company and its
subsidiary also indemnified the general partner of the Wendy's Partnership (MCC
Food Service), and an individual who serves as an officer of MCC Food Service,
regarding the removal and replacement of the former general partner of the
Wendy's Partnership, and the performance of MCC Food Service's duties as the
general partner of the Wendy's Partnership.
In March 1997, the Company borrowed $750,000 from Robert E. Schermer,
Sr. The note is unsecured and requires monthly payments of interest only at
prime plus 8% provided the Company is not in default under its first and second
mortgage long-term debt. Unpaid principal and accrued interest must be paid by
the later of December 31, 1997 or 91 days after the first and second mortgage
long-term debt is paid off with the Company's long-term lender.
58
<PAGE> 59
PRINCIPAL SHAREHOLDERS
The following table sets forth information regarding ownership of
Common Shares at July 31, 1997, by management and all person beneficially owning
5% or more of Meritage's outstanding Common Shares.
<TABLE>
<CAPTION>
=================================================================================================================
COMMON SHARES (1) SERIES A CONVERTIBLE PREFERRED STOCK (1)
- -----------------------------------------------------------------------------------------------------------------
NAME NO. OF SHARES PERCENT OF CLASS NO. OF SHARES PERCENT OF CLASS
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Robert E. Schermer, Sr. 163,247(2) 4.9% 20,000 14.5%
- -----------------------------------------------------------------------------------------------------------------
Christopher B. Hewett 1,612,729(3) 49.3% 31,800 22.9%
- -----------------------------------------------------------------------------------------------------------------
Robert E. Schermer, Jr. 39,572(4) 1.2% 20,000 14.5%
- -----------------------------------------------------------------------------------------------------------------
Pauline M. Krywanski --- --- --- ---
- -----------------------------------------------------------------------------------------------------------------
James R. Saalfeld 5,234 * 1,067 *
- -----------------------------------------------------------------------------------------------------------------
Gary R. Garrabrant 6,323 * --- ---
- -----------------------------------------------------------------------------------------------------------------
David S. Lundeen 46,359 1.4% 12,500 9.0%
- -----------------------------------------------------------------------------------------------------------------
Joseph L. Maggini 52,645(5) 1.6% 10,000 7.2%
- -----------------------------------------------------------------------------------------------------------------
Jerry L. Ruyan 207,732 6.4% --- ---
- -----------------------------------------------------------------------------------------------------------------
All Executive Officers and
Directors as a Group 2,133,841 62.7% 95,367 68.9%
(9 Persons)
=================================================================================================================
<FN>
* Less than 1%
(1) Unless otherwise indicated, the persons named have sole voting and
investment power and beneficial ownership of the securities.
(2) Includes 2,000 shares held by Mr. Schermer, Sr.'s wife.
(3) Includes 1,551,300 shares held by MCC of which Mr. Hewett is the majority
shareholder, an executive officer and director.
(4) Includes 400 shares held by Mr. Schermer, Jr. as custodian for his minor child.
(5) Includes 2,000 shares held by Mr. Maggini jointly with his wife and 1,000 shares held directly by his wife.
</TABLE>
59
<PAGE> 60
FEDERAL INCOME TAX CONSEQUENCES
The following discussion addresses only federal income tax consequences
of the transaction to limited partners of the Wendy's Partnership.
Non-affiliated limited partners should consult with their own advisors as to the
effect of any local, state or foreign tax consequences to them. No ruling will
be sought from the Internal Revenue Service nor will any opinion be received
with respect to the tax treatment of the transaction.
The transaction will be treated for federal income tax purposes as a
termination of the Wendy's Partnership and a taxable sale of the limited
partnership units. The particular tax consequences for a non-affiliated limited
partner will depend upon a number of factors related to the particular limited
partner's tax situation, including the limited partner's adjusted tax basis in
the units. The gain or loss recognized will be based on the difference between
the value of the Meritage Common Shares received and the non-affiliated limited
partner's adjusted tax basis in such units. To the extent that the amount
realized exceeds the non-affiliated limited partner's adjusted basis for the
units sold, the limited partner will recognize a loss.
Except as described below, any gain or loss recognized upon a sale of
units will be treated as gain or loss attributable to the sale or disposition of
a capital asset. A non-affiliated limited partner would recognize ordinary
income, however, only to the extent that the amount realized upon the sale of a
unit that is considered attributable to the non-affiliated limited partner's
share of the "unrealized receivables" of the Wendy's Partnership, as defined in
Section 751 of the Internal Revenue Code, exceeds the basis attributable to
those assets. "Unrealized receivables" include, to the extent not previously
includable in Wendy's Partnership income, any rights to payment for services
rendered or to be rendered, and also any amounts that would be subject to
recapture as ordinary income (e.g., depreciation recapture with respect to
personal property) if the Wendy's Partnership had sold its assets at their fair
market value at the time of the sale of a unit. To the extent a non-affiliated
limited partner recognizes a capital loss, such loss can be applied to offset
capital gains from other sources. Individuals may use capital losses in excess
of capital gains to offset up to $3,000 of ordinary income in any single year
($1,500 for a married individual filing a separate return). Any corporation's
capital losses that are not used currently can be carried forward and used in
subsequent years. A corporation's capital losses in excess of current capital
gains generally may be carried back three years, with any remaining unused
portion available to be carried forward for five years.
Basis of Units
In general, a non-affiliated limited partner had an initial tax basis
equal to such person's cash investment in the Wendy's Partnership plus a
proportionate share of the Wendy's Partnership's nonrecourse liabilities at the
time the units were acquired. A non-affiliated limited partner's initial basis
generally has been increased by such limited partner's share of Wendy's
Partnership taxable income and any increases in his or her share of liabilities
of the Wendy's Partnership. Generally, such non-affiliated limited partner's
initial basis has been decreased, but not below zero, by the share of the
Wendy's Partnership cash distributions, any decreases in the share of
liabilities of the Wendy's Partnership, the share of losses of the Wendy's
Partnership, and the share of nondeductible expenditures of the Wendy's
Partnership that are not chargeable to capital. Because "syndication costs" are
chargeable to capital and not deductible for tax purposes, a non-affiliated
limited partner's basis in the units would include the share of the syndication
costs incurred by the Partnership at formation.
Passive Activity Income
A non-affiliated limited partner who disposes of an entire interest in
the Wendy's Partnership will be able to utilize any unused "passive" losses form
the Wendy's Partnership, net of any gain recognized on the dispositions, to
offset income, including income from sources other than the sale of units.
Any gain recognized by a non-affiliated limited partner in connection
with the sale of a unit pursuant to the transaction will constitute "passive
activity income" for purposes of the "passive activity loss" limitation rules.
Accordingly, such income generally may be offset by losses from all sources,
including suspended passive losses with respect to the Wendy's Partnership and
passive or active losses from other activities.
60
<PAGE> 61
Any loss recognized by a non-affiliated limited partner in connection
with the sale of less than all of that limited partner's units may be subject to
limitation under the passive loss rules. Non-affiliated limited partners should
consult with their own tax advisors concerning whether, and the extent to which,
the limited partner has available suspended "passive activity" losses from
either the Wendy's Partnership or other investments that may be used to offset
gain from a sale of units and whether any losses recognized are subject to
limitation under the passive loss rules.
Backup Withholding
A limited partner (other than corporations and certain foreign
individuals) may be subject to 31% backup withholding unless the limited partner
provides his or her taxpayer identification number and certifies that such
holder is not subject to backup withholding. A non-affiliated limited partner
subject to backup withholding must contact Meritage as set forth in the Letter
of Transmittal. If backup withholding applies, Meritage will withhold 31% from
payments to such non-affiliated limited partner.
DESCRIPTION OF CAPITAL SHARES
COMMON SHARES
The holders of Meritage's Common Shares, par value $.01 per share, are
entitled to one vote for each share held of record on each matter submitted to a
vote of stockholders. Cumulative voting in the election of directors is not
permitted. As a result, the holder of more than 50% of the outstanding shares
have the power to elect all members of Meritage's Board of Directors. The quorum
required at a stockholders' meeting for consideration of any matter is a
majority of the shares entitled to vote on that matter represented in person or
by proxy. If a quorum is present, the affirmative vote of a majority of the
shares represented at the meeting and entitled to vote on the matter is required
for stockholder approval, except in the case of certain major corporate actions
detailed below.
Certain major corporate actions such as the merger or liquidation of
Meritage, an amendment to Meritage's Articles of Incorporation, or the sale of
all or substantially all of Meritage's assets, require the approval of the
affirmative vote of a majority of all shares entitled to vote on the matter,
whether or not present at a meeting called for that purpose. Meritage has
elected to be subject to Chapter 7A of the Michigan Business Corporation Act.
Consequently, certain business combinations such as mergers, liquidations, sales
of assets or exchanges of shares, between Meritage and an "interested
shareholder" (as defined in the Chapter 7A) cannot be consummated unless certain
voting requirements or certain price requirements are met. The voting
requirements require (i) an advisory statement by Meritage's Board of Directors,
(ii) a vote in favor of the business combination by the holders of not less than
90% of the votes of each class of stock of Meritage entitled to be cast by
shareholders of Meritage, and (iii) a vote in favor of the business combination
by not less than 2/3 of the votes of each class of stock entitled to be cast by
shareholders of Meritage other than the "interested shareholder," its affiliates
and associates. The price requirements mandate that the holders of Common Shares
of Meritage receive cash at least equal to the higher of (i) the highest price
per share of Common Shares paid by the "interested shareholder" within a two
year period immediately prior to the announcement date of the business
combination or in the transaction in which the "interested shareholder" became
an "interested shareholder" whichever is higher, or (ii) the market value per
share of Common Shares on the announcement date or the date on which the
"interested shareholder" first became an "interested shareholder," whichever is
higher. The pricing requirements also require certain consideration to be paid
with respect to any class or series of outstanding stock other than Meritage's
Common Shares.
The Common Shares are neither redeemable nor convertible, and the
holders of Common Shares have no preemptive rights to purchase any securities of
Meritage. Subject to the rights of any preferred stock issued and so designated,
holders of Common Shares are entitled to receive ratably such dividends as may
be lawfully declared by the Board of Directors and paid by Meritage and, in the
event of liquidation, dissolution or winding up of Meritage, are entitled to
share ratably in all assets after payment of liabilities and subject to any
liquidation rights of any preferred stock issued and so designated.
All outstanding Common Shares of Meritage are validly issued, fully
paid and nonassessable. Total authorized Common Shares are 30,000,000 shares.
61
<PAGE> 62
Effective August 13, 1996, Meritage opted out of Chapter 7B of the Act.
Chapter 7B would have required purchasers of 20% or more of the Company's Common
Shares to obtain shareholder approval, or else the purchased shares would be
non-voting shares.
PREFERRED SHARES
Meritage is authorized to issue up to 5,000,000 shares of Preferred
Stock, $.01 par value per share. The Preferred Stock may be issued from time to
time in one or more series. The Board of Directors is authorized to determine
the rights, preferences, privileges and restrictions granted to and imposed upon
any series of Preferred Stock and to fix the number of shares of any series of
Preferred Stock and the designation of any such series. The issuance of shares
of Preferred Stock could adversely affect the rights of holders of Common Shares
and could be used to prevent a hostile takeover attempt.
Series A Convertible Preferred Shares
The Series A Convertible Preferred Shares is the only series authorized
by the Board of Directors. These shares have an annual dividend rate of $0.90
per share. The right to payment of dividends is cumulative, and dividends are
payable quarterly. The liquidation value of these shares is $10 per share. Upon
a dissolution, liquidation, merger of substantially all the assets, or winding
up of Meritage, the holders of these shares will be entitled to receive, before
any payment to holders of Common Shares, all accrued but unpaid dividends plus a
liquidation value of $10 per share.
The Series A Convertible Preferred Shares are convertible into Common
Shares at a conversion price of $7 for each Common Share (taking the Series A
Convertible Preferred Shares at a liquidation value of $10 per share). The
conversion price is subject to adjustment upon the subdivision into a greater or
combined into a lesser number of Common Shares, whether by stock split or stock
dividend. Upon the merger or consolidation of the Meritage, or the
reclassification of the Common Shares, the holders of Series A Convertible
Preferred Shares will be entitled to receive the stock, securities and/or
property which they would have received had they converted their Preferred
Shares into Common Shares as of the record date for determination of the holders
of Common Shares entitled to participate in such transaction.
The Series A Convertible Preferred Shares are subject to mandatory
conversion, upon the option of Meritage, whenever the average of the closing
sale prices for the Common Shares is at least 120% of the then-effective
conversion price for at least 20 trading days within a period of 30 trading
days, ending no earlier than five trading days prior to the date of the notice
of such mandatory conversion.
Holders of this Series A Convertible Preferred Shares are not entitled
to voting rights, but if Meritage fails to make six consecutive dividend
payments, the number of directors on the Board of Directors of Meritage will be
increased by two and the holders of the Series A Convertible Preferred Shares,
voting as a class, with one vote per share, will be entitled to elect two
directors, as long as any arrearages and dividend payments remain outstanding.
Meritage may not, except upon the affirmative vote of the holders of two-thirds
of the Series A Convertible Preferred Shares outstanding at the time, amend the
terms of such shares in any manner that would result in the subordination of
the Series A Convertible Preferred Shares.
TRANSFER AGENT
Meritage's transfer agent and registrar for the Common Shares is
ChaseMellon Shareholder Services of East Hartford, Connecticut.
62
<PAGE> 63
COMPARATIVE RIGHTS
Upon completion of the transaction, the limited partners of the Wendy's
Partnership, a Michigan limited partnership, will become stockholders of
Meritage, a Michigan corporation. The following summary compares a number of
differences between the rights of stockholders of Meritage versus the rights of
limited partners of the Wendy's Partnership. With respect to the capital stock
of Meritage, the summary is qualified in its entity by the more complete legal
description contained under "Description of Capital Shares."
Generally, the rights of stockholders of Meritage are governed by the
Michigan Business Corporation Act and Meritage's charter documents. The rights
of Limited Partners are generally governed by the Wendy's Partnership Agreement
and Michigan partnership law.
FEDERAL INCOME TAXATION
Meritage is classified as a corporation for Federal income tax
purposes, and as such, is taxed with respect to its income after allowable
deductions and credits. Stockholders will not be taxed with respect to
Meritage's income. They will generally be taxed with respect to dividends
received from Meritage.
The Wendy's Partnership is not a tax paying entity. Rather, each
limited partner includes that partner's share of the income and, subject to
certain limitations, the losses as such of the Wendy's Partnership, in computing
such partner's taxable income without regard to the cash distributed to the
partner. Generally, cash distributions to partners are not taxable, except to
the extent distributions exceed such partner's adjusted basis in the unit.
MANAGEMENT
The business and affairs of Meritage will be managed by or under the
direction of the Board of Directors of the Company. Meritage elects its Board of
Directors annually at its stockholders' meeting. The Meritage Bylaws provide
that vacancies resulting from death, resignation, removal, an increase in the
number of directors or otherwise may be filled by a majority vote of the
directors then in office (even if the number of directors then in office is less
than a quorum) unless filled by proper action of the shareholders. Each director
who is appointed to fill a vacancy shall hold office only until the next
election of directors by shareholders.
