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Meritage Hospitality Group Inc – ‘S-4/A’ on 10/15/97

As of:  Wednesday, 10/15/97   ·   Accession #:  950152-97-7227   ·   File #:  333-33461

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  As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

10/15/97  Meritage Hospitality Group Inc    S-4/A                  4:512K                                   Bowne BCL/FA

Pre-Effective Amendment to Registration of Securities Issued in a Business-Combination Transaction   —   Form S-4
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: S-4/A       Meritage Hospitality Group Inc. S-4 Amend No. 1      153    737K 
 2: EX-23.1     Consent of Experts or Counsel                          1      5K 
 3: EX-23.4     Consent of Experts or Counsel                          1      6K 
 4: EX-99.2     Miscellaneous Exhibit                                 45    227K 


S-4/A   —   Meritage Hospitality Group Inc. S-4 Amend No. 1
Document Table of Contents

Page (sequential) | (alphabetic) Top
 
11st Page   -   Filing Submission
2Meritage Hospitality Group Inc
5Wendy's of West Michigan Limited Partnership
7Available Information
8Summary
"The Parties
"The Transaction
"Wendy's Partnership Authorization
9Meritage Common Shares Outstanding
"Wendy's Partnership Units Outstanding
10Certain Risk Factors
12Risks Associated with Meritage's Business
"Recommendation of the General Partner
13Material Effects to the Limited Partners
"Background and Reasons for the Transaction
"Tax Effects
"No Dissenters' Rights
"Fiduciary Duties of the General Partner
14Market Quotations
15Meritage Hospitality Group Inc. Summary Consolidated Financial Data
19Wendy's of West Michigan Limited Partnership Summary Consolidated Financial Data
23Comparative Per Share and Unit Data
24Risk Factors and Other Considerations
"Risks Associated with Dissolution of the Wendy's Partnership
"Conflicts of Interest
"No Independent Representation of Limited Partners
"Alternatives Not Pursued
25Change in Nature of Investment and Status of Limited Partners
"Risks Associated with Investment in Meritage Common Shares
"Limited Public Trading Market
"Substantial Debt
26Continuing Losses
"Common Share Ownership and Control by Insiders
"Legal Proceedings
27Broadened Business Orientation
"Risks of the Lodging Industry
29Risks Affecting Restaurant Operations
30Geographic Concentration of Operations
31Capitalization
"August 31, 1997
"Price Range of Common Shares
32Distribution Policies
"Background of the Transaction
33Fees and Expenses of the Transaction
34Determination of Consideration for Units
"Background of the Wendy's Partnership
"Other Considerations
35Fairness of Transaction
37Opinion of Financial Advisor to the General Partner
44Selected Consolidated Financial Data
46General
"Results of Operations
50Food Service Group
51Lodging Group
54Liquidity and Capital Resources
58Financing and Encumbrances
59Inflation and Changing Prices
62Restaurant Operating Expenses
64Business
65Replacement and Restructuring of Management
68Competition and Industry Conditions
69Relationship with Wendy's International
70Governmental Regulations
"Other Assets
71Properties
73Management
"Directors and Executive Officers
75Executive Compensation
76Certain Relationships and Related Transactions
79Principal Shareholders
80Federal Income Tax Consequences
"Passive Activity Income
81Description of Capital Shares
"Common Shares
82Preferred Shares
"Transfer Agent
83Comparative Rights
"Federal Income Taxation
"Voting Rights
84Amendments to Governing Documents
"Dividends and Distributions
"Continuity of Existence
"Rights Upon Liquidation
85Dissenters' Rights
"Liability; Indemnification
"Meetings
86Experts
87Index to Financial Statements
90Report of Independent Certified Public Accountants
91Consolidated Balance Sheets
93Consolidated Statements of Operations
99Notes to Consolidated Financial Statements
117Balance Sheets
119Statements of Income
122Statements of Cash Flows
125Notes to Financial Statements
134Wendy's of West Michigan Limited Partnership Unaudited Interim Financial Statements
142Unaudited Pro Forma Consolidated Balance Sheet
"Meritage
143Unaudited Pro Forma Consolidated Statement of Operations
144Year Ended November 30, 1996
145Unaudited Pro Forma Consolidated Statement of Cash Flows
"Nine Month Period Ended August 31, 1997
147Notes to Unaudited Pro Forma Consolidated Financial Statements
149Item 20. Indemnification of Directors and Officers
150Item 21. Exhibits and Financial Statement Schedules
151Item 22. Undertakings
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As filed with the Securities and Exchange Commission on October 15, 1997 Registration No. 333-33461 ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 -------------- AMENDMENT NO. 1 TO FORM S-4 REGISTRATION STATEMENT under THE SECURITIES ACT OF 1933 -------------- 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. [ ] CALCULATION OF REGISTRATION FEE [Enlarge/Download Table] ======================================= ====================================== ====================================== TITLE OF EACH CLASS OF PROPOSED MAXIMUM AGGREGATE AMOUNT OF SECURITIES TO BE REGISTERED OFFERING PRICE (1) REGISTRATION FEE (2) --------------------------------------- -------------------------------------- -------------------------------------- Common Shares $4,320,000 $1,309 ======================================= ====================================== ====================================== <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). 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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SUBJECT TO COMPLETION, DATED OCTOBER 15, 1997 MERITAGE HOSPITALITY GROUP INC. PROSPECTUS FOR 1,500,000 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. 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 lesser of the average high and low bid price on the OTC Bulletin Board for the 10 trading days preceding the date of dissolution or $4.125 per share. 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, after which the sale of assets and dissolution will occur. 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. Meritage's Common Shares are listed on the Chicago Stock Exchange under the symbol "MHG" and on the OTC Bulletin Board under the symbol "MHGI." On October 9, 1997, the average high and low bid price on the OTC Bulletin Board was $3 1/2 per share. Units of the Wendy's Partnership are not publicly traded. There have been, to Meritage's knowledge, no sales of the Wendy's Partnership units in the past year. SEE "RISK FACTORS" SUMMARIZED ON PAGE 7 AND IN FULL ON PAGE 16, FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY THE LIMITED PARTNERS. AMONG THESE ARE: - Conflicts of Interest - Meritage can effect the transaction without the consent of non-affiliated limited partners. Meritage controls 54% of the limited partnership units and an affiliate controls the general partner, which believes the transaction is fair and is recommending the transaction to the limited partners. - No independent representation of limited partners. - Limited Trading Market for Meritage's Common Shares - The price established for the transaction may exceed that which could be realized upon sale. - Continuing Losses - Meritage has operated at a loss since fiscal 1993. * Based on an assumed price of $3.50 for Meritage Common Shares plus an additional number of shares. The actual number of shares issued will be determined by the trading formula upon dissolution. -------------------- 2
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION NOR HAS THE 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 October __, 1997 3
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TABLE OF CONTENTS [Enlarge/Download Table] PAGE ---- AVAILABLE INFORMATION........................................................................................7 SUMMARY......................................................................................................8 The Parties.........................................................................................8 The Transaction.....................................................................................8 Wendy's Partnership Authorization...................................................................8 Meritage Common Shares Outstanding..................................................................9 Wendy's Partnership Units Outstanding...............................................................8 Certain Risk Factors...............................................................................10 Recommendation of the General Partner..............................................................12 Material Effects to the Limited Partners ..........................................................13 Background and Reasons for the Transaction.........................................................13 Tax Effects........................................................................................13 No Dissenters' Rights..............................................................................13 Fiduciary Duties of the General Partner............................................................13 Market Quotations..................................................................................14 Meritage Hospitality Group Inc. Summary Consolidated Financial Data................................15 Wendy's of West Michigan Limited Partnership Summary Consolidated Financial Data...................19 COMPARATIVE PER SHARE AND UNIT DATA.........................................................................23 RISK FACTORS AND OTHER CONSIDERATIONS.......................................................................24 Risks Associated with Dissolution of the Wendy's Partnership.......................................24 Conflicts of Interest.........................................................................24 No Dissenters' Rights.........................................................................24 No Independent Representation of Limited Partners.............................................24 Alternatives Not Pursued......................................................................24 Change in Nature of Investment and Status of Limited Partners.................................25 Risks Associated with Investment in Meritage Common Shares.........................................25 Limited Public Trading Market.................................................................25 Substantial Debt..............................................................................25 Continuing Losses.............................................................................26 Common Share Ownership and Control by Insiders................................................26 Legal Proceedings.............................................................................26 Risks Associated with Meritage's Business..........................................................27 Broadened Business Orientation................................................................27 Risks of the Lodging Industry.................................................................27 Risks Affecting Restaurant Operations.........................................................29 Geographic Concentration of Operations........................................................30 CAPITALIZATION..............................................................................................31 PRICE RANGE OF COMMON SHARES................................................................................31 DISTRIBUTION POLICIES.......................................................................................32 BACKGROUND AND REASONS FOR THE TRANSACTION..................................................................32 Background of the Transaction......................................................................32 Fees and Expenses of the Transaction...............................................................33 Determination of Consideration for Units...........................................................34 Background of the Wendy's Partnership..............................................................34 Other Considerations...............................................................................34 Fairness of Transaction............................................................................35 OPINION OF FINANCIAL ADVISOR TO THE GENERAL PARTNER.........................................................37 SELECTED CONSOLIDATED FINANCIAL DATA........................................................................44 MERITAGE HOSPITALITY GROUP INC. SELECTED CONSOLIDATED FINANCIAL DATA...............................................................45 4
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[Enlarge/Download Table] PAGE ---- MERITAGE HOSPITALITY GROUP INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.......................................................46 General............................................................................................46 Results of Operations..............................................................................46 Liquidity and Capital Resources....................................................................54 Inflation and Changing Prices .....................................................................59 WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP SELECTED CONSOLIDATED FINANCIAL DATA...............................................................60 WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.......................................................61 Results of Operations..............................................................................61 Liquidity and Capital Resources....................................................................63 Inflation and Changing Prices .....................................................................63 BUSINESS....................................................................................................64 General............................................................................................64 Broadened Business Orientation.....................................................................65 Replacement and Restructuring of Management........................................................65 Food Service Group.................................................................................65 Lodging Group......................................................................................66 Competition and Industry Conditions................................................................68 Relationship with Wendy's International............................................................69 Governmental Regulations...........................................................................70 Other Assets.......................................................................................70 Properties.........................................................................................71 Legal Proceedings..................................................................................71 MANAGEMENT..................................................................................................73 Directors and Executive Officers...................................................................73 Executive Compensation.............................................................................75 Certain Relationships and Related Transactions.....................................................76 PRINCIPAL SHAREHOLDERS......................................................................................79 FEDERAL INCOME TAX CONSEQUENCES.............................................................................80 DESCRIPTION OF CAPITAL SHARES...............................................................................81 Common Shares......................................................................................81 Preferred Shares...................................................................................82 Transfer Agent.....................................................................................82 COMPARATIVE RIGHTS..........................................................................................83 Federal Income Taxation............................................................................83 Management.........................................................................................83 Voting Rights......................................................................................83 Amendments to Governing Documents..................................................................84 Dividends and Distributions........................................................................84 Continuity of Existence............................................................................84 Rights Upon Liquidation............................................................................84 Dissenters' Rights.................................................................................85 Liability; Indemnification.........................................................................85 Meetings...........................................................................................85 LEGAL MATTERS...............................................................................................86 EXPERTS.....................................................................................................86 INDEX TO FINANCIAL STATEMENTS...............................................................................87 5
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[Enlarge/Download Table] PAGE ---- 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 WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP UNAUDITED INTERIM FINANCIAL STATEMENTS....................................................................................W-22 MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS........................................................................P-1 6
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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. For further information pertaining to Meritage and the shares to be issued, reference is made to the Registration Statement and the exhibits thereto, which may be inspected without charge at the office of the Commission. THIS MATERIAL CONCERNING MERITAGE 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, OFFERING FOR SALE OR UNDERWRITING ALL OR ANY PART OF THIS TRANSACTION. WENDY'S DOES NOT ENDORSE OR MAKE ANY RECOMMENDATIONS WITH RESPECT TO THIS TRANSACTION. NEITHER THE TRANSACTION NOR THE CONTENTS OF THIS PROSPECTUS (AND SPECIFICALLY, ANY FINANCIAL DATA OR PROJECTIONS CONTAINED HEREIN) HAVE BEEN APPROVED OR ENDORSED BY WENDY'S INTERNATIONAL, INC. AND WENDY'S INTERNATIONAL, INC. ASSUMES NO OBLIGATIONS TO ANY INVESTOR IN CONNECTION WITH THIS TRANSACTION OR THE ACCURACY OR ADEQUACY OF ANY PORTION OF THIS PROSPECTUS, INCLUDING ANY STATEMENTS MADE WITH RESPECT TO IT. 7
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WENDY'S INTERNATIONAL, INC. FURTHER DISCLAIMS ANY LIABILITY UNDER STATE OR FEDERAL SECURITIES LAWS ARISING OUT OF OR IN CONNECTION WITH THIS TRANSACTION, INCLUDING WITHOUT LIMITATION ANY LIABILITY AS A SELLER, AFFILIATE OR CONTROLLING PERSON OF A SELLER OR AFFILIATE. WENDY'S INTERNATIONAL, INC. HAS NOT PARTICIPATED IN THE PREPARATION OF PRO FORMA PROJECTIONS, NOR HAS WENDY'S INTERNATIONAL, INC. APPROVED OR ENDORSED SUCH PROJECTIONS. WENDY'S INTERNATIONAL, INC. ASSUMES NO OBLIGATION TO ANY INVESTOR IN CONNECTION WITH THIS TRANSACTION OR THE ACCURACY OR ADEQUACY OF ANY PORTION OF THIS PROSPECTUS, INCLUDING THE PRO FORMA PROJECTIONS. 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 is considering the sale of one or more of its hotels. The Company has retained a professional brokerage firm to assist it in this regard but does not have any agreement for the sale of any of the hotels at this time. 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 lesser of (i) the average high and low bid price on the OTC Bulletin Board for the 10 trading days preceding the date of dissolution, or (ii) $4.125 per share. 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 BEFORE ____ 1997, THEY INDICATE TO THE CONTRARY IN WRITING TO THE WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP AT 40 PEARL STREET, N.W., SUITE 900, GRAND RAPIDS, MICHIGAN 49503, ATTENTION: GENERAL COUNSEL. LIMITED 8
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PARTNERS MAY HAVE CLAIMS AGAINST MERITAGE OR THE WENDY'S PARTNERSHIP RELATING TO THE TRANSACTION. FAILURE TO USE THIS OBJECTION PROCEDURE WOULD BE RAISED BY MERITAGE AS A DEFENSE TO ANY SUCH CLAIMS. LIMITED PARTNERS SHOULD CONSULT WITH THEIR OWN COUNSEL ON THESE MATTERS. WE ARE NOT ASKING YOU FOR A PROXY AND YOU ARE REQUESTED NOT TO SEND US A PROXY. MERITAGE COMMON SHARES OUTSTANDING 3,217,595 Common Shares are currently issued and outstanding. WENDY'S PARTNERSHIP UNITS OUTSTANDING 1,256.8 units are currently outstanding of which 680.8 units are owned by Meritage. 9
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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. Meritage's management and directors beneficially own over 62% of its Common Stock, which will still be at approximately ___% following the transaction and, therefore, those persons will control the future course of operations of Meritage. - 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 that will terminate December 31, 2026 and 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. If the Wendy's Partnership were dissolved as of the date of this Prospectus and without regard to the proposed transaction, each unit holder would receive approximately $2,664.07 per unit in book value of net assets. The sale of those assets could result in a higher or lower amount of cash. - NO DISSENTERS' 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. - ALTERNATIVES NOT PURSUED. The general partner, which is an affiliate of Meritage, did not pursue a strategy of continuing the operations of the Wendy's Partnership, selling the Wendy's Partnership to a third party or liquidating it by sales of properties followed by a cash liquidation because it considered these alternatives as inferior to the proposal of Meritage, and because Meritage controls both the Wendy's Partnership and the general partner and would not favor any of those alternatives. 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. The shares may trade below the value established for the exchange of shares in the transaction through the trading formula. See "Determination of Consideration for Units." - SUBSTANTIAL DEBT. Meritage had $25.1 million of long-term debt and capitalized lease payments outstanding at August 31, 1997. The Company has $75,000 of long term borrowings available to fund a marina development project. Its expansion programs will likely result in additional debt. The Company has obtained waivers of default under its primary financing arrangements and a moratorium on payments due in October, November and December, 1997. Meritage Capital Corp. ("MCC"), which owns 48.2% of Meritage's Common Shares, has guaranteed certain portions of Meritage's debt and pledged those shares as security for a portion of Meritage's debt. Should the Company's lenders foreclose on the debt and the guarantee, control of Meritage could change. See "Management's Discussion and Results of Operations - Liquidity and Capital Resources." 10
