SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[x] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the quarterly period ended August 31, 1999.
or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the transition period from ___________________
to ____________________
Commission File Number: 0-17442
MERITAGE HOSPITALITY GROUP INC.
- --------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Michigan 38-2730460
--------------------------------- --------------------
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
40 Pearl Street, N.W., Suite 900
Grand Rapids, Michigan 49503
--------------------------------- ----------------
(Address of Principal Executive Zip Code
Offices)
(616) 776-2600
----------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities and Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
As of October 4, 1999 there were 5,752,677 outstanding Common Shares, $.01 par
value.
<PAGE>
SAFE HARBOR STATEMENT
Certain statements contained in this report that are not historical facts
constitute forward-looking statements, within the meaning of the Private
Securities Litigation Reform Act of 1995, and are intended to be covered by the
safe harbors created by that Act. Reliance should not be placed on
forward-looking statements because they involve known and unknown risks,
uncertainties and other factors which may cause actual results, performance or
achievements to differ materially from those expressed or implied. Any
forward-looking statement speaks only as of the date made. The Company
undertakes no obligation to update any forward-looking statements to reflect
events or circumstances after the date on which they are made.
Statements concerning expected financial performance, on-going business
strategies and possible future action which the Company intends to pursue to
achieve strategic objectives constitute forward-looking information.
Implementation of these strategies and the achievement of such financial
performance are each subject to numerous conditions, uncertainties and risk
factors. Factors which could cause actual performance to differ materially from
these forward looking statements include, without limitation, competition;
changes in local and national economic conditions; changes in consumer tastes
and views about the nutritional quality of quick-service food; severe weather;
changes in travel patterns; increases in food, labor and energy costs; the
availability and cost of suitable restaurant sites; fluctuating insurance rates;
the availability of an adequate number of employees; the general reputation of
Wendy's restaurants; and the recurring need for renovation and capital
improvements. Also, the Company's business is subject to extensive government
regulations relating to, among other things, zoning, minimum wage, public health
certification and food safety, and the operation of its restaurants. Because
Meritage's restaurant operations are concentrated in smaller urban areas of
Michigan, a marked decline in the Michigan economy could adversely affect
Meritage's operations.
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements.
The following unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not contain all the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation of
the financial position, results of operations, stockholders' equity and cash
flows of the Company have been included. For further information, please refer
to the consolidated financial statements and footnotes thereto included in the
Company's Annual Report on Form 10-K for the fiscal year ended November 30,
1998. The results of operations for the three and nine month periods ended
August 31, 1999 are not necessarily indicative of the results to be expected for
the full year.
2
<PAGE>
Meritage Hospitality Group Inc. and Subsidiaries
Consolidated Balance Sheets
August 31, 1999 and November 30, 1998
ASSETS
August 31,
1999 November 30,
(Unaudited) 1998
------------ -------------
Current Assets
Cash and cash equivalents $ 1,536,011 $ 2,109,358
Receivables 236,699 70,974
Notes receivable, current portion 475,000 2,719,617
Inventories 193,970 165,156
Prepaid expenses and other current assets 58,509 90,796
----------- -----------
Total current assets 2,500,189 5,155,901
Property, Plant and Equipment, net 16,317,409 13,182,940
Other Assets
Note receivable, net of current portion -- 500,000
Goodwill, net of amortization of $289,905
and $153,758, respectively 5,019,818 5,155,965
Franchise fees, net of amortization of
$34,448 and $17,806, respectively 665,552 632,194
Financing costs, net of amortization of
$14,126 and $3,314, respectively 319,109 261,815
Other assets 33,197 75,431
----------- -----------
Total other assets 6,037,676 6,625,405
----------- -----------
Total assets $24,855,274 $24,964,246
=========== ===========
See notes to unaudited financial statements.
3
<PAGE>
Meritage Hospitality Group Inc. and Subsidiaries
Consolidated Balance Sheets - continued
August 31, 1999 and November 30, 1998
LIABILITIES AND STOCKHOLDERS' EQUITY
August 31,
1999 November 30,
(Unaudited) 1998
------------- -------------
Current Liabilities
Current portion of long-term debt $ 834,573 $ 1,199,458
Current portion of obligations
under capital leases 361,940 294,577
Short-term borrowings -- 1,100,000
Trade accounts payable 893,126 727,199
Amount due related party -- 245,260
Income taxes payable 5,000 50,000
Accrued liabilities 1,088,506 1,308,987
------------ ------------
Total current liabilities 3,183,145 4,925,481
Long-Term Debt 12,809,949 10,623,946
Obligations Under Capital Leases 1,109,768 1,395,049
Deferred Revenue 1,771,769 1,992,026
Net Liabilities of Discontinued Operations 177,547 593,855
Commitments and Contingencies -- --
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 44,520 (liquidation
value - $445,200) 445 445
Common stock - $0.01 par value;
authorized 30,000,000 shares;
issued and outstanding 5,750,706
and 5,742,586, respectively 57,507 57,426
Additional paid in capital 13,314,891 13,299,467
Note receivable from the sale of
shares, net of valuation allowance
of $5,177,707 and $4,666,755,
respectively (1,660,962) (1,660,962)
Accumulated deficit (5,908,785) (6,262,487)
------------ ------------
Total stockholders' equity 5,803,096 5,433,889
------------ ------------
Total liabilities and
stockholders' equity $ 24,855,274 $ 24,964,246
============ ============
See notes to unaudited financial statements.