The general partner of a limited partnership under Michigan law is
accountable to limited partners as a fiduciary and consequently must exercise
good faith and integrity in the resolution of any conflicts of interest in all
other dealings with respect to the partnership. Under the Wendy's Partnership
Agreement, a majority in interest of the limited partners may remove the general
partner. Michigan corporate law requires directors to discharge their duties in
good faith, with the care an ordinarily prudent person in a like position would
exercise under similar circumstances and in a manner reasonably believed to be
in the best interest of the corporation. Directors may be removed, with or
without cause, by a majority of Meritage's Common Shares entitled to vote at an
election of directors.
Pursuant to the Wendy's Partnership Agreement, the general partner is
entitled to a management fee of 2% of gross operating revenues. This would have
called for payment to the general partner of $494,032 for fiscal 1994, $507,292
for fiscal 1995 and $488,767 for fiscal 1996. However, this amount was
voluntarily reduced to $160,000 for each of those years. The former general
partner also received a management fee on an annual basis of $160,000 in fiscal
1997 until its replacement by Meritage. MCC Food Service, the present general
partner, has also voluntarily agreed to reduce the management fee to an annual
basis of $160,000 for fiscal 1997.
VOTING RIGHTS
Holders of Meritage Common Shares have voting rights and are subject to
terms described under "Description of Capital."
63
<PAGE> 64
Under the Wendy's Partnership Agreement, the majority in interest of
the limited partners have the right, subject to certain limitations, to amend
the Wendy's Partnership Agreement to (i) dissolve the Wendy's Partnership, (ii)
remove a general partner and elect a substitute general partner upon such
removal, or (iii) approve or disapprove the sale of all, or substantially all,
of the assets of the Wendy's Partnership.
AMENDMENTS TO GOVERNING DOCUMENTS
Meritage's Articles of Incorporation may be amended by the holders of a
majority of all outstanding shares entitled to vote thereon at a meeting of
shareholders. Under the Wendy's Partnership Agreement, amendments must be
approved by the general partner and a majority in interest of limited partners.
No amendment can reduce a limited partner's interest or increase his or her
obligations without his or her written consent provided, however, that a limited
partner's interest can be reduced to admit additional partners.
DIVIDENDS AND DISTRIBUTIONS
Meritage presently does not intend to pay dividends on the Common
Shares. Dividends may be paid if, as, and when declared by the Board of
Directors in its sole discretion. Meritage's loan agreement with its long-term
lender currently prohibits the payment of dividends.
The Wendy's Partnership Agreement provides for cash distributions to
its limited partners. On a semi-annual basis, the general partner reviews the
Wendy's Partnership's results of operations and cash requirements and determines
the cash flow from operations available for distribution to the limited
partners. Pursuant to the Wendy's Partnership's loan agreement, the Wendy's
Partnership must maintain certain minimum Tangible New Worth and Cash
Availability (as defined in the loan agreement) which may limit the amount of
cash distributions to the limited partners.
Cash distributions for the two most recent fiscal years are set forth
below:
<TABLE>
<CAPTION>
===================================================================================================================
DATE OF DISTRIBUTION PER LIMITED PARTNERSHIP UNIT TOTAL CASH DISTRIBUTION
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
January 1995 $ 200.00 $ 253,899
- -------------------------------------------------------------------------------------------------------------------
July 1995 $ 250.00 $ 317,374
- -------------------------------------------------------------------------------------------------------------------
January 1996 $ 100.00 $ 126,950
- -------------------------------------------------------------------------------------------------------------------
July 1996 $ 150.00 $ 190,424
===================================================================================================================
</TABLE>
CONTINUITY OF EXISTENCE
Under Michigan law, Meritage has perpetual existence. Pursuant to the
Wendy's Partnership Agreement, unless otherwise terminated, the term of the
Wendy's Partnership will expire on December 31, 2026.
RIGHTS UPON LIQUIDATION
Upon liquidation, dissolution or winding up of the affairs of Meritage,
the remaining assets (after provisions for payment of creditors) are distributed
first to holders of preferred stock and second to holders of Common Shares.
In a liquidation of the Wendy's Partnership, available cash and
property would be distributed in proportion to the respective capital accounts
of the limited partners, following provisions for contingent and other
liabilities of the Wendy's Partnership.
64
<PAGE> 65
DISSENTERS' RIGHTS
Holders of Meritage shares have the right, in certain circumstances, to
dissent from certain extraordinary corporate transactions as to which they have
voting rights by demanding payment in cash for their shares equal to the fair
market value of such shares, as determined by agreement with the corporation or
by a court in an action timely brought by the corporation or the dissenters.
Under applicable Michigan limited partnership laws and the Wendy's Partnership
Agreement, limited partners have no dissenters' rights.
LIABILITY; INDEMNIFICATION
The liability of Meritage's directors to Meritage or its shareholders
is limited to the fullest extent permitted by law. Directors are not personally
liable to Meritage or its shareholders for any breach of duty as a director,
except for: a breach of the director's duty of loyalty; acts or omissions not in
good faith or involving intentional misconduct or knowing violation of law;
unlawful distributions to shareholders and loans to directors, officers or
employees; or a transaction from which the director derived an improper personal
benefit.
Michigan corporations may indemnify their directors and officers. These
provisions are generally referred to as "statutory indemnification" provisions.
Corporations are permitted to adopt charter provisions or bylaws which provide
for additional indemnification of directors and officers. These non-exclusive
provisions are generally referred to as "non-statutory indemnification"
provisions. Non-statutory indemnification provisions are generally adopted to
expand the circumstances and liberalize the conditions under which
indemnification will occur. Michigan law expressly permits indemnification of
amounts paid in settlement in connection with suits brought by or in the right
of the corporation. As a result, directors, officers, employees or agents who
agree to a settlement in a derivative suit brought on behalf of Meritage may be
indemnified by Meritage for the amount paid in settlement as well as expenses
incurred in connection with the suit if the standards set forth in Michigan law
and the Meritage Bylaws are met. The Meritage Bylaws provide that its officers,
directors, employees and agents shall be indemnified to the fullest extent
authorized or permitted by law.
The Wendy's Partnership Agreement provides that the Wendy's Partnership
will indemnify the general partner, its affiliates and their respective agents
against any loss or liability incurred by the Wendy's Partnership or by such
person in connection with the Wendy's Partnership, including reasonable
attorneys' fees; provided that the party seeking indemnification acted in good
faith and in the best interest of the Wendy's Partnership, and the loss or
liability did not result from such person's negligence or misconduct. Such
indemnification is to be recovered only from the assets of the Wendy's
Partnership.
The Wendy's Partnership will indemnify the general partner, its
affiliates and their respective agents for settlements and related expenses of
lawsuits alleging securities violations, provided that a court either approves
the settlement and the indemnification or approves indemnification of litigation
costs if a successful defense is made.
The general partner will not be personally liable to return the capital
contribution of any limited partner.
Limited partners are not bound by the obligations of the Wendy's
Partnership. Under Michigan law, a limited partner who receives distributions
which are construed as a return of capital or who receives a distribution when
limited partnership liabilities exceed limited partnership assets, may be liable
to return such funds to the limited partnership.
MEETINGS
Michigan law provides that if a corporation's annual meeting is not
held for 90 days after the date designated therefor, or for 15 months after its
last annual meeting, a court may order the meeting or election to be held upon
application by a shareholder.
65
<PAGE> 66
Under Michigan law, special meetings of stockholders may be called by
the board of directors and by such person or persons as so authorized by the
articles or the bylaws. Meritage's Bylaws provide that special meetings of
shareholders may be called at any time by the Board of Directors, the Chief
Executive Officer or shareholders owning 10% of the shares entitled to vote at
the meeting.
Meetings of the Wendy's Partnership may be called by the general
partner or by ten percent in interest of the limited partners who are affiliates
or promoters of the general partner for any matters upon which the partners may
vote.
LEGAL MATTERS
Certain legal matters in connection with the Common Shares offered
hereby will be passed upon for Meritage by Keating, Muething & Klekamp PLL,
Cincinnati, Ohio. Members of that firm beneficially own 22,500 Common Shares and
5,000 shares of the Series A Convertible Preferred Stock.
EXPERTS
Meritage's financial statements as of November 30, 1996, 1995 and, and
1994 and for the years then included in this Prospectus have been so included in
reliance on the report of Grant Thornton LLP, independent certified public
accountants, given on the authority of said firm as experts in auditing and
accounting.
The Wendy's Partnership's financial statements as of November 30, 1996
and December 31, 1995 and for the Eleven months ended November 30, 1996 and the
years ended December 31, 1995 and 1994 included in this Prospectus have been so
included in reliance on the report of BDO Seidman, LLP, independent certified
public accountants, given on the authority of said firm as experts in auditing
and accounting.
66
<PAGE> 67
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES PAGE
----
<S> <C>
Report of Independent Certified Public Accountants .........................................................M-3
Consolidated Balance Sheets - November 30, 1996 and 1995 and May 31, 1997 (unaudited).......................M-4
Consolidated Statements of Operations - Years Ended November 30, 1996, 1995 and 1994
and Six Month Periods Ended May 31, 1997 (unaudited) and May 31, 1996 (unaudited).........................M-6
Consolidated Statements of Stockholders' Equity - Years Ended November 30, 1996, 1995
and 1994 and Six Month Period Ended May 31, 1997 (unaudited)..............................................M-8
Consolidated Statements of Cash Flows - Years Ended November 30,1996, 1995
and 1994 and Six Month Periods Ended May 31, 1997 (unaudited) and May 31, 1996 (unaudited)................M-9
Notes to Consolidated Financial Statements ................................................................M-12
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP PAGE
----
Report of Independent Certified Public Accountants .........................................................W-3
Balance Sheets - November 30, 1996 and December 31, 1995 .................................................. W-5
Statements of Income - Eleven Months Ended November 30, 1996 and Years Ended
December 31, 1995 and 1994................................................................................W-7
Statements of Changes in Partners' Equity - Eleven Months ended November 30, 1996
and Years Ended December 31, 1995 and 1994 ..............................................................W-9
Statements of Cash Flows - Eleven Months Ended November 30, 1996 and Years Ended
December 31, 1995 and 1994 ..............................................................................W-10
Notes to Financial Statements .............................................................................W-13
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES PAGE
----
Unaudited Pro Forma Consolidated Balance Sheet - May 31, 1997 ..............................................P-1
Unaudited Pro Forma Consolidated Statement of Operations - Six Month Period Ended
May 31, 1997 .............................................................................................P-2
Unaudited Pro Forma Consolidated Statement of Operations - Year Ended November 30, 1996 ....................P-3
Unaudited Pro Forma Consolidated Statement of Cash Flows - Six Month Period Ended
May 31, 1997 .............................................................................................P-4
Unaudited Pro Forma Consolidated Statement of Cash Flows - Year Ended November 30, 1996 ....................P-5
Notes to Unaudited Pro Forma Consolidated Financial Statements .............................................P-6
</TABLE>
67
<PAGE> 68
CONSOLIDATED FINANCIAL STATEMENTS AND REPORT OF
INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
YEARS ENDED NOVEMBER 30, 1996, 1995 AND 1994
AND SIX MONTHS ENDED MAY 31, 1997 AND 1996
M-1
<PAGE> 69
CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
Report of Independent Certified Public Accountants............................................... M-3
FINANCIAL STATEMENTS
Consolidated Balance Sheets.................................................................. M-4
Consolidated Statements of Operations........................................................ M-6
Consolidated Statements of Stockholders' Equity.............................................. M-8
Consolidated Statements of Cash Flows........................................................ M-9
Notes to Consolidated Financial Statements................................................... M-12
</TABLE>
M-2
<PAGE> 70
Grant Thornton LLP
Accountants and Management Consultants
Suite 400
First Center Office Plaza
26911 Northwestern Highway
Southfield, Michigan 48034
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Meritage Hospitality Group Inc.
We have audited the accompanying consolidated balance sheets of Meritage
Hospitality Group Inc. (a Michigan corporation) and subsidiaries as of November
30, 1996 and 1995, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended November 30, 1996. 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 audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Meritage
Hospitality Group Inc. and subsidiaries as of November 30, 1996 and 1995 and the
consolidated results of their operations and their consolidated cash flows for
each of the three years in the period ended November 30, 1996, in conformity
with generally accepted accounting principles.
As discussed in Note G to the consolidated financial statements, effective
December 1, 1993 the Company changed its method of accounting for income taxes.