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As of the end of the third quarter, August 31, 1997, the Company's total indebtedness was $25.1 million, which represented 99.1% of the total capitalization. Total interest expense for the nine month period ended August 31, 1997 was $2,168,567 as compared to cash flow from operations (excluding payment of interest expense) of $1,753,650 for the same nine month period. Thus, the total interest expense is 123.7% of the operating cash flow (excluding interest expense). The ratio of earnings to fixed charges for the nine months ended August 31, 1997 was less than one and produced a fixed charges coverage deficiency of $1,572,814. The historical ratio of earnings to fixed charges and any coverage deficiency is demonstrated in the table under "Summary Consolidated Financial Data." - CONTINUING LOSSES. Meritage has had continuing losses since fiscal 1993 resulting in a cumulative deficit at August 31, 1997 of $7,237,118 which would not be changed by completion of the transaction. - 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 not able immediately to carry back its 1996 tax loss to offset such payment, any amount that Meritage would be required to pay would be refunded within 120 days of payment. On May 19, 1997, a majority limited interest of the Wendy's Partnership removed Wendy's West Michigan, Inc. as general partner of the Wendy's Partnership and appointed MCC Food Service, an affiliate of Meritage, as the substitute general partner. Approximately 180 unit holders (from whom Meritage acquired 482.55 of its total partnership units) had previously consented to the removal of the former general partner and the appointment of Meritage or its designee as the new general partner. This action was carried out in connection with Meritage's acquisition of a controlling interest in the Wendy's Partnership, and in accordance with Meritage's representations during the tender offer that it may remove the general partner and substitute itself or its designee as the new general partner. On May 21, 1997, the former general partner commenced a lawsuit against Meritage, MHG Food Service, and MCC Food Service. The former general partner also attempted to assert claims on behalf of the Wendy's Partnership as well. On August 29, 1997, the former general partner amended its complaint to include Meritage Capital Corp. and Meritage's principal officers as defendants. In addition, the principal shareholders of the former general partner and two limited partners intervened in the lawsuit. The former general partner and its principal shareholders seek, 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, (iii) unspecified damages for breach of contract, and (iv) unspecified damages for various business torts and misrepresentation. The former general partner's motion for a temporary restraining order was denied on May 21, 1997. The intervening limited partners have alleged claims similar to those alleged by the former general partner. In September 1997, the Wendy's Partnership, Meritage, MHG Food Service, MCC Food Service and Meritage Capital Corp. filed claims against the former general partner and its principal shareholders alleging (i) breach of contract, (ii) violation of SEC Rule 10b-5, (iii) business defamation, (iv) tortious interference, and (v) breach of fiduciary duty. Wendy's 11
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International stated that it does not intend to take a position as to the rights of either party with respect to the specific issues which have thus far been 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 is considering the sale of one or more of its hotels. The Company has retained a professional brokerage firm to assist it in this regard but does not have any agreement for the sale of any of the hotels at this time. 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. 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 believes that an exchange of limited partnership units for Meritage Common Shares presents a better investment opportunity, both as to its liquidity and potential for growth, than would be presented by a continued operation of the Wendy's Partnership or a possible liquidation and sale. Furthermore, it also bases its belief as to the fairness of the transaction upon the opinion of Roney & Co. that the terms of the merger are fair to the limited partners from a financial point of view. For these reasons, the general partner is recommending approval of the transaction. See "Background and Reasons for the Transaction." Based upon the range of prices at which limited partners sold their units to Meritage in voluntary transactions, and upon the presence of an independent fairness opinion, the general partner did not obtain 12
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independent representation by way of separate counsel and separate investment bankers for the limited partners believing that the costs to the Wendy's Partnership would far outweigh the utility that would be provided in such circumstances. 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 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 established an exchange value for each unit of $7,500, which it believes is fair because it exceeds the highest purchase price which Meritage paid for units in 1996. The general partner, MCC Food Service, has obtained an opinion of an independent financial advisor that the terms of the transaction are fair to the limited partners not affiliated with Meritage from a financial point of view. See "Opinion of Financial Advisor to the General Partner." 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." NO DISSENTERS' RIGHTS 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. FIDUCIARY DUTIES OF THE GENERAL PARTNER The general partner of a limited partnership is accountable to the limited partners as a fiduciary and consequently, must exercise good faith and integrity in the resolution of any conflicts of interest and in other dealings with respect to partnership affairs. The fiduciary obligations of the general partner are in addition to the several duties and obligations of and limitations on the general partner set forth in the Wendy's Partnership Agreement. Where the question has arisen, courts have held that a limited partner may institute legal action on behalf of himself/herself or all other similarly situated limited partners (as a class action) to recover damages for a 13
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breach by the general partner of its fiduciary duty, or on behalf of the Wendy's Partnership (a partnership derivative action) to recover damages from third parties when the general partners have become disabled or wrongfully refused to bring such action. The Wendy's Partnership Agreement provides that the general partner will not be liable to the Wendy's Partnership or to any other limited partner for any loss or damage arising out of its management of the Wendy's Partnership or any other activities in its capacity as the general partner, unless such loss or damage is caused by bad faith or negligence of the general partner. Therefore, the limited partners may have a more limited right of action than they would have absent such limitation in the Wendy's Partnership Agreement. The Wendy's Partnership Agreement also provides that the Wendy's Partnership will indemnify the general partner for any loss or damage incurred by it in connection with Wendy's Partnership business unless the loss or damage is caused by the bad faith or negligence of the general partner. 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 valued at $7,200 per unit. See "Price Range of Common Shares." Units of the Wendy's Partnership are not publicly traded. Since the close of Meritage's tender offer on October 31, 1996, there have been, to Meritage's knowledge, no sales of the Wendy's Partnership units among unaffiliated parties. Meritage purchased 41 units in November 1996 for Meritage's Series A Convertible Preferred Stock valued at $7,200 per unit. 14
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MERITAGE HOSPITALITY GROUP INC. SUMMARY CONSOLIDATED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE AND RATIO DATA) [Enlarge/Download Table] Years Ended November 30, ------------------------------------------------------------------------------ 1996 ------ Actual Pro Forma 1995 1994 1993 1992 ------------------------------------------------------------------------------ Statement of Operations Data Net Revenue Rooms $ 6,282 $ 6,282 $ 5,999 $ 6,048 $ 5,681 $ 5,820 Food, beverage and other 10,603 35,139 8,442 9,312 8,564 8,525 ------------------------------------------------------------------------------ Total Revenue 16,885 41,421 14,441 15,360 14,245 14,345 Cost and expenses Cost of food and beverages 3,334 10,504 2,864 3,042 2,852 2,800 Operating expenses 9,492 24,069 7,215 7,180 7,024 6,690 General and administrative expenses 3,951 5,003 4,980 2,597 2,131 2,013 Depreciation and amortization 1,082 2,242 1,426 1,232 1,175 1,143 ------------------------------------------------------------------------------ Total costs and expenses 17,859 41,818 16,485 14,051 13,182 12,646 ------------------------------------------------------------------------------ Earnings (loss) from operations (974) (397) (2,044) 1,309 1,063 1,699 Other income (expense) Interest (net) (985) (1,825) (968) (1,119) (1,063) (1,374) Other 13 (32) 242 12 395 199 ------------------------------------------------------------------------------ Total other expense (972) (1,857) (726) (1,107) (668) (1,175) ------------------------------------------------------------------------------ Earnings (loss) before federal income tax and cumulative effect of change in accounting principle (1,946) (2,254) (2,770) 202 395 524 Federal income tax expense (benefit) (20) (20) (721) 112 165 225 ------------------------------------------------------------------------------ Earnings (loss) before cumulative effect of change in accounting principle (1,926) (2,234) (2,049) 90 230 299 Cumulative effect of prior years of changing to a different method of accounting for income taxes --- --- --- (117) --- --- ------------------------------------------------------------------------------ Net earnings (loss) (1,926) (2,234) (2,049) (27) 230 299 Preferred Stock Dividends --- --- --- --- --- --- ------------------------------------------------------------------------------ Net Earning (loss) on Common Shares $ (1,926) $ (2,234) $ (2,049) $ (27) $ 230 $ 299 ============================================================================== Earnings (loss) per share Before cumulative effect of change in accounting principle $ (0.62) $ (0.52) $ (1.13) $ 0.06 $ 0.15 $ 0.20 Cumulative effect of change in accounting principle --- --- --- (0.08) --- --- After cumulative effect of change in accounting principle $ (0.62) $ (0.52) $ (1.13) $ (0.02) $ 0.15 $ 0.20 ============================================================================== Weighted average shares outstanding 3,082 4,316 1,816 1,520 1,520 1,520 ============================================================================== Ratio of earnings to fixed charges --- --- --- --- 1.34 1.31 Coverage deficiency (1) $ 1,947 $ 2,234 $ 2,049 $ 27 --- --- Continued on next page 15
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MERITAGE HOSPITALITY GROUP INC. SUMMARY CONSOLIDATED FINANCIAL DATA (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AND RATIO DATA) [Download Table] Nine Months Ended August 31, ---------------------------- 1997 (2) ----------------------- Statement of Operations Data Actual Pro Forma 1996 ------------------------------------- Net Revenue Rooms $ 4,716 $ 4,716 $ 4,828 Food, beverage and other 26,568 26,568 6,577 ------------------------------------- Total Revenue 31,284 31,284 11,405 Cost and expenses Cost of food and beverages 7,724 7,724 2,075 Operating expenses 18,521 18,521 5,751 General and administrative expenses 3,043 3,043 2,246 Depreciation and amortization 1,649 1,831 675 ------------------------------------- Total costs and expenses 30,937 31,119 10,747 ------------------------------------- Earnings from operations 347 165 658 Other expense Interest (net) (1,729) (1,729) (678) Other (292) (190) --- ------------------------------------- Total other expense (2,021) (1,919) (678) ------------------------------------- Loss before federal income tax and cumulative effect of change in accounting principle (1,674) (1,754) (20) Federal income tax benefit --- --- (7) ------------------------------------- Loss before cumulative effect of change in accounting principle (1,674) (1,754) (13) Cumulative effect of prior years of changing to a different method of accounting for income taxes --- --- --- Net loss (1,674) (1,754) (13) ------------------------------------- Preferred Stock Dividends 70 70 --- ------------------------------------- Net loss on Common Shares $ (1,744) $ (1,824) $ (13) ===================================== Loss per share Before cumulative effect of change in accounting principle $ (0.54) $ (0.41) $ (0.00) Cumulative effect of change in accounting principle --- --- --- ------------------------------------- After cumulative effect of change $ (0.54) $ (0.41) $ (0.00) in accounting principle ===================================== Weighted average shares outstanding 3,214 4,450 3,044 ===================================== Ratio of earnings to fixed charges --- --- --- Coverage deficiency (1) $ 1,573 $ 1,754 $ 20 Continued on next page 16
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MERITAGE HOSPITALITY GROUP INC. SUMMARY CONSOLIDATED FINANCIAL DATA (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AND RATIO DATA) [Enlarge/Download Table] Years Ended November 30, ----------------------------------------------------------------------------- 1996 ---- Actual Pro Forma 1995 1994 1993 1992 ----------------------- ----- ---- ---- ---- BALANCE SHEET DATA (2) Cash and cash equivalents $ 2,265 $ 2,171 $ 1,337 $ 622 $ 451 $ 577 Working capital 103 9 44 406 (450) (4,429) Property and equipment, net 21,757 22,797 13,218 13,645 14,069 14,867 Total assets 31,929 34,843 17,984 19,688 20,004 20,145 Long-term debt, including current maturities 24,293 24,293 11,443 12,647 12,905 13,209 Total Liabilities 29,908 28,502 14,929 14,463 14,752 15,123 Shareholders' equity 2,021 6,341 3,055 5,225 5,252 5,022 STATEMENT OF CASH FLOWS DATA Net increase (decrease) in cash and cash equivalents 929 94 715 171 (127) 322 Net cash provided by (used in) operating activities (1,496) (641) 425 990 1,056 1,687 Dividends - common stock 1,510 1,510 --- --- --- --- Dividends - preferred stock --- --- --- --- --- --- Distribution to partners --- 317 --- --- --- --- Continued on next page 17
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MERITAGE HOSPITALITY GROUP INC. SUMMARY CONSOLIDATED FINANCIAL DATA (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AND RATIO DATA) [Download Table] Nine Months Ended August 31, ------------------------------------ 1997 ---- Actual Pro Forma 1996 ----------------------- -------- BALANCE SHEET DATA (2) Cash and cash equivalents $ 998 $ 904 $ 1,166 Working capital (1,889) (1,983) 566 Property and equipment, net 21,199 22,239 14,243 Total assets 30,639 33,452 19,763 Long-term debt, including current maturities 25,100 25,100 14,551 Total Liabilities 30,416 28,909 16,842 Shareholders' equity 223 4,543 2,921 STATEMENT OF CASH FLOWS DATA Net increase (decrease) in cash and cash equivalents (1,267) (1,362) (171) Net cash provided by (used in) operating activities (415) (415) (610) Dividends - common stock --- --- 1,510 Dividends - preferred stock 70 70 --- Distribution to partners --- --- --- <FN> (1) Earnings are inadequate to cover fixed charges in years ended 1996, 1995 and 1994 as well as the nine months ended August 31, 1997 and August 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. 18
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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) [Enlarge/Download Table] (1) (2) Eleven Months Ended Years Ended December 31, November 30, 1996 ------------------------------------------------- ---------------------- Statement of Earnings Data Actual Pro Forma 1995 1994 1993 1992 ------------------------------------------------------------------------------ Net Revenue Food, beverage and other $ 24,687 $ 24,687 $ 25,601 $ 24,910 $ 23,685 $ 22,743 ------------------------------------------------------------------------------ Total Revenue 24,687 24,687 25,601 24,910 23,685 22,743 Cost and expenses Cost of food and beverages 7,223 7,223 7,391 7,295 7,187 6,850 Operating expenses 14,662 14,662 15,099 13,987 13,264 12,819 General and administrative expenses 1,046 1,046 1,250 1,279 1,203 1,098 Depreciation and Amortization 769 971 853 857 971 950 ------------------------------------------------------------------------------ Total cost and expenses 23,700 23,902 24,593 23,418 22,625 21,717 ------------------------------------------------------------------------------ Earnings from operations 987 785 1,008 1,492 1,060 1,026 Other income (expense) Interest (net) (403) (403) (512) (557) (622) (661) Other (25) (25) 31 6 --- (17) ------------------------------------------------------------------------------ Total other expense (428) (428) (481) (551) (622) (678) ------------------------------------------------------------------------------ Earnings before extraordinary item 559 357 527 941 438 348 Extraordinary item --- --- (21) --- (87) --- ------------------------------------------------------------------------------ Net earnings $ 559 $ 357 $ 506 $ 941 $ 351 $ 348 ============================================================================== Net earnings attributable to: Limited Partners $ 553 $ 353 $ 501 $ 931 $ 348 $ 345 General Partner 6 4 5 10 3 3 ------------------------------------------------------------------------------ $ 559 $ 357 $ 506 $ 941 $ 351 $ 348 ============================================================================== Earnings per unit of limited partnership unit Before extraordinary item $ 440.22 $ 281.15 $ 415.14 $ 740.96 $ 345.06 $ 274.42 Extraordinary item - loss on extinguishment of debt --- --- (16.18) --- (68.53) --- ------------------------------------------------------------------------------ After extraordinary item $ 440.22 $ 281.15 $ 398.96 $ 740.96 $ 276.53 $ 274.42 ============================================================================== Number of limited partnership units outstanding 1256.8 1256.8 1256.8 1256.8 1256.8 1256.8 ============================================================================== Ratio of earnings to fixed charges 2.36 1.87 1.94 2.65 1.49 1.52 ============================================================================== Continued on next page 19
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP SUMMARY CONSOLIDATED FINANCIAL DATA (CONTINUED) (IN THOUSANDS, EXCEPT PER LIMITED PARTNER UNIT DATA, PARTNERSHIP UNITS OUTSTANDING AND RATIO DATA) [Download Table] Nine Months Ended August 31, ---------------------------- 1997 (2) ---------------------- Actual Pro Forma 1996 ------------------------------------- Statement of Earnings Data Net Revenue Food, beverage and other $ 20,399 $ 20,399 $ 19,795 ------------------------------------- Total Revenue 20,399 20,399 19,795 Cost and expenses Cost of food and beverages 5,838 5,838 5,781 Operating expenses 12,177 12,177 11,722 General and administrative expenses 962 962 958 Depreciation and amortization 692 857 631 Total cost and expenses 19,669 19,834 19,092 ------------------------------------- Earnings from operations 730 565 703 Other expense Interest (net) (320) (320) (326) Other (190) (190) --- ------------------------------------- Total other expense (510) (510) (326) ------------------------------------- Earnings before extraordinary item 220 55 377 Extraordinary item --- --- --- ------------------------------------- Net earnings $ 220 $ 55 $ 377 ===================================== Net earnings attributable to: Limited Partners $ 218 $ 54 $ 373 General Partner 2 1 4 ------------------------------------- $ 220 $ 55 $ 377 ===================================== Earnings per unit of limited partnership unit Before extraordinary item $ 173.01 $ 42.86 $ 297.24 Extraordinary item - loss on extinguishment of debt --- --- --- ------------------------------------- After extraordinary item $ 173.01 $ 42.86 $ 297.74 ===================================== Number of limited partnership units 1256.8 1256.8 1256.8 outstanding ===================================== Ratio of earnings to fixed charges 1.66 1.16 2.11 Continued on next page 20
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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) [Enlarge/Download Table] (1) (2) Years Ended December 31, Eleven months Ended ------------------------ November 30, 1996 1995 1994 1993 1992 ----------------- ---- ---- ---- ---- Actual Pro Forma ------ --------- Balance Sheet Data Cash $ 394 $ 394 $ 411 $ 776 $ 409 $ 422 Working capital (850) (850) (912) (824) (1,089) (2,733) Property and equipment, net 5,897 8,371 5,671 5,933 5,763 5,611 Total assets 9,076 11,550 8,832 9,698 9,341 9,478 Long-term debt, including current maturities 4,379 4,379 4,469 5,127 5,494 4,176 Total liabilities 5,974 5,974 5,971 6,773 6,975 7,464 Partners' equity Limited Partners 3,131 5,580 2,892 2,956 2,402 2,054 General Partner (29) (4) (31) (31) (36) (40) Statement of Cash Flows Data Net increase (decrease) in cash (17) (17) (365) 367 (12) 194 Net cash provided by operating activities 1,201 1,201 1,366 1,808 627 1,207 Distributions 317 317 571 381 --- --- Continued on next page 21
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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) [Download Table] Nine Months Ended August 31, ---------------------------- 1997 ---- Actual Pro Forma 1996 ------ --------- ---- Balance Sheet Data (2) Cash $ 408 $ 408 $ 277 Working capital (1,009) (1,009) (1,074) Property and equipment, net 5,777 8,252 5,735 Total assets 8,649 11,124 8,662 Long-term debt, including current maturities 3,919 3,919 4,111 Total liabilities 5,328 5,328 5,687 Partners' equity Limited Partners 3,348 5,798 3,005 General Partner (27) (2) (30) Statement of Cash Flows Data Net increase (decrease) in cash 14 14 (6) Net cash provided by operating activities 1,126 1,126 1,206 Distributions --- --- 317 <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. 22
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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 is 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 2,142.86 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. [Enlarge/Download Table] MERITAGE THE PARTNERSHIP (PER SHARE) (PER UNIT) ------------------------------------- EARNINGS (LOSS) PER SHARE OR UNIT: Fiscal 1996 $ (0.62) $ 440.22 Fiscal 1996 - Pro Forma (0.52) 281.15 Fiscal 1995 (1.13) 398.96 Fiscal 1994 (0.02) 740.96 Fiscal 1993 0.15 276.53 Fiscal 1992 0.20 274.42 Nine months ended August 31, 1997 - Unaudited (0.54) 173.01 Nine months ended August 31, 1997 - Pro Forma (0.41) 42.86 Nine months ended August 31, 1996 - Unaudited (0.00) 297.24 COMMON STOCK DIVIDENDS DECLARED/DISTRIBUTIONS PER SHARE OR UNIT: Fiscal 1996 0.50 250.00 Fiscal 1996 - Pro Forma 0.42 250.00 Fiscal 1995 --- 450.00 Fiscal 1994 --- 300.00 Fiscal 1993 --- --- Fiscal 1992 --- --- Nine months ended August 31, 1997 - Unaudited --- --- Nine months ended August 31, 1997 - Pro Forma --- --- Nine months ended August 31, 1996 - Unaudited 0.50 250.00 BOOK VALUE PER SHARE OR UNIT: Fiscal 1996 0.29 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 Nine months ended August 31, 1997 - Unaudited (0.36) 2,664.07 Nine months ended August 31, 1997 - Pro Forma 0.71 4,613.15 Nine months ended August 31, 1996 - Unaudited 0.91 2,390.77 23
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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. MCC Food Service is a wholly-owned subsidiary of MCC which owns approximately 48% of Meritage's outstanding Common Shares. After the transaction, all of the income and losses of the Wendy's Partnership will accrue to Meritage. Meritage desires to obtain the remaining units of the Wendy's Partnership at the best price available to it. Therefore, Meritage is not making any recommendation with respect to the transaction. However, Meritage does believe that the transaction is fair, from a financial point of view, to the non-affiliated limited partners because the price paid equals the highest price paid in independent transactions for units, and because of the opinion of Roney & Co. that the terms of the transaction are fair from a financial point of view. See "Background and Reasons for the Transaction." No Dissenters' 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. Pursuant to Section 12.7 of the Amended and Restated Agreement of Limited Partnership for the Wendy's Partnership, limited partners who do not indicate their opposition to the transaction in writing to the Wendy's Partnership at 40 Pearl Street, N.W., Suite 900, Grand Rapids, Michigan 49503, Attention: General Counsel before _________________, 1997, will be deemed to have consented to the transaction. 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. Alternatives Not Pursued The general partner, which is an affiliate of Meritage, did not pursue a strategy of continuing the operations of the Wendy's Partnership, selling the Wendy's Partnership to a third party or liquidating it by sales of 24