4
<PAGE>
Meritage Hospitality Group Inc. and Subsidiaries
Consolidated Statements of Operations
For the Nine Month Periods Ended August 31,
(Unaudited)
1999 1998
--------------- ---------------
Food and beverage revenue $ 22,003,792 $ 20,041,338
Costs and expenses
Cost of food and beverages 6,357,974 5,753,689
Operating expenses 12,652,221 11,794,667
General and administrative expenses 1,379,106 2,166,414
Depreciation and amortization 952,987 892,878
--------------- ---------------
Total costs and expenses 21,342,288 20,607,648
--------------- ---------------
Operating earnings (loss) 661,504 (566,310)
Other income (expense)
Interest expense (1,006,170) (1,096,529)
Interest income 354,392 47,734
Other income 6,000 519,739
Gain on disposal of assets 297,227 -
Minority interest - 25,677
--------------- ---------------
Total other expense (348,551) (503,379)
--------------- ---------------
Earnings (loss) from
continuing operations 312,953 (1,069,689)
Earnings (loss) from discontinued
operations - Note C 70,800 (479,232)
--------------- ---------------
Earnings (loss) before
extraordinary item 383,753 (1,548,921)
Extraordinary item - loss on early
extinguishment of debt - (141,740)
--------------- ---------------
Net earnings (loss) 383,753 (1,690,661)
Dividends on preferred stock 30,051 93,411
--------------- ---------------
Net earnings (loss) on common shares $ 353,702 $ (1,784,072)
=============== ===============
Net earnings (loss) per common share -
basic and diluted
Continuing operations $ 0.05 $ (0.25)
Discontinued operations 0.01 (0.10)
Extraordinary item - (0.03)
--------------- ---------------
Net earnings (loss) per common share $ 0.06 $ (0.38)
=============== ===============
Weighted average shares outstanding - basic 5,746,905 4,687,097
=============== ===============
Weighted average shares outstanding - diluted 5,767,049 4,687,097
=============== ===============
See notes to unaudited financial statements.
5
<PAGE>
Meritage Hospitality Group Inc. and Subsidiaries
Consolidated Statements of Operations
For the Three Month Periods Ended August 31,
(Unaudited)
1999 1998
----------- -----------
Food and beverage revenue $ 7,983,256 $ 7,327,427
Costs and expenses
Cost of food and beverages 2,287,957 2,085,371
Operating expenses 4,486,859 4,163,240
General and administrative expenses 503,536 596,448
Depreciation and amortization 330,138 273,757
----------- -----------
Total costs and expenses 7,608,490 7,118,816
----------- -----------
Income from operations 374,766 208,611
Other income (expense)
Interest expense (336,822) (355,771)
Interest income 104,802 (267,710)
Other income 6,000 --
----------- -----------
Total other expense (226,020) (623,481)
----------- -----------
Earnings (loss) from operations 148,746 (414,870)
Extraordinary item - loss on
early extinguishment of debt -- (141,740)
----------- -----------
Net earnings (loss) 148,746 (556,610)
Dividends on preferred stock 10,017 31,137
----------- -----------
Net earnings (loss) on common shares $ 138,729 $ (587,747)
=========== ===========
Net earnings (loss) per common share -
basic and diluted
Continuing operations $ 0.02 $ (0.08)
Extraordinary item -- (0.03)
----------- -----------
Net earnings (loss) per common share $ 0.02 $ (0.11)
=========== ===========
Weighted average shares outstanding - basic 5,750,631 5,225,656
=========== ===========
Weighted average shares outstanding - diluted 5,796,223 5,225,656
=========== ===========
See notes to unaudited financial statements.
6
<PAGE>
Meritage Hospitality Group Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
For the Year Ended November 30, 1998
and the Nine Month Period Ended August 31, 1999 (Unaudited)
<TABLE>
<CAPTION>
Series A Note
Convertible Additional Receivable
Preferred Common Paid-In Sale of Accumulated
Stock Stock Capital Shares Deficit Total
----------- ---------- ------------ ------------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 1, 1997 $ 1,384 $ 32,188 $ 12,982,295 $ (5,700,645) $ (7,285,261) $ 29,961
Issuance of 1,999,935 shares
of common stock - 19,999 4,561,155 - - 4,581,154
Conversion of 73,867 shares
of convertible preferred
shares into 523,873 common
shares (739) 5,239 (4,500) - - -
Cancellation of 20,000 shares
of convertible preferred
stock (200) - (199,800) - - (200,000)
Dividends paid - preferred
stock - - - - (107,928) (107,928)
Recognition of interest
income on note receivable
from sale of shares - - 627,072 (627,072) - -
Establishment of valuation
allowance on note
receivable from sale of
shares - - (4,666,755) 4,666,755 - -
Net earnings - - - - 1,130,702 1,130,702
-------- --------- ------------ ------------- ------------- -------------
Balance at November 30, 1998 445 57,426 13,299,467 (1,660,962) (6,262,487) 5,433,889
Issuance of 8,120 shares of
common stock - 81 15,424 - - 15,505
Dividends paid - preferred
stock - - - - (30,051) (30,051)
Recognition of interest
income on note receivable
from sale of shares - - 510,952 (510,952) - -
Increase in valuation
allowance on note receivable
from sale of shares - - (510,952) 510,952 - -
Net earnings - - - - 383,753 383,753
-------- --------- ------------ ------------- ------------- -------------
Balance at August 31, 1999 $ 445 $ 57,507 $ 13,314,891 $ (1,660,962) $ (5,908,785) $ 5,803,096
======== ========= ============ ============= ============= =============
</TABLE>
See notes to unaudited financial statements.