/s/ Grant Thornton LLP
Detroit, Michigan
January 21, 1997 (except for
Note N as to which
the date is August 6, 1997)
M-3
<PAGE> 71
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
================================================================================
<TABLE>
<CAPTION>
NOVEMBER 30,
---------------------------- MAY 31,
ASSETS 1996 1995 1997
----------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $ 2,265,497 $ 1,336,891 $ 1,122,182
----------- ----------- -----------
Trade accounts receivable, less allowance
for doubtful accounts of $54,000 in 1997,
$54,000 in 1996 and $29,000 in 1995
respectively 938,448 570,428 684,497
Inventories 354,226 208,891 368,106
Deferred income taxes 14,000 111,900 14,000
Refundable income taxes - 321,600
Prepaid expenses and other current assets 487,295 465,225 673,766
----------- ----------- -----------
Total Current Assets 4,059,466 3,014,935 2,862,551
PROPERTY, PLANT AND EQUIPMENT, NET 21,757,068 13,218,340 21,497,733
DEFERRED INCOME TAXES 621,000 437,100 621,000
OTHER ASSETS
Goodwill, net of amortization of $2,136,398,
$1,994,342 in 1997 and 1996 3,687,764 - 3,596,793
Land held for expansion 697,313 642,757 697,313
Financing costs, net of amortization of 81,232,
$38,591 in 1997 and 1996 605,593 - 577,952
Cash surrender value of life insurance, net of policy
loans of $111,798, $77,564 and $99,270 in
1997, 1996 and 1995, respectively 260,710 188,875 199,267
Marina development costs - - 485,386
Sundry 239,950 46,066 271,666
----------- ----------- -----------
5,491,330 877,698 5,828,377
AMOUNTS DUE FROM RELATED PARTIES - 435,430 -
----------- ----------- -----------
Total Assets $31,928,864 $17,983,503 $30,809,661
=========== =========== ===========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
M-4
<PAGE> 72
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
================================================================================
<TABLE>
<CAPTION>
NOVEMBER 30,
LIABILITIES AND ---------------------------- MAY 31,
STOCKHOLDERS' EQUITY 1996 1995 1997
----------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C>
CURRENT LIABILITIES
Note payable - Bank $ - $ 200,551 $ -
Current portion of long-term debt 395,120 237,651 922,936
Current portion of obligations under capital lease 232,442 - 250,454
Amounts due to stockholders and related parties - 2,300 -
Trade accounts payable 2,228,406 448,886 2,416,233
Accrued expenses 936,111 2,081,866 870,546
Other 164,275 - 188,071
----------- ----------- -----------
Total Current Liabilities 3,956,354 2,971,254 4,648,240
LONG-TERM DEBT 21,711,847 11,204,883 21,851,593
OBLIGATIONS UNDER CAPITAL LEASES 1,953,999 - 1,825,387
DEFERRED INCOME TAXES 818,000 752,000 818,000
DEFERRED COMPENSATION 61,444 - -
COMMITMENTS AND CONTINGENCIES (NOTES H AND N) - - -
MINORITY INTEREST 1,405,777 - 1,441,722
STOCKHOLDERS' EQUITY
Preferred stock - $0.01 par value; authorized
5,000,000 shares; 200,000 shares designated
as Series A convertible cumulative
preferred stock, issued and outstanding,
138,387 shares ($1,383,870 liquidation
value) in 1997 and 108,387 shares in 1996 and 1995 1,084 - 1,384
Common stock - $0.01 par value; authorized
30,000,000 shares; issued and outstanding
3,216,379, 3,204,483 and 3,020,150 shares,
respectively 32,045 30,200 32,164
Additional paid in capital 12,616,727 10,684,750 12,975,142
Note receivable from sale of shares (5,135,716) (5,602,532) (5,412,183)
Accumulated deficit (5,492,697) (2,057,052) (7,371,788)
----------- ----------- -----------
Total Stockholders' Equity 2,021,443 3,055,366 224,719
----------- ----------- -----------
Total Liabilities and Stockholders' Equity $31,928,864 $17,983,503 $30,809,661
=========== =========== ===========
</TABLE>
M-5
<PAGE> 73
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
================================================================================
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
FOR THE YEARS ENDED NOVEMBER 30, ENDED MAY 31,
1996 1995 1994 1997 1996
------------ ----------- ------------- ----------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenue
Room rents $ 6,281,711 $ 5,999,024 $ 6,047,510 $ 2,502,555 $ 2,571,115
Food and beverages 9,885,062 8,245,880 9,100,158 16,098,443 3,861,790
Sundry 555,049 149,321 174,761 276,918 207,568
Telephone 163,040 46,795 37,599 120,300 51,751
------------ ----------- ------------- ----------- -------------
Total revenue 16,884,862 14,441,020 15,360,028 18,998,216 6,692,224
Cost and expenses
Cost of food and beverages 3,334,434 2,863,554 3,041,499 4,870,949 1,339,262
Operating expenses 9,492,345 7,215,061 7,179,572 11,771,010 3,522,786
General and administrative expenses 3,951,400 4,979,621 2,597,278 1,934,579 1,576,310
Depreciation and amortization 1,081,704 1,426,642 1,232,187 1,077,568 449,377
------------ ----------- ------------- ----------- -------------
Total costs and expenses 17,859,883 16,484,878 14,050,536 19,654,106 6,887,735
------------ ----------- ------------- ----------- -------------
Earnings (loss) from operations (975,021) (2,043,858) 1,309,492 (655,890) (195,511)
Other income (expense)
Interest expense (1,642,735) (1,355,389) (1,206,151) (1,431,246) (724,744)
Interest income 658,007 387,099 87,028 283,431 357,652
Gain (loss) on sale of assets (6,900) 241,646 11,769 - -
Minority interest 21,079 - - (35,946) -
------------ ----------- ------------- ----------- -------------
(970,549) (726,644) (1,107,354) (1,183,761) (367,092)
------------ ----------- ------------- ----------- -------------
Earnings (loss) before federal
income tax and cumulative
effect of change in
accounting principle (1,945,570) (2,770,502) 202,138 (1,839,651) (562,603)
Federal income tax expense (benefit) (20,000) (721,400) 112,000 - 191,285
------------ ----------- ------------- ----------- -------------
Earnings (loss) before
cumulative effect of
change in accounting
principle (1,925,570) (2,049,102) 90,138 (1,839,651) (371,318)
Cumulative effect on prior years of
changing to a different method of
accounting for income taxes - - 117,300 - -
------------ ----------- ------------- ----------- -------------
Net loss $ (1,925,570) $(2,049,102) $ (27,162) $(1,839,651) $ (371,318)
============ =========== ============= =========== =============
</TABLE>
M-6
<PAGE> 74
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS - CONTINUED
================================================================================
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
FOR THE YEARS ENDED NOVEMBER 30, ENDED MAY 31,
1996 1995 1994 1997 1996
------- --------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Earnings (loss) per share
Before cumulative effect of
change in accounting principle $ (.62) $ (1.13) $ .06 $ (.59) $ (.12)
Cumulative effect of change in
accounting principle - - (.08) - -
------- --------- -------- -------- --------
After cumulative effect of change
in accounting principle $ (.62) $ (1.13) $ (.02) $ (.59) $ (.12)
======= ========= ======== ======== ========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
M-7
<PAGE> 75
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
================================================================================
<TABLE>
<CAPTION>
SERIES A NOTE RETAINED
CONVERTIBLE ADDITIONAL RECEIVABLE EARNINGS
PREFERRED COMMON PAID-IN SALE OF (ACCUMULATED
STOCK STOCK CAPITAL SHARES DEFICIT) TOTAL
------------ ------- ------------ ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 1, 1993 $ -- $15,200 $ 5,217,820 $ -- $ 19,212 $ 5,252,232
Net loss -- -- -- -- (27,162) (27,162)
------------ ------- ------------ ----------- ----------- -----------
Balance at December 1, 1994 -- 15,200 5,217,820 -- (7,950) 5,225,070
Issuance of common stock -- 15,000 5,466,930 (5,481,930) -- --
Recognition of interest income on
note receivable from sale of shares -- -- -- (120,602) -- (120,602)
Net loss -- -- -- -- (2,049,102) (2,049,102)
------------ ------- ------------ ----------- ----------- -----------
Balance at November 30, 1995 -- 30,200 10,684,750 (5,602,532) (2,057,052) 3,055,366
Issuance of 108,387 shares of preferred
stock 1,084 -- 1,082,786 -- -- 1,083,870
Issuance of 184,333 shares of common
stock -- 1,845 1,139,281 -- -- 1,141,126
Recognition of interest income on note
receivable from sale of shares -- -- -- (573,274) -- (573,274)
Dividends paid ($.50 per share) -- -- -- -- (1,510,075) (1,510,075)
Payment and present value adjustment
on note receivable from sale of shares -- -- (290,090) 1,040,090 -- 750,000
Net loss -- -- -- -- (1,925,570) (1,925,570)
------------ ------- ------------ ----------- ----------- -----------
Balance at November 30, 1996 1,084 32,045 12,616,727 (5,135,716) (5,492,697) 2,021,443
Issuance of 11,896 shares of
common stock 119 58,715 58,834
Issuance of 30,000 shares of
preferred stock 300 299,700 300,000
Dividends paid - preferred stock (39,440) (39,440)
Recognition of interest income on note
receivable from sale of shares (276,467) (276,467)
Net loss (1,839,651) (1,839,651)
------------ ------- ------------ ----------- ----------- -----------
Balance at May 31, 1997 (unaudited) $ 1,384 $32,164 $ 12,975,142 $(5,412,183) $(7,371,788) $ 224,719
============ ======= ============ =========== =========== ===========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
M-8
<PAGE> 76
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
================================================================================
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
FOR THE YEARS ENDED NOVEMBER 30, ENDED MAY 31,
1996 1995 1994 1997 1996
----------- ----------- ----------- ----------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(1,925,570) $(2,049,102) $ (27,162) $(1,839,651) $(371,318)
Adjustments to reconcile net loss to net
cash provided by operating activities
Cumulative effect of change in
accounting principle -- -- 117,300 -- --
Depreciation and amortization 1,081,704 1,426,642 1,232,187 1,077,568 449,377
Compensation paid by issuance
of preferred and
common stock 310,099 -- -- 58,834 --
Minority interest in earnings of
consolidated subsidiaries -- -- -- 35,946 --
Deferred income tax expense
(benefit) (20,000) (431,900) 14,000 -- --
Loss (gain) on disposal of
property, plant and equipment 6,900 (241,646) (11,769) -- --
Bad debt expense 32,655 280,910 8,395 -- --
Interest income on note
receivable from sale of shares (573,274) (120,602) -- (276,467) (300,130)
(Increase) decrease in assets
Accounts receivable (201,742) 84,754 (241,604) 253,951 (143,605)
Inventories 41,198 (12,131) (21,502) (13,880) --
Prepaid expenses and other
current assets 104,707 (7,477) -- (186,470) 460,761
Refundable income taxes 321,600 (318,705) (114,795) -- (191,286)
Increase in marina development
costs -- -- -- (191,141) --
Increase (decrease) in liabilities
Accounts payable and
accrued expenses (674,696) 1,814,566 34,831 146,056 (807,238)
----------- ----------- ----------- ----------- ---------
Net cash (used in) provided
by operating activities (1,496,419) 425,309 989,881 (935,254) (903,439)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property, plant and
equipment (2,211,392) (456,132) (470,858) (471,925) (769,267)
Proceeds from sale of property,
plant and equipment 40,146 616,646 100,964 -- --
Additions to amount due from
related parties -- (682,248) (673,635) -- (31,762)
Payments on amounts due from
related parties 433,130 2,270,524 694,186 -- 435,124
Acquisition of business, net of cash
acquired (3,184,460) -- -- -- --
Increase in other assets (679,214) (5,981) (30,863) (109,021) (486,371)
----------- ----------- ----------- ----------- ---------
Net cash (used in) provided
by investing activities (5,601,790) 1,742,809 (380,206) (580,946) (852,276)
</TABLE>
M-9
<PAGE> 77
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
================================================================================
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
FOR THE YEARS ENDED NOVEMBER 30, ENDED MAY 31,
1996 1995 1994 1997 1996
------------ ----------- ----------- ----------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term debt $ 37,717,705 $ 46,887 $ -- $ 750,000 $ 14,875,000
Proceeds from short-term borrowings -- -- -- -- (2,300)
Payments related to borrowings from
stockholders and related parties -- (248,163) (21,557) -- --
Principal payments of notes payable -- -- (7,640) -- --
Principal payments of long-term debt (29,446,007) (1,251,712) (409,429) (526,895) (11,587,069)
Partial prepayment of note receivable -- -- -- -- 750,000
Payments on obligations under
capital leases (29,808) -- -- (110,780) --
Collection on note receivable from
sale of shares 750,000 -- -- -- --
Proceeds from issuance of preferred
and common shares 545,000 -- -- 300,000 --
Dividends paid (1,510,075) -- -- (39,440) (1,510,075)
------------ ----------- ----------- ----------- ------------
Net cash provided by
(used in) financing
activities 8,026,815 (1,452,988) (438,626) 372,885 2,525,556
------------ ----------- ----------- ----------- ------------
Net increase (decrease)
in cash 928,606 715,130 171,049 (1,143,315) 769,841
Cash and cash equivalents - beginning
of period 1,336,891 621,761 450,712 2,265,497 1,336,891
------------ ----------- ----------- ----------- ------------
Cash and cash equivalents - end of period $ 2,265,497 $ 1,336,891 $ 621,761 $ 1,122,182 $ 2,106,732
============ =========== =========== =========== ============
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest and income taxes:
Interest $ 1,709,312 $ 1,355,389 $ 1,206,151 $ 1,359,681 $ 724,745
Income taxes $ -- $ -- $ 192,500 $ -- $ --
</TABLE>
During the six months ended May 31, 1997 non-cash activities consisted of the
acquisition of equipment in the amount of $244,637 and an increase in marina
development costs in the amount of $200,000 by the use of debt financing.
Non-cash investing activities for the year ended November 30, 1996 represents
the acquisition of majority equity interest in Wendy's of West Michigan Limited
Partnership and includes assets acquired and liabilities assumed.
<TABLE>
<S> <C>
Fair value of assets net of cash acquired $10,532,850
Liabilities assumed 7,348,390
-----------
$ 3,184,460
===========
</TABLE>
M-10
<PAGE> 78
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
================================================================================
In connection with this acquisition, the Company issued 171,900 shares of common
stock and 29,520 shares of preferred stock with a value of $1,369,575.
During the year ended November 30, 1995 a non-cash transaction occurred whereby
1,500,000 Common Shares were issued in exchange for a non-interest bearing note
receivable in the amount of $10,500,000. The discounted present value of the
note receivable was $5,481,930.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
M-11
<PAGE> 79
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
NOTE A - NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
The Company conducts its operations in two business segments. The lodging
industry segment consists of three full service hotels. The food service
industry segment consists of a limited partnership which operates twenty-six
Wendy's Old Fashioned Hamburger restaurants under franchise agreements with
Wendy's International Inc. All operations of the Company are located in
Michigan.
INTERIM FINANCIAL DATA
The consolidated financial statements and related notes thereto as of May 31,
1997 and for the six months ended May 31, 1997 and 1996 are unaudited. The
information reflects all adjustments, consisting only of normal recurring
entries, that, in the opinion of management, are necessary to present fairly the
financial position, results of operations and cash flows of the Company for the
periods indicated. Results of operations for the interim periods are not
necessarily indicative of the results of operations for the full fiscal year.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
the following wholly-owned subsidiaries:
St. Clair Inn, Inc.
Thomas Edison Inn, Incorporated
Grand Harbor Resort
Grand Harbor Yacht Club Inc.
MCC Food Service
All significant intercompany balances and transactions have been eliminated.
INVENTORIES
Inventories are stated at the lower of cost or market as determined by the
first-in, first-out method. Inventories consist of restaurant food items,
beverages and food serving supplies.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost. Depreciation is computed
principally using the straight-line method based upon estimated useful lives
ranging from 3 to 39 years. Amortization of leasehold improvements is provided
over the terms of the various leases.
INCOME TAXES
Income taxes are accounted for by using an asset and liability approach.
Deferred tax assets and liabilities are recognized for the expected future tax
consequences of temporary differences between the financial basis and tax basis
of assets and liabilities. Assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled.
FRANCHISE FEES
Franchise fees for hotel and restaurant units are amortized using the
straight-line method over the terms of the individual franchise agreements.
M-12
<PAGE> 80
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
NOTE A - NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FINANCING COSTS
Financing costs are amortized using the straight-line method over the terms of
the various loan agreements.
GOODWILL
Goodwill is amortized using the straight-line method over periods of up to
twenty years.
The Company evaluates the reasonableness of its amortization for goodwill. In
addition, if it becomes probable that expected future undiscounted cash flows
associated with goodwill are less than the carrying value, the assets are
written down to their fair value.
OBLIGATIONS UNDER CAPITALIZED LEASES
Lease transactions relating to certain restaurant buildings and equipment are
classified as capital leases. These assets have been capitalized and the related
obligations recorded based on the fair market value of the assets at the
inception of the leases. Amounts capitalized are being amortized over the terms
of the leases.
FRANCHISE COSTS AND OTHER ADVERTISING COSTS
Royalties and national advertising costs are based on a percentage of monthly
sales. These costs and other advertising costs are charged to operations as
incurred.
USE OF ESTIMATES
In the preparation of financial statements management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and revenue and expenses
during the reporting period. Actual results could differ from those estimates.
EARNINGS (LOSS) PER SHARE
Earnings (loss) per share is computed based upon the weighted average number of
shares outstanding during each year. The weighted average number of shares
outstanding is 3,212,097 and 3,020,150 for the six months ended May 31, 1997 and
1996 and 3,081,885, 1,815,984 and 1,520,150 shares for the years ended November
30, 1996, 1995 and 1994, respectively.
CASH EQUIVALENTS
For purposes of the statement of cash flows, the Company considers all highly
liquid debt instruments purchased with a maturity of three months or less to be
cash equivalents.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of financial instruments approximate their fair values.