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properties followed by a cash liquidation because it considered these alternatives as inferior to the proposal of Meritage, and because Meritage controls both the Wendy's Partnership and the general partner and would not favor any of those alternatives. 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 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." RISKS ASSOCIATED WITH INVESTMENT IN MERITAGE COMMON SHARES Limited Public 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 $25.1 million of long-term debt outstanding at August 31, 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 August 31, 1997, $800,000 had been borrowed on the marina development loan leaving $75,000 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. Meritage obtained waivers of default under its primary financing arrangements and a moratorium on payments due in October, November and December, 1997. MCC, which owns 48.2% of Meritage's Common Shares, has guaranteed certain portions of Meritage's debt and pledged those shares as security for a portion of Meritage's debt. Should the Company's lenders foreclose on the debt and the guarantee, control of Meritage could change. See "Management's Discussion and Results of Operations - Liquidity and Capital Resources." As of the end of the third quarter, August 31, 1997, the Company's total indebtedness was $25.1 million, which represented 99.1% of the total capitalization. Total interest expense for the nine month period ended August 31, 1997 was $2,168,567 as compared to cash flow from operations (excluding payment of interest expense) of $1,753,650 for the same nine month period. Thus, the total interest expense is 123.7% of the operating cash flow 25
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(excluding interest expense). The ratio of earnings to fixed charges for the nine months ended August 31, 1997 was less than 1. The resulting fixed ratio deficiency was $1,572,814. The historical ratio of earnings to fixed charges and any coverage deficiency is demonstrated in the table under "Summary Consolidated Financial Data." Continuing Losses Meritage has had continuing losses since fiscal 1993 resulting in a cumulative deficit at August 31, 1997 of $7,237,118 which would not be changed by completion of the transaction. Since fiscal 1994 it has also had losses from operations. The depreciation component of its losses relates to its hotel properties and it is expected to continue as long as those properties are held. The interest component of its losses could be reduced if Meritage sells any of its hotel properties but there is no assurance that this will occur. 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, 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 not able immediately to carry back its 1996 tax loss to offset such payment, any amount that Meritage would be required to pay would be refunded within 120 days of payment. On May 19, 1997, a majority limited interest of the Wendy's Partnership removed Wendy's West Michigan, Inc. as general partner of the Wendy's Partnership and appointed MCC Food Service, an affiliate of Meritage, as the substitute general partner. Approximately 180 unit holders (from whom Meritage acquired 482.55 of its total partnership units) had previously consented to the removal of the former general partner and the appointment of Meritage or its designee as the new general partner. This action was carried out in connection with Meritage's acquisition of a controlling interest in the Wendy's Partnership, and in accordance with Meritage's representations during the tender offer that it may remove the general partner and substitute itself or its designee as the new general partner. On May 21, 1997, the former general partner commenced a lawsuit against Meritage, MHG Food Service, and MCC Food Service. (Case No. 97-05360-CB, Kent County (Michigan) Circuit Court, Buth, J.). The former general partner also attempted to assert claims on behalf of the Wendy's Partnership as well. On August 29, 1997, the former general partner amended its complaint to include Meritage Capital Corp. and Meritage's principal officers as defendants. In addition, the principal shareholders of the former general partner and two limited partners intervened in the lawsuit. The former general partner and its principal shareholders seek, 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 26
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would prohibit the defendants from participating in the management of the Wendy's Partnership, (iii) unspecified damages for breach of contract, and (iv) unspecified damages for various business torts and misrepresentation. The former general partner's motion for a temporary restraining order was denied on May 21, 1997. The intervening limited partners have alleged claims similar to those alleged by the former general partner. In September 1997, the Wendy's Partnership, Meritage, MHG Food Service, MCC Food Service and Meritage Capital Corp. filed claims against the former general partner and its principal shareholders alleging (i) breach of contract, (ii) violation of SEC Rule 10b-5, (iii) business defamation, (iv) tortious interference, and (v) breach of fiduciary duty. Wendy's International stated that it does not intend to take a position as to the rights of either party with respect to the specific issues which have thus far been 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 is considering the sale of one or more of its hotels. The Company has retained a professional brokerage firm to assist it in this regard but does not have any agreement for the sale of any of the hotels at this time. 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 how long it would take to sell these assets at prices 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 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 34% of the tax profit in income taxes prior to the application of any available NOL carryforward 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 27
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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 in 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. Capital expenditures to the properties for maintenance, improvements and modernization often do not increase revenues, but rather, are necessary to maintain current revenue. Given Meritage's significant level of debt, it may be difficult to obtain debt financing for such capital expenditures as Meritage may not be able to demonstrate revenue growth from such investments. Therefore, Meritage may have to fund property maintenance costs from current cash flow and may have to delay improvements and modernization. In addition, hotels are especially susceptible to the impact of economic and other conditions outside the control of the hotel owner. Meritage plans to expand the Wendy's restaurant business through the building of new stores. Debt financing may be more readily available for this type of expansion due to the existence of new collateral and the increase in revenues generated by the new stores. 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. During fiscal year 1996, lodging revenue generated by quarter were as follows: First Quarter - 22%, Second Quarter - 23%, Third Quarter - 32% and Fourth Quarter - 23%. 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. 28
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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, concept 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 safety and 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. Part of Meritage's business strategy is to expand its operations through the development and acquisition of Wendy's restaurants. The approval of Wendy's International is required for the development or acquisition of any interest in Wendy's restaurants outside of Meritage's designated market area (the Michigan counties of Allegan, Calhoun, Kalamazoo, Kent, Muskegon, Ottawa and Van Buren) Wendy's consent to any acquisitions or development may be withheld in Wendy's sole and absolute 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 29
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area, and any quick-service restaurant outside of Meritage's market area that sells chicken sandwiches, hamburgers or products similar to Wendy's International and which is located within a three mile radius of another Wendy's restaurant. 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. The franchise agreements with Wendy's International generally have a 20 year term and can be renewed for an additional 10 years provided certain conditions are met. 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. 30
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CAPITALIZATION The following table sets forth the capitalization of Meritage at August 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. [Download Table] August 31, 1997 ------------------------------- Actual Pro Forma ------------ ------------ Long-term debt, including current maturities $ 25,100,309 $ 25,100,309 Shareholders' equity: Preferred Stock, 5,000,000 shares authorized, 138,387 issued and outstanding 1,384 1,384 Common Shares, 30,000,000, 3,217,094 (actual) and 4,451,380 (as adjusted) issued and outstanding 32,171 44,514 Additional paid-in capital 12,977,101 17,284,758 Note receivable from sale of shares (5,550,415) (5,550,415) Accumulated deficit (7,237,118) (7,237,118) ------------ ------------ Total Shareholders' equity $ 223,123 $ 4,543,123 ------------ ------------ Total capitalization $ 25,323,432 $ 29,643,432 ============ ============ 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. [Download Table] ============================================== =========== =========== HIGH LOW ---------------------------------------------- ----------- ----------- 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 ============================================== =========== =========== 31
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[Download Table] ============================================== =========== =========== HIGH LOW ---------------------------------------------- ----------- ----------- FISCAL YEAR 1997 ---------------------------------------------- ----------- ----------- First Quarter $ 6 1/4 $ 5 3/8 ---------------------------------------------- ----------- ----------- Second Quarter $ 5 1/4 $ 4 ---------------------------------------------- ----------- ----------- Third Quarter $ 4 $ 2 5/8 ---------------------------------------------- ----------- ----------- Fourth Quarter (through October 9) $ 3 1/2 $ 3 1/64 ============================================== =========== =========== 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. There have been no additional distributions since July 1996. 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 Wendy's Partnership will receive Meritage Common Shares in consideration of the sale of assets. The Wendy's Partnership will then be dissolved and the Common Shares 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 lesser of (i) the average high and low bid price on the OTC Bulletin Board for the 10 trading days preceding the date of dissolution, or (ii) $4.125 per share. 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. 32
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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. 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. Meritage initiated this transaction in fulfillment of that statement as soon as practical after it obtained the necessary consents of Wendy's International to its acquisition of the franchises and the business 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. 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. A majority in interest of the Wendy's Partnership (held by approximately 180 unit holders) consented to the replacement of the former general partner with MCC Food Service. The removal of the former general partner was carried out in connection with Meritage's assumption of control of a majority of the units of the Wendy's Partnership, and in accordance with Meritage's representations during the tender offer that it may remove the general partner and substitute itself or its designee as the new general partner. 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. FEES AND EXPENSES OF THE TRANSACTION Meritage will pay the following fees associated with the transaction: [Download Table] Securities and Exchange Commission registration fee............ $ 1,500 Legal fees and expenses ....................................... 50,000 Accounting fees and expenses .................................. 15,000 Printing fees ................................................. 10,000 State securities laws fees and expenses ....................... 10,000 Miscellaneous ................................................. 8,000 ------- $94,500 ======= 33
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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. Meritage initially determined to base the number of shares to be issued for each unit on the average trading prices during the ten trading days preceding the date of dissolution of the Wendy's Partnership. In September 1997, it restructured the offer to place a ceiling of $4.125 per share on the value of Meritage's shares to be issued in the exchange, with the result that the transaction will now consist of that number of Meritage Common Shares that is equal to $7,500 per unit divided by the lesser of (i) the trading range formula, or (ii) $4.125 per share. The ceiling of $4.125 per share was added to improve the fairness of the transaction, and was established based on the estimated fair market value of the Company's total assets, including the net present value of the note receivable from the sale of shares to MCC which, due to GAAP requirements, is carried at zero value on Meritage's audited financial statements. See "Business - Other Assets." The choice of this figure is arbitrary and may have no relation to where Meritage Common Shares will trade now or in the future. 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 could have determined to continue the Wendy's Partnership in its present form, attempted to sell it to a third party or sell all of its assets for cash and liquidate. The lack of market liquidity for the units, the fact that net sales and distributions over the last three fiscal years of the Wendy's Partnership have been relatively static or declining, and the sales by limited partners to Meritage resulting in Meritage controlling the 34
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Wendy's Partnership, all led to a decision to terminate rather than continue the Wendy's Partnership operations. Since Meritage owns a controlling position of the Wendy's Partnership, a sale to a third party was not a viable alternative. Finally, a plan to sell all of the assets and reduce the Wendy's Partnership to cash followed by a liquidation would have involved an indeterminate amount of time and expense without any probability that the prices received for the properties would exceed the price being offered by Meritage. In addition, it was clear that Meritage (as the controlling party of the Wendy's Partnership) would not favor any of these alternatives and desired to acquire the remainder of the Wendy's Partnership for itself. The general partner believes that the transaction proposed by Meritage will provide unit holders with securities for which there is a public, although limited, market and thus provide a liquidity to the unit holders for their investment which they have not previously enjoyed. Furthermore, the general partner believes an investment in Meritage, as an enterprise not confined to the operation of Wendy's restaurants in Western and Southern Michigan and with other current operations, will provide greater growth activities than continuation of the Wendy's Partnership and a greater value than would be realized in the sale of assets followed by liquidation. 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 $494,032 for fiscal 1994 and $507,292 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 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 of a limited partnership is accountable to the limited partners as a fiduciary and consequently, must exercise good faith and integrity in the resolution of any conflicts of interest and in other dealings with respect to partnership affairs. The fiduciary obligations of the general partner are in addition to the several duties and obligations of and limitations on the general partner set forth in the Wendy's Partnership Agreement. Where the question has arisen, courts have held that a limited partner may institute legal action on behalf of himself/herself or all other similarly situated limited partners (as a class action) to recover damages for a breach by the general partner of its fiduciary duty, or on behalf of the Wendy's Partnership (a partnership derivative action) to recover damages from third parties when the general partners have become disabled or wrongfully refused to bring such action. The Wendy's Partnership Agreement provides that the general partner will not be liable to the Wendy's Partnership or to any other limited partner for any loss or damage arising out of its management of the Wendy's Partnership or any other activities in its capacity as the general partner, unless such loss or damage is caused by bad faith or negligence of the general partner. Therefore, the limited partners may have a more limited right of action than they would have absent such limitation in the Wendy's Partnership Agreement. The Wendy's Partnership Agreement also provides that the Wendy's Partnership will indemnify the general partner for any loss or damage incurred by it in connection with Wendy's Partnership business unless the loss or damage is caused by the bad faith or negligence of the general partner. FAIRNESS OF TRANSACTION The general partner, MCC Food Service, an affiliate of Meritage, believes that the transaction is fair, from a financial point of view, to the non-affiliated limited partners and recommends approval for the transaction. In arriving at these conclusions, the general partner based its belief upon the following factors: - 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. 35
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- 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$2,664.07 as of August 31, 1997. - The opinion of the independent financial advisor that the proposed transaction is fair to non-affiliated limited partners from a financial point of view. 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. Meritage acknowledges that the transaction may be viewed as unfair from a procedural standpoint for the following reasons: - The result is already determined since Meritage controls a sufficient interest in the Wendy's Partnership to accomplish the transaction regardless of the objections of unaffiliated limited partners. - No separate consent of the unaffiliated limited partners regarding the transaction is required. - There are no dissenters' rights. - No independent representation of the unaffiliated limited partners is required. The general partner gave greater weight to the substantive fairness considerations than to procedural matters. It also gave greater weight to the previous consideration paid by Meritage in its acquisitions of units and to the opinion of the independent financial advisor than to the other factors listed. 36
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OPINION OF FINANCIAL ADVISOR TO THE GENERAL PARTNER BACKGROUND In September, 1997, the Board of Directors of MCC Food Service the general partner of the Wendy's Partnership, retained Roney & Co., L.L.C. ("Roney") to render a fairness opinion. As part of its services, Roney analyzed the Wendy's Partnership and its operations, historical performance, future prospects, industry data and comparable companies, in order to provide an opinion as to the fairness, from a financial point of view, of the consideration paid to the limited partners of the Wendy's Partnership. Meritage had earlier obtained a report from Roney dated June 26, 1996 which valued the Wendy's Partnership units based on its 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. Roney is a nationally recognized investment banking firm regularly engaged, with respect to restaurant and food service companies and other corporations, in the valuation of businesses and their securities in connection with mergers and acquisitions, negotiated underwritings, competitive biddings, and secondary distributions of listed and unlisted securities. The Board of Directors of MCC Food Service selected Roney on the basis of its familiarity with the restaurant and food service industry, its qualifications, ability, previous experience and its reputation with respect to mergers and acquisitions. No limitations were imposed by the MCC Food Service Board of Directors upon Roney with respect to the investigations made or procedures followed by Roney in rendering its opinion. CERTAIN FINANCIAL PROJECTIONS OF THE WENDY'S PARTNERSHIP During the course of discussions between Meritage, the Wendy's Partnership and Roney, the Wendy's Partnership provided to Roney certain non-public business and financial information about the Wendy's Partnership, including then current projections of future results of operations for the fiscal years ending November 30, 1998, 1999, 2000, 2001 and 2002. The projections utilized focused on internal growth at the existing restaurants. Projections of sales revenue (dollars in thousands) for such fiscal years were $27,783, $28,477, $29,189, $29,919 and $30,667, respectively; operating income/EBITDA projections (dollars in thousands) were $1,976, $2,019, $2,063, $2,107 and $2,153 respectively. Unaudited results forecasted for the year ended November 30, 1997 were revenue (dollars in thousands) of $27,105, operating income/EBITDA of $1,934 and net income of $389. The Wendy's Partnership does not as a matter of course make public any projections as to future performance or earnings, and the projections set forth above are not included in this Prospectus. The projections were not prepared with a view to public disclosure or compliance with the published guidelines of the Securities and Exchange Commission or the guidelines established by the American Institute of Certified Public Accountants regarding projections or forecasts. The Wendy's Partnership's internal operating projections (upon which the projections provided to Roney were based in part) are, in general, prepared solely for internal use and capital budgeting and other management decisions and are subjective in many respects and thus susceptible to various interpretations and periodic revisions based on actual experience and business developments. The projections were based on a number of assumptions that are beyond the control of the Wendy's Partnership or its respective financial advisors. Many of the assumptions upon which the projections were based are dependent upon economic forecasting (both general and specific to the Wendy's Partnership's business), which is inherently uncertain and subjective. Accordingly, there can be no assurance that the projected results would be realized or that actual results would not be significantly higher or lower than those projected. Neither the Wendy's Partnership nor Roney assumes any responsibility for the accuracy of any of the projections. 37