7
<PAGE>
Meritage Hospitality Group Inc. and Subsidiaries
Consolidated Statements of Cash Flows
For the Nine Month Periods Ended August 31,
(Unaudited)
1999 1998
----------- -----------
Cash Flows from Operating Activities
Net earnings (loss) $ 383,753 $(1,690,661)
Adjustments to reconcile net earnings
(loss) to net cash provided by
operating activities
Depreciation and amortization 952,987 892,878
Compensation and fees paid by
issuance of common stock 15,505 3,927
Insurance proceeds in excess
of net book value of
fire damaged assets 102,733 --
Minority interest in net earnings
of consolidated subsidiaries -- (25,677)
Interest expense refinanced as
long-term debt -- 5,547
(Decrease) increase in deferred
revenue (220,257) 2,047,141
(Increase) decrease in current
assets (162,252) 290,509
Decrease in net (liabilities) assets
of discontinued operations (416,308) 759,207
(Decrease) increase in current
liabilities (344,814) 313,230
----------- -----------
Net cash provided by operating
activities 311,347 2,596,101
Cash Flows from Investing Activities
Purchase of property, plant and equipment (4,007,301) (276,405)
Payment for franchise agreements (50,000) --
Collection on notes receivable 2,744,617 --
Payment for acquisition of business -- (755,200)
Decrease (increase) in other assets 22,947 (39,575)
----------- -----------
Net cash used in investing
activities (1,289,737) (1,071,180)
Cash Flows from Financing Activities
Proceeds from long-term debt 2,972,422 --
Payment of financing costs (68,106) (94,825)
Principal payments on long-term debt (1,151,304) (770,862)
Payments on obligations under
capital leases (217,918) (195,575)
Payments on notes payable (1,100,000) --
Proceeds from issuance of stock -- 4,928
Preferred dividends paid (30,051) (93,411)
----------- -----------
Net cash provided by (used in)
financing activities 405,043 (1,149,745)
----------- -----------
Net (decrease) increase in cash (573,347) 375,176
Cash and Cash Equivalents -
Beginning of Period 2,109,358 1,061,475
----------- -----------
Cash and Cash Equivalents -
End of Period $ 1,536,011 $ 1,436,651
=========== ===========
Supplemental Cash Flow Information - See Note A
See notes to unaudited financial statements.
8
<PAGE>
Meritage Hospitality Group Inc. and Subsidiaries
Notes to Unaudited Financial Statements
For the Nine Month Periods Ended August 31,
Note A - Supplemental Cash Flow Information
1999 1998
------------ -----------
Cash paid for interest expense $ 1,099,534 $ 1,058,798
Schedule of non-cash investing
and financing transactions
$550,000 short term note payable
retired and replaced
by construction loan $ -
============
Acquisition of remaining 46% of
Wendy's of West Michigan Limited
Partnership, including assets
acquired and liabilities assumed
Fair value of tangible and
intangible assets acquired $ 3,748,187
Reduction of minority interest 1,575,738
Amount of cash payment (755,200)
-----------
1,992,359 common shares issued $ 4,568,725
===========
Sale of hotel assets
Selling price, net of selling
costs $ 4,334,643
Cash proceeds from sale of
hotel assets 2,959,643
-----------
Note receivable from sale of
hotel assets $ 1,375,000
===========
Note B - Earnings (Loss) Per Share
Basic earnings per share is computed by dividing earnings on common shares
by the weighted average number of common shares outstanding during each period.
Diluted earnings per share reflect per share amounts that would have resulted if
dilutive potential common stock had been converted to common stock.
The following table reconciles the numerators and denominators used to
calculate basic and diluted earnings per share for the three and nine month
periods ended August 31, 1999 and 1998:
<TABLE>
<CAPTION>
Three months ended August 31, Nine months ended August 31,
-------------------------------- --------------------------------
1999 1998 1999 1998
------------- -------------- ------------- --------------
<S> <C> <C> <C> <C>
Numerators
Earnings (loss) from continuing operations $ 148,746 $ (414,870) $ 312,953 $ (1,069,689)
Less preferred stock dividends 10,017 31,137 30,051 93,411
-------------- --------------- ------------- --------------
Earnings (loss) on common shares - basic 138,729 (446,007) 282,902 (1,163,100)
Effect of dilutive securities
Convertible preferred stock - - - -
Stock options - - - -
-------------- --------------- -------------- --------------
Earnings (loss) on common shares - diluted $ 138,729 $ (446,007) $ 282,902 $ (1,163,100)
============== =============== ============== =============
</TABLE>
9
<PAGE>
Meritage Hospitality Group Inc. and Subsidiaries
Notes to Unaudited Financial Statements - continued
For the Nine Month Periods Ended August 31,
Note B - Earnings (Loss) Per Share (continued)
Three months Nine months
ended August 31, ended August 31,
------------------------ ------------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
Denominators
Weighted average common
shares outstanding -
basic 5,750,631 5,225,656 5,746,905 4,687,097
Effect of dilutive
securities
Convertible preferred
stock - - - -
Stock options 45,592 - 20,144 -
---------- ---------- ---------- ---------
Weighted average common
shares outstanding -
diluted 5,796,223 5,225,656 5,767,049 4,687,097
========== ========== ========== =========
For the three and nine months ended August 31, 1999 and 1998, convertible
preferred stock was not included in the computation of diluted earnings per
share because the effect of conversion would be antidilutive. For the three and
nine months ended August 31, 1998, stock options were not included in the
computation of diluted earnings per share because the option prices were greater
than average quarterly market prices.
Note C - Discontinued Operations
Effective May 31, 1998, the Company began accounting for its lodging
business segment as discontinued operations. As of August 31, 1999 and November
30, 1998, assets and liabilities of the discontinued lodging segment included in
the balance sheet are summarized below:
August 31, November 30,
Assets 1999 1998
-------------- -------------
Current assets $ - $ 13,264
Other assets - 16,511
Liabilities
Current liabilities (177,547) (623,630)
-------------- -------------
Net liabilities of discontinued operations $ (177,547) $ (593,855)
============== =============
10
<PAGE>
Meritage Hospitality Group Inc. and Subsidiaries
Notes to Unaudited Financial Statements - continued
For the Nine Month Periods Ended August 31,
Note C - Discontinued Operations (continued)
A summary of the results of operations of the discontinued operations for
the three and nine month periods ended August 31, 1998 is as follows:
For the nine month period ended August 31, 1998
Revenues $ 6,350,989
Costs and expenses 5,830,821
----------------
Earnings from operations 520,168
Other expense (943,452)
----------------
Loss from operations of discontinued operations (423,284)
Gain on disposal of discontinued operations 480,418
----------------
Net income from discontinued operations $ 57,134
================
For the three month period ended August 31, 1998
Revenues $ 2,126,018
Costs and expenses 1,814,635
----------------
Earnings from operations 311,383
Other expense (255,435)
----------------
Income from operations of discontinued operations 55,948
Gain on disposal of discontinued operations 480,418
----------------
Net income from discontinued operations $ 536,366
================
The loss from discontinued operations included on the consolidated
statement of operations for the nine months ended August 31, 1998 of $479,232
includes only operations through May 31, 1998, the measurement date for
discontinued operations. As described above, the income from operations from the
measurement date through August 31, 1998 of $536,366 is required to be deferred
until the disposal of the business segment (September 1, 1998).