M-13
<PAGE> 81
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
NOTE A - NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECLASSIFICATIONS
Certain reclassifications have been made to the 1995 and 1994 financial
statements to conform to the presentation of the 1996 financial statements.
NEW PRONOUNCEMENTS
In March 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 121 (SFAS 121) - "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of".
SFAS 121 establishes accounting standards for the impairment of long-lived
assets, certain identifiable intangibles and goodwill related to those assets to
be held and used and for long-lived assets and certain intangibles to be
disposed of. The adoption of this standard in 1996 had no effect on the
consolidated financial statements of the Company.
In October 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123 (SFAS 123) - "Accounting for Stock-Based
Compensation." SFAS 123 establishes accounting and reporting standards for
stock-based employee compensation plans with adoption required for fiscal years
beginning after December 15, 1995. As permitted under the provisions of this
statement, the Company has elected to continue the use of APB Opinion No. 25 to
measure compensation costs and will make the pro forma disclosures of net
earnings and earnings per share.
NOTE B - ACQUISITION
During the year, the Company began purchasing partnership units in Wendy's of
West Michigan Limited Partnership (the "Wendy's Partnership") and at November
30, 1996 the Company had acquired a majority interest (54.0%). Certain of the
units in the Wendy's Partnership were purchased from Stockholders/Directors at
prices no more favorable than that paid to non-related parties. The Company then
transferred this interest to its wholly-owned subsidiary, MHG Food Service Inc.
The acquisition has been accounted for as a purchase and the acquisition cost
has been allocated to assets acquired and liabilities assumed based upon
estimates of their fair values. A total of $1,719,819, representing the excess
of acquisition cost over the fair value of assets acquired has been allocated to
goodwill.
M-14
<PAGE> 82
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
NOTE B - ACQUISITION (CONTINUED)
The Company's consolidated results of operations include the Wendy's Partnership
activity from November 1, 1996 (effective date of acquisition). The unaudited
pro forma information below presents combined results of operations as if the
acquisition had occurred at the beginning of the periods presented. The
unaudited pro forma information is not necessarily indicative of the results of
operations of the combined company had the acquisition occurred at the beginning
of the periods presented, nor is it necessarily indicative of future results.
<TABLE>
<CAPTION>
YEARS ENDED NOVEMBER 30,
-------------------------------
1996 1995
----------- -----------
(UNAUDITED)
<S> <C> <C>
Revenues $43,974,000 $39,806,000
Net loss $(2,256,000) $(2,330,000)
Loss per share $ (.73) $ (1.28)
</TABLE>
The Company entered into an agreement on October 21, 1996, to acquire the
General Partnership interest in the Wendy's Partnership.
NOTE C - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are summarized as follows:
<TABLE>
<CAPTION>
NOVEMBER 30,
---------------------------- MAY 31,
1996 1995 1997
----------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Land and improvements $ 2,014,914 $ 1,515,513 $ 1,638,861
Buildings and improvements 21,597,196 18,522,242 22,006,170
Furnishings and equipment 14,552,410 7,067,815 15,038,217
Leasehold improvements 2,192,253 - 2,269,187
Leased property/capital leases 2,825,338 - 2,825,338
----------- ----------- -----------
43,182,111 27,105,570 43,777,773
Less accumulated depreciation
and amortization (21,425,043) (13,887,230) (22,280,040)
----------- ----------- -----------
$21,757,068 $13,218,340 $21,497,733
=========== =========== ===========
</TABLE>
Depreciation and amortization expense was approximately $1,012,000, $883,000 and
$1,047,000 for the years ended November 30, 1996, 1995 and 1994, and $882,000
and $449,000 for the six months ended May 31, 1997 and 1996, respectively.
M-15
<PAGE> 83
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
NOTE D - AMOUNTS DUE FROM RELATED PARTIES AND RELATED PARTY TRANSACTIONS
Amounts due from related parties at November 30, 1995 consisted of amounts due
from a stockholder and former officer of the Company, Donald W. Reynolds
("Reynolds"), or from companies related by common ownership to Reynolds. During
the year ended November 30, 1996, the Company collected approximately $433,000
of these receivables and wrote off the remainder.
In 1994 and 1995, the Company and each of its subsidiaries had a management
agreement with an affiliated company that was wholly-owned by Reynolds. The
agreement was terminated on January 25, 1996. Management fees charged to
operations totaled approximately $58,000, $403,000 and $457,000 for the years
ended November 30, 1996, 1995 and 1994, respectively. The Board of Directors
approved a 1-1/2% loan guarantee fee to be paid to Reynolds for the years ended
November 30, 1995 and 1994. The fee paid was $193,875 for 1995 and $193,500 for
1994.
NOTE E - ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
NOVEMBER 30,
------------------------- MAY 31,
1996 1995 1997
-------- ---------- --------
(unaudited)
<S> <C> <C> <C>
Litigation expenses $ - $1,361,470 $ -
Professional fees 56,697 246,788 4,000
Property taxes 213,005 189,461 292,859
Payroll and related payroll taxes 526,812 125,685 439,369
Interest and other expenses 139,597 158,462 134,318
-------- ---------- --------
$936,111 $2,081,866 $870,546
======== ========== ========
</TABLE>
NOTE F - LONG-TERM DEBT
Long-term debt consists of the following obligations at:
<TABLE>
<CAPTION>
NOVEMBER 30,
---------------------------- MAY 31,
1996 1995 1997
---------- ---------- ----------
(unaudited)
<S> <C> <C> <C>
Mortgage note payable to bank, due $23,174 per
month including interest at prime plus 2% not to
exceed 10.5% due October 1, 1997 $ -- $2,924,975 $ --
Mortgage note payable to bank, due $28,108 per
month including interest at prime plus 1%, due
October 31, 1997 -- 3,464,780 --
Term note payable to bank, due $16,531 per month
including interest at prime plus 1% due October
31, 1997 -- 808,922 --
</TABLE>
M-16
<PAGE> 84
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
==================================================
NOTE F - LONG-TERM DEBT (CONTINUED)
<TABLE>
<CAPTION>
NOVEMBER 30,
------------------------ MAY 31,
1996 1995 1997
---------- ---------- ----------
(unaudited)
<S> <C> <C> <C>
Mortgage note payable to bank, due $37,194 per
month including interest at prime plus 2% but not
to exceed 10.5%, due October 1, 1997 -- 3,929,506 --
Mortgage note payable to insurance company, due in
monthly installments beginning January 1, 1997 of
$137,897 including interest at 10.3% through
December 31, 2003. (1) 14,000,000 -- 13,891,775
Mortgage note payable to insurance company, due in
monthly installments of interest at prime plus 8%
beginning January 1, 1997 through November 1, 1997
and monthly installments of principal of $50,000
beginning December 1, 1997 through March 1, 1998,
$100,000 beginning April 1, 1998 through May 1,
2002 plus interest and final principal payment of
$50,000 plus interest due June 1, 2002. (2) 5,250,000 -- 5,250,000
Note payable to bank, due in monthly installments
of $14,693 including interest at 8.8% through
October 8, 2000. (3) 582,359 -- 518,665
Term note payable to bank, due in monthly
installments of $43,313, including interest at 1%
over prime per month through February 2005 when
any remaining unpaid principal will be due. Under
the revolving loan agreement, the required monthly
payments described above may be offset by
additional borrowings up to the unused available
borrowings. The total available borrowings under
the loan agreement were $2,978,702 as of November
30, 1996. (4) 2,192,351 -- 1,886,536
Note payable to Chairman of the Board and
shareholder, interest due monthly at prime plus 8%
beginning April 15, 1997. Principal is due the
later of December 31, 1997 or 91 days after the
Company's primary lender is paid in full -- -- 750,000
</TABLE>
M-17
<PAGE> 85
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
==================================================
NOTE F - LONG-TERM DEBT (CONTINUED)
<TABLE>
<CAPTION>
NOVEMBER 30,
------------------------- MAY 31,
1996 1995 1997
----------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Mortgage note payable to insurance company due in
monthly installments of interest at prime plus 1%
beginning June 1, 1997. Principal payments of
$35,000 are required at the time of the sale of
any of the marina condominium units. The total
available borrowings was $675,000 as of May 31,
1997 -- -- 200,000
Other notes and land contracts payable, requiring
monthly payments aggregating $4,100 and $8,950,
respectively, subject to interest at rates ranging
from 6.9% to 11.0% 82,257 314,351 277,553
----------- ----------- -----------
22,106,967 11,442,534 22,774,529
Less current portion 395,120 237,651 922,936
----------- ----------- -----------
$21,711,847 $11,204,883 $21,851,593
=========== =========== ===========
</TABLE>
The prime lending rate was 8.25% at November 30, 1996 and 8.50% at May 31, 1997.
(1) The mortgage is collateralized by the hotel properties.
(2) The mortgage is collateralized by the Meritage Capital Corp. note, common
stock of the Company, life insurance policies in the amount of $5,100,000,
other property and equipment and a second security interest in the hotel
properties.
(3) The note is collateralized by certain equipment.
(4) The note is collateralized by substantially all of the assets of the
Wendy's Partnership and by the guaranty of the General Partner and the
personal guarantees of the shareholders of the General Partner.
Minimum principal payments on long-term debt to maturity as of November 30, 1996
are as follows:
<TABLE>
<S> <C>
1997 $ 395,120
1998 1,389,380
1999 1,678,253
2000 1,997,253
2001 1,911,939
Thereafter 14,735,022
-----------
$22,106,967
===========
</TABLE>
M-18
<PAGE> 86
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
NOTE F - LONG-TERM DEBT (CONTINUED)
Loan covenants of the various loan agreements include a requirement for
maintenance of a prescribed amount of net worth and certain financial ratios and
restrictions on certain common stock purchases, dividends, additional
indebtedness and executive compensation. At November 30, 1996 the Company failed
to meet one of the covenants of its agreements with the insurance company. A
waiver has been obtained.
NOTE G - INCOME TAXES
In December 1993, the Company changed its method of accounting for income taxes
from Accounting Principles Board Opinion No. 11 (APB 11) and adopted Statement
of Financial Accounting Standards No. 109 (SFAS 109), "Accounting for Income
Taxes." The adoption of SFAS 109 changed the Company's method of accounting for
income taxes from the deferred method to an asset and liability approach.
Previously, the Company deferred the past tax effects of timing differences
between financial reporting and taxable income. The asset and liability approach
requires the recognition of deferred tax liabilities and assets for the expected
future tax consequences of temporary differences between the carrying amounts
and the tax bases of assets and liabilities.
Income tax expense is summarized as follows:
<TABLE>
<CAPTION>
FOR THE YEARS FOR THE SIX MONTHS
ENDED NOVEMBER 30, ENDED MAY 31,
1996 1995 1994 1997 1996
--------- --------- -------- -------- ---------
(unaudited)
<S> <C> <C> <C> <C> <C>
Current expense (benefit) $ - $(289,500) $ 98,000 $ - $(191,825)
Deferred expense (benefit) (20,000) (431,900) 14,000 - -
--------- --------- -------- -------- ---------
$ (20,000) $(721,400) $112,000 $ - $(191,825)
========= ========= ======== ======== =========
</TABLE>
Deferred tax assets and liabilities at November 30, consist of the following:
<TABLE>
<CAPTION>
NOVEMBER 30,
-------------------------- MAY 31,
1996 1995 1997
---------- --------- ----------
(unaudited)
<S> <C> <C> <C>
Deferred tax assets:
Net operating loss carryforward $1,181,000 $ 267,400 $1,832,000
AMT credit carryforward 105,000 140,000 105,000
Allowance for doubtful accounts 8,500 111,900 8,500
Michigan Single Business Tax - Federal 63,000 69,000 63,000
Contribution carryforward 6,500 - 6,500
---------- --------- ----------
1,364,000 588,300 2,015,000
Deferred tax liabilities
Depreciation (635,000) (549,000) (715,000)
Michigan Single Business Tax - State (183,000) (203,000) (183,000)
---------- --------- ----------
(818,000) (752,000) (898,000)
Less valuation allowance (729,000) (39,300) (1,300,000)
---------- --------- ----------
Net deferred tax liability $ (183,000) $(203,000) $ (183,000)
========== ========= ==========
</TABLE>
M-19
<PAGE> 87
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
NOTE G - INCOME TAXES (CONTINUED)
The net operating loss carryforward expires in 2010 - 2012.
The change in the valuation allowance is primarily attributable to the increase
in net operating loss carryforward.
The income tax provision reconciled to the tax computed at the statutory Federal
rate was as follows:
<TABLE>
<CAPTION>
FOR THE YEARS FOR THE SIX MONTHS
ENDED NOVEMBER 30, ENDED MAY 31,
1996 1995 1994 1997 1996
--------- --------- -------- --------- ---------
(unaudited)
<S> <C> <C> <C> <C> <C>
Tax (benefit) at statutory
rates applied to income
before federal income tax $(654,700) $(942,000) $ 68,700 $(625,000) $(191,285)
Effect of nondeductible items (51,000) 24,700 43,300 54,000 --
Difference in rates of net operating loss carrybacks -- 151,300 -- -- --
Other (4,000) 5,300 -- -- --
Valuation allowance 689,700 39,300 -- 571,000 --
--------- --------- -------- --------- ---------
$ (20,000) $(721,400) $112,000 $ -- $(191,285)
========= ========= ======== ========= =========
</TABLE>
NOTE H - LEASE COMMITMENTS
The Wendy's Partnership leases land and buildings used in operations under
operating agreements, with remaining lease terms (including renewal options of
up to twelve years) ranging from one to seventeen years. Included in the leases
are five with parties related through common ownership of general partners,
where a stockholder of the general partner is also a stockholder/director of the
Company.
Certain restaurant leases (eight restaurant buildings, excluding land which is
accounted for as an operating lease) and equipment leases have been capitalized.
Minimum future obligations under capital leases and noncancellable operating
leases in effect are as follows:
<TABLE>
<CAPTION>
OPERATING LEASES
----------------------------
CAPITAL RELATED
YEARS ENDING NOVEMBER 30, LEASES PARTIES OTHERS
------------------------- ---------- ---------- ----------
<S> <C> <C> <C>
1997 $ 465,323 $ 285,552 $ 362,378
1998 465,323 153,127 294,506
1999 465,323 111,629 208,334
2000 465,323 111,629 193,511
2001 449,365 111,629 172,440
Later Years 769,948 419,892 344,880
--------- --------- ---------
Total minimum lease obligations 3,080,605 $1,193,458 $1,576,049
========== ==========
Less amount representing interest imputed
at approximately 11% 894,164
---------
Present value of minimum lease obligations $2,186,441
==========
</TABLE>
M-20
<PAGE> 88
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
NOTE H - LEASE COMMITMENTS (CONTINUED)
The present value of minimum rental obligations is reflected in the balance
sheets as current and long-term obligations under capital leases.
Accumulated amortization of leased property under capital leases was $1,648,146,
at November 30, 1996.
In addition to minimum future obligations, percentage rentals may be paid under
all restaurant leases on the basis of percentage of sales in excess of minimum
prescribed amounts.
Total rental expense since the date of acquisition of the Wendy's Partnership is
not significant.