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OPINION OF FINANCIAL ADVISER On October 13, Roney delivered its written opinion to MCC Food Service's Board of Directors to the effect that, as of such date, the purchase price for the assets was fair, from a financial point of view, to the unaffiliated limited partners of the Wendy's Partnership. Such opinion describes the assumptions made, matters considered and the scope of the review undertaken and procedures followed by Roney. Roney's opinion to the Board of Directors addresses only the fairness from a financial point of view of the consideration to be received by such limited partners pursuant to the transaction described in this Prospectus and does not constitute a recommendation to any limited partner of the Wendy's Partnership with respect to the approval of the transaction contemplated by the Prospectus. LIMITED PARTNERS ARE URGED TO READ CAREFULLY SUCH OPINION IN ITS ENTIRETY, WHICH SETS FORTH THE ASSUMPTIONS MADE, MATTERS CONSIDERED AND LIMITS OF THE REVIEW UNDERTAKEN THE FOLLOWING IS THE FULL TEXT OF RONEY'S OPINION: October 13, 1997 The Board of Directors MCC Food Service Inc., - General Partner of Wendy's of West Michigan Limited Partnership 40 Pearl Street, N.W., Suite 900 Grand Rapids, MI 49503 Gentlemen: You have requested our opinion as to the fairness, from a financial point of view, of the proposed consideration to be received by the limited partners of Wendy's of West Michigan Limited Partnership ("WWMLP") in connection with the consideration to be paid by Meritage Hospitality Group Inc. ("Meritage") for the assets ("Transaction") of WWMLP. Under the proposed terms of the Transaction, the limited partners of WWMLP would receive $7,500 per unit ("Consideration") of Meritage Common Shares in exchange for each unit of the limited partners. The Consideration would be paid in Meritage Common Shares, which will be registered on Form S-4, at the Transaction closing date, based on THE LESSER OF the average high and low bid price on the OTC Bulletin Board for the 10 trading days preceding the date of dissolution and $4.125. Roney & Co. ("Roney") is a regional investment banking firm of recognized standing. As part of our investment banking services, we are regularly engaged in the valuation of corporate entities in connection with public offerings, valuations and merger and acquisition transactions. Our research analysts publish regular reports on restaurants and other food service companies. Our firm makes principal markets in various restaurant and other food service company stocks, and we have managed public offerings for restaurant and other food service companies. In arriving at the opinion as set forth below, we have, among other things: I. Reviewed WWMLP's Annual Reports, which contained audited financial statements and related financial information for the fiscal years ending December 31, 1994, 1995, and the eleven months ended November 30, 1996; II. Reviewed WWMLP's internal financial statements for the nine months ended August 31, 1997, and management's "statement recap" for the above mentioned period; III. Reviewed the historical unit price and acquisition activity for the limited partnership units in transactions made by Meritage and its affiliates; IV. Reviewed the historical sales activity and trading volumes for Meritage's common stock over the last 12 months; 38
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V. Reviewed certain internal historical and financial forecasts relating to the business, earnings, cashflow, assets and prospects for WWMLP furnished to us by WWMLP; VI. Conducted discussions with members of senior management of WWMLP concerning its business and prospects; VII. Visited several of WWMLP's locations in 1996 and WWMLP headquarters in September, 1997; VIII. Reviewed certain asset appraisal information prepared on Meritage's hotel assets as well as other assets owned by Meritage; IX. Reviewed letters of intent and draft purchase agreements received by Meritage for the purchase of all three of its hotel properties; X. Reviewed an asset value mark to market analysis, prepared by Meritage executives, that detailed the effect of the contemplated sale of all three of its hotel properties on its shareholder equity value. Such analysis was utilized by Meritage in establishing the $4.125 price in the Transaction Consideration conversion formula; XI. Discussed with WWMLP's operating executives the prospects of WWMLP, identifying areas of potential concern relating to the current and projected financial performance; XII. Reviewed the S-4 Registration Statement filed by Meritage with the Securities and Exchange Commission on August 12, 1997; XIII. Discussed with WWMLP's management and advisors the legal, financial and practical ramifications of the Transaction; XIV. Performed various analysis and models including purchase price premium, discounted cashflow, comparable companies, and comparable merger and acquisition transaction analysis; XV. Compared certain financial characteristics of WWMLP to other publicly held companies in the industry that we deemed to be relevant; XVI. Researched current industry conditions and trends concerning the valuation of recent mergers and acquisitions; and XVII. Reviewed such other financial and industry data and performed such other analysis and took into account such other matters as we deemed necessary. In preparing our opinion, we have relied on and assumed the accuracy and completeness of all financial and other information supplied or otherwise made available to us by WWMLP. We have not assumed any responsibility for independent verification of such information or any independent appraisal of WWMLP's assets. With respect to the financial forecasts furnished to us by WWMLP, we have assumed, without any further independent investigations and analysis by Roney, that they have been reasonably prepared and reflect the best currently available estimates and judgment of WWMLP's management as to the expected future financial performance of WWMLP. In our analyses, we have made numerous assumptions with respect to industry performance, business and economic conditions, and other matters, many of which are beyond the control of WWMLP. Any estimates contained in our analyses are not necessarily indicative of future results or value, which may be significantly more or less favorable than such estimates. Estimates of values of companies do not purport to be appraisals or necessarily reflect the price at which companies or their securities actually may be sold. No company or transaction utilized in our analyses was identical to WWMLP or the Transaction highlighted in the S-4 Registration Statement. Accordingly, such analyses 39
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are not based solely on arithmetic calculations, rather, they involve complex considerations and judgments concerning differences in financial and operating characteristics of the relevant companies, the timing of the relevant transactions and prospective buyer interests, as well as other factors that could affect the public trading markets of WWMLP or companies to which they are being compared. None of the analyses performed by us was assigned a greater significance than any other. It should be noted that this opinion is based on economic and market conditions and other circumstances existing on, and information made available as of, the date hereof. In addition, our opinion is, in any event, limited to the fairness, from a financial point of view, of the Consideration being offered to the limited partners of WWMLP pursuant to the Transaction and does not address WWMLP's underlying business decision to effect the Transaction or any other terms of the Transaction. In the ordinary course of our business, we may actively trade securities of Meritage for our own account and for the accounts of customers and, accordingly, we may at any time hold a long or short position in such securities. Our opinion is directed to the Board of Directors of MCC Food Service, the general partner of WWMLP, and does not constitute a recommendation to the Board of Directors of MCC Food Service in connection with any matter relating to the Transaction and has been prepared solely for the confidential use of the Board of Directors and senior management of WWMLP and will not be reproduced, summarized, described or referred to or given to any other person without our prior written consent. Notwithstanding the foregoing, this opinion may be included in the S-4 Registration Statement filed in connection with the Transaction, provided that this opinion will be reproduced in full, and any description of or reference to us or summary of the opinion in such proxy statement will be in a form acceptable to us and our counsel. On the basis of, and subject to, the foregoing, we are of the opinion that, as of the date hereof, the Consideration received by the limited partners of WWMLP ($7,500 per unit of Meritage Common Shares based on the following formula: THE LESSER OF the average high and low bid price on the OTC Bulletin Board for the 10 trading days preceding the date of dissolution, or $4.125), as proposed in the S-4 Registration Statement, is fair, from a financial point of view. Sincerely, [RONEY & CO. LOGO] Roney's opinion is directed to the MCC Food Service Board of Directors (acting as the general partner of the Wendy's Partnership) only, and such opinion is directed only to the fairness from a financial point of view and does not constitute a recommendation to any holder of the Wendy's Partnership limited partnership units as to whether such holder should object to the transaction or take any other action available. For purposes of its opinion and in connection with its review of the proposed transaction, Roney, among other things; (a) participated in discussions among representatives of Meritage, MCC Food Service, the Wendy's Partnership and their respective advisers that resulted in the filing of this Prospectus of which this Registration Statement is a part; (b) reviewed drafts of this Prospectus, of which this Prospectus is a part, as well as several other documents; (c) reviewed certain publicly available financial statements, both audited and unaudited, for the Wendy's Partnership and Meritage, including those included in the Annual Reports, which contained audited financial statements for the years ended November 30, 1994, 1995 and 1996; (d) reviewed certain financial statements and other financial and operating data concerning the Wendy's Partnership and Meritage prepared by their management teams; (e) reviewed the historical sales and trading volumes for Meritage's Common Stock over the last 12 months; (f) reviewed certain financial projections of the Wendy's Partnership, prepared on a stand-alone basis, by the Wendy's Partnership's management; (g) discussed certain aspects of the past and current business operations, results of the Wendy's Partnership's customer profiles and purchasing preferences, financial condition and future prospects of the Wendy's Partnership with certain members of the management of the Wendy's Partnership, MCC Food Service and Meritage; (h) reviewed the unit purchases described in this Prospectus, the 40
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reported market prices and historical trading activity of the Wendy's Partnership's units as well as the historical trading activity of Meritage's Common Stock; (i) reviewed the proposed sale terms for Meritage's three hotel properties and the applicable mark to market and stockholder equity analysis resulting from these proposed transactions; (j) reviewed certain aspects of the financial performance of the Wendy's Partnership and compared such financial performance of the Wendy's Partnership with the stock market data relating to similar data available for certain other restaurant companies and certain of their publicly traded securities; (k) reviewed certain of the financial terms, to the extent publicly available, of certain recent business combinations involving other restaurant companies; and (l) conducted such other studies, analyses and examinations as Roney deemed appropriate. Roney relied upon and assumed without independent verification the accuracy and completeness of all of the financial and other information provided to it by MCC Food Service, Meritage, the Wendy's Partnership, their respective representatives and of the publicly available information reviewed by Roney. Roney also relied upon the management of MCC Food Service, Meritage and the Wendy's Partnership as to the reasonableness and achievability of the financial and operating forecasts provided to Roney (and the assumptions and basis therefore). In that regard, Roney assumed that such forecasts, including without limitation projected cost savings and operating synergies resulting from the operational improvements, reflect the best currently available estimates and judgements of management and that such projections and forecasts will be realized in the amounts and in the time periods currently estimated by the management of MCC Food Service, Meritage and the Wendy's Partnership. Roney did not independently verify and relied on and assumed that the aggregate value of assets set forth in the balance sheet of Meritage at July 31, 1997, was accurate and complied fully with applicable law, and sound business practice as of the date of such financial statements. Roney did not independently verify the carrying values of property, plant and equipment as well as other assets carried on Meritage's balance sheet, and Roney assumed that such values were representative of such date. Roney did not verify contracts, by third parties, to purchase any of Meritage's assets. Roney was not retained to and did not conduct a physical inspection of any of the properties or facilities of MCC Food Service, Meritage and the Wendy's Partnership, nor did Roney make any independent evaluation or appraisal of the assets, liabilities or prospects of MCC Food Service, Meritage or the Wendy's Partnership. Prior to rendering its written opinion dated October 13, 1997, Roney rendered an oral opinion to the MCC Food Service Board of Directors on September 23, 1997. Set forth below is a brief summary of the analyses performed by Roney in reaching its October 13, 1997 opinion. In analyzing the value of the Wendy's Partnership's limited partner units, Roney (i) analyzed and reviewed the proposed consideration offered by Meritage, $7,500, versus the historical unit price and acquisition activity for the limited partnership units in transactions made by Meritage and its affiliates over the last twelve months (the "Purchase Price Premium Analysis"); (ii) performed a discounted cashflow analysis; (iii) performed a comparable company analysis; and (iv) performed a comparable merger and acquisition transaction analysis. The following description summarizes the analyses used by Roney as the basis for its opinion: UNIT TRADING HISTORY (PURCHASE PREMIUM ANALYSIS) Roney analyzed the purchase prices of the limited partner units, paid by Meritage or its affiliates over the 12-month period preceding this Prospectus and the purchase price premiums implied by the Purchaser's offer as of certain such dates. This analysis indicated that limited partner unit holders in this Transaction would be receiving a premium of 4.2% to 50.0% based on other unit purchases made by Meritage over the last 12 months. Roney noted that the market for the limited partner units was highly illiquid for a publicly traded limited partnership and experienced relatively few trades historically. DISCOUNTED CASH FLOW ANALYSIS Roney performed a discounted cash flow analysis of the projected unleveraged cash flows of the Wendy's Partnership from November 30, 1997 through November 30, 2002, if the Wendy's Partnership performed in accordance with management's forecast. Roney also analyzed two other scenarios utilizing figures that were different than management's forecast ("Aggressive" and "Conservative" scenarios). Roney also estimated the terminal value of the Wendy's Partnership's common equity as of November 30, 1997, by applying a range of multiples to the Wendy's Partnership's projected 2002 cashflow. Roney applied a discount rate of 13.6% and a terminal value multiple of 5.5x to the projected unleveraged cash flows. This analysis resulted in a range of values for the Wendy's Partnership of $4,700 to $6,599 per limited partner unit, with a mean value of $5,656. 41
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COMPARABLE COMPANY ANALYSIS Roney reviewed certain actual and estimated financial, operating and stock market information of the Wendy's Partnership, if applicable, and a group ("the Wendy's Partnership Group") of publicly traded restaurant companies judged to be generally comparable to the Wendy's Partnership. Restaurant companies selected as comparable to the Wendy's Partnership were Au Bon Pain Co., Inc, Blimpie International, Inc., Boston Chicken, Inc., Schlotzsky's, Inc., Back Yard Burgers, Inc., Checkers Drive-In Restaurants, CKE Restaurants, Inc., Consolidated Products, Davco Restaurants, Inc., Einstein Bagel Corporation, Koo Koo Roo, Inc., McDonald's Corporation, Morgan's Foods, Inc., Nathan's Famous, NPC International, Inc., PJ America, Inc., Papa John's International, Inc., Quality Dining, Inc., Rally's Hamburgers, Inc., Sbarro, Inc., Showbiz Pizza Time, Inc., Taco Cabana, Inc., and Wendy's International. Roney selected the following companies to be representative comparable companies to the Wendy's Partnership: i) Davco Restaurants; ii) Morgan's Foods; iii) Taco Cabana, Inc. and iv) Wendy's International. These four companies had a range of Total Consideration to LTM EBITDA of 5.8x to 8.1x with a mean of 7.1x. Roney also compared equity values as a multiple of trailing net income, projected 1997 net income, and current book value in addition to reviewing multiples of last twelve months operating income and last twelve months sales. All multiples were calculated using closing stock prices on September 15, 1997. Applying the comparable company multiples to the subject, the indicated value of each share of limited partner unit ranged from $5,825 to $5,829, with an overall mean value of $5,827. ANALYSIS OF SELECTED MERGER TRANSACTIONS Using publicly available information, Roney analyzed the purchase prices and multiples paid in the following selected transactions in the restaurant industry from 1994 through September 1997: Apple South/Apple-Tenn-Flo L.P., Quality Dining, Inc./Grayling Corporation, Apple South, Inc./Marcus Group, Apple South, Inc./DF&R Restaurants, Inc., Quality Dining/Burger King Franchisee, Shareholders/Dave & Buster's, Private-Strategic/Private I (Quick Service Segment), Private-Strategic/Private II (Quick Service Segment), Quality Dining, Inc./Bruegger's Bagels, and Compass Group PLC/DAKA International Inc. In addition, Roney analyzed the limited information available on an Investor Group's proposed purchase of Davco Restaurants, Inc. While this transaction is still pending, the estimated purchase price and estimated multiples are relevant to this analysis. Roney compared purchase prices as a multiple of LTM Earnings before Interest, Taxes, Depreciation and Amortization ("EBITDA") for the year that each transaction was consummated. Roney utilized the averages of the Quality Dining, Inc./Grayling Corporation, Apple South, Inc./Marcus Group, Private-Strategic/Private I (Quick Service Segment), and Private-Strategic/Private II (Quick Service Segment) transactions. These calculations yielded a range of multiples from approximately 4.50x to 6.63x EBITDA resulting in an average of approximately 5.37x. In addition, Roney estimated and utilized, based on the limited information, the multiples being proposed in the Davco transaction. This analysis resulted in a range for each limited partner unit of $5,652 to $6,590, with a mean of $6,034. The purchase premium analysis, discounted cash flow analysis, comparable company analysis, and comparable transaction analysis resulted in an overall value range for each limited partner unit of $5,392 to $6,339, with a mean of $5,866. In addition, Roney reviewed and analyzed the mark to market, asset sale value analysis of Meritage, which was utilized to formulate part of the conversion pricing mechanism. This analysis, prepared by Meritage, assumes the sale of its three hotel properties based upon sales figures highlighted in letters of intent or similar documents Meritage has received from interested third parties, as well as appraisal information regarding some of Meritage's other assets. Roney found that the conversion pricing language of "the lesser of the average high and low bid price on the OTC Bulletin Board for the 10 trading days preceding the date of dissolution, or $4.125", to be fair from a financial point of view, to the Wendy's Partnership limited partners. In connection with its written opinion dated as of the date of this Prospectus, Roney performed procedures to update certain of its analyses and reviewed the assumptions on which such analyses were based and the factors considered in connection therewith. Although the summary set forth above does not purport to be a complete description of the analyses performed by Roney, the material analyses performed by Roney in rendering its opinion have been summarized above. However, the preparation of a fairness opinion is not necessarily susceptible to partial analysis or summary description. Roney believes that its analyses and the summary set forth above must be considered as a whole and that selecting portions of its analyses, without considering all factors and analyses, would create an incomplete view of the process underlying the analyses by which Roney reached its opinions. In addition, Roney may have given 42
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various analyses more or less weight than any other analysis, but no analysis was given materially more weight than any other analysis. Also Roney may have deemed various assumptions more or less probable than other assumptions, so that the ranges of valuations resulting from any particular analysis described above should not be taken to be Roney's view of the actual value of the Wendy's Partnership. In performing its analyses, Roney made numerous assumptions with respect to industry performance, general business and economic conditions and other matters, many of which are beyond the control of the Wendy's Partnership. The analyses performed by Roney are not necessarily indicative of actual value or actual future results, which may be significantly more or less favorable than suggested by such analyses. Such analyses were prepared solely as part of Roney's analysis of the fairness, from a financial point of view, of the consideration to be received. The analyses do not purport to be appraisals or to reflect the prices at which a company might actually be sold or the prices at which any securities may trade at the present time or at any time in the future. Roney used in its analyses various projections of future performance prepared by the management of the Wendy's Partnership. The projections are based on numerous variables and assumptions which are inherently unpredictable and must be considered not certain of occurrence as projected. Accordingly, actual results could vary significantly from those assumed in the projections and any related analyses. Roney's opinion does not address the relative merits of the Transaction as compared to any alternative business strategies that might exist for the Wendy's Partnership or the effect of any other business combination in which the Wendy's Partnership might engage. In addition, as described above, Roney's opinion to the MCC Food Service Board of Directors was one of many factors taken into consideration by the MCC Food Service Board of Directors in making its determination to approve the Transaction. Meritage paid Roney a fee of $30,000 for the report it made in June 1996. The Wendy's Partnership has agreed to pay Roney a fee of $50,000 in connection with the opinion delivered with respect to the present transaction involving the Wendy's Partnership. 43
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SELECTED CONSOLIDATED FINANCIAL DATA The selected consolidated statement of operations, balance sheet, and statement of cash flows 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, balance sheet, and statement of cash flows data as of, and for, the nine month periods ended August 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 August 31, 1997 are not necessarily indicative of results for the full fiscal year. 44