11
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Results of Operations
CONTINUING OPERATIONS
The Company's continuing operations consists of its operation of 28
"Wendy's Old Fashioned Hamburgers" restaurants (under franchise agreements with
Wendy's International) throughout Western and Southern Michigan. Due to the
discontinued Lodging Group operations, results of continuing operations for the
three and nine month periods ended August 31, 1999 and August 31, 1998 also
include expenses related to the Company's corporate office and are summarized in
the following table:
<TABLE>
<CAPTION>
Statements of Operations
----------------------------------------------------------------------------------
Three month periods ended August 31, Nine month periods ended August 31,
-------------------------------------- -------------------------------------
$ (000's) % of Revenue $ (000's) % of Revenue
----------------- --------------- ----------------- ---------------
1999 1998 1999 1998 1999 1998 1999 1998
------- -------- ------ ------ ------- -------- ----- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Food and beverage revenue $ 7,983 $ 7,327 100.0% 100.0% $22,004 $ 20,041 100.0% 100.0%
Costs and expenses
Cost of food and beverages 2,288 2,085 28.7 28.5 6,358 5,754 28.9 28.7
Operating expenses 4,487 4,163 56.2 56.9 12,652 11,794 57.5 58.8
General and administrative
Restaurant operations 294 296 3.7 4.0 873 940 4.0 4.7
Corporate level expenses 209 300 2.6 4.1 506 1,226 2.3 6.1
Depreciation and amortization 330 274 4.1 3.7 953 893 4.3 4.5
------- -------- ------ ------ ------- -------- ----- ------
Total costs and expenses 7,608 7,118 95.3 97.2 21,342 20,607 97.0 102.8
Income (loss) from operations 375 209 4.7 2.8 662 (566) 3.0 (2.8)
Other income (expense)
Interest expense (337) (356) (4.1) (4.8) (1,006) (1,096) (4.6) (5.5)
Interest income 105 (268) 1.3 (3.7) 354 47 1.6 0.3
Other income 6 - 0.0 - 6 519 0.0 2.6
Gain on sale of assets - - - - 297 - 1.4 -
Minority interest - - - - - 26 - 0.1
------- -------- ------ ------ ------- -------- ----- ------
Total other expense (226) (624) (2.8) (8.5) (349) (504) (1.6) (2.5)
------- -------- ------ ------ ------- -------- ----- ------
Earnings (loss) from
continuing operations $ 149 $ (415) 1.9% (5.7%) $ 313 $ (1,070) 1.4% (5.3%)
======= ========= ====== ======= ======= ========= ====== =======
</TABLE>
Revenue
Food and beverage revenue increased $656,000 or 9.0% for the three months
ended August 31, 1999 compared to the same period of 1998. For the nine months
ended August 31, 1999, food and beverage revenue increased $1,963,000 or 9.8%
compared to the same period of 1998. Revenue for the three and nine months ended
August 31, 1999 includes sales from three new restaurants opened February 18,
March 18, and June 24, respectively. In April 1999, one of the Company's
existing restaurants was damaged by fire and was closed for renovation. This
restaurant reopened October 1, 1999. Food and beverage revenue on a per
restaurant basis for restaurants in operation during the first three quarters of
1999 and 1998, and for the nine months ended August 31, 1999 and 1998, are set
forth in the following table:
12
<PAGE>
Average Net Sales
Per Restaurant Unit
Increase % Increase
1999 1998 (Decrease) (Decrease)
---------- ---------- ---------- ----------
Three months ended August 31 $ 301,321 $ 293,119 $ 8,202 2.8%
Three months ended May 31 287,207 267,199 20,008 7.5%
Three months ended February 28 257,908 240,465 17,443 7.3%
---------- ---------- ---------
Nine months ended August 31 $ 846,436 $ 800,783 $ 45,653 5.7%
========== ========== ========
The 2.8% ($197,000) increase in same store sales for the third quarter of
1999 was primarily attributable to (i) increased customer traffic during late
night hours (sales between the hours of 10:00 p.m. and midnight) resulting in a
$29,000 increase in late-night sales, (ii) an increase in "upsizing" (the
addition of a larger beverage and larger french fry to the standard combo meal
for an additional 39 cents) which accounted for $27,000 of the sales increase,
and (iii) an increase in the selling price of beverages in July 1999. Same store
sales for the nine months ended August 31, 1999 increased 5.7% ($1,096,000). The
increase is primarily attributable to an increase in late-night sales of
$237,000 over the prior year, and increased "combo" meal and "upsizing" sales
over the prior year. The increase in combo meals and upsizing sales has
contributed to a 4% increase in average sales per transaction for both the three
and nine months ended August 31, 1999.
Cost of Food and Beverages
Cost of food and beverages as a percentage of food and beverage revenue was
28.7% for the three months ended August 31, 1999 compared to 28.5% for the three
months ended August 31, 1998. Cost of food and beverages for the nine months
ended August 31, 1999 was 28.9% compared to 28.7% for the same period of 1998.
The .2 percentage point increase in cost of food and beverages for the three
months ended August 31, 1999 is primarily due to an increase in the average cost
of beef from 91 cents per pound for the three months ended August 31, 1998, to
99 cents per pound for the three months ended August 31, 1999. Food costs have
remained constant or declined for most of the major food products for the nine
months ended August 31, 1999 compared to the nine months ended August 31, 1998.