NOTE I - SERIES A CONVERTIBLE CUMULATIVE PREFERRED STOCK
In 1996, the Company designated a series of non-voting preferred stock
consisting of 200,000 shares of $0.01 par value. The shares have an annual
dividend rate of $0.90 per share and the payment of the dividends are
cumulative. The shares are also convertible into common shares at the conversion
price of $7.00 per share. The shares also have a liquidation value of $10.00 per
share.
Under certain conditions relating to the market value of the Company's common
stock, the Company has the option to cause the preferred stock to be converted
into common stock.
NOTE J - NOTE RECEIVABLE FROM SALE OF SHARES
On September 19, 1995, a stock purchase and sale agreement (Agreement) was
executed by the Company, its principal stockholder and Meritage Capital Corp.
("MCC"). Under the agreement, the Company sold 1,500,000 shares of previously
authorized newly issued common stock to MCC at a total price of $10,500,000.
Upon execution of the agreement, MCC gave the Company a non-interest bearing
promissory note in the amount of $10,500,000. The Note provides that MCC does
not have to make any payments to the Company for five years from the date of the
Note (September 19, 1995). Beginning on the fifth anniversary of the Note, MCC
is required to make six annual payments of $1,625,000.
The Note is secured by the shares issued to MCC under the Agreement. The Note
was discounted at 11% and is recorded as a reduction of stockholders' equity.
During the year ended November 30, 1996 the Company received an unscheduled
principal payment of $750,000. As a result, the present value of the note was
recalculated and reduced by approximately $290,000.
M-21
<PAGE> 89
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
NOTE K - EMPLOYEE BENEFIT PLANS
The Company maintains a defined contribution 401(k) plan that covers
substantially all employees of the lodging industry segment and corporate
employees. Contributions to the Plan may be made by the Company (which are
discretionary) or by plan participants through elective salary reductions. No
contributions were made to the plan by the Company during six months ended May
31, 1997 and 1996 and the years ended November 30, 1996, 1995 and 1994.
The Wendy's Partnership maintains a 401(k) profit sharing plan that covers
substantially all of its employees. Contributions to the plan may be made by the
subsidiary (which are discretionary) or by plan participants through elective
salary reductions. Contributions to the plan by the subsidiary since its date of
acquisition are not significant.
The Wendy's Partnership has a deferred compensation agreement with a key
employee which provides for the payment of $150,000 upon the completion of the
five-year term of the agreement in December 1998. The agreement is funded by the
Wendy's Partnership through payment of premiums on a split dollar life insurance
contract.
NOTE L - STOCK OPTION PLANS
The 1996 Management Equity Incentive Plan ("Incentive Plan") and, the 1996
Directors' Share Option Plan ("Directors' Plan") were approved by stockholders
on May 21, 1996.
The Incentive Plan provides for 300,000 shares of common stock to be reserved
for options that may be issued under the plan. The Board of Directors has the
discretion to designate an option to be an Incentive Share Option or a
non-qualified share option. The plan provides that the option price is not less
than the fair market value of the common stock at the date of grant. Unless the
option agreement provides otherwise, options granted under the plan become
exercisable on a cumulative basis at the rate of 20 percent during each of the
second through fifth years after the date of grant. Options granted under the
plan may have a term of from one to ten years.
The Directors' Plan provides for the non-discretionary grant of options to
non-employee directors of the Company to purchase a combined maximum of 60,000
shares. The plan provides that the option price is not less than the greater of
the fair market value of the common stock on the date of grant or $7.00 per
share. The plan provides that each non-employee director, on the date such
person becomes a non-employee director, will be granted options to purchase
5,000 shares of stock. Provided that such person is still serving as a
non-employee director, they will automatically be granted options to purchase
1,000 additional shares each year thereafter on the date of the Annual
Shareholders' Meeting. Options granted under the plan have a term of ten years.
M-22
<PAGE> 90
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
NOTE L - STOCK OPTION PLANS (CONTINUED)
The following table summarizes the changes in the number of common shares under
stock options granted pursuant to the preceding plans:
<TABLE>
<CAPTION>
1996 MANAGEMENT 1996 DIRECTOR'S
EQUITY INCENTIVE PLAN STOCK OPTION PLAN
--------------------------- -------------------------
AVERAGE AVERAGE
OPTION PRICE OPTION PRICE
SHARES PER SHARE SHARES PER SHARE
-------- ------------ ------ -----------
<S> <C> <C> <C> <C>
Options outstanding at December 1, 1995 - - - -
Options granted during the year 190,000 50,000
------- ------
Options outstanding at November 30, 1996 190,000 $7.00 50,000 $7.00
Options granted during the period 113,500 6,000
------- ------
Options outstanding at May 31, 1997 303,500 $7.00 56,000 $7.00
======= ======
Options exercisable at November 30, 1996 - 50,000
======= ======
Options exercisable at May 31, 1997 28,500 56,000
======= ======
Options available for grant at November 30, 1996 110,000 10,000
======= ======
Options available for grant at May 31, 1997 171,500 64,000
======= ======
</TABLE>
NOTE M - BUSINESS SEGMENT INFORMATION
The Company operates in two business segments, lodging and food service
operations. Intersegment transactions are not reported separately since they are
not significant.
Identifiable assets are those assets applicable to the respective industry
segment.
Data by business segment is as follows:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED NOVEMBER 30, 1996
--------------------------------------------
LODGING FOOD
GROUP SERVICE CONSOLIDATED
------------ ------------ ------------
<S> <C> <C> <C>
Revenues $ 14,762,822 $ 2,122,040 $ 16,884,862
Loss from operations $ (966,885) $ (8,136) $ (975,021)
Identifiable assets $ 21,418,956 $ 10,509,908 $ 31,928,864
Depreciation and amortization expense $ 1,009,771 $ 71,933 $ 1,081,704
Capital additions $ 2,198,341 $ 13,051 $ 2,211,392
</TABLE>
M-23
<PAGE> 91
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
NOTE M - BUSINESS SEGMENT INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED MAY 31, 1997
(UNAUDITED)
------------------------------------------------
LODGING FOOD
GROUP SERVICE CONSOLIDATED
----------- ----------- ------------
<S> <C> <C> <C>
Revenues $ 5,956,766 $13,041,450 $18,998,216
Earnings (loss) from operations (954,665) 298,775 (655,890)
Identifiable assets 21,730,195 9,079,466 30,809,661
Depreciation and amortization expense 619,620 457,948 1,077,568
Capital additions 323,364 393,198 716,562
</TABLE>
NOTE N - LEGAL PROCEEDINGS
The Company is involved in certain routine legal proceedings which are
incidental to the business. Except as described below, all of these proceedings
arose in the ordinary course of the Company's business and, in the opinion of
the Company, any potential liability of the Company with respect to these legal
actions will not, in the aggregate, be material to the Company's financial
condition. The Company maintains various types of insurance which cover most of
the actions brought against the Company.
On December 5, 1996, the Company received a notice from the Internal Revenue
Service that approximately $2.1 million, which the Company deducted as a
business expense in connection with litigation in 1995 and 1996 relating to the
replacement and restructuring of former management, should be treated as a
capital expenditure and, therefore, disallowed as a deduction. The Company
believes the deduction was proper and is vigorously contesting the disallowance.
To the extent the IRS completely prevails in its position, the Company would be
required to make a payment of approximately $340,000 in additional federal and
state income taxes, not including any interest or penalties. If the Company is
able to carry back its 1996 tax loss, any amount that the Company would be
required to pay would be refunded within 120 days of payment.
NOTE O - SUBSEQUENT EVENTS
On May 19, 1997, Wendy's West Michigan, Inc. was removed as general partner of
the Wendy's Partnership and replaced with MCC Food Service, an affiliate of
Meritage. On May 21, 1997, Wendy's West Michigan, Inc. commenced a lawsuit
against Meritage, MHG Food Service, and MCC Food Service (Case No. 97-05360-CB,
Kent County (Michigan) Circuit Court, Buth, J.). Wendy's West Michigan, Inc. has
attempted to assert claims on behalf of the Wendy's Partnership as well. The
complaint seeks, among other things, (i) a declaration that Wendy's West
Michigan, Inc. is the general partner of the Wendy's Partnership, (ii)
injunctive relief in the form of a temporary restraining order or a preliminary
injunction which would prohibit the defendants from participating in the
management of the Wendy's Partnership, and (iii) damages for various business
torts. Plaintiff's motion for a temporary restraining order was denied on May
21, 1997. Defendants believe that the lawsuit is entirely without merit and are
seeking its dismissal.
The loan agreement with the Company's primary lender contains numerous covenants
regarding the maintenance of a prescribed amount of net worth, certain financial
ratios, and restrictions on certain common stock purchases, dividends,
additional indebtedness and executive compensation. At May 31, 1997, the Company
failed to meet certain of these covenants. However, a waiver has been obtained
through December 30, 1997.
M-24
<PAGE> 92
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
======================================================
FINANCIAL STATEMENTS
ELEVEN MONTHS ENDED NOVEMBER 30, 1996 AND
YEARS ENDED DECEMBER 31, 1995 AND 1994
W-1
<PAGE> 93
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
CONTENTS
================================================================================
<TABLE>
<S> <C>
INDEPENDENT AUDITORS' REPORT W-3
FINANCIAL STATEMENTS
Balance Sheets W-5
Statements of Income W-7
Statements of Changes in Partners' Equity W-9
Statements of Cash Flows W-10
Notes to Financial Statements W-13
</TABLE>
W-2
<PAGE> 94
BDO Seidman, LLP
Accountants and Consultants
99 Monroe Avenue N.W., Suite 800
Grand Rapids, Michigan 49503
INDEPENDENT AUDITORS' REPORT
To the Partners
Wendy's of West Michigan
Limited Partnership
Kalamazoo, Michigan
We have audited the accompanying balance sheets of Wendy's of West Michigan
Limited Partnership as of November 30, 1996 and December 31, 1995, and the
related statements of income, changes in partners' equity and cash flows for the
eleven months ended November 30, 1996 and years ended December 31, 1995 and
1994. These financial statements are the responsibility of the Partnership'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 that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Wendy's of West Michigan
Limited Partnership at November 30, 1996 and December 31, 1995, and the results
of its operations and its cash flows for the eleven months ended November 30,
1996 and years ended December 31, 1995 and 1994, in conformity with generally
accepted accounting principles.
/s/ BDO Seidman, LLP
January 10, 1997
W-3
<PAGE> 95
WENDY'S OF WEST MICHIAGN LIMITED PARTNERSHIP
================================================================================
FINANCIAL STATEMENTS
======================================================
W-4
<PAGE> 96
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
BALANCE SHEETS
================================================================================
<TABLE>
<CAPTION>
NOVEMBER 30, December 31,
1996 1995
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS (Note 3)
CURRENT ASSETS
Cash $ 394,066 $ 411,198
Receivables, including amounts due from related parties 215,879 53,887
Inventories 180,250 145,807
Prepaid expenses 125,445 139,202
- -----------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 915,640 750,094
- -----------------------------------------------------------------------------------------------------------------
PROPERTY AND EQUIPMENT
Land 749,000 749,000
Leasehold improvements 2,192,253 2,156,926
Buildings and improvements 2,398,127 2,398,127
Furnishings and equipment 4,296,289 3,595,913
Vehicles 79,734 83,826
Leased property under capital leases (Note 4) 2,825,338 2,825,338
- -----------------------------------------------------------------------------------------------------------------
12,540,741 11,809,130
Less accumulated depreciation and amortization 6,643,697 6,137,807
- -----------------------------------------------------------------------------------------------------------------
NET PROPERTY AND EQUIPMENT 5,897,044 5,671,323
- -----------------------------------------------------------------------------------------------------------------
OTHER ASSETS
Goodwill, net of amortization of $1,981,200 and $1,799,590 1,981,087 2,162,697
Franchise fees, net of amortization of $395,488 and $365,643 154,512 184,357
Other 127,404 63,534
- -----------------------------------------------------------------------------------------------------------------
TOTAL OTHER ASSETS 2,263,003 2,410,588
- -----------------------------------------------------------------------------------------------------------------
$ 9,075,687 $ 8,832,005
=================================================================================================================
</TABLE>
W-5
<PAGE> 97
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
BALANCE SHEETS
================================================================================
<TABLE>
<CAPTION>
NOVEMBER 30, December 31,
1996 1995
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
LIABILITIES AND PARTNERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 770,770 $ 785,355
Accruals:
Salaries and wages 349,320 305,044
Taxes 267,698 293,705
Percentage rent 107,257 79,816
Other current liabilities, including amounts due to related parties 38,546 38,963
Current maturities of obligations under capital leases (Note 4) 232,442 159,572
- --------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 1,766,033 1,662,455
DEFERRED COMPENSATION (Note 2) 61,444 -
OBLIGATIONS UNDER CAPITAL LEASES, less current maturities (Note 4) 1,953,999 1,808,828
LONG-TERM DEBT, less current maturities (Note 3) 2,192,351 2,500,340
- --------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 5,973,827 5,971,623
- --------------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES (Notes 1, 2, 4 and 5)
PARTNERS' EQUITY (Note 1)
Limited Partners 3,130,775 2,891,712
General Partner (28,915) (31,330)
- --------------------------------------------------------------------------------------------------------------------
TOTAL PARTNERS' EQUITY 3,101,860 2,860,382
- --------------------------------------------------------------------------------------------------------------------
$ 9,075,687 $ 8,832,005
====================================================================================================================
</TABLE>
See accompanying notes to financial statements.
W-6
<PAGE> 98
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
STATEMENTS OF INCOME
================================================================================
<TABLE>
<CAPTION>
ELEVEN Years ended
MONTHS ENDED December 31,
NOVEMBER 30, ------------------------------------
1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
NET SALES $24,438,338 $25,364,596 $24,701,627
COST OF SALES 7,222,691 7,390,886 7,295,008
- --------------------------------------------------------------------------------------------------------------------
Gross profit 17,215,647 17,973,710 17,406,619
- --------------------------------------------------------------------------------------------------------------------
EXPENSES (INCOME)
Restaurant operating costs, including
amounts to related parties:
Labor 6,747,046 6,962,082 6,396,415
Occupancy 2,555,026 2,526,139 2,305,252
Advertising 1,535,930 1,519,903 1,464,845
Food service supplies 1,008,536 1,087,791 1,023,853
Royalties 977,508 1,014,569 988,084
Other 1,838,291 1,988,597 1,808,872
- --------------------------------------------------------------------------------------------------------------------
Total restaurant operating costs 14,662,337 15,099,081 13,987,321
General and administrative expenses, including
amounts to related parties 1,046,177 1,250,468 1,278,659
Depreciation and amortization 768,653 852,803 856,871
Interest expense 403,435 511,939 557,056
Loss (gain) on sale of assets 25,453 1,097 (5,675)
Other income (249,260) (236,309) (208,256)
Insurance proceeds in excess of net book value of
fire damaged assets - (32,377) -
- --------------------------------------------------------------------------------------------------------------------
Net expenses 16,656,795 17,446,702 16,465,976
- --------------------------------------------------------------------------------------------------------------------
Income before extraordinary item 558,852 527,008 940,643
EXTRAORDINARY ITEM - loss on extinguishment of debt
- (20,536) -
- --------------------------------------------------------------------------------------------------------------------
NET INCOME $ 558,852 $ 506,472 $ 940,643
====================================================================================================================
</TABLE>
W-7
<PAGE> 99
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
STATEMENTS OF INCOME
================================================================================
<TABLE>
<CAPTION>
ELEVEN Years ended
MONTHS ENDED December 31,
NOVEMBER 30, ------------------------------------
1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income attributed to:
Limited Partners $ 553,263 $ 501,407 $ 931,237
General Partner 5,589 5,065 9,406
- --------------------------------------------------------------------------------------------------------------------
$ 558,852 $ 506,472 $ 940,643
====================================================================================================================
Income before extraordinary item per unit of limited
partnership interest (1,256.8 units outstanding)
$ 440.22 $ 415.14 $ 740.96
====================================================================================================================
Extraordinary item - loss on extinguishment of debt per unit of limited
partnership interest (1,256.8 units
outstanding) $ - $ (16.18) $ -
====================================================================================================================
Net income per unit of limited partnership interest
(1,256.8 units outstanding) $ 440.22 $ 398.96 $ 740.96
====================================================================================================================
</TABLE>
See accompanying notes to financial statements.