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MERITAGE HOSPITALITY GROUP INC. SELECTED CONSOLIDATED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA) [Enlarge/Download Table] Nine Months Years Ended November 30, Ended August 31, ------------------------------------------------------- ---------------- 1996 1995 1994 1993 1992 1997 1996 ---- ---- ---- ---- ---- ---- ---- STATEMENT OF OPERATIONS DATA Total revenue $ 16,885 $ 14,441 $ 15,360 $ 14,245 $ 14,345 $ 31,284 $ 11,405 Operating costs and expenses 17,859 16,485 14,051 13,182 12,646 30,937 10,747 Earnings (loss) from operations (974) (2,044) 1,309 1,063 1,699 347 658 Earnings (loss) before cumulative effect of change in accounting principle (1,926) (2,049) 90 230 299 (1,674) (13) Net earnings (loss) (1,926) (2,049) (27) 230 299 (1,674) (13) Earnings (loss) per share: Before cumulative effect of change in accounting principle (0.62) (1.13) 0.06 0.15 0.20 (0.54) (0.00) After cumulative effect of change in accounting principle (0.62) (1.13) (0.02) 0.15 0.20 (0.54) (0.00) Cash dividends declared per common share 0.50 --- --- --- --- --- 0.50 BALANCE SHEET DATA Cash and cash equivalents 2,265 1,337 622 451 577 998 1,166 Working capital 103 44 406 (450) (4,429) (1,889) 566 Property and equipment, net 21,757 13,218 13,645 14,069 14,867 21,199 14,243 Total assets 31,929 17,984 19,688 20,004 20,145 30,639 19,763 Long-term debt, including current maturities 24,293 11,443 12,647 12,905 13,209 25,100 4,551 Total liabilities 29,908 14,929 14,463 14,752 15,123 30,416 16,842 Shareholders' equity 2,021 3,055 5,225 5,252 5,022 223 2,921 STATEMENT OF CASH FLOWS DATA Net increase (decrease) in cash and cash equivalents 929 715 171 (127) 322 (1,267) (171) Net cash provided by (used in) operating activities (1,496) 425 990 1,056 1,687 (415) (610) Dividends - common stock 1,510 --- --- --- --- --- 1,510 Dividends - preferred stock --- --- --- --- --- 70 --- 45
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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 138,387 of such shares ($1,383,870 liquidation value), consisting of 108,867 shares ($1,088,670 liquidation value) issued for cash (24,367 shares of which certain executive officers and management elected to take in lieu of all or a portion of their year end cash bonuses), and 29,520 shares ($295,200 liquidation value) 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 nine months ended August 31, 1997 and 1996. [Download Table] STATEMENTS OF OPERATIONS ---------------------------------------------- NINE MONTH PERIODS ENDED AUGUST 31, ---------------------------------------------- 1997 1996 1997 1996 ----------------------- ------------------ (as a percentage (in thousands) of revenues) ----------------------- ------------------ Net revenue Room revenue $ 4,716 $ 4,828 43.3% 42.3% Food and beverage revenue 5,380 6,105 49.4 53.5 Telephone and other revenue 789 472 7.2 4.1 ----------------------- ------------------ Total revenue 10,885 11,405 100.0 100.0 Cost and expenses Cost of food and beverages 1,886 2,075 17.3 18.2 Operating expenses 6,344 5,751 58.3 50.4 General and administrative expenses 2,080 2,246 19.1 19.7 Depreciation and amortization 839 675 7.7 5.9 ----------------------- ------------------ Total cost and expenses 11,149 10,747 102.4 94.2 Earnings (loss) from operations (264) 658 (2.4) 5.8 Other income (expense) Interest expense (1,839) (1,195) (16.9) (10.5) Interest income 429 517 3.9 4.5 ----------------------- ------------------ Total other expense (1,410) (678) (12.9) (5.9) ----------------------- ------------------ Loss before federal income tax (1,674) (20) (15.4) (0.2) Federal income tax benefit ---- 7 ---- 0.1 ----------------------- ------------------ Net loss $ (1,674) $ (13) (15.4)% (0.1)% ======================= ================== 46
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The following summarizes the Company's results of operations for the Lodging Group for the years ended November 30, 1996, 1995 and 1994. [Enlarge/Download Table] STATEMENTS OF OPERATIONS ------------------------------------------------------------------------- 1996 1995 1994 1996 1995 1994 ------------------------------------ ------------------------------ (in thousands) (as a percentage of revenues) ------------------------------------ ------------------------------ 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 other 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)% ==================================== ================================ 47
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Comparison of Nine Month Periods Ended August 31, 1997 and August 31, 1996 -------------------------------------------------------------------------- REVENUE Total revenue for the Lodging Group was $10,884,943 for the nine month period ended August 31, 1997 compared to $11,404,897 for the same period of 1996, a decrease of 4.6%. Total revenue for the Lodging Group was $4,928,178 for the three month period ended August 31, 1997 compared to $4,712,674 for the same period of 1996, an increase of 4.6%. The following table outlines revenues (excluding telephone and other revenue) by category: [Enlarge/Download Table] Nine month periods ended August 31, Three month periods ended August 31, --------------------------------------------- ---------------------------------------------- $ in Thousands Decrease $ in Thousands Decrease ------------------- --------------------- ------------------- ---------------------- 1997 1996 $ % 1997 1996 $ % ------------------- --------------------- ------------------- ---------------------- Room revenue $ 4,716 $ 4,828 $ (112) (2.3%) $ 2,214 $ 2,257 $ (43) (1.9%) Food and beverage revenue 5,380 6,105 (725) (11.8%) 2,230 2,243 (13) (.5%) ------------------- --------------------- ------------------- ---------------------- Total $10,096 $10,933 $ (837) (7.7%) $ 4,444 $ 4,500 $ (56) (1.2%) =================== ===================== =================== ====================== The decrease in room revenue was attributable to a decrease in hotel occupancy from 61.6% to 59.5% for the nine month periods ended August 31, 1996 and 1997, respectively. The decrease in occupancy was partially offset by an increase in the overall average daily rate of $5.56 (7.2%) from $77.54 for the nine month period ended August 31, 1996 to $83.10 for the same period of 1997. For the third quarter, hotel occupancy decreased from 76.9% in 1996 to 75.6% in 1997 and was partially offset by a $4.39 (5.0%) increase in overall average daily rate from $87.14 for the three month period ended August 31, 1996 to $91.53 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 over the past year causing a negative impact on room revenue. The decrease in food and beverage revenue of 11.8% for the nine month periods ended August 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 in lounge entertainment and menu offerings instituted by new management were not well received by the local clientele, thus compounding 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 its menu offerings. Although the long-term results of these marketing efforts cannot be determined at this time, food and beverage revenue decreased only 0.5% in the third quarter of 1997 compared to the third quarter of 1996 which represents a significant improvement over the first six months of 1997. Telephone and other revenue increased $316,760 (67.1%) for the nine month period ended August 31, 1997 compared to the same period of 1996. For the third quarter, telephone and other revenue increased $270,573 (127.0%). The increase in other revenue was primarily attributable to the sale of four marina condominium units for $229,700 in the third quarter. Public room rental income and commissions from rental of audio/visual equipment have also contributed to the increase in other revenue. The increase in telephone revenue for both the three and nine months ended August 31, 1997 compared to the same periods of 1996 was due to the installation of new telephone systems at the Thomas Edison Inn and St. Clair Inn. This has resulted in improved accounting for telephone charges which has contributed to the generation of additional telephone revenue. 48
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COST OF FOOD AND BEVERAGES Cost of food and beverages as a percentage of food and beverage revenue for the nine month period ended August 31, 1997 was 35.0% compared to 34.0 % for the same period of 1996. For the third quarter, cost of food and beverages as a percentage of food and beverage revenue was 33.6% in 1997 compared to 32.8% in 1996. The increase was attributable to the decline in catering functions at the hotels, which have a relatively lower cost. OPERATING EXPENSES Operating expenses for the nine month periods ended August 31, 1997 and 1996 were $6,343,936 and $5,750,952, respectively, an increase of $592,984 (10.3%). As a percentage of total revenue, operating expenses increased 7.9 percentage points, from 50.4% for the nine month period ended August 31, 1996 to 58.3% for the same period of 1997. The increase in operating expenses for the nine months ended August 31, 1997 is partially due to a one-time accounting adjustment of approximately $171,000 which decreased operating expenses in 1996. Cost of marina condominium unit sales and an increase in property tax expense resulted in increased operating expenses of approximately $269,000 for the nine months ended August 31, 1997 compared to the same period of 1996. The remaining increase is primarily attributable to a reclassification in payroll and certain other expenses. Operating expenses for the third quarter of 1997 and 1996 were $2,469,125 and $2,228,167, respectively, an increase of $240,958 (10.8%). As a percentage of total revenue, operating expenses increased 2.8 percentage points, from 47.3% for the third quarter of 1996 to 50.1% for the same period of 1997. Cost of marina condominium unit sales and an increase in property tax expense resulted in increased operating expenses of approximately $189,000 for the third quarter of 1997 compared to the third quarter of 1996. GENERAL AND ADMINISTRATIVE General and administrative expenses decreased $166,139 (7.4%), from $2,246,325 for the nine month period ended August 31, 1996 to $2,080,186 for the same period of 1997. For the third quarter, general and administrative expenses increased $130,531 (19.5%) from $670,015 in 1996 to $800,546 in 1997. The decrease in general and administrative expenses for the nine months ended August 31, 1997 compared to the same period of 1996 was due to approximately $375,000 of non-recurring expenses incurred in 1996 in connection with the replacement and restructuring of management of the Company. Excluding the $375,000 of non-recurring expenses incurred in the first and second quarters of 1996, general and administrative expenses have increased in 1997 as a result of increased management salaries required to implement the Company's strategy to expand the Company through business acquisitions. DEPRECIATION AND AMORTIZATION Depreciation and amortization expense increased $163,859, from $675,372 for the nine month period ended August 31, 1996 to $839,231 for the same period of 1997. For the third quarter, depreciation and amortization increased $72,468, from $225,995 in 1996 to $298,463 in 1997. The increase in depreciation and amortization for both the three and nine month periods 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 nine month periods ended August 31, 1997 and 1996 was $1,839,037 and $1,194,996, respectively. For the third quarter of 1997 and 1996, interest expense was $634,970 and $470,252, respectively. The increase of $644,041 for the nine month period ended August 31, 1997 and $164,718, for the third quarter ended August 31, 1997 was due to additional borrowings. The additional debt included acquisition financing relating to the 49
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acquisition of the Wendy's Partnership units in October 1996 and the development of the marina condominium project at the Grand Harbor Yacht Club in 1997. See "Liquidity and Capital Resources" of this item for details of the Company's long-term debt. INTEREST INCOME Interest income decreased from $517,382 for the nine month period ended August 31, 1996 to $429,562 for the same period of 1997. Interest income decreased from $159,730 for the third quarter of 1996 to $153,163 for the third quarter of 1997. The decrease in interest income was due to a decrease in cash and cash equivalents during the three and nine month periods. The decrease was 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. FOOD SERVICE GROUP On October 31, 1996, the Company acquired a majority interest in the Wendy's Partnership. At August 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 nine month period ended August 31, 1997. Below is a summary of the results of the Food Service Group (comprised of the Wendy's Partnership) for the nine month period ended August 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. [Download Table] $ in Thousands % of Revenue ------------------------------------- Net revenue Food and beverage revenue $ 20,263 99.3% Other revenue 136 0.7 ------------------------------------- Total revenue 20,399 100.0 Cost and expenses Cost of food and beverages 5,838 28.6 Operating expenses 12,177 59.7 General and administrative expenses 962 4.7 Depreciation and amortization 692 3.4 ------------------------------------ Total cost and expenses 19,669 96.4 Earnings from operations 730 3.6 Other income (expense) Interest expense (330) (1.6) Interest income 10 0.0 Loss on disposal of assets (190) (0.9) -------------------------------------- Total other expense (510) (2.5) -------------------------------------- Earnings before federal income tax 220 1.1 ------------------------------------- Federal income tax 0 0.0 Net earnings $ 220 1.1% ===================================== 50
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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 telephone and other revenue) by category: [Enlarge/Download Table] Increase %Increase 1996 1995 (Decrease) (Decrease) ------------------------------------------------------------------- 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%) =================================================================== 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 other 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. 51
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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 Wendy's Partnership). 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. 52
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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 telephone and other revenue) by category: [Enlarge/Download Table] Increase %Increase 1995 1994 (Decrease) (Decrease) ------------------------------------------------------------------- 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%) =================================================================== 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 expense 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. 53
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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. 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 - Nine months ended August 31, 1997 Cash and cash equivalents ("cash") decreased $1,267,286 from $2,265,497 as of November 30, 1996 to $998,211 as of August 31, 1997. The decrease in cash was the result of the following: [Download Table] Net cash used in operating activities $ (414,917) Net cash used in investing activities (1,030,402) Net cash provided by financing activities 178,033 ----------------- Net decrease in cash $ (1,267,286) ================= Net cash used in operating activities of $414,917 was due to the net loss before depreciation and amortization of $24,396 plus other non-cash effects on net income and net cash used in operating activities which totaled $58,416. 54
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The net change in non-cash assets and liabilities of $332,105 accounted for the remaining net cash used in operating activities. Included in this amount was an increase in marina development costs of $342,878. Net cash used in investing activities of $1,030,402 was the result of purchases of property, plant and equipment of $837,382. Increases in other assets accounted for the remaining $193,020. Net cash provided by financing activities of $178,033 was the result of proceeds from long-term borrowings of $936,346 and proceeds from the issuance of preferred shares of $300,000. These two items were offset by principal payments of long-term debt of $817,039 and payments on obligations under capital leases of $170,697. For the nine months ended August 31, 1997, the Company also paid dividends on preferred stock of $70,577. 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: [Download Table] 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 ================ 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 August 31, 1997, the Company's current liabilities exceeded its current assets by $1,888,533 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 0.58:1 and 1.03:1 respectively. The discussion above of cash flows for the nine months ended August 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 $819,433 increase in current portion of long-term debt from November 30, 1996 to August 31, 1997, which is due to principal payment requirements on the $5,250,000 second mortgage which begin December 1, 1997. See item 2 below for a description of the terms of the second mortgage. 55
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The Company's long-term debt consists primarily of the following: 1) $13,834,833 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. (1) 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. (1) 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 marina condominium units. As of August 31, 1997, the loan balance was $800,000 and the Company had $75,000 of available borrowings under the loan. (1) 4) $1,725,413 revolving term loan of the Wendy's Partnership requiring monthly payments of a minimum of $43,313, including interest at 1% over the prime rate, through February 2005 when any remaining unpaid principal 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 Wendy's Partnership had $1,067,690 of available unused borrowings at August 31, 1997. The loan is secured by the Company and substantially all of the assets of the Wendy's Partnership. 5) $496,806 note payable requiring monthly payments of $14,693, including interest at 8.8%, through October 2000. 6) $750,000 note payable to the Company's Chairman of the Board of Directors (and a shareholder of the Company). The loan requires the Company to make monthly payments of interest only at the prime rate plus 8% provided the Company is not in default under its first, second and third 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. (1) (1) 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 August 31, 1997, the Company failed to meet certain of these covenants. However, a waiver has been obtained through December 30, 1997. In addition to the loan covenant waiver, effective October 1, 1997 the Company obtained a three month principal and interest payment waiver on the mortgage loans with its primary lender. Based on the terms of the loan agreement, the principal and interest payment waiver extends to the payments due on the note payable to the Company's Chairman of the Board of Directors. 56
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A summary of the financial covenants as well as the Company's actual results as of August 31, 1997 are as follows: [Download Table] COVENANT DESCRIPTION COVENANT ACTUAL RESULTS COVENANT REQUIREMENT COMPLIANCE Minimum Net Worth $4,000,000 $223,123 Waiver obtained through December 30, 1997 Coverage Ratio - Earnings before interest, taxes depreciation and amortization ("EBITDA") of hotels: Debt Service 1.10:1 .60:1 Waiver obtained through December 30, 1997 Coverage Ratio - EBITDA of hotels less capital expenditures: Debt Service .30:1 .10:1 Waiver 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 October 1, 1997. The Company estimates capital expenditures for the next twelve months 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 an estimated $124,000 (as of August 31, 1997) of final expenditures for 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: - Waiver of the October, November, and December loan payments on the mortgage loans as described above which total approximately $675,000 (which will be available for operating purposes). - 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 $1,068,000 as of August 31, 1997. - Attempting to sell the vacant land held for expansion valued at approximately $1,000,000 to $1,500,000. 57
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- Attempting to reducing the negative cash flow from the lodging group through improving operating results by (i) enhancing revenue as a result of increased marketing efforts, and (ii) decreasing expenses as a result of renewed efforts to reduce payroll expenditures in response to lower sales volume in the off-peak periods. - Attempting to execute a sale/leaseback of real estate (restaurant buildings) owned by the Wendy's Partnership which would net the Company approximately $2,500,000 from the transaction after closing costs and the retirement of the underlying mortgage loans on the Wendy's properties. - Continuing to explore the sale of one or more of the Company's hotel properties. 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. 58
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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 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. Effective September 30, 1997 the Company obtained a waiver of principal and interest payments due in October, November and December, 1997 on the mortgage loans (Loans I, II, and III). Based on the terms of the loan agreement, the principal and interest payment waiver extends to the payments due on the note payable to the Company's Chairman of the Board. 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 $1,725,413. 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 August 31, 1997, the loan was paid down to a balance of $1,725,413 while the permitted (amortized) balance was $2,793,103. 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. 59
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP SELECTED CONSOLIDATED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER UNIT DATA) [Enlarge/Download Table] (1) Years Ended December 31, Nine Months Eleven Months Ended ------------------------ Ended August 31, November 30, 1996 1995 1994 1993 1992 1997 1996 ----------------- ---- ---- ---- ---- ---- ---- INCOME STATEMENT DATA Total Revenue $ 24,687 $ 25,601 $ 24,910 $ 23,685 $ 22,743 $ 20,399 $ 19,795 Operating costs and expenses 23,700 24,593 23,418 22,625 21,717 19,669 19,092 Earnings from operations 987 1,008 1,492 1,060 1,026 730 703 Earnings before extraordinary item 559 527 941 438 348 220 377 Net earnings 559 506 941 351 348 220 377 Net earnings attributable to: Limited Partners $ 553 $ 501 $ 931 $ 348 $ 345 $ 218 $ 373 General Partner 6 5 10 3 3 2 4 -------------------------------------------------------------------------------- $ 559 $ 506 $ 941 $ 351 $ 348 $ 220 $ 377 ================================================================================ Earnings before extraordinary item per limited partnership unit $ 440.22 $ 415.14 $ 740.96 $ 345.06 $ 274.42 $ 173.01 $ 297.24 Net earnings per limited partnership unit 440.22 398.96 740.96 276.53 274.42 173.01 297.24 Cash distributions per limited partnership unit 250.00 450.00 300.00 --- --- --- 250.00 BALANCE SHEET DATA Cash 394 411 776 409 422 408 277 Working capital (850) (912) (824) (1,089) (2,733) (1,009) (1,074) Property and equipment, net 5,897 5,671 5,933 5,763 5,611 5,777 5,735 Total assets 9,076 8,832 9,698 9,341 9,478 8,649 8,662 Long-term debt, including current maturities 4,379 4,469 5,127 5,494 4,176 3,919 4,111 Total liabilities 5,793 5,972 6,773 6,976 7,464 5,328 5,687 Partners' equity: Limited Partners 3,131 2,892 2,956 2,402 2,054 3,348 3,005 General Partner (29) (31) (31) (36) (40) (27) (30) Partners' equity per limited partnership unit 2,491.07 2,300.85 2,351.90 1,910.94 1,634.41 2,664.07 2,390.77 STATEMENT OF CASH FLOWS DATA Net increase (decrease) in cash (17) (365) 367 (12) 194 14 (6) Net cash provided by operating activities 1,201 1,366 1,808 627 1,207 1,126 1,206 Distributions 317 571 381 --- --- --- 317 <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. 60