The .2 percentage point increase in cost of food and beverages for the nine
months ended August 31, 1999 is primarily attributable to the increase in combo
sales (from approximately 34% of sales during the nine months ended August 31,
1998 to approximately 40% of sales during the same period of 1999), which are
priced at a discount of approximately 8% of the price of the individual
products. Cost of food and beverage percentages of 28.7% for the three months
ended August 31, 1999, and 28.9% for the nine months ended August 31, 1999, are
in line with the Company's and Wendy's International's guidelines.
Operating Expenses
Operating expenses as a percentage of revenue decreased .7 percentage
points for the three months ended August 31, 1999 compared to the same period of
1998 (from 56.9% of revenue in 1998 to 56.2% in 1999). For the nine months ended
August 31, 1999, operating expenses were reduced 1.3 percentage points (from
58.8% of revenue in 1998 to 57.5% in 1999). The net decrease in operating
expenses as a percentage of revenue was primarily the result of reductions in
rent expense and advertising expense in excess of increased payroll costs and
building repairs and maintenance. A detailed discussion follows:
13
<PAGE>
- Rent Expense
Rent expense decreased $108,000 and $294,000 for the three and nine months
ended August 31, 1999, respectively, compared to the same periods of 1998. As a
percentage of revenue, rent expense decreased from 4.6% of revenue for both the
three and nine months ended August 31, 1998, to 2.9% of revenue for the three
months ended August 31, 1999 and 2.8% for the nine months ended August 31, 1999.
The reduction in rent expense resulted from the September 1998 purchase of five
restaurants which were previously leased. The Company has realized a
corresponding increase in interest and depreciation expense due to this
purchase. The elimination of this rent expense was slightly offset by increased
rent at certain leased restaurants due to increased sales volume at these
restaurants for both the three and nine months ended August 31, 1999.
- Advertising Expense
As a percentage of revenue, advertising expense decreased 1.3 percentage
points (a reduction of $61,000 and $162,000) for the three and nine month
periods ended August 31, 1999, compared to the same periods in 1998. The reduced
expense for the third quarter was the result of an increase in advertising
rebates from PepsiCo compared to rebates received during 1998 from Coca-Cola.
Advertising expense for the three and nine months ended August 31, 1999 included
$43,000 and $73,000 respectively of advertising costs incurred by the three new
restaurants opened during 1999. The decrease for the nine month period also
reflected (i) a savings from a program sponsored by Wendy's International which
reduced the national advertising contribution paid by the franchisees for the
first quarter of 1999, and (ii) a refund from the Company's local advertising
cooperative due to an overpayment from the prior year.
- Increased Payroll Costs
Payroll costs for the three months ended August 31, 1999 increased from
30.0% of revenue in 1998 to 32.3% of revenue in 1999. The Company has continued
to be affected by a tight labor market and its effect on the availability and
cost of labor. As a percentage of revenue, restaurant crew labor costs increased
1.8 percentage points (a 10.8% increase) for the three months ended August 31,
1999, compared to the same period of 1998, due to the following factors:
(i) an increase in the average hourly rate of 5.6%;
(ii) an increase in the overtime premium paid and additional hourly
employee assignments due to the general labor shortage in the
Company's market;
(iii) higher than normal staffing at the new restaurant opened in June 1999
during the opening phase when the restaurant operated under "new
restaurant labor guidelines"; and
(iv) increased average same store sales of 2.8%.
Also contributing to the increase in payroll costs was an increase of .3
percentage points for training of newly hired restaurant managers in connection
with new restaurant development and as a result of turnover due to the very
tight labor market (the unemployment rate in the Company's market has fallen
below 3%). Payroll taxes also increased due to increased wages.
The same factors described above impacted payroll costs for the nine months
ended August 31, 1999 compared to the same period of 1998. Payroll costs
increased from 31.2% of revenue in 1998 to 33.0% of revenue in 1999. As a
percentage of sales, restaurant crew labor costs increased 1.3 percentage points
14
<PAGE>
(a 7.8% increase) for the nine months ended August 31, 1999 compared to the same
period of 1998, due to the following factors:
(i) an increase in the average hourly rate of 4.6%;
(ii) an increase in the overtime premium paid and additional hourly
employee assignments due to the general labor shortage in the
Company's market;
(iii) pre-opening labor costs and higher than normal staffing at the three
new restaurants during the opening phase when these restaurants
operated under "new restaurant labor guidelines"; and
(iv) increased average same store sales of 5.7%.
Compounding these cost increases, for the nine months ended August 31,
1999, employee health insurance costs increased from 1.8% of revenue to 2.1% of
revenue due to an increase in premiums. Beginning April 1, 1999, a portion of
the total premium increase was shared by the employees. Also contributing to the
increase in payroll costs for the nine months ended August 31, 1999 were
increased training costs for newly hired store managers.
- Building Repairs and Maintenance
As a percentage of revenue, building repairs increased .5 percentage points
(from $80,000 to $125,000) for the three months ended August 31, 1999, compared
to the same period of 1998. For the nine months ended August 31, 1999, building
repairs increased .3 percentage points (from $228,000 to $310,000). The increase
in building repairs and maintenance for the three months ended August 31, 1999
was primarily the result of exterior painting on eleven restaurants during the
third quarter of 1999 at a cost of approximately $33,000. In addition to the
third quarter painting costs, building repairs and maintenance for the nine
months ended August 31, 1999 reflect a significant increase in the cost of snow
removal in the first quarter of 1999 compared to the first quarter of 1998. The
Company also experienced an increase in pest control maintenance costs (which
was mandated in connection with the Wendy's system's overall food safety
program) and increased parking lot maintenance costs during 1999.