W-8
<PAGE> 100
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
STATEMENTS OF CHANGES IN PARTNERS' EQUITY
================================================================================
<TABLE>
<CAPTION>
Limited General
Partners Partner Total
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
BALANCE, January 1, 1994 $2,401,668 $(36,280) $2,365,388
Net income for the year 931,237 9,406 940,643
Distributions to partners (377,040) (3,808) (380,848)
- --------------------------------------------------------------------------------------------------------------------
BALANCE, December 31, 1994 2,955,865 (30,682) 2,925,183
Net income for the year 501,407 5,065 506,472
Distributions to partners (565,560) (5,713) (571,273)
- --------------------------------------------------------------------------------------------------------------------
BALANCE, December 31, 1995 2,891,712 (31,330) 2,860,382
Net income for the period 553,263 5,589 558,852
Distributions to partners (314,200) (3,174) (317,374)
- --------------------------------------------------------------------------------------------------------------------
BALANCE, November 30, 1996 $3,130,775 $(28,915) $3,101,860
====================================================================================================================
</TABLE>
See accompanying notes to financial statements.
W-9
<PAGE> 101
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
================================================================================
<TABLE>
<CAPTION>
ELEVEN Years ended
MONTHS ENDED December 31,
NOVEMBER 30, ------------------------------------
1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income $ 558,852 $ 506,472 $ 940,643
Adjustments to reconcile net income to net cash from
operating activities:
Loan costs written off due to refinancing - 20,536 -
Loan costs incurred due to refinancing - (31,477) -
Depreciation and amortization 768,653 852,803 856,871
Loss (gain) on sale of property and equipment
25,453 1,097 (5,675)
Undepreciated cost of equipment destroyed by fire
- 1,194 -
Increase in cash value of life insurance (61,444) - -
Increase in deferred compensation 61,444 - -
Changes in operating assets and liabilities:
Receivables (161,992) 13,681 (23,268)
Inventories (34,443) 16,968 18,242
Prepaid expenses 13,757 25,429 (41,188)
Accounts payable (14,585) (8,681) (12,976)
Accrued salaries and wages 44,276 21,391 203,215
Accrued taxes (26,007) (35,821) (61,574)
Accrued percentage rent 27,441 (6,580) 1,596
Other current liabilities (417) (11,234) (68,239)
- --------------------------------------------------------------------------------------------------------------------
Net cash from operating activities 1,200,988 1,365,778 1,807,647
- --------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Proceeds from sale of property and equipment
5,449 122,500 24,961
Additions to property and equipment (427,872) (471,092) (690,879)
Payment of franchise fees - (50,000) (25,000)
Purchase of other assets (8,784) - -
- --------------------------------------------------------------------------------------------------------------------
Net cash for investing activities (431,207) (398,592) (690,918)
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
W-10
<PAGE> 102
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
================================================================================
<TABLE>
<CAPTION>
ELEVEN Years ended
MONTHS ENDED December 31,
NOVEMBER 30, ------------------------------------
1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
FINANCING ACTIVITIES
Proceeds from long-term debt $ - $ 2,022,499 $ -
Repayment of short-term notes payable - (102,724) (1,776)
Repayment of long-term debt (307,989) (2,537,612) (239,521)
Payments made on obligations under capital leases
(161,550) (142,920) (128,005)
Distributions to partners (317,374) (571,273) (380,848)
- --------------------------------------------------------------------------------------------------------------------
Net cash for financing activities (786,913) (1,332,030) (750,150)
- --------------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH (17,132) (364,844) 366,579
CASH, beginning of period 411,198 776,042 409,463
- --------------------------------------------------------------------------------------------------------------------
CASH, end of period $ 394,066 $ 411,198 $ 776,042
====================================================================================================================
</TABLE>
W-11
<PAGE> 103
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
================================================================================
<TABLE>
<CAPTION>
ELEVEN Years ended
MONTHS ENDED December 31,
NOVEMBER 30, ------------------------------------
1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for interest expense $ 408,680 $ 499,673 $ 558,000
- --------------------------------------------------------------------------------------------------------------------
Noncash investing and financing transactions:
Capital lease obligation incurred for use of
equipment 379,591 - -
Retirement of note payable - bank with new
revolving term note payable - bank
- 1,331,221 -
- --------------------------------------------------------------------------------------------------------------------
Purchase of land:
Cost of land - - 121,000
Short-term note payable - - 104,500
- --------------------------------------------------------------------------------------------------------------------
Cash down payment for land - - 16,500
- --------------------------------------------------------------------------------------------------------------------
Purchase of vehicle:
Cost of vehicle - - 10,482
Trade-in allowance - - 7,019
- --------------------------------------------------------------------------------------------------------------------
Cash paid for vehicle - - 3,463
====================================================================================================================
</TABLE>
See accompanying notes to financial statements.
W-12
<PAGE> 104
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
================================================================================
1. SUMMARY OF ORGANIZATION
SIGNIFICANT
ACCOUNTING Wendy's of West Michigan Limited Partnership
POLICIES (Partnership) is a Michigan limited
partnership organized on July 31, 1986. The
Partnership operates 26 Wendy's Old Fashioned
Hamburger restaurants in western Michigan
under franchise agreements with Wendy's
International, Inc. Subject to the consent of
the Limited Partners where required by the
Partnership Agreement, the General Partner has
the exclusive right to manage the Partnership.
The Limited Partners are not liable for
Partnership debts beyond the amount of their
original contributions and share of
undistributed net profits.
The Partnership Agreement provides that the
Limited Partners (as a group) are to share in
99% of the Partnership's net income or loss,
except as discussed in the following
paragraph, and receive 99% of all cash flow
from operations as defined by the Partnership
Agreement.
The net profits of the Partnership arising
from the sale or other disposition, whether as
a result of foreclosure, condemnation or
otherwise, of all or part of the property,
shall be allocated among the Partners in
accordance with the provisions of the
Partnership Agreement.
A Partnership administration fee is payable to
the General Partner equal to 2% of gross
partnership revenues from operations, as
defined in the Partnership Agreement. The
General Partner has elected to reduce the
Partnership administration fee to the General
Partner from 2% of gross partnership revenues
from operations to $146,667, $160,000 and
$160,000 for 1996, 1995 and 1994,
respectively.
The Partnership shall exist until December 31,
2026, unless terminated sooner as provided in
the Partnership Agreement. A Limited Partner
may, in accordance with the agreement, assign
his interest in the Partnership by a properly
executed and
W-13
<PAGE> 105
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
================================================================================
acknowledged instrument, the terms of which
are not inconsistent with or contrary to the
provisions of the Partnership Agreement and
are otherwise satisfactory to the General
Partner, subject to the approval of the
General Partner.
During the period ended November 30, 1996,
Meritage Hospitality Group Inc. (Meritage)
acquired 680.8 units of limited partnership
interest, representing approximately 54% of
the outstanding limited partner units. As a
result, the Partnership has changed its fiscal
year-end to November 30, 1996 to conform with
Meritage's fiscal year-end.
Meritage entered into an agreement on October
21, 1996, to acquire the general partnership
interest in the Partnership. This acquisition
is conditioned upon, among other things, the
approval of Wendy's International, Inc., the
franchisor of the Wendy's restaurants operated
by the Partnership.
Competition in the quick-service restaurant
industry is intense. Most of the Partnership's
restaurants are in close proximity to other
quick-service restaurants which compete on the
basis of price, service and product quality
and variety. Meritage and the current General
Partner believe that the Partnership competes
effectively in these areas.
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.
W-14
<PAGE> 106
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
================================================================================
INVENTORIES
Inventories are stated at the lower of cost
(first-in, first-out) or market. Inventories
consist of restaurant food items and food
serving supplies.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost.
Expenditures for renewals and betterments
which extend the originally estimated economic
life of assets are capitalized. Expenditures
for maintenance or repairs are charged to
expense when incurred. For financial reporting
purposes, depreciation is computed using the
straight-line method over the estimated
economic lives of the assets. For tax
purposes, useful lives and methods are used as
permitted by the Internal Revenue Code.
Amortization of leasehold improvements is
provided over the primary terms of the various
leases.
ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED
ASSETS
In 1995, the Partnership adopted Statement of
Financial Accounting Standards (SFAS) No. 121,
Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be
Disposed of. This statement requires that
long-lived assets and certain identifiable
intangibles to be held and used by an entity
be reviewed for impairment whenever events or
changes in circumstances indicate that the
carrying amount of an asset may not be
recoverable. This statement also requires that
long-lived assets and certain identifiable
intangibles to be disposed of be reported at
the lower of carrying amount or fair value
less cost to sell. This new accounting
standard had no impact on the financial
statements.
W-15
<PAGE> 107
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
================================================================================
OTHER ASSETS
Franchise fees for restaurant units are being
amortized over the terms of the individual
restaurant franchise agreements. Loan costs
are being amortized over 120 months, the
period of the loan. All amortization is under
the straight-line method.
The excess of cost over fair value of net
assets acquired (goodwill) is being amortized
on the straight-line method over 240 months.
Amortization expense for goodwill for the
periods 1996, 1995 and 1994 amounted to
$181,610, $198,120 and $198,120, respectively.
The Partnership evaluates the recoverability
of the goodwill whenever events or changes in
circumstances indicate that the carrying
amount of goodwill may not be recoverable and
considers whether the goodwill should be
completely or partially written off or the
amortization period accelerated. The
Partnership assesses the recoverability of
goodwill based on undiscounted estimated
future operating cash flows. If the
Partnership determines that the carrying value
of the goodwill has been impaired, the
measurement of the impairment will be based on
discounted estimated future operating cash
flows.
FRANCHISE COSTS AND OTHER ADVERTISING COSTS
Royalties and national advertising costs are
based on a percentage of monthly sales. These
costs and other advertising costs are charged
to operations as incurred.
CAPITALIZED LEASE OBLIGATIONS
Lease transactions relating to certain
restaurant buildings and equipment are
classified as capital leases. These assets
have been capitalized and the related
obligations recorded based on the fair market
value of the assets at the inception of the
leases. Amounts capitalized are being
amortized over the terms of the leases.
W-16
<PAGE> 108
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
================================================================================
INCOME TAXES
No provision for income taxes has been made in
the accompanying financial statements. A
Partner's share of the income or loss of the
Partnership is includable in the individual
tax returns of the Partners.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of the Partnership's
financial instruments, consisting of cash,
receivables, accounts payable and long-term
debt, approximate their fair value.
RECLASSIFICATIONS
Certain balances from the 1995 financial
statements have been reclassified to be
consistent with classifications as reported in
the 1996 financial statements. These
reclassifications had no effect on previously
reported net income or partners' equity.
2. DEFERRED COMPENSATION The Partnership has a deferred compensation
agreement with a key employee which provides
for the payment of $150,000 upon the
completion of the five-year term of the
agreement in December 1998. The agreement is
funded by the Partnership through payment of
premiums on a split dollar life insurance
contract which had a cash value at November
30, 1996 of $61,444. Charges to operations
related to this agreement were $27,913,
$25,295 and $16,000 for 1996, 1995 and 1994,
respectively. In accordance with the
agreement, the Partnership is required to make
premium payments of approximately $31,000 and
$36,000 during 1997 and 1998, respectively.
W-17
<PAGE> 109
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
================================================================================
3. LONG-TERM DEBT Long-term debt at November 30, 1996 and
December 31, 1995 consisted of a revolving
term note payable - bank, secured by
substantially all assets of the Partnership
and by the guaranty of the General Partner and
the personal guarantees of the shareholders of
the General Partner. The loan agreement
requires monthly payments of $43,313,
including interest at 1% over prime
(effectively 9.25% at November 30, 1996)
through February 2005 when any remaining
unpaid principal will be due. Under the
revolving loan agreement, the required monthly
payments described above may be offset by
additional borrowings up to the unused
available borrowings. The total available
borrowings under the loan agreement were
$2,978,702 as of November 30, 1996. The total
available borrowings decrease monthly based on
the original term note amortization over 120
months. The loan agreement also requires that
the Partnership maintain certain financial
ratios and a minimum tangible net worth, as
defined in the loan agreement, of
approximately $668,000. The Partnership was in
compliance with these covenants at November
30, 1996. The outstanding balances were
$2,192,351 and $2,500,340 as of November 30,
1996 and December 31, 1995, respectively.
The following is a schedule by year of annual
maturities under the loan agreements:
<TABLE>
<CAPTION>
Year ending November 30,
-------------------------------------------------------------------------------
<S> <C>
1997 $ -
1998 -
1999 49,146
2000 339,034
2001 375,677
Later years 1,428,494
-------------------------------------------------------------------------------
$2,192,351
===============================================================================
</TABLE>
W-18
<PAGE> 110
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
================================================================================
4. DESCRIPTION OF The Partnership leases land and buildings used
LEASING in operations under operating agreements, with
ARRANGEMENTS remaining lease terms (including renewal
(INCLUDING THOSE options of up to twelve years) ranging from
WITH AFFILIATED one to seventeen years. Included in the leases
PARTNERSHIP) are five leases with parties related through
common ownership of general partners.
Total lease expense (including taxes,
insurance and maintenance when included in
rent) related to all operating leases and all
percentage rentals is as follows:
<TABLE>
<CAPTION>
Period ended 1996 1995 1994
-------------------------------------------------------------------------------
<S> <C> <C> <C>
Leases with related parties:
Minimum rentals $ 266,358 $ 230,848 $ 172,403
Percentage rentals 168,370 150,867 125,957
Other leases:
Minimum rentals 403,613 414,539 415,357
Percentage rentals 275,993 309,228 313,461
-------------------------------------------------------------------------------
$1,114,334 $1,105,482 $1,027,178
===============================================================================
</TABLE>
Certain restaurant leases (eight restaurant
buildings, excluding land which is accounted
for as an operating lease) and equipment
leases have been capitalized. Minimum future
obligations under capital leases and
noncancellable operating leases in effect are
as follows:
W-19
<PAGE> 111
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
================================================================================
<TABLE>
<CAPTION>
Operating leases
--------------------------------
Capital Related
Year ending November 30, leases parties Others
--------------------------------------------------------------------------------
<S> <C> <C> <C>
1997 $ 465,323 $ 285,552 $ 362,378
1998 465,323 153,127 294,506
1999 465,323 111,629 208,334
2000 465,323 111,629 193,511
2001 449,365 111,629 172,440
Later years 769,948 419,892 344,880
--------------------------------------------------------------------------------
Total minimum lease
obligations 3,080,605 $ 1,193,458 $ 1,576,049
================================
Less amount representing
interest imputed at
approximately 11% 894,164
----------------------------------------------
Present value of minimum
lease obligations $ 2,186,441
==============================================
</TABLE>
The present value of minimum rental
obligations is reflected in the balance sheets
as current and long-term obligations under
capital leases.