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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. [Enlarge/Download Table] STATEMENTS OF OPERATIONS ----------------------------------------------------------------------- 1995 1994 1995 1994 ----------------------------- ---------------------------- (in thousands) (as a percentage of net sales) ----------------------------- ---------------------------- 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% ======================================================================= 61
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Sales Net sales (excluding other income) 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. Average Net Sales Per Restaurant Unit ------------------------------------- [Enlarge/Download Table] Increase % Increase 1995 1994 (Decrease) (Decrease) ---- ---- ---------- ----------- 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)% =========== =========== ============ ============ 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 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 62
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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 "Restaurant Operating Expenses", 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. 63
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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 can be renewed for an additional 10 years. 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. 64
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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 is considering the sale of one or more of its hotels. The Company has retained a professional brokerage firm to assist it in this regard but does not have any binding agreement for the sale of any of the hotels at this time. 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 determine how long it would take to sell these assets at prices 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. 65
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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. 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. The following table summarizes key information for each hotel property: 66
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[Enlarge/Download Table] --------------------------------------------------------------------------------------------------------------------- Thomas Edison Inn St. Clair Inn Grand Haven Holiday Inn ----------------- ------------- ----------------------- Location in Michigan Port Huron St. Clair Grand Haven Number of guest rooms 149 78 121 Year built 1987 1926 1969 Date acquired by MHGI July 1987 October 1985 October 1985 Completed renovations during the year ended November 30, 1996 $650,000 $500,000 $700,000 For the twelve months ended November 30, 1996: Average occupancy 65.50% 56.60% 57.70% Average daily rate $80.48 $83.26 $71.02 Total room revenue/total available rooms $52.75 $47.12 $40.94 --------------------------------------------------------------------------------------------------------------------- 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 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 67
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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. On July 21, 1997, the Grand Haven Holiday Inn and Holiday Inns Franchising, Inc. entered into a voluntary termination agreement pursuant to which the Grand Haven Holiday Inn will leave the Holiday Inn system no later than October 15, 1997. After this time, the hotel will be independently operated under the name "Grand Harbor Resort & Yacht Club." 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, including the newly renovated 55-slip Grand Harbor Yacht Club which is adjacent to the hotel. Pursuant to the voluntary termination agreement, the Grand Haven Holiday Inn released Holiday Inn from all claims under the franchise agreement. Holiday Inn, in turn, agreed not to pursue any claims against the Grand Haven Holiday Inn for default or liquidated damages under the franchise agreement. 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 growth 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: [Enlarge/Download Table] ================== ====================== ====================== =============================== ==================== FISCAL YEAR THOMAS EDISON INN ST. CLAIR INN GRAND HAVEN HOLIDAY INN NATIONAL AVE.* ------------------ ---------------------- ---------------------- ------------------------------- -------------------- 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 68
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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: [Enlarge/Download Table] ================== ====================== ====================== =============================== ==================== FISCAL YEAR THOMAS EDISON INN ST. CLAIR INN GRAND HAVEN HOLIDAY INN NATIONAL AVE.* ------------------ ---------------------- ---------------------- ------------------------------- -------------------- 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 The following table illustrates the percentages of occupancy for 1995 and 1996 as compared to the national occupancy rate: [Enlarge/Download Table] ================== ====================== ====================== =============================== ==================== FISCAL YEAR THOMAS EDISON INN ST. CLAIR INN GRAND HAVEN HOLIDAY INN NATIONAL AVE.* ------------------ ---------------------- ---------------------- ------------------------------- -------------------- 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 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 owned by other entities. 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 69
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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. The approval of Wendy's International is required for the development or acquisition of any interest in Wendy's restaurants outside of Meritage's designated market area (the Michigan counties of Allegan, Calhoun, Kalamazoo, Kent, Muskegon, Ottawa and Van Buren). Wendy's consent to any acquisitions or development may be withheld in Wendy's sole and absolute 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 and which is located within a three mile radius of another Wendy's restaurant. 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. 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 $5.15 per hour as of September 1, 1997. 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 70
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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 hotel 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 24 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. 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 not able immediately to carry back its 1996 tax loss to offset such payment, then any amount that Meritage would be required to pay would be refunded within 120 days of payment. On May 19, 1997, a majority limited interest of the Wendy's Partnership removed Wendy's West Michigan, Inc. as general partner of the Wendy's Partnership and appointed MCC Food Service, an affiliate of Meritage, as the substitute general partner. Approximately 180 unit holders (from whom Meritage acquired 482.55 of its total partnership units) had previously consented to the removal of the former general partner and the appointment of Meritage or its designee as the new general partner. This action was carried out in connection with Meritage's acquisition of a controlling interest in the Wendy's Partnership, and in accordance with Meritage's representations during the tender offer that it may remove the general partner and substitute itself or its designee as the new general partner. On May 21, 1997, the former general partner commenced a lawsuit against Meritage, MHG Food Service, and MCC Food Service. (Case No. 97-05360-CB, Kent County (Michigan) Circuit Court, Buth, J.). The former general partner also attempted to assert claims on behalf of the Wendy's Partnership as well. On August 29, 1997, the former general partner amended its complaint to include Meritage Capital Corp. and 71
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Meritage's principal officers as defendants. In addition, the principal shareholders of the former general partner and two limited partners intervened in the lawsuit. The former general partner and its principal shareholders seek, 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, (iii) unspecified damages for breach of contract, and (iv) unspecified damages for various business torts and misrepresentation. The former general partner's motion for a temporary restraining order was denied on May 21, 1997. The intervening limited partners have alleged claims similar to those alleged by the former general partner. In September 1997, the Wendy's Partnership, Meritage, MHG Food Service, MCC Food Service and Meritage Capital Corp. filed claims against the former general partner and its principal shareholders alleging (i) breach of contract, (ii) violation of SEC Rule 10b-5, (iii) business defamation, (iv) tortious interference, and (v) breach of fiduciary duty. Wendy's International stated that it does not intend to take a position as to the rights of either party with respect to the specific issues which have thus far been raised by this lawsuit. The consent of Wendy's International to MCC Food Service serving as the general partner has already been obtained. 72
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MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS The following is information concerning each director and executive officer of Meritage as of September 1, 1997: [Enlarge/Download Table] ===================================== ================= ========================================================== NAME AGE POSITION ------------------------------------- ----------------- ---------------------------------------------------------- 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 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. Mr. Hewett was nominated for election to the Board of Directors of Frisch's Restaurants, Inc., which operates more than 100 Big Boy restaurants, at its November 1997 Annual Shareholders' Meeting. 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 73
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transportation. Her most recent position with Med Trans was Director of Financial Operations for the Midwest Region. Ms. Krywanski is a Certified Public Accountant. 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. From 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. Mr. Lundeen is presently a private investor. From 1995 to September 1997, he 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. The following is information concerning each director and executive officer of MCC Food Service (the general partner of the Wendy's Partnership) as of September 1, 1997: [Enlarge/Download Table] ===================================== ================= ========================================================== NAME AGE POSITION ------------------------------------- ----------------- ---------------------------------------------------------- Christopher B. Hewett 38 Chairman of the Board, Chief Executive Officer and Director ------------------------------------- ----------------- ---------------------------------------------------------- Ray E. Quada 53 President and Chief Operating Officer ------------------------------------- ----------------- ---------------------------------------------------------- Robert E. Schermer, Jr. 38 Executive Vice President, Treasurer, Secretary and Director ===================================== ================= ========================================================== Ray E. Quada has been the Chief Operating Officer of the Wendy's Partnership since March 1990. From March 1987 to March 1990, Mr. Quada was the general manager of an entity affiliated with the Wendy's Partnership and, in that capacity, oversaw the operations of the Wendy's Partnership. From 1994 through 1997, Mr. Quada was a member of Board of Directors of First Michigan Bank. Mr. Quada has been a shareholder of the former general partner since January 1994. 74
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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: [Enlarge/Download Table] =================================================================================================================== SUMMARY COMPENSATION TABLE =================================================================================================================== ANNUAL COMPENSATION LONG-TERM COMPENSATION SECURITIES UNDER-LYING OPTIONS NAME AND PRINCIPAL POSITION YEAR SALARY BONUS -------------------------------- ---------- --------------- -------------- ---------------------------------------- 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. 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: [Enlarge/Download Table] =================================================================================================================== OPTION GRANTS IN FISCAL 1996 ------------------------------------------------------------------------------------------------------------------- POTENTIAL REALIZABLE VALUE AT ASSUMED ANNUAL RATES OF STOCK PRICE APPRECIATION FOR OPTION TERM NUMBER OF % OF TOTAL SECURITIES OPTIONS UNDERLYING GRANTED TO EXERCISE EXPIRATION NAME OPTIONS GRANTED EMPLOYEES IN PRICE ($ DATE 5% 10% FISCAL 1996 PER SHARE) -------------------------- ---------------- ---------------- -------------- ----------- ------------ -------------- 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 ========================== ================ ================ ============== =========== ============ ============== 75
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[Enlarge/Download Table] =================================================================================================================== 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 END FISCAL YEAR END SHARES NAME ACQUIRED ON VALUE REALIZED EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE EXERCISE --------------------------- --------------- ----------------- ------------------------- --------------------------- 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. 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 transactions. 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 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 in 1996. 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 that could be obtained from unaffiliated parties. 76
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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. 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 shares 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. 77
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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. 78
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PRINCIPAL SHAREHOLDERS The following table sets forth information regarding ownership of Common Shares at September 30, 1997, by management and all person beneficially owning 5% or more of Meritage's outstanding Common Shares. [Enlarge/Download Table] ================================ =================================== ============================================ COMMON SHARES (1) SERIES A CONVERTIBLE PREFERRED STOCK (1) -------------------------------- ----------------------------------- -------------------------------------------- NAME NO. OF SHARES PERCENT OF CLASS NO. OF SHARES PERCENT OF CLASS -------------------------------- ---------------- ------------------ ----------------- -------------------------- Robert E. Schermer, Sr. 163,390(2) 5.0% 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 6,395 * --- --- -------------------------------- ---------------- ------------------ ----------------- -------------------------- David S. Lundeen 46,359 1.4% 12,500 9.0% -------------------------------- ---------------- ------------------ ----------------- -------------------------- Joseph L. Maggini 52,788(5) 1.6% 10,000 7.2% -------------------------------- ---------------- ------------------ ----------------- -------------------------- Jerry L. Ruyan 207,875 6.4% --- --- -------------------------------- ---------------- ------------------ ----------------- -------------------------- All Executive Officers and Directors as a Group 2,134,342 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. 79
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FEDERAL INCOME TAX CONSEQUENCES The following discussion addresses only material 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 gain. 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 from 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. 80
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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. 81
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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. 82
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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 entirety 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 The following are material federal income tax differences between Meritage and the Wendy's Partnership. 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." 83
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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: [Enlarge/Download Table] ======================================== ===================================== ==================================== DATE OF DISTRIBUTION PER LIMITED PARTNERSHIP UNIT TOTAL CASH DISTRIBUTION ---------------------------------------- ------------------------------------- ------------------------------------ January 1995 $ 200.00 $ 253,899 ---------------------------------------- ------------------------------------- ------------------------------------ July 1995 $ 250.00 $ 317,374 ---------------------------------------- ------------------------------------- ------------------------------------ January 1996 $ 100.00 $ 126,950 ---------------------------------------- ------------------------------------- ------------------------------------ July 1996 $ 150.00 $ 190,424 ======================================== ===================================== ==================================== There have been no additional distributions since July 1996. 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. 84
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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. 85
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Under Michigan law, special meetings of shareholders 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 1994, and for the years then ended, 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. 86
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INDEX TO FINANCIAL STATEMENTS [Enlarge/Download Table] MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES Page ---- Report of Independent Certified Public Accountants .........................................................M-3 Consolidated Balance Sheets - November 30, 1996 and 1995 and August 31, 1997 (unaudited)....................M-4 Consolidated Statements of Operations - Years Ended November 30, 1996, 1995 and 1994 and Nine Month Periods Ended August 31, 1997 (unaudited) and August 31, 1996 (unaudited)..................M-6 Consolidated Statements of Stockholders' Equity - Years Ended November 30, 1996, 1995 and 1994 and Nine Month Period Ended August 31, 1997 (unaudited)..........................................M-8 Consolidated Statements of Cash Flows - Years Ended November 30, 1996, 1995 and 1994 and Nine Month Periods Ended August 31, 1997 (unaudited) and August 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 WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP Page ---- Unaudited Balance Sheet - August 31, 1997 .................................................................W-23 Unaudited Statements of Operations - Nine Months Periods Ended August 31, 1997 and 1996 .................. W-25 Unaudited Statements of Changes in Partners' Equity - Periods Ended August 31, 1997, November 30, 1996 and August 31, 1996 .....................................................................W-26 Unaudited Statements of Cash Flows - Nine Month Periods Ended August 31, 1997 and 1996 ...................W-27 Note to Unaudited Financial Statements ....................................................................W-29 MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES Page ---- Unaudited Pro Forma Consolidated Balance Sheet - August 31, 1997 ...........................................P-1 Unaudited Pro Forma Consolidated Statement of Operations - Nine Month Period Ended August 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 - Nine Month Period Ended August 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 87
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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 NINE MONTHS ENDED AUGUST 31, 1997 AND 1996 M-1
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CONTENTS PAGE 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 M-2
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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, and Note O as to which the date is September 30, 1997.) M-3
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ================================================================================ [Enlarge/Download Table] NOVEMBER 30, ---------------------------- AUGUST 31, ASSETS 1996 1995 1997 ----------- ----------- ----------- (UNAUDITED) CURRENT ASSETS Cash and cash equivalents $ 2,265,497 $ 1,336,891 $ 998,211 Trade accounts receivable, less allowance for doubtful accounts of $58,000 in 1997, $54,000 in 1996 and $29,000 in 1995 respectively 938,448 570,428 624,068 Inventories 354,226 208,891 347,604 Deferred income taxes 14,000 111,900 14,000 Refundable income taxes - 321,600 Prepaid expenses and other current assets 487,295 465,225 589,955 ----------- ----------- ----------- Total Current Assets 4,059,466 3,014,935 2,573,838 PROPERTY, PLANT AND EQUIPMENT, NET 21,757,068 13,218,340 21,199,265 DEFERRED INCOME TAXES 621,000 437,100 621,000 OTHER ASSETS Goodwill, net of amortization of $2,194,284 and $1,994,342 in 1997 and 1996 3,687,764 - 3,588,088 Land held for expansion 697,313 642,757 697,313 Financing costs, net of amortization of $101,974 and $38,591 in 1997 and 1996 605,593 - 556,632 Cash surrender value of life insurance, net of policy loans of $298,144, $77,564 and $99,270 in 1997, 1996 and 1995, respectively 260,710 188,875 14,059 Marina development costs - - 1,102,399 Sundry 239,950 46,066 286,143 ----------- ----------- ----------- Total Other Assets 5,491,330 877,698 6,244,634 AMOUNTS DUE FROM RELATED PARTIES - 435,430 - ----------- ----------- ----------- Total Assets $31,928,864 $17,983,503 $30,638,737 =========== =========== =========== M-4
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS - CONTINUED ================================================================================ [Enlarge/Download Table] NOVEMBER 30, LIABILITIES AND ------------------------------- AUGUST 31, STOCKHOLDERS' EQUITY 1996 1995 1997 ------------ ------------ ------------ (UNAUDITED) CURRENT LIABILITIES Note payable - Bank $ - $ 200,551 $ - Current portion of long-term debt 395,120 237,651 1,214,553 Current portion of obligations under capital lease 232,442 - 257,319 Amounts due to stockholders and related parties - 2,300 - Trade accounts payable 2,228,406 448,886 1,927,596 Accrued expenses 936,111 2,081,866 918,094 Other 164,275 - 144,809 ------------ ------------ ------------ Total Current Liabilities 3,956,354 2,971,254 4,462,371 LONG-TERM DEBT 21,711,847 11,204,883 21,870,012 OBLIGATIONS UNDER CAPITAL LEASES 1,953,999 - 1,758,425 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 - 1,506,806 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 1,084 - 1,384 Common stock - $0.01 par value; authorized 30,000,000 shares; issued and outstanding 3,217,094, 3,204,483 and 3,020,150 shares, in 1997, 1996 and 1995 respectively 32,045 30,200 32,171 Additional paid in capital 12,616,727 10,684,750 12,977,101 Note receivable from sale of shares (5,135,716) (5,602,532) (5,550,415) Accumulated deficit (5,492,697) (2,057,052) (7,237,118) ------------ ------------ ------------ Total Stockholders' Equity 2,021,443 3,055,366 223,123 ------------ ------------ ------------ Total Liabilities and Stockholders' Equity $ 31,928,864 $ 17,983,503 $ 30,638,737 ============ ============ ============ THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. M-5