General and Administrative
Restaurant Operations
General and administrative expenses for the restaurant operations for the
three and nine months ended August 31, 1998 included a general partner
administrative fee of $40,000 and $120,000 respectively. The general partner
administrative fee was eliminated in December 1998.
Excluding the general partner administrative fee, general and
administrative expenses increased $38,000 for the three months ended August 31,
1999 compared to the same period of 1998 (from $256,000 to $294,000). The
increase for the three months ended August 31, 1999 was primarily due to
increased administrative payroll and related payroll costs, an increase in
office expenses and an increase in new store development costs. As a percentage
of revenue, general and administrative expenses (excluding the general partner
administration fee) increased from 3.4% of revenue for the third quarter of 1998
to 3.7% of revenue for the third quarter of 1999.
Excluding the general partner administrative fee, general and
administrative expenses increased $53,000 for the nine months ended August 31,
15
<PAGE>
1999 (from $820,000 to $873,000). The increase for the nine months ended August
31, 1999 was primarily due to an increase in administrative payroll and related
payroll costs, an increase in office expenses, an increase in transportation
costs, and an increase in new store development costs. These increases were
partially offset by a decrease in Michigan single business tax expense, a
decrease in legal and professional fees, and a decrease in outside recruiting
costs. As a percentage of revenue, general and administrative expenses
(excluding the general partner administration fee) decreased from 4.1% of
revenue to 4.0% of revenue.
Corporate Level Expenses
General and administrative expenses for corporate level expenses decreased
$91,000 (from $300,000 to $209,000), from 4.1% of revenue to 2.6% of revenue for
the three months ended August 31, 1999 compared to the same period of 1998. The
decrease was primarily due to (i) a $37,000 reduction in legal and professional
fees, (ii) a $29,000 reduction in salaries, bonuses, and related costs resulting
from the elimination of several positions, and (iii) a $45,000 decrease in life
insurance premiums resulting from the sale of policies earlier this year. These
decreases were offset by an increase in public market expense resulting from the
payment of a $30,000 application fee to register the Company's common stock on
the American Stock Exchange.
For the nine months ended August 31, 1999, general and administrative
expenses decreased approximately $720,000 (from $1,226,000 to $506,000), from
6.1% of revenue to 2.3% of revenue. The decrease was primarily due to reductions
in the same expense categories described above including (i) a $424,000
reduction in legal expenses resulting from the recovery of $192,000 of legal
expenses from insurance proceeds in 1999, and unusually high legal costs in 1998
due to active litigation, (ii) a $188,000 decrease in salaries, bonuses and
related costs, and (iii) a $128,000 reduction in life insurance premiums.
Offsetting these decreases was a $59,000 increase in public market expense due
to the $30,000 application fee for registration on the American Stock Exchange
and the engagement in 1999 of an investor relations firm at a cost of $22,000.
Depreciation and Amortization
Depreciation and amortization expense increased $56,000 for the three
months ended August 31, 1999 and $60,000 for the nine months ended August 31,
1999, compared to the same periods of 1998. The increase for both the three and
nine months ended August 31, 1999 was primarily attributable to the acquisition
of five restaurants in September 1998 and the addition of three new restaurants
in 1999.
Interest Expense
Interest expense for the third quarter of 1999 and 1998 was $337,000 and
$356,000, respectively. Interest expense for the nine months ended August 31,
1999 and 1998 was $1,006,000 and $1,096,000, respectively. Long-term debt was
restructured during the fourth quarter of 1998 which resulted in a weighted
average interest rate of approximately 9% for the three and nine months ended
August 31, 1999 compared to approximately 14% for the same periods of 1998. All
of the Company's long-term debt is now at fixed interest rates compared to the
long-term debt prior to the debt restructuring when the Company had both fixed
and variable interest rates.
The impact on interest expense of this significant reduction in interest
rates more than offsets the additional interest expense incurred due to the
Company's increase in long-term debt. Long-term debt has increased from $9.4
million as of August 31, 1998 (prior to the Company's debt restructuring) to
16
<PAGE>
$15.1 million as of August 31, 1999. The increase in long-term debt was due to
borrowings of $10.1 million in the fourth quarter of 1998 of which $4.2 million
was used to acquire five restaurants that had been previously leased by the
Company. The remaining $5.9 million was used to refinance existing long-term
debt at a lower interest rate. During the first nine months of fiscal 1999, the
Company has borrowed an additional $2.9 million to finance the land and building
for three new restaurants opened during the first nine months of 1999 and to
acquire land for a restaurant currently under construction.
Interest Income
Interest income increased $373,000 for the third quarter (from negative
$268,000 in 1998 to $105,000 in 1999), and $307,000 for the nine months ended
August 31, 1999 (from $47,000 in 1998 to $354,000 in 1999). In June 1998, the
Company discontinued its recognition of non-cash interest income on the
Company's note receivable from the sale of stock and reversed the year-to-date
interest income previously recognized. This resulted in the negative interest
income for the third quarter of 1998. The cash interest income recorded in 1998
and 1999 was primarily the result of interest earned on the notes receivable
obtained in the sale of the Thomas Edison Inn and the Grand Harbor Resort &
Yacht Club.
Other Income
Other income of $519,000 for the nine months ended August 31, 1998 was
primarily due to the forfeiture of an earnest deposit in April 1998 in the
amount of $500,000 on a contract to sell one of the Company's hotel properties.
Gain on Disposal of Assets
A gain of $297,000 was recognized for the nine months ended August 31,
1999. The gain on disposal of assets was due to the sale of life insurance
policies during the first two quarters ($200,000), and from the excess of
insurance proceeds over the net book value of fire damaged equipment ($97,000).
The Company expects that insurance will cover substantially all of the costs to
restore and equip the fire damaged restaurant.
Lodging Group - Discontinued Operations
During the second quarter of 1998, the Company entered into agreements to
sell its two hotel properties resulting in the discontinuance of the Company's
Lodging Group as of September 1, 1998. For details of the impact on the
Company's operating results see Note C of the Company's financial statements.