Accumulated amortization of leased property
under capital leases was $1,648,146 and
$1,495,796 at November 30, 1996 and December
31, 1995, respectively.
In addition to minimum future obligations,
percentage rentals may be paid under all
restaurant leases on the basis of percentage
of sales in excess of minimum prescribed
amounts.
W-20
<PAGE> 112
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
================================================================================
5. PROFIT-SHARING The Partnership maintains a 401(k)
PLAN profit-sharing plan. The plan covers
substantially all employees of the Partnership
who are at least 21 years old and who have
completed at least one year of service (of at
least 1,000 hours) with the Partnership.
Contributions to the plan may be made by the
Partnership (which are purely discretionary in
nature) or by plan participants through
elective salary reductions. Contributions to
the plan by the Partnership for the periods
ended 1996 and 1995, totaled $30,721 and
$12,000. There were no contributions to the
plan by the Partnership for the year ended
December 31, 1994.
W-21
<PAGE> 113
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
MAY 31, 1997
<TABLE>
<CAPTION>
MERITAGE
HOSPITALITY PRO
GROUP INC. & PRO FORMA FORMA CONSOLIDATED
SUBSIDIARIES ADJUSTMENTS REF. PRO FORMA
----------------------------------------------------------------
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 1,122,182 $ (61,500) (1) $ 1,060,682
Accounts receivable 684,497 684,497
Inventories 368,106 368,106
Deferred income taxes 14,000 14,000
Prepaid expenses and other 673,766 673,766
----------------------------------------------------------------
TOTAL CURRENT ASSETS 2,862,551 (61,500) 2,801,051
PROPERTY, PLANT AND EQUIPMENT, NET 21,497,733 1,040,116 (1) 22,537,849
DEFERRED INCOME TAXES 621,000 621,000
OTHER ASSETS 2,231,584 2,231,584
GOODWILL 3,596,793 1,899,662 (1) 5,496,455
----------------------------------------------------------------
Total Assets $30,809,661 $ 2,878,278 $33,687,939
================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Current portion of long-term debt $ 922,936 $ 922,936
Current portion of obligations under
capital leases 250,454 250,454
Trade accounts payable 2,416,233 2,416,233
Accrued expenses 1,058,617 1,058,617
----------------------------------------------------------------
Total Current Liabilities 4,648,240 4,648,240
LONG-TERM DEBT, EXCLUSIVE OF CURRENT
PORTION 21,851,593 21,851,593
OBLIGATIONS UNDER CAPITAL LEASES, EXCLUSIVE
OF CURRENT PORTION 1,825,387 1,825,387
DEFERRED INCOME TAXES 818,000 818,000
MINORITY INTEREST 1,441,722 (1,441,722) (1) ---
----------------------------------------------------------------
Total Liabilities 30,584,942 (1,441,722) 29,143,220
SHAREHOLDERS' EQUITY
Preferred shares 1,384 1,384
Common shares 32,164 12,343 (1) 44,507
Additional paid in capital 12,975,142 4,307,657 (1) 17,282,799
Note receivable from sale of shares (5,412,183) (5,412,183)
Accumulated deficit (7,371,788) (7,371,788)
----------------------------------------------------------------
Total Shareholders' Equity 224,719 4,320,000 4,544,719
----------------------------------------------------------------
Total Liabilities & Shareholders' Equity $30,809,661 $ 2,878,278 $33,687,939
================================================================
</TABLE>
SEE NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
P-1
<PAGE> 114
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
SIX MONTHS ENDED MAY 31, 1997
<TABLE>
<CAPTION>
MERITAGE
HOSPITALITY PRO
GROUP INC. & PRO FORMA FORMA CONSOLIDATED
SUBSIDIARIES ADJUSTMENTS REF. PRO FORMA
--------------------------------------------------------------------
<S> <C> <C> <C> <C>
REVENUE
Room rents $ 2,502,555 $ 2,502,555
Food and beverage revenue 16,098,443 16,098,443
Sundry revenue 276,918 276,918
Telephone revenue 120,300 120,300
--------------------------------------------------------------------
Total Revenue 18,998,216 18,998,216
--------------------------------------------------------------------
COST AND EXPENSES
Cost of food and beverages 4,870,949 4,870,949
Operating expenses 11,771,010 11,771,010
General and administrative expenses 1,934,579 1,934,579
Depreciation and amortization 1,077,568 121,786 (3) 1,199,354
--------------------------------------------------------------------
Total costs and expenses 19,654,106 121,786 19,775,892
--------------------------------------------------------------------
LOSS FROM OPERATIONS (655,890) (121,786) (777,676)
OTHER INCOME (EXPENSE)
Interest expense (1,431,246) (1,431,246)
Interest income 283,431 283,431
Minority interest (35,946) 35,946 (4)
--------------------------------------------------------------------
Loss before federal income tax (1,839,651) (85,840) (1,925,491)
--------------------------------------------------------------------
FEDERAL INCOME TAX BENEFIT
Net loss $(1,839,651) $ (85,840) $ (1,925,491)
====================================================================
LOSS PER SHARE $ (0.59) $ (0.43)
=========== ===========
AVERAGE NUMBER OF SHARES OUTSTANDING 3,212,097 4,448,748
=========== ===========
</TABLE>
SEE NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
P-2
<PAGE> 115
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED NOVEMBER 30, 1996
<TABLE>
<CAPTION>
MERITAGE WENDY'S OF
HOSPITALITY WEST MICHIGAN PRO
GROUP INC. & LIMITED PRO FORMA FORMA CONSOLIDATED
SUBSIDIARIES PARTNERSHIP ADJUSTMENTS REF. PRO FORMA
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
REVENUE
Room rents $ 6,281,711 $ 6,281,711
Food and beverage revenue 9,885,062 24,272,961 34,158,023
Sundry revenue 555,049 263,254 818,303
Telephone revenue 163,040 163,040
----------------------------------------------------------------------
Total Revenue 16,884,862 24,536,215 41,421,077
----------------------------------------------------------------------
COST AND EXPENSES
Cost of food and beverages 3,334,434 7,168,861 10,503,295
Operating expenses 9,492,345 14,576,864 24,069,209
General and administrative expenses 3,951,400 1,051,455 5,002,855
Depreciation and amortization 1,081,704 770,036 387,529 (3) 2,239,269
----------------------------------------------------------------------
Total costs and expenses 17,859,883 23,567,216 387,529 41,814,628
----------------------------------------------------------------------
EARNINGS (LOSS) FROM OPERATIONS (975,021) 968,999 (387,529) (393,551)
OTHER INCOME (EXPENSE)
Interest expense (1,642,735) (404,710) (446,875) (2) (2,494,320)
Interest income 658,007 11,432 669,439
Loss on sale of assets (6,900) (25,453) (32,353)
Minority interest 21,079 (21,079) (4)
----------------------------------------------------------------------
Income (loss) before federal income tax (1,945,570) 550,268 (855,483) (2,250,785)
FEDERAL INCOME TAX BENEFIT (20,000) (20,000)
----------------------------------------------------------------------
Net income (loss) $ (1,925,570) $ 550,268 $(855,483) $(2,230,785)
======================================================================
LOSS PER SHARE $ (0.62) $ (0.52)
=========== ===========
AVERAGE NUMBER OF SHARES OUTSTANDING 3,081,885 4,316,171
=========== ===========
</TABLE>
SEE NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
P-3
<PAGE> 116
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF CASH FLOWS
SIX MONTH PERIOD ENDED MAY 31, 1997
<TABLE>
<CAPTION>
MERITAGE
HOSPITALITY PRO
GROUP INC. & PRO FORMA FORMA CONSOLIDATED
SUBSIDIARIES ADJUSTMENTS REF. PRO FORMA
----------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
<S> <C> <C> <C> <C>
Net loss $(1,839,651) $ (85,840) $(1,925,491)
Adjustments to reconcile net loss to net cash
provided by operating activities
Depreciation and amortization 1,077,568 121,786 1,199,354
Compensation and fees paid by issuance of
common stock 58,834 58,834
Minority interest in the net earnings of
consolidated subsidiaries 35,946 (35,946) (4) 0
Interest income on note receivable from
sale of shares (276,467) (276,467)
(Increase) decrease in assets
Accounts receivable 253,951 253,951
Inventories (13,880) (13,880)
Prepaid expenses and other current assets (186,470) (186,470)
Increase in marina development costs (191,141) (191,141)
Increase in liabilities
Accounts payable and accrued expenses 146,056 146,056
----------------------------------------------------
Net cash used in operating activities (935,254) (935,254)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property, plant and equipment (471,925) (471,925)
Cost of acquisition of business (61,500) (1) (61,500)
Increase in other assets (109,021) (109,021)
----------------------------------------------------
Net cash used in investing operations (580,946) (61,500) (642,446)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term debt 750,000 750,000
Principal payments of long-term debt (526,895) (526,895)
Payments on obligations under capital leases (110,780) (110,780)
Proceeds from issuance of preferred shares 300,000 300,000
Dividends paid (39,440) (39,440)
----------------------------------------------------
Net cash provided by financing
activities 372,885 372,885
----------------------------------------------------
Net decrease in cash (1,143,315) (61,500) (1,204,815)
Cash and cash equivalents - beginning of period 2,265,497 2,265,497
----------------------------------------------------
Cash and cash equivalents - end of period $ 1,122,182 $ (61,500) $ 1,060,682
====================================================
</TABLE>
SEE NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
P-4
<PAGE> 117
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF CASH FLOWS
YEAR ENDED NOVEMBER 30, 1996
<TABLE>
<CAPTION>
MERITAGE WENDY'S OF
HOSPITALITY WEST MICHIGAN PRO
GROUP INC. & LIMITED PRO FORMA FORMA CONSOLIDATED
SUBSIDIARIES PARTNERSHIP ADJUSTMENTS REF. PRO FORMA
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (1,925,570) $ 550,268 $ (855,483) $ (2,230,785)
Adjustments to reconcile net loss to net cash
provided by operating activities
Depreciation and amortization 1,081,704 770,036 387,529 (3) 2,239,269
Compensation paid by issuance of
preferred and common stock 310,099 310,099
Minority interest in the net loss of
consolidated subsidiaries (21,079) 21,079 (4)
Decrease income tax benefit (20,000) (20,000)
Loss on disposal of property, plant
and equipment 6,900 25,453 32,353
Bad debt expense 32,655 32,655
Interest income on note receivable from
sale of shares (573,274) (573,274)
(Increase) decrease in assets
Accounts receivable (201,742) (167,105) (368,847)
Inventories 41,198 (19,790) 21,408
Prepaid expenses and other current assets 104,707 19,729 124,436
Refundable income taxes 321,600 321,600
Increase (decrease) in liabilities
Accounts payable and accrued expenses (674,696) 145,259 (529,437)
-------------------------------------------------------------------
Net cash (used in) provided by
operating activities (1,517,498) 1,323,850 (446,875) (640,523)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property, plant and equipment (2,211,392) (559,606) (2,770,998)
Proceeds from sale of property, plant and
equipment 40,146 5,447 45,593
Payments on amounts due from related parties 433,130 433,130
Acquisition of business, net of cash acquired (3,163,381) (260,834) (5) (3,424,215)
Increase (decrease) in other assets (679,214) (95,228) (774,442)
Increase in deferred compensation 61,444 61,444
-------------------------------------------------------------------
Net cash used in investing operations (5,580,711) (587,943) (260,834) (6,429,488)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term debt 37,717,705 37,717,705
Principal payments of long-term debt (29,446,007) (308,156) (29,754,163)
Payments on obligations under capital leases (29,808) (142,835) (172,643)
Collection on note receivable from sale of shares 750,000 750,000
Proceeds from issuance of preferred and
common shares 545,000 545,000
Dividends paid (1,510,075) (317,374) (1,827,449)
-------------------------------------------------------------------
Net cash provided by (used in)
financing activities 8,026,815 (768,365) 7,258,450
-------------------------------------------------------------------
Net increase (decrease) in cash 928,606 (32,458) (707,709) 188,439
Cash and cash equivalents - beginning of period 1,336,891 293,292 1,630,183
-------------------------------------------------------------------
Cash and cash equivalents - end of period $ 2,265,497 $ 260,834 $ (707,709) $ 1,818,622
===================================================================
</TABLE>
SEE NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
P-5
<PAGE> 118
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
MHG Food Service, a subsidiary of Meritage, owns approximately 54% of
the outstanding limited partnership units of the Wendy's of West Michigan
Limited Partnership and has appointed MCC Food Service, Inc., an affiliate of
Meritage, as the General Partner of the Wendy's Partnership. Under the
transaction, a newly formed limited partnership, which will be an affiliate of
Meritage, intends to purchase the assets, and assume the liabilities, of the
Wendy's Partnership in exchange for Meritage Common Shares. Following such
purchase, the Wendy's Partnership will be dissolved. Upon dissolution, the
Meritage Common Shares would be distributed to non-affiliated limited partners.
The number of Meritage Common Shares in each case will be that number that has a
value of $7,500 per unit, based on the average high and low bid price on the OTC
Bulletin Board for the 10 trading days preceding the date of dissolution. Units
held by Meritage will be canceled. The transaction is accounted for under the
purchase method of accounting.
The unaudited pro forma consolidated balance sheet as of May 31, 1997
reflects this acquisition as if it occurred on that date. The Wendy's
Partnership financial statements have been included in the consolidated
financial statements of Meritage since the acquisition of a majority interest of
the Wendy's Partnership by Meritage on October 31, 1996.
The unaudited pro forma consolidated statements of operations and the
unaudited pro forma consolidated statements of cash flows for the six months
ended May 31, 1997 and for the year ended November 30, 1996 present the
historical results of the Company combined with the historical results of the
Wendy's Partnership and the pro forma adjustments as if the Wendy's Partnership
had been acquired on December 1, 1995. The historical results of the Wendy's
Partnership include operations from December 1, 1995 through October 31, 1996.
Consolidated financial statements were prepared beginning November 1, 1996.
The pro forma financial information should be read in conjunction with
the historical consolidated financial statements and notes thereto contained in
the Company's Form 10-K for the year ended November 30, 1996 and the quarterly
report on Form 10-Q for the six months ended May 31, 1997, and the historical
financial statements of the Wendy's Partnership included in this report on Form
S-4. The pro forma results do not reflect any benefit from economies which might
be achieved from combined operations. These pro forma results do not purport to
be indicative of the financial condition or results of operations that would
have occurred had the acquisitions taken place on the basis presumed above, nor
are they indicative of future combined operations.