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS ================================================================================ [Enlarge/Download Table] FOR THE NINE MONTHS FOR THE YEARS ENDED NOVEMBER 30, ENDED AUGUST 31, 1996 1995 1994 1997 1996 ------------ ------------ ------------ ------------ ------------ (UNAUDITED) Net revenue Room rents $ 6,281,711 $ 5,999,024 $ 6,047,510 $ 4,716,238 $ 4,828,014 Food and beverages 9,885,062 8,245,880 9,100,158 25,642,161 6,104,500 Sundry 555,049 149,321 174,761 734,117 366,668 Telephone 163,040 46,795 37,599 191,358 105,715 ------------ ------------ ------------ ------------ ------------ Total revenue 16,884,862 14,441,020 15,360,028 31,283,874 11,404,897 Cost and expenses Cost of food and beverages 3,334,434 2,863,554 3,041,499 7,724,026 2,074,310 Operating expenses 9,492,345 7,215,061 7,179,572 18,521,209 5,750,952 General and administrative expenses 3,951,400 4,979,621 2,597,278 3,042,245 2,246,325 Depreciation and amortization 1,081,704 1,426,642 1,232,187 1,649,448 675,372 ------------ ------------ ------------ ------------ ------------ Total cost and expenses 17,859,883 16,484,878 14,050,536 30,936,928 10,746,959 ------------ ------------ ------------ ------------ ------------ Earnings (loss) from operations (975,021) (2,043,858) 1,309,492 346,946 657,938 Other income (expense) Interest expense (1,642,735) (1,355,389) (1,206,151) (2,168,567) (1,194,997) Interest income 658,007 387,099 87,028 439,260 517,382 Gain (loss) on sale of assets (6,900) 241,646 11,769 (190,453) - Minority interest 21,079 - - (101,030) - ------------ ------------ ------------ ------------ ------------ (970,549) (726,644) (1,107,354) (2,020,790) (677,615) ------------ ------------ ------------ ------------ ------------ Earnings (loss) before federal income tax and cumulative effect of change in accounting principle (1,945,570) (2,770,502) 202,138 (1,673,844) (19,677) Federal income tax expense (benefit) (20,000) (721,400) 112,000 - (6,690) ------------ ------------ ------------ ------------ ------------ Earnings (loss) before cumulative effect of change in accounting principle (1,925,570) (2,049,102) 90,138 (1,673,844) (12,987) 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) (1,673,844) (12,987) M-6
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS - CONTINUED ================================================================================ [Enlarge/Download Table] FOR THE NINE MONTHS FOR THE YEARS ENDED NOVEMBER 30, ENDED AUGUST 31, 1996 1995 1994 1997 1996 ----------- ----------- ----------- ------------ ---------- (UNAUDITED) Preferred stock dividends - - - 70,577 - ----------- ----------- ----------- ------------ ---------- Net loss on common shares $(1,925,570) $(2,049,102) $ (27,162) $ (1,744,421) $ (12,987) =========== =========== =========== ============ ========== Earnings (loss) per share Before cumulative effect of change in accounting principle $ (.62) $ (1.13) $ .06 $ (.54) $ (.00) Cumulative effect of change in accounting principle - - (.08) - - ----------- ----------- ----------- ------------ ---------- After cumulative effect of change in accounting principle $ (.62) $ (1.13) $ (.02) $ (.54) $ (.00) =========== =========== =========== ============ ========== Weighted average shares outstanding 3,081,885 1,815,984 1,520,150 3,213,736 3,043,903 =========== =========== =========== ============ ========== THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. M-7
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY ================================================================================ [Enlarge/Download Table] SERIES A NOTE RETAINED CONVERTIBLE ADDITIONAL RECEIVABLE EARNINGS PREFERRED COMMON PAID-IN SALE OF (ACCUMULATED STOCK STOCK CAPITAL SHARES DEFICIT) TOTAL ---------- --------- ---------- ---------- ----------- ----------- 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 12,611 shares of common stock 126 60,674 60,800 Issuance of 30,000 shares of preferred stock 300 299,700 300,000 Dividends paid - preferred stock (70,577) (70,577) Recognition of interest income on note receivable from sale of shares (414,699) (414,699) Net loss (1,673,844) (1,673,844) ------ ------- ----------- ----------- ----------- ----------- Balance at August 31, 1997 (unaudited) $1,384 $32,171 $12,977,101 $(5,550,415) $(7,237,118) $ 223,123 ====== ======= =========== =========== =========== =========== THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. M-8
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS ================================================================================ [Enlarge/Download Table] FOR THE NINE MONTHS FOR THE YEARS ENDED NOVEMBER 30, ENDED AUGUST 31, 1996 1995 1994 1997 1996 ---------- ---------- ---------- ---------- ---------- (UNAUDITED) CASH FLOWS FROM OPERATING ACTIVITIES Net loss $(1,925,570) $(2,049,102) $ (27,162) $(1,673,844) $ (12,987) 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 1,649,448 675,372 Compensation paid by issuance of preferred and common stock 310,099 - - 60,800 - Minority interest in earnings of consolidated subsidiaries - - - 101,030 - Deferred income tax expense (benefit) (20,000) (431,900) 14,000 - (6,690) Loss (gain) on disposal of property, plant and equipment 6,900 (241,646) (11,769) 190,453 - Provision for bad debts 32,655 280,910 8,395 4,000 - Interest income on note receivable from sale of shares (573,274) (120,602) - (414,699) (436,073) (Increase) decrease in assets Accounts receivable (201,742) 84,754 (241,604) 310,380 (294,224) Inventories 41,198 (12,131) (21,502) 6,622 - Prepaid expenses and other current assets 104,707 (7,477) - (102,660) 15,009 Refundable income taxes 321,600 (318,705) (114,795) - 460,068 Increase in marina development costs - - - (342,878) - Increase (decrease) in liabilities Accounts payable and accrued expenses (674,696) 1,814,566 34,831 (203,569) (1,010,555) ----------- ----------- ----------- ----------- ----------- Net cash (used in) provided by operating activities (1,496,419) 425,309 989,881 (414,917) (610,080) CASH FLOWS FROM INVESTING ACTIVITIES Purchase of property, plant and equipment (2,211,392) (456,132) (470,858) (837,382) (1,699,839) 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) - (70,000) Payments on amounts due from related parties 433,130 2,270,524 694,186 - 435,430 Acquisition of business, net of cash acquired (3,184,460) - - - - Increase in other assets (679,214) (5,981) (30,863) (193,020) (371,373) ----------- ----------- ----------- ----------- ----------- Net cash (used in) provided by investing activities (5,601,790) 1,742,809 (380,206) (1,030,402) (1,705,782) M-9
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED ================================================================================ [Enlarge/Download Table] FOR THE NINE MONTHS FOR THE YEARS ENDED NOVEMBER 30, ENDED AUGUST 31, 1996 1995 1994 1997 1996 ------------ ------------ ------------ ------------ ------------ (UNAUDITED) CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from long-term debt $ 37,717,705 $ 46,887 $ - $ 936,346 $ 14,875,000 Payments on 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) (817,039) (11,967,558) Payments on obligations under capital leases (29,808) - - (170,697) - Collection on note receivable from sale of shares 750,000 - - - 750,000 Proceeds from issuance of preferred and common shares 545,000 - - 300,000 - Dividends paid (1,510,075) - - (70,577) (1,510,075) ------------ ------------ ------------ ------------ ------------ Net cash provided by (used in) financing activities 8,026,815 (1,452,988) (438,626) 178,033 2,145,067 ------------ ------------ ------------ ------------ ------------ Net increase (decrease) in cash 928,606 715,130 171,049 (1,267,286) (170,795) 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 $ 998,211 $ 1,166,096 ============ ============ ============ ============ ============ SUPPLEMENTAL CASH FLOW INFORMATION Cash paid for interest and income taxes: Interest $ 1,709,312 $ 1,355,389 $ 1,206,151 $ 1,978,230 $ 1,222,245 Income taxes $ - $ - $ 192,500 $ - $ - During the nine months ended August 31, 1997 non-cash activities consisted of 1) the acquisition of equipment in the amount of $244,637; 2) an increase in marina development costs in the amount of $1,233,366 of which $800,000 was by the use of debt financing and 3) compensation and fees in the amount of $60,800 paid by the issuance of common stock. 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. [Download Table] Fair value of assets net of cash acquired $10,532,850 Liabilities assumed 7,348,390 ----------- $ 3,184,460 =========== M-10
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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
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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 August 31, 1997 and for the nine months ended August 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 Inc. Grand Harbor Yacht Club Inc. MHG Food Service Inc. 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. M-12
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED ================================================================================ NOTE A - NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) FRANCHISE FEES Franchise fees for hotel and restaurant units are amortized using the straight-line method over the terms of the individual franchise agreements. 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 3,213,736 and 3,043,903 for the nine months ended August 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. M-13
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED ================================================================================ NOTE A - NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts of financial instruments approximate their fair values. 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
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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. [Download Table] YEARS ENDED NOVEMBER 30, ---------------------------- 1996 1995 ---------- ---------- (UNAUDITED) Revenues $43,974,000 $39,806,000 Net loss $(2,256,000) $(2,330,000) Loss per share $ (.73) $ (1.28) 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: [Download Table] NOVEMBER 30, ------------------------------ AUGUST 31, 1996 1995 1997 ------------ ------------ ------------ (Unaudited) Land and improvements $ 2,014,914 $ 1,515,513 $ 1,936,538 Buildings and improvements 21,597,196 18,522,242 22,121,785 Furnishings and equipment 14,552,410 7,067,815 14,905,431 Leasehold improvements 2,192,253 - 2,130,074 Leased property/capital leases 2,825,338 - 2,825,338 ------------ ------------ ------------ 43,182,111 27,105,570 43,919,166 Less accumulated depreciation and amortization (21,425,043) (13,887,230) (22,719,901) ------------ ------------ ------------ $ 21,757,068 $ 13,218,340 $ 21,199,265 ============ ============ ============ 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 $1,356,000 and $675,000 for the nine months ended August 31, 1997 and 1996, respectively. M-15
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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 [Download Table] Accrued expenses consist of the following: NOVEMBER 30, ------------------------- AUGUST 31, 1996 1995 1997 -------- ---------- -------- (Unaudited) Litigation expenses $ - $1,361,470 $ - Professional fees 56,697 246,788 41,000 Property taxes 213,005 189,461 157,672 Payroll and related payroll taxes 526,812 125,685 303,175 Interest and other expenses 139,597 158,462 416,247 -------- ---------- -------- $936,111 $2,081,866 $918,094 ======== ========== ======== NOTE F - LONG-TERM DEBT Long-term debt consists of the following obligations at: [Download Table] NOVEMBER 30, ----------------------- AUGUST 31, 1996 1995 1997 ---------- ---------- --------- (Unaudited) 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 - M-16
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED ================================================================================ NOTE F - LONG-TERM DEBT (CONTINUED) [Enlarge/Download Table] NOVEMBER 30, --------------------------- AUGUST 31, 1996 1995 1997 --------- ---------- --------- (Unaudited) 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 - 13,834,833 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 - 496,806 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 - 1,725,413 Note payable to Chairman of the Board and shareholder, unsecured, 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 M-17
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED ================================================================================ NOTE F - LONG-TERM DEBT (CONTINUED) [Enlarge/Download Table] NOVEMBER 30, ---------------------------- AUGUST 31, 1996 1995 1997 ----------- ----------- ----------- (Unaudited) 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 $75,000 as of August 31, 1997. - - 800,000 Other notes and land contracts payable, requiring monthly payments aggregating $15,390, $4,100 and $8,950, respectively, subject to interest at rates ranging from 6.9% to 11.0%. 82,257 314,351 227,513 ----------- ----------- ----------- 22,106,967 11,442,534 23,084,565 Less current portion 395,120 237,651 1,214,553 ----------- ----------- ----------- $21,711,847 $11,204,883 $21,870,012 =========== =========== =========== The prime lending rate was 8.25% at November 30, 1996 and 8.50% at August 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: [Download Table] 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 =========== M-18
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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: [Enlarge/Download Table] FOR THE YEARS FOR THE NINE MONTHS ENDED NOVEMBER 30, ENDED AUGUST 31, 1996 1995 1994 1997 1996 --------- --------- --------- --------- --------- (Unaudited) Current expense (benefit) $ - $(289,500) $ 98,000 $ - $ (6,690) Deferred expense (benefit) (20,000) (431,900) 14,000 - - --------- --------- --------- --------- --------- $ (20,000) $(721,400) $ 112,000 $ - $ (6,690) ========= ========= ========= ========= ========= Deferred tax assets and liabilities consist of the following: [Enlarge/Download Table] NOVEMBER 30, --------------------------- AUGUST 31, 1996 1995 1997 ----------- ----------- ----------- (Unaudited) Deferred tax assets: Net operating loss carryforward $ 1,181,000 $ 267,400 $ 1,807,000 AMT credit carryforward 105,000 140,000 105,000 Allowance for doubtful accounts 8,500 111,900 10,000 Michigan Single Business Tax - Federal 63,000 69,000 63,000 Contribution carryforward 6,500 - 6,500 ----------- ----------- ----------- 1,364,000 588,300 1,991,500 Deferred tax liabilities Depreciation (635,000) (549,000) (759,000) Michigan Single Business Tax - State (183,000) (203,000) (183,000) ----------- ----------- ----------- (818,000) (752,000) (942,000) Less valuation allowance (729,000) (39,300) (1,232,500) ----------- ----------- ----------- Net deferred tax liability $ (183,000) $ (203,000) $ (183,000) =========== =========== =========== M-19
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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: [Enlarge/Download Table] FOR THE YEARS FOR THE NINE MONTHS ENDED NOVEMBER 30, ENDED AUGUST 31, 1996 1995 1994 1997 1996 --------- --------- --------- --------- --------- (Unaudited) Tax (benefit) at statutory rates applied to income before federal income tax $(654,700) $(942,000) $ 68,700 $(569,000) $ (6,690) Effect of nondeductible items (51,000) 24,700 43,300 (14,500) - Difference in rates of net operating loss carrybacks - 151,300 - - - Other (4,000) 5,300 - - - Valuation allowance 689,700 39,300 - 583,500 - --------- --------- --------- --------- --------- $ (20,000) $(721,400) $ 112,000 $ - $ (6,690) ========= ========= ========= ========= ========= 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: [Enlarge/Download Table] OPERATING LEASES ---------------------------- CAPITAL RELATED YEARS ENDING NOVEMBER 30, LEASES PARTIES OTHERS ------------------------ ----------- ----------- ----------- 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 =========== M-20
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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 was $96,822 for the year ended November 30, 1996 and $956,034 for the nine months ended August 31, 1997. 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
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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 nine months ended August 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
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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: [Enlarge/Download Table] 1996 MANAGEMENT 1996 DIRECTOR'S EQUITY INCENTIVE PLAN STOCK OPTION PLAN -------------------------- ------------------------ AVERAGE AVERAGE OPTION PRICE OPTION PRICE SHARES PER SHARE SHARES PER SHARE -------- ----------- -------- ----------- 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 August 31, 1997 303,500 $7.00 56,000 $7.00 ======== ======= Options exercisable at November 30, 1996 - 50,000 ======== ======= Options exercisable at August 31, 1997 28,500 56,000 ======== ======= Options available for grant at November 30, 1996 110,000 10,000 ======== ======= Options available for grant at August 31, 1997 171,500 64,000 ======== ======= 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. [Enlarge/Download Table] Data by business segment is as follows: FOR THE YEAR ENDED NOVEMBER 30, 1996 ---------------------------------------------- LODGING FOOD GROUP SERVICE CONSOLIDATED ----------- ---------- ------------ 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 M-23
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED ================================================================================ NOTE M - BUSINESS SEGMENT INFORMATION (CONTINUED) [Enlarge/Download Table] FOR THE NINE MONTHS ENDED AUGUST 31, 1997 (UNAUDITED) ------------------------------------ LODGING FOOD GROUP SERVICE CONSOLIDATING CONSOLIDATED ----- ------- ------------- ------------ Revenues $ 10,884,943 $ 20,398,931 $ 31,283,874 Earnings (loss) from operations (264,691) 729,915 (118,278) 346,946 Identifiable assets 21,989,443 8,649,294 30,638,737 Depreciation and amortization expense 839,231 691,939 118,278 1,649,448 Capital additions 489,869 592,143 1,082,012 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 interest or penalties. If the Company is not able to immediately carry back its 1996 tax loss to offset such payment, then 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. 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 August 31, 1997, the Company failed to meet certain of M-24
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED ================================================================================ these covenants. However, a waiver has been obtained through December 30, 1997. On September 30, 1997 the Company received a waiver of principal and interest payments due in October, November and December, 1997 from its primary lender on its mortgage notes. This payment waiver also extends to principal and interest payments due on the unsecured note to the Company's Chairman of the Board. M-25
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WENDYS OF WEST MICHIGAN LIMITED PARTNERSHIP Financial Statements Eleven Months Ended November 30, 1996 and Years Ended December 31, 1995 and 1994 W-1
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP CONTENTS 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 W-2
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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
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP FINANCIAL STATEMENTS W-4
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP BALANCE SHEETS [Enlarge/Download Table] NOVEMBER 30, December 31, 1996 1995 ----------------------------------------------------------------------------------------------------------------- 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 ================================================================================================================= W-5
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP BALANCE SHEETS [Enlarge/Download Table] NOVEMBER 30, December 31, 1996 1995 -------------------------------------------------------------------------------------------------------------------- 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 ==================================================================================================================== See accompanying notes to financial statements. W-6
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP STATEMENTS OF INCOME [Enlarge/Download Table] Years ended ELEVEN December 31, MONTHS ENDED ------------------------------------ NOVEMBER 30, 1996 1995 1994 -------------------------------------------------------------------------------------------------------------------- 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 ==================================================================================================================== W-7
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP STATEMENTS OF INCOME [Enlarge/Download Table] Years ended ELEVEN December 31, MONTHS ENDED ------------------------------------ NOVEMBER 30, 1996 1995 1994 -------------------------------------------------------------------------------------------------------------------- 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 ==================================================================================================================== See accompanying notes to financial statements. W-8
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP STATEMENTS OF CHANGES IN PARTNERS' EQUITY [Enlarge/Download Table] Limited General Partners Partner Total -------------------------------------------------------------------------------------------------------------------- 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 ==================================================================================================================== See accompanying notes to financial statements. W-9
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP STATEMENTS OF CASH FLOWS [Enlarge/Download Table] ELEVEN Years ended MONTHS ENDED December 31, NOVEMBER 30, ------------------------------------ 1996 1995 1994 -------------------------------------------------------------------------------------------------------------------- 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) -------------------------------------------------------------------------------------------------------------------- W-10
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP STATEMENTS OF CASH FLOWS [Enlarge/Download Table] ELEVEN Years ended MONTHS ENDED December 31, NOVEMBER 30, ------------------------------------ 1996 1995 1994 -------------------------------------------------------------------------------------------------------------------- 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 ==================================================================================================================== W-11
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[Enlarge/Download Table] Wendy's of West Michigan Limited Partnership Statement of Cash Flows ELEVEN Years ended MONTHS ENDED December 31, NOVEMBER 30, ------------------------------------ 1996 1995 1994 -------------------------------------------------------------------------------------------------------------------- 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 ==================================================================================================================== See accompanying notes to financial statements. W-12