17
<PAGE>
Liquidity and Capital Resources
Cash Flows
Cash and cash equivalents ("cash") decreased $573,000 from $2,109,000 as of
November 30, 1998 to $1,536,000 as of August 31, 1999. The decrease in cash was
the result of the following:
Net cash provided by operating activities $ 311,000
Net cash used in investing activities (1,289,000)
Net cash provided by financing activities 405,000
------------
Net decrease in cash $ (573,000)
============
Net cash provided by operating activities decreased $2,285,000 for the nine
months ended August 31, 1999 compared to the same period of 1998 despite an
increase in net earnings of $2,074,000. The decrease was due in large part to
the receipt of $2,090,000 in marketing and conversion funds (deferred revenue)
from the Company's beverage supplier in May 1998. The decrease also reflects a
net change of $1,176,000 in cash flow from net assets of discontinued
operations. For the nine months ended August 31, 1998, assets of discontinued
operations were sold generating cash compared to the same period of 1999 when
liabilities of discontinued operations were retired using cash.
Net cash used in investing activities increased $219,000 for the nine
months ended August 31, 1999 compared to the same period of 1998. The 1999
activity reflects an investment of $3,889,000 in three new restaurants opened in
1999 and the land for a fourth restaurant currently under construction. This
investment in new restaurants compares to an investment of $755,000 in 1998 for
the acquisition of the remaining interest in the former Wendy's of West Michigan
Limited Partnership. Offsetting the $3,889,000 investment in new restaurants in
1999 was $2,745,000 of receipts on notes receivable related to the sale of the
Company's hotel properties.
Net cash provided by financing activities increased $1,555,000 for the nine
months ended August 31, 1999 compared to the same period of 1998. The increase
is primarily the result of proceeds from long-term debt of $2,972,000 used to
finance the investment in three new restaurants and the land for a fourth
restaurant currently under construction. This source of cash was offset by an
increase in principal payments on long-term debt of $380,000 for the nine months
ended August 31, 1999 compared to the same period of 1998, and the payoff of
$1,100,000 of short-term notes payable from proceeds from the note receivable
described in the previous paragraph. Scheduled principal payments on long-term
debt were significantly reduced for the nine month period ended August 31, 1999
compared to the same period of 1998 due to the restructuring of long-term debt
discussed earlier. This reduction in scheduled principal payments on long-term
debt was more than offset by the payment of $900,000 made during the third
quarter of 1999 on long-term debt which was also paid from proceeds from the
note receivable described in the previous paragraph. These notes payable had
been incurred when the Company sold participation interests in the notes
receivable resulting from the sale of the hotel properties.
Financial Condition
As of August 31, 1999, the Company's current liabilities exceeded its
current assets by $683,000, compared to November 30, 1998 when current assets
exceeded current liabilities by $230,000. At these dates, the ratios of current
assets to current liabilities were 0.8:1 and 1.0:1 respectively. The discussion
18
<PAGE>
above of Cash Flows for the nine months ended August 31, 1999 explains the
decrease in cash as well as the most significant reasons for the decrease in
working capital.
The cash management issues currently facing the Company can be described in
two key areas: (i) on-going operations and capital improvements at the existing
Wendy's restaurants, and (ii) investment in new Wendy's restaurants.
The single most significant issue facing management at existing restaurants
is the combination of decreased availability of employees and the continued
increasing cost of labor. Wendy's International has established a "Service
Excellence" program which incorporates the use of new tools (e.g. timing
mechanisms to improve drive-through service times) to allow for lower labor
costs per customer. The required capital expenditures for the Service Excellence
program are estimated at an average cost of approximately $10,000 per restaurant
over the next twelve months. In addition to those capital expenditure
requirements, the Company estimates that the existing restaurants will require
approximately $450,000 of capital improvements over the next twelve months.
The Company has invested approximately $3,900,000 into new restaurants
during the nine months ended August 31, 1999. This investment consists of land,
building and equipment for three new restaurants and land for a fourth
restaurant which is scheduled to open in Spring 2000. The Company has obtained
mortgage loans totaling $3,201,000 for these three restaurants. The mortgage
loans are amortized over 20 years at fixed interest rates ranging from 8.42% to
8.53%. The fourth restaurant requires an additional investment of approximately
$900,000 in the upcoming six months. The financing for this new restaurant is
being provided by Fleet Business Credit Corporation under a program approved by
Wendy's International. The Company has received a forward commitment to finance
$2,500,000 in new store investments for two additional restaurants over the next
twelve months at a fixed interest rate equal to 2.2% over the then-current 20
year treasuries (approximately 8.2% at current rates).
Construction has begun on a fifth new restaurant which will be leased. This
restaurant is the Company's first prototype restaurant that combines a Wendy's
restaurant with a Meijer convenience store-gas station facility. The Company has
also made refundable deposits on several potential restaurant sites. If
purchased, construction at these sites would begin in fiscal 2000. Financing for
the restaurant under construction and any future restaurants would be provided
through a combination of (i) proceeds from borrowings under the forward fixed
rate financing commitment, (ii) leasing of real estate and equipment, and (iii)
equipment financing. It is anticipated that these financing options will provide
for approximately 90% of the cost for newly opened units over the next twelve
months. The Company has begun discussions with a number of lenders to provide
the equipment financing.
The Company's various loan agreements contain loan covenants requiring the
maintenance of certain financial ratios including:
- Fixed Charge Coverage Ratio ("FCCR") of 1.2:1 for the Wendy's
operation as a whole;
- FCCR of 1.2 : 1 for the Wendy's restaurants that are subject to a real
estate mortgage; and
- FCCR of 1.4 : 1 for the Wendy's restaurants that are subject to both a
real estate mortgage and a business value loan.
At August 31, 1999, the Company was in compliance with these covenants.