The pro forma adjustments are as follows:
1. To record the distribution of 1,234,286 Meritage Common Shares which
have been estimated at $3.50 per share ($4,320,000) to non-affiliated
limited partners. As a result of the purchase, the value of assets
acquired have been adjusted to fair market value, to goodwill for the
amount of the excess purchase price over fair market value of the net
assets acquired and minority interest has been eliminated as a result
of 100% ownership of the Partnership upon completion of the
transaction. The net purchase price of $4,381,500 ($4,320,000 in
Meritage Common Shares plus $61,500 of estimated fees and expenses of
the transaction) is allocated as follows:
<TABLE>
<S> <C>
Property, plant and equipment $1,040,116
Minority interest 1,441,722
Goodwill 1,899,662
----------
Total $4,381,500
==========
</TABLE>
P-6
<PAGE> 119
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
2. To record interest expense of $446,875 for the year ended November 30,
1996 from borrowings ($3,000,000) to fund the purchase of 482.55
partnership units acquired by the Company through a tender offer
completed on October 31, 1996 resulting in Meritage obtaining a
majority interest in the Partnership.
3. To record depreciation and amortization of $121,786 for the six months
ended May 31, 1997 and $387,529 for the year ended November 30, 1996.
The excess purchase price over the fair market value of the assets
acquired is being amortized over a period of twenty years. The increase
in property, plant and equipment to fair market value is being
depreciated over the estimated useful life of the assets.
4. To eliminate the minority interest in the earnings of the Partnership.
Upon completion of the transaction described above, a wholly owned
subsidiary of Meritage, MHG Food Service, will own 100% of the
Partnership.
5. To eliminate the reduction of cash acquired in the acquisition of
the majority interest in the Wendy's Partnership by Meritage. The cash
acquired is included in the historical financial statements of the
Wendy's Partnership.
P-7
<PAGE> 120
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Section 561 of the Michigan Business Corporation Act provides generally and
in pertinent part that a Michigan corporation may indemnify its directors and
officers against expenses, including judgments, penalties, fines, attorney's
fees and amounts paid in settlement actually and reasonably incurred by them in
connection with any civil or criminal suit or action, other than actions by or
in the right of the corporation, if the person acted in good faith and in a
manner the person reasonably believed to be in or not opposed to the best
interests of the corporation or its shareholders, and with respect to any
criminal suit or proceeding, if the person had no reasonable cause to believe
his/her conduct was unlawful. Section 562 provides that, in connection with the
defense or settlement of any action by or in the right of the corporation, a
Michigan corporation may indemnify its directors and officers against expenses
actually and reasonably incurred by them in connection with the matters in
issue, if they acted in good faith and in a manner they reasonably believed to
be in or not opposed to the best interests of the corporation or its
shareholders. The right to indemnification is mandatory in the case of a
director or officer who is successful on the merits or otherwise and if the
expenses are reasonable and actually incurred. Permissive indemnification is to
be made by a court of competent jurisdiction, the majority vote of a quorum of
disinterested directors, the written opinion of independent legal counsel, by
all independent directors who are not parties to or threatened to be made
parties to the action or suit, or by the disinterested shareholders or a
committee designated by the Board of Directors and consisting of directors who
are not parties to, or threatened to be made parties to, the proceedings.
The Company's Bylaws, as well as specific indemnification agreements
with the Company's directors and officers, provide that the Company shall
indemnify such persons to the fullest extent permitted by law.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
<TABLE>
<CAPTION>
Exhibit No. Description of Document
- ----------- -------------------------
<S> <C>
3.1 Restated Articles of Incorporation of Meritage Hospitality Group Inc. (1).
3.2 Restated and Amended Bylaws of Meritage Hospitality Group Inc. (2).
4.1 Certificate of Designation of Series A Convertible Preferred Shares of Meritage Hospitality
Group Inc. (2).
4.2 Subscription Agreement relating to issuance of Series A Convertible Preferred Shares of
Meritage Hospitality Group Inc. (2).
5 Opinion of Keating, Muething & Klekamp, PLL. (3)
10.1 Meritage Hospitality Group Inc. 401(k) Profit Sharing Plan, Qualified Retirement Plan and
Trust - Basic Plan Document and Adoption Agreement, as amended March 1, 1997. (1)
10.2 Stock Purchase and Sale Agreement dated September 19, 1995 between Meritage, MCC, Donald W.
Reynolds and Innkeepers Management Company, and accompanying exhibits (4).
10.3 Loan Agreement dated November 26, 1996 among Meritage Hospitality Group Inc., St. Clair Inn,
Inc., Grand Harbor Resort Inc., Thomas Edison Inn, Incorporated, MHG Food Service Inc. and
Grand Harbor Yacht Club Inc., as obligors, and Great American Life Insurance Company, as lender
(2).
</TABLE>
II-1
<PAGE> 121
<TABLE>
<S> <C>
10.4 Promissory Note dated November 26, 1996 by St. Clair Inn, Inc., Grand Harbor Resort Inc., and
Thomas Edison Inn, Incorporated, as makers, and Great American Life Insurance Company, as payee
(2).
10.5 Promissory Note dated November 26, 1996 by Meritage Hospitality Group Inc., MHG Food Service
Inc. and Grand Harbor Yacht Club Inc., as makers, and Great American Life Insurance Company, as
payee (2).
10.6 Amendment No. 1 to Loan Agreement dated November 26, 1996 among Meritage
Hospitality Group Inc., St. Clair Inn, Inc., Grand Harbor Resort Inc., Thomas Edison Inn,
Incorporated, MHG Food Service Inc. and Grand Harbor Yacht Club Inc., as obligors, and
Great American Life Insurance Company, as lender. (1).
10.7 Promissory Note dated May 23, 1997 by Grand Harbor Yacht Club Inc., as maker, and
Great American Life Insurance Company, as payee. (1).
10.8 Business Loan Agreement dated February 22, 1995 between Wendy's of West Michigan Limited
Partnership and First of America Bank-Michigan, N.A. (5).
10.9 Promissory Note dated February 22, 1995 by Wendy's of West
Michigan Limited Partnership, as maker, and First of America
Bank-Michigan, N.A., as payee (5).
10.10 Consent Agreement dated May 16, 1997 between Wendy's International, Inc., Wendy's
of West Michigan Limited Partnership, Meritage Hospitality Group Inc., MHG Food Service
Inc., Meritage Capital Corp., MCC Food Service Inc., Robert E. Schermer, Jr. and
Christopher B. Hewett, with sample Unit Franchise Agreement, Guaranties, and Release of
Claims attached as exhibits. (1).
MANAGEMENT COMPENSATORY CONTRACTS
10.11 Amended 1996 Management Equity Incentive Plan (1).
10.12 Amended 1996 Directors' Share Option Plan (1).
10.11 Directors' Compensation Plan (6).
10.12 Employee Share Purchase Plan (6).
---------------------------
21 Subsidiaries of the Registrant (2).
23.1 Consent of Grant Thornton LLP. (3)
23.2 Consent of BDO Seidman, LLP. (3)
23.3 Consent of Keating, Muething & Klekamp, PLL (contained in
Exhibit 5)
24 Powers of Attorney (contained on the signature page)
</TABLE>
---------------------------
(1) Incorporated by reference to the Quarterly Report on Form 10-Q for the
Company's fiscal quarter ended May 31, 1997.
(2) Incorporated by reference to the Annual Report on Form 10-K for the
Company's fiscal year ended November 30, 1996.
(3) Filed herewith.
II-2
<PAGE> 122
(4) Incorporated by reference to the Quarterly Report on Form 10-QSB for the
Company's fiscal quarter ended August 31, 1995.
(5) Incorporated by reference to the Annual Report on Form 10-K for Wendy's of
West Michigan Limited Partnership for the fiscal year ended December 31,
1994.
(6) Incorporated by reference to Registration Statement No. 333-06657 on Form
S-8 filed with the Securities and Exchange Commission by the Company on June
24, 1996.
ITEM 22. UNDERTAKINGS.
The undersigned Registrant hereby undertakes as follows:
1. To file, during any period in which offers or sales are being made,
a post-effective amendment to this Registration Statement (i) to include any
prospectus required by Section 10(a)(3) of the Securities Act, (ii) to reflect
in the prospectus any facts or events arising after the effective date of the
Registration Statement for the most recent post-effective amendment thereof
which, individually or in the aggregate, represents a fundamental change in the
information set forth in the Registration Statement, and (iii) to include any
material information with respect to the Plan of distribution not previously
disclosed in the Registration Statement or any material change to such
information in the Registration Statement.
2. That, for the purpose of determining any liability under the
Securities Act, each such post-effective amendment shall be deemed to be a new
registration statement relating to the securities offered therein, and the
offering of such securities at the time shall be deemed to be the initial bona
fide offering thereof.
3. To remove from registration by means of post-effective amendment any
of the securities being registered which remain unsold in the termination of the
offering.
4. To supply by means of a post-effective amendment all information
concerning a transaction, and the Company being acquired involved therein, that
was not the subject of and included in the Registration Statement when it became
effective.
5. Prior to any public reoffering of the securities registered
hereunder through use of a prospectus which is a part of this registration
statement, by any person or party who is deemed to be an underwriter within the
meaning of Rule 145(c), the issuer undertakes that such reoffering prospectus
will contain the information called for by the applicable registration form with
respect to reoffering by persons who may be deemed underwriters, in addition to
the information called for by the other items of the applicable form.
6. That every prospectus (i) that is filed pursuant to paragraph 5
immediately preceding, or (ii) that purports to meet the requirements of Section
10(a)(3) of the Securities Act and is used in connection with an offering of
securities subject to Rule 415, will be filed as a part of an amendment to the
registration statement and will not be used until such amendment is effective,
and that, for purposes of determining any liability under the Securities Act of
1933, each such post-effective amendment shall be deemed to be a new
registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
7. Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to directors, officers and controlling
persons of Meritage pursuant to the provisions described under Item 20 above, or
otherwise (other than insurance), Meritage has been advised that in the opinion
of the Securities and Exchange Commission, such indemnification is against
public policy as expressed in the Act and is, therefore, unenforceable. In the
event that a claim for indemnification against such liabilities (other than the
payment by Meritage of expenses incurred or paid by a director, officer or
controlling person of Meritage in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the Securities being registered, Meritage will, unless in the
opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it, other than indemnification pursuant to court order and
not including any coverage under, or agreement to pay premiums for, any policy
of insurance, is against public policy as expressed in the Act and will be
governed by the final adjudication of such issue.
II-3
<PAGE> 123
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, Meritage
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-4 and has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized in the City of Grand Rapids, State of Michigan, as of the 8th day of
August, 1997.
MERITAGE HOSPITALITY GROUP INC.
By: /s/ Christopher B. Hewett
---------------------------------------
Christopher B. Hewett
President and Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated. The persons whose names are marked an
asterisk (*) below hereby designate Messrs. Hewett and Schermer, Jr. to sign all
amendments, including post effective amendments to this Registration Statement
as well as any related Registration Statement, or amendment thereto, filed
pursuant to Rule 462(b) promulgated under the Securities Act of 1933.
<TABLE>
<CAPTION>
SIGNATURE CAPACITY DATE
-------------- --------------- ---------
<S> <C> <C>
/s/ Christopher B. Hewett President, Chief Executive Officer August 8, 1997
- ----------------------------------- and Director (Principal Executive
Christopher B. Hewett Officer)
*/s/ Robert E. Schermer, Sr. Chairman of the Board August 8, 1997
- -----------------------------------
Robert E. Schermer, Sr.
/s/ Robert E. Schermer, Jr. Executive Vice President and Director August 8, 1997
- ------------------------------------
Robert E. Schermer, Jr.
*/s/ Gary R. Garrabrant Director August 8, 1997
- ------------------------------------
Gary R. Garrabrant
*/s/ David S. Lundeen Director August 8, 1997
- ------------------------------------
David S. Lundeen
*/s/ Joseph L. Maggini Director August 8, 1997
- ------------------------------------
Joseph L. Maggini
</TABLE>
II-4
<PAGE> 124
<TABLE>
<S> <C> <C>
*/s/ Jerry L. Ruyan Director August 8, 1997
- -----------------------------------
Jerry L. Ruyan
*/s/ William D. Badgerow Vice President, Treasurer and Chief August 8, 1997
- ------------------------------------ Financial Officer (Principal Accounting
William D. Badgerow Officer and Principal Financial Officer)
(Through 5/20/97)
*/s/ Pauline M. Krywanski Vice President, Treasurer and Chief August 8, 1997
- ------------------------------------ Financial Officer (Principal Accounting
Pauline M. Krywanski Officer and Principal Financial Officer)
(Effective 5/20/97)
</TABLE>
II-5
<PAGE> 1
EXHIBIT 5
[FIRM LETTERHEAD]
FACSILILE (513) 578-6956
August 12, 1997
Direct Dial: (513) 579-6411
E-Mail [email protected]
Meritage Hospitality Group Inc.
40 Pearl Street, N.W., Suite 900
Grand Rapids, Michigan 49503
Gentlemen:
We have examined the corporate records and proceedings of Meritage
Hospitality Group Inc., (the "Corporation") as well as the Wendy's of West
Michigan Limited Partnership Agreement with respect to:
1. The organization of the Corporation; and
2. The legal sufficiency of all corporate proceedings taken in
connection with the authorization of the issuance of up to $4,320,000 in market
value of Common Stock to be issued and exchanged for the Wendy's of West
Michigan Limited Partnership Units and registered pursuant to a Registration
Statement on Form S-4 filed with the Securities and Exchange Commission.
Based upon such examination, we are of the opinion:
1. That the Corporation is a duly organized and validly existing
corporation in good standing under the laws of the State of Michigan; and
2. That the Corporation has taken all necessary and required corporate
action in connection with the proposed issuance of the aforesaid Common Stock,
and that when exchanged for the Limited Partnership Units, such Common Stock
will be duly authorized, validly issued, fully paid and non-assessable shares
of Common Stock of the Corporation free of any claim of preemptive rights.
-------------------------------
<PAGE> 2
Meritage Hospitality Group
Page 2
August 12, 1997
We hereby consent to be named in the Registration Statement and the
Prospectus part thereof as the attorneys who will pass upon legal matters in
connection with the aforesaid Common Stock and to the filing of this opinion as
an exhibit to the Registration Statement, and furthermore consent to all
references made to this firm in the Registration Statement.
Very truly yours,
KEATING, MUETHING & KLEKAMP, P.P.L.
BY: /s/ Gary P. Kreider
-------------------------------------
Gary P. Kreider
<PAGE> 1
Exhibit 23.1
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We have issued our reports dated January 21, 1997, accompanying the financial
statements and schedule of Meritage Hospitality Group Inc. contained in the
Registration Statement and Prospectus. We consent to the use of the
aforementioned reports in the Registration Statement and Prospectus, and to the
use of our name as it appears under the caption "Experts".
GRANT THORNTON LLP
/s/ Grant Thornton LLP
Detroit, Michigan
August 11, 1997
<PAGE> 1
Exhibit 23.2
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Meritage Hospitality Group Inc.
Grand Rapids, Michigan
We hereby consent to the use in the Prospectus constituting a part of this
Registration Statement of our report dated January 10, 1997, relating to the
financial statements of Wendy's of West Michigan Limited Partnership, which is
contained in that Prospectus.
We also consent to the reference to us under the caption "Experts" in the
Prospectus.
BDO SEIDMAN, LLP
/s/ BDO Seidman, LLP
Grand Rapids, Michigan
August 8, 1997