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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
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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
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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
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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
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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
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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: [Download Table] Year ending November 30, --------------------------------------------- 1997 $ - 1998 - 1999 49,146 2000 339,034 2001 375,677 Later years 1,428,494 --------------------------------------------- $ 2,192,351 ============================================= W-18
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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: [Download Table] Period ended 1996 1995 1994 ------------------------------------------------------------------------------- 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 =============================================================================== 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
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS [Download Table] Operating leases -------------------------------- Capital Related Year ending November 30, leases parties Others -------------------------------------------------------------------------------- 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 ============================================== 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
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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
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP UNAUDITED INTERIM FINANCIAL STATEMENTS W-22
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP UNAUDITED BALANCE SHEET AUGUST 31, 1997 [Download Table] ASSETS CURRENT ASSETS Cash $ 407,733 Receivables 82,544 Inventories 169,380 Prepaid expenses 120,409 ---------- Total current assets 780,066 PROPERTY, PLANT AND EQUIPMENT, NET 5,777,418 OTHER ASSETS Goodwill, net of amortization of $2,129,790 1,832,497 Financing costs, net of amortization of $32,474 51,974 Other 207,340 ---------- Total other assets 2,091,811 ---------- Total assets $8,649,295 ========== See note to unaudited financial statements W-23
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP UNAUDITED BALANCE SHEET - CONTINUED AUGUST 31, 1997 [Download Table] LIABILITIES AND PARTNERS' EQUITY CURRENT LIABILITIES Current portion of long-term debt $ 123,186 Current portion of obligations under capital lease 257,319 Trade accounts payable 733,458 Accrued expenses 657,912 Other 17,028 ----------- Total current liabilities 1,788,903 LONG-TERM DEBT 1,780,477 OBLIGATIONS UNDER CAPITAL LEASES 1,758,425 ----------- Total liabilities 5,327,805 PARTNERS' EQUITY Limited partners 3,348,209 General partner (26,719) ----------- Total partners' equity 3,321,490 ----------- Total liabilities and partners' equity $ 8,649,295 =========== See note to unaudited financial statements W-24
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP UNAUDITED STATEMENTS OF INCOME FOR THE NINE MONTH PERIODS ENDED AUGUST 31, 1997 AND 1996 [Download Table] 1997 1996 ------------ ------------ NET REVENUE Food and beverages $ 20,262,599 $ 19,669,964 Other 136,332 125,478 ------------ ------------ Total revenue 20,398,931 19,795,442 COST AND EXPENSES Cost of food and beverages 5,837,745 5,781,189 Operating expenses 12,177,273 11,722,248 General and administrative expenses 962,059 957,606 Depreciation and amortization 691,939 631,252 ------------ ------------ Total costs and expenses 19,669,016 19,092,295 ------------ ------------ EARNINGS FROM OPERATIONS 729,915 703,147 OTHER INCOME (EXPENSE) Interest expense (329,529) (334,676) Interest income 9,697 8,872 Loss on disposal of assets (190,453) --- ------------ ------------ Total other expense (510,285) (325,804) ------------ ------------ NET INCOME $ 219,630 $ 377,343 ============ ============ NET INCOME ATTRIBUTED TO: Limited Partners 217,434 373,570 General Partner 2,196 3,773 ------------ ------------ $ 219,630 $ 377,343 ============ ============ NET INCOME PER LIMITED PARTNERSHIP UNIT (1256.8 units outstanding) $ 173.01 $ 297.24 ============ ============ See note to unaudited financial statements W-25
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP UNAUDITED STATEMENTS OF CHANGES IN PARTNERS' EQUITY FOR THE PERIODS ENDED AUGUST 31, 1997, NOVEMBER 30, 1996 AND AUGUST 31, 1996 [Download Table] Limited Partners General Partner Total ----------- ----------- ----------- Balance, December 1, 1995 $ 2,945,356 $ (30,787) $ 2,914,569 Net income for the period 373,570 3,773 377,343 Distribution to partners (314,200) (3,174) (317,374) ----------- ----------- ----------- Balance, August 31, 1996 3,004,726 (30,188) 2,974,538 Net income for the period 126,049 1,273 127,322 ----------- ----------- ----------- Balance, November 30, 1996 3,130,775 (28,915) 3,101,860 Net income for the period 217,434 2,196 219,630 ----------- ----------- ----------- Balance, August 31, 1997 $ 3,348,209 $ (26,719) $ 3,321,490 =========== =========== =========== See note to unaudited financial statements W-26
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP UNAUDITED STATEMENTS OF CASH FLOWS FOR THE NINE MONTH PERIODS ENDED AUGUST 31, 1997 AND 1996 [Enlarge/Download Table] 1997 1996 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 219,630 $ 377,343 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 691,939 631,252 Loss on disposal of assets 190,453 --- (Increase) decrease in assets Receivables 133,335 (4,023) Inventories 10,870 (27,884) Prepaid expenses 5,036 24,604 Increase (decrease) in liabilities: Accounts payable and accrued expenses (125,193) 204,614 ----------- ----------- Net cash provided by operating activities 1,126,070 1,205,906 CASH FLOWS FROM INVESTING ACTIVITIES Purchase of property, plant and equipment (347,507) (500,386) Increase in other assets (60,874) (25,000) ----------- ----------- Net cash used in investing activities (408,381) (525,386) CASH FLOWS FROM FINANCING ACTIVITIES Principal payments on long-term debt (533,325) (253,466) Payments on obligations under capital leases (170,697) (115,510) Distribution to partners --- (317,374) ----------- ----------- Net cash used in financing activities (704,022) (686,350) ----------- ----------- Net increase in cash 13,667 (5,830) CASH - BEGINNING OF PERIOD 394,066 283,292 ----------- ----------- CASH - END OF PERIOD $ 407,733 $ 277,462 =========== =========== See note to unaudited financial statements W-27
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP UNAUDITED STATEMENTS OF CASH FLOWS (CONTINUED) FOR THE NINE MONTH PERIODS ENDED AUGUST 31, 1997 AND 1996 SUPPLEMENTAL CASH FLOW INFORMATION [Download Table] 1997 1996 -------- -------- Cash paid for interest expense $333,518 $335,760 Schedule of non cash investing and financing transactions: Acquisition of equipment: Cost of equipment $244,637 $ --- Equipment loan 244,637 --- -------- -------- Cash down payment for equipment $ --- $ --- ======== ======== See note to unaudited financial statements W-28
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP NOTE TO UNAUDITED FINANCIAL STATEMENTS FOR THE NINE MONTHS ENDED AUGUST 31, 1997 AND 1996 NOTE A - BASIS OF PRESENTATION In the opinion of management, the accompanying unaudited financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position at August 31, 1997 and the results of operations, partners' equity and cash flows for the nine months ended August 31, 1997 and 1996. The accompanying financial statements have been prepared in accordance with generally accepted accounting principles for the interim financial information and with the instructions to Rule 10-01 of Regulation S-X. Accordingly, they do not include footnotes and certain financial presentations normally required under generally accepted accounting principles and therefore, should be read in conjunction with the audited financial statements of Wendy's of West Michigan Limited Partnership beginning on page W-1. The results of operations for the nine months ended August 31, 1997 are not necessarily indicative of the results to be expected for the full year. W-29
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET AUGUST 31, 1997 [Enlarge/Download Table] MERITAGE HOSPITALITY PRO GROUP INC. & PRO FORMA FORMA CONSOLIDATED SUBSIDIARIES ADJUSTMENTS REF. PRO FORMA ------------------------------------------------------------- ASSETS CURRENT ASSETS Cash and cash equivalents $ 998,211 $ (94,500) (1) $ 903,711 Accounts receivable 624,068 624,068 Inventories 347,604 347,604 Deferred income taxes 14,000 14,000 Prepaid expenses and other 589,955 589,955 ------------------------------------------------------------- TOTAL CURRENT ASSETS 2,573,838 (94,500) 2,479,338 PROPERTY, PLANT AND EQUIPMENT, NET 21,199,265 1,040,116 (1) 22,239,381 DEFERRED INCOME TAXES 621,000 621,000 OTHER ASSETS 2,656,546 2,656,546 GOODWILL 3,588,088 1,867,578 (1) 5,455,666 ------------------------------------------------------------- Total Assets $ 30,638,737 $ 2,813,194 $ 33,451,931 ============================================================= LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Current portion of long-term debt $ 1,214,553 $ 1,214,553 Current portion of obligations under capital leases 257,319 257,319 Trade accounts payable 1,927,596 1,927,596 Accrued expenses 1,062,903 1,062,903 ------------------------------------------------------------- Total Current Liabilities 4,462,371 4,462,371 LONG-TERM DEBT, 21,870,012 21,870,012 OBLIGATIONS UNDER CAPITAL LEASES, 1,758,425 1,758,425 DEFERRED INCOME TAXES 818,000 818,000 MINORITY INTEREST 1,506,806 (1,506,806) (1) --- ------------------------------------------------------------- Total Liabilities 30,415,614 (1,506,806) 28,908,808 SHAREHOLDERS' EQUITY Preferred shares 1,384 1,384 Common shares 32,171 12,343 (1) 44,514 Additional paid in capital 12,977,101 4,307,657 (1) 17,284,758 Note receivable from sale of shares (5,550,415) (5,550,415) Accumulated deficit (7,237,118) (7,237,118) ------------------------------------------------------------- Total Shareholders' Equity 223,123 4,320,000 4,543,123 ------------------------------------------------------------- Total Liabilities & Shareholders' Equity $ 30,638,737 $ 2,813,194 $ 33,451,931 ============================================================= SEE NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS P-1
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS NINE MONTHS ENDED AUGUST 31, 1997 [Enlarge/Download Table] MERITAGE HOSPITALITY PRO GROUP INC. & PRO FORMA FORMA CONSOLIDATED SUBSIDIARIES ADJUSTMENTS REF. PRO FORMA -------------------------------------------------------------------- REVENUE Room rents $ 4,716,238 $ 4,716,238 Food and beverage revenue 25,642,161 25,642,161 Sundry revenue 734,117 734,117 Telephone revenue 191,358 191,358 -------------------------------------------------------------------- Total Revenue 31,283,874 31,283,874 COST AND EXPENSES Cost of food and beverages 7,724,026 7,724,026 Operating expenses 18,521,209 18,521,209 General and administrative expenses 3,042,245 3,042,245 Depreciation and amortization 1,649,448 181,475 (3) 1,830,923 -------------------------------------------------------------------- Total costs and expenses 30,936,928 181,475 31,118,403 -------------------------------------------------------------------- EARNINGS FROM OPERATIONS 346,946 (181,475) 165,471 OTHER INCOME (EXPENSE) Interest expense (2,168,567) (2,168,567) Interest income 439,260 439,260 Loss on disposal of assets (190,453) (190,453) Minority interest (101,030) 101,030 (4) -------------------------------------------------------------------- Loss before federal income tax (1,673,844) (80,445) (1,754,289) -------------------------------------------------------------------- FEDERAL INCOME TAX BENEFIT Net loss (1,673,844) (80,445) (1,754,289) PREFERRED STOCK DIVIDENDS 70,577 70,577 -------------------------------------------------------------------- NET LOSS ON COMMON SHARES $(1,744,421) $ (80,445) (1,824,866) ============ =========== ============ LOSS PER SHARE $ (0.54) $ (0.41) =========== ============ AVERAGE NUMBER OF SHARES OUTSTANDING 3,213,736 4,450,006 =========== ============ SEE NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS P-2
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS YEAR ENDED NOVEMBER 30, 1996 [Enlarge/Download Table] MERITAGE WENDY'S OF HOSPITALITY WEST MICHIGAN PRO GROUP INC. & LIMITED PRO FORMA FORMA CONSOLIDATED SUBSIDIARIES PARTNERSHIP ADJUSTMENTS REF. PRO FORMA ------------------------------------------------------------------- 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 1,081,704 770,036 390,982 (3) 2,242,722 ------------------------------------------------------------------- Total costs and expenses 17,859,883 23,567,216 390,982 41,818,081 ------------------------------------------------------------------- EARNINGS (LOSS) FROM OPERATIONS (975,021) 968,999 (390,982) (397,004) 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) ------------------------------------------------------------------- Earnings (loss) before federal income tax (1,945,570) 550,268 (858,936) (2,254,238) FEDERAL INCOME TAX BENEFIT (20,000) (20,000) ------------------------------------------------------------------- Net earnings (loss) $(1,925,570) $ 550,268 $(858,936) $(2,234,238) =================================================================== LOSS PER SHARE $ (0.62) $ (0.52) =========== =========== AVERAGE NUMBER OF SHARES OUTSTANDING 3,081,885 4,316,171 =========== =========== SEE NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS P-3
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF CASH FLOWS NINE MONTH PERIOD ENDED AUGUST 31, 1997 [Enlarge/Download Table] MERITAGE HOSPITALITY PRO GROUP INC. & PRO FORMA FORMA CONSOLIDATED SUBSIDIARIES ADJUSTMENTS REF. PRO FORMA ------------------------------------------------------------------ CASH FLOWS FROM OPERATING ACTIVITIES Net loss $(1,673,844) $ (80,445) $(1,754,289) Adjustments to reconcile net loss to net cash provided by operating activities Depreciation and amortization 1,649,448 181,475 (2) 1,830,923 Compensation and fees paid by issuance of common stock 60,800 60,800 Provision for bad debts 4,000 4,000 Loss on disposal of assets 190,453 190,453 Minority interest in the net earnings of consolidated subsidiaries 101,030 (101,030) (4) 0 Interest income on note receivable from sale of shares (414,699) (414,699) (Increase) decrease in assets Accounts receivable 310,380 310,380 Inventories 6,622 6,622 Prepaid expenses and other current assets (102,660) (102,660) Increase in marina development costs (342,878) (342,878) Increase in liabilities Accounts payable and accrued expenses (203,569) (203,569) ----------------------------------------------------------------- Net cash used in operating activities (414,917) (414,917) CASH FLOWS FROM INVESTING ACTIVITIES Purchase of property, plant and equipment (837,382) (837,382) Cost of acquisition of business (94,500) (1) (94,500) Increase in other assets (193,020) (193,020) ----------------------------------------------------------------- Net cash used in investing operations (1,030,402) (94,500) (1,124,902) CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from long-term debt 936,346 936,346 Principal payments of long-term debt (817,039) (817,039) Payments on obligations under capital leases (170,697) (170,697) Proceeds from issuance of preferred shares 300,000 300,000 Dividends paid (70,577) (70,577) ----------------------------------------------------------------- Net cash provided by financing activities 178,033 178,033 ----------------------------------------------------------------- Net decrease in cash (1,267,286) (94,500) (1,361,786) Cash and cash equivalents - beginning of period 2,265,497 2,265,497 ----------------------------------------------------------------- Cash and cash equivalents - end of period $ 998,211 $ (94,500) $ 903,711 ================================================================= SEE NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS P-4
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MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF CASH FLOWS YEAR ENDED NOVEMBER 30, 1996 [Enlarge/Download Table] MERITAGE WENDY'S OF HOSPITALITY WEST MICHIGAN PRO GROUP INC. & LIMITED PRO FORMA FORMA CONSOLIDATED SUBSIDIARIES PARTNERSHIP ADJUSTMENTS REF. PRO FORMA ---------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net loss $ (1,925,570) $ 550,268 $ (858,936) $ (2,234,238) Adjustments to reconcile net loss to net cash provided by operating activities Depreciation and amortization 1,081,704 770,036 390,982 (3) 2,242,722 Compensation paid by issuance of preferred and common stock 310,099 310,099 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 (1,496,419) 1,323,850 (467,954) (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 Cost of acquisition of business (94,500) (1) (94,500) Acquisition of business (3,184,460) (260,834) (5) 21,079 (4) (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 (5,601,790) (587,943) (334,255) (6,523,988) 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) (802,209) 93,939 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 $ (802,209) $ 1,724,122 ====================================================================== SEE NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS P-5
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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 (i) the lesser of the average high and low bid price on the OTC Bulletin Board for the 10 trading days preceding the date of dissolution, or (ii) $4.125 per share. 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 August 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 nine months ended August 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 nine months ended August 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 $4,414,500 ($4,320,000 in Meritage Common Shares plus $94,500 of estimated fees and expenses of the transaction) is allocated as follows: [Download Table] Property, plant and equipment $ 1,040,116 Minority interest 1,506,806 Goodwill 1,867,578 ------------ Total $ 4,414,500 ============ P-6
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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 $181,475 for the nine months ended August 31, 1997 and $390,982 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 ($260,834) in the acquisition of the majority interest in the Wendy's Partnership by Meritage completed on October 31, 1996. The cash acquired is included in the historical financial statements of the Wendy's Partnership. P-7
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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. II-1
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ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. [Download Table] Exhibit No. Description of Document ----------- ----------------------------------------------------------------- 3.1 Restated Articles of Incorporation of Meritage Hospitality Group Inc. (1). 3.2 Restated and Amended Bylaws of Meritage Hospitality Group Inc. (2). 3.3 Amended and Restated Agreement of Limited Partnership of the Wendy's of West Michigan Limited Partnership (3). 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. (8). 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 (5). 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). 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. (6). 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 (6). II-2
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[Download Table] 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 (7). 10.12 Employee Share Purchase Plan (7). --------------------------- 21 Subsidiaries of the Registrant (2). 23.1 Consent of Grant Thornton LLP. (4). 23.2 Consent of BDO Seidman, LLP. 23.3 Consent of Keating, Muething & Klekamp, PLL (contained in Exhibit 5). 23.4 Consent of Roney & Co. (4). 24 Powers of Attorney (contained on the signature page). 99.1 Opinion of Roney & Co. (contained in the prospectus). 99.2 Background Report of Roney & Co. (4). --------------------------- <FN> (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) 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, 1995. (4) Filed herewith. (5) Incorporated by reference to the Quarterly Report on Form 10-QSB for the Company's fiscal quarter ended August 31, 1995. (6) 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. (7) 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. (8) Previously filed. 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. II-3
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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. 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 this Amendment on Form S-4 and has duly caused this Amendment to 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 10th day of October, 1997. MERITAGE HOSPITALITY GROUP INC. By: /s/ Christopher B. Hewett -------------------------------- Christopher B. Hewett President and Chief Executive Officer II-4
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Pursuant to the requirements of the Securities Act of 1933, this Amendment to this Registration Statement has been signed by the following persons in the capacities and on the dates indicated. [Enlarge/Download Table] SIGNATURE CAPACITY DATE --------- -------- ---- /s/ Christopher B. Hewett President, Chief Executive Officer October 10, 1997 ------------------------------------ and Director (Principal Executive Christopher B. Hewett Officer) * Chairman of the Board October 10, 1997 ------------------------------------ Robert E. Schermer, Sr. /s/ Robert E. Schermer, Jr. Executive Vice President and Director October 10, 1997 ------------------------------------ Robert E. Schermer, Jr. * Director October 10, 1997 ------------------------------------ Gary R. Garrabrant * Director October 10, 1997 ------------------------------------ David S. Lundeen * Director October 10, 1997 ------------------------------------ Joseph L. Maggini * Director October 10, 1997 ------------------------------------ Jerry L. Ruyan /s/ William D. Badgerow Vice President, Treasurer and Chief October 10, 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 October 10, 1997 ------------------------------------ Financial Officer (Principal Accounting Pauline M. Krywanski Officer and Principal Financial Officer) (Effective 5/20/97) *By: /s/ Christopher B. Hewett Attorney-in-Fact October 10, 1997 ------------------------------ Christopher B. Hewett II-5

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12/31/2610125
3/1/1258
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11/30/023741
6/1/0259104
5/1/02104
3/1/0258SC 13D/A
11/30/0137
11/30/003710-K
10/8/00104
11/30/993710-K
11/30/983710-K
4/1/9856104
3/1/9856104
12/31/9756104
12/30/9756112
12/1/9755104
11/30/97374110-K,  8-K,  8-K/A,  DEF 14A
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10/31/97103
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8/12/9739S-4
8/6/9790
7/31/973241
7/21/9768
6/1/97105
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5/23/9759150
5/21/9711111
5/20/977378DEF 14A
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5/16/97151
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4/15/97104
3/1/9775150
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1/24/9777
1/21/9790
1/10/97115
1/1/97104
12/5/9671111
11/30/961915110-K
11/26/9658150
11/19/9677
11/1/9654147
10/31/96141488-K,  8-K/A
10/24/9674
10/22/9625
10/21/96102126
10/1/9670
9/18/9614
9/16/9673
8/31/961814110QSB
8/13/96828-K
7/10/963377
6/26/9637
6/24/96151S-8
6/11/9633
5/21/9664109DEF 14A,  PRE 14A
4/26/963255
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3/27/9677
3/20/9674
2/26/9658
1/25/96651038-K
1/8/966576
12/31/9538151
12/15/95101SC 13D/A
12/1/9576147
11/30/953110910KSB,  10KSB/A
10/18/9531
9/19/9577150
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2/22/95150
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