19
<PAGE>
The Company's loan agreements and its operating agreements with Wendy's
International restrict the amount of currently generated operating cash flow
from the Wendy's operation that may be utilized to fund corporate level
expenses. The Company anticipates that this requirement will be met in the
current year given the reductions in corporate level expenses and the receipt of
non-operating cash during this fiscal year. Approximately $1,136,000 of such
non-operating proceeds were received during the first nine months of the year.
In light of the operational and investment cash management issues discussed
above, the Company plans to meet its current obligations over the next twelve
months by:
- Utilizing cash reserves in excess of $1,500,000.
- Using $900,000 of annual projected operating cash generated from
existing Wendy's restaurants.
- Generating additional operating cash flow from newly opened
restaurants.
- Exploring the acquisition of a working capital and an equipment line
of credit.
- Exploring the financing of certain capital expenditures at existing
Wendy's restaurants.
- Participating in vendor financing programs for capital expenditures
required under the Service Excellence program.
- Exploring the use of equipment financing for certain of the new
restaurants.
- Reducing or deferring capital expenditures described above.
There can be no assurances, however, that the Company will be able to
complete the above activities or that completion would yield the results
expected. Also, $475,000 of the notes receivable have been assigned with
recourse. To the extent those notes are not paid by their makers, the Company
would be obligated to make the payments to the assignee upon completion of its
collection efforts. Although the Company believes that the collateral is
sufficient to cover the remaining obligations on those notes, there is no
assurance that the Company would be able to effect such a realization when
payments on the notes would ultimately be due to the assignee, and no assurances
that the amounts recovered would be sufficient to cover amounts due the
assignee. In such circumstances, the Company would be required to secure
necessary funds through borrowings or other means.
Computer Systems - Year 2000 Impact
The Company and its vendors have become increasingly reliant on computer
systems to process transactions and to provide relevant business information.
The majority of computer systems designed prior to the mid-1990's are
susceptible to a well publicized problem associated with an inability to process
date related information beginning with the year 2000. Almost all of the
Company's computer hardware was acquired within the past three years. The
Company is completing its review of its computer hardware and software with the
assistance of the software designers to ensure that all significant software
applications are year 2000 compliant. Based on the results of the review to
date, the Company believes that the point-of-sale system (which monitors all
sales, inventory and labor activity) is year 2000 compliant. The critical
20
<PAGE>
systems which are used to (i) produce financial statements, (ii) process
payroll, and (iii) process purchases and cash disbursements have also been
tested and are year 2000 compliant. However, the Company's software used to
compare actual product usage with planned product usage is not year 2000
compliant. The Company plans to replace its product usage software with year
2000 compliant software.
The Company estimates that the required replacement and enhancement of
systems for year 2000 compliance will cost approximately $150,000. The Company
does not expect to incur significant additional costs to complete its review of
computer systems to determine what measures are required to be year 2000
compliant. However, the Company can make no assurance that all year 2000 risks
to the Company and to its critical vendor systems can be identified and
successfully negated through modification or replacement of existing programs.
Although the Company has performed a detailed review of its computer systems,
there is no assurance that unanticipated year 2000 issues could arise that could
have adverse financial and operational effects on the Company.
Despite assurances from its various software vendors, the Company could
find that its critical computer systems are not year 2000 compliant or that it
experiences computer equipment failures. In such event, the Company's
contingency plan includes the following:
1) Point-of-Sale System - The Company would immediately begin to manually
process its sales, monitor its inventory, and record its labor
expense. This manual system would remain in effect until such time as
the year 2000 issues are corrected or a replacement computerized
system is installed. It is possible, however, that if the year 2000
issues cannot be corrected, or a replacement system cannot be
installed within a short period of time, there could be adverse
financial and operational effects on the Company.
2) Financial Statements, Cash Disbursements and Payroll Systems - The
Company would initiate one or more of the following contingency plans
until the year 2000 issue can be corrected: (i) manual processing,
(ii) utilization of an alternative software program on a "stop-gap"
basis until the system can be corrected, or (iii) contract with a
third party vendor to process payments, payroll and financial
statements. If the year 2000 issues cannot be corrected on a timely
basis, there could be adverse financial and operational effects on the
Company.
Although the Company has not been informed of material year 2000 issues by
third parties with which it has a material relationship, there is no assurance
that these entities will be year 2000 compliant on a timely basis. Unanticipated
failures or significant delays in furnishing products or services by third
parties or general public infrastructure service providers could have adverse
financial and operational effects on the Company.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Not Applicable.
21
<PAGE>
PART II
OTHER INFORMATION
Item 5. Other Information.
On September 24, 1999, the Company's common shares began trading on the
American Stock Exchange under the ticker symbol "MHG". The Company's shares were
previously traded on the OTC Bulletin Board under the symbol "MHGI" and on the
Chicago Stock Exchange under the symbol "MHG".
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibit List.
Exhibit No. Description of Document
----------- -----------------------
27 Financial Data Schedule.
- --------------
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter for which
this report is filed.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: October 4, 1999 MERITAGE HOSPITALITY GROUP INC.
By: /s/ Robert E. Schermer, Jr.
--------------------------------------
Robert E. Schermer, Jr.
President and Chief Executive Officer
By: /s/ Pauline M. Krywanski
--------------------------------------
Pauline M. Krywanski
Vice President and Treasurer
(Chief Financial Officer)
22
<PAGE>
EXHIBIT INDEX
Exhibit No. Description of Document
- ----------- ------------------------------------------------------
27 Financial Data Schedule.
23
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<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> NOV-30-1999
<PERIOD-END> AUG-31-1999
<CASH> 1,536,011
<SECURITIES> 0
<RECEIVABLES> 65,264
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<INVENTORY> 193,970
<CURRENT-ASSETS> 2,500,189
<PP&E> 17,877,260
<DEPRECIATION> 1,559,851
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<CURRENT-LIABILITIES> 3,183,145
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<COMMON> 57,507
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<SALES> 22,003,792
